Part III. Administrative, Procedural, and Miscellaneous

Common Mistakes on Tax Returns

Notice 2004–13

The purpose of this notice is to alert taxpayers about common mistakes made by individuals while preparing their federal income tax returns. These mistakes may result in taxpayers failing to fully pay their correct tax liabilities. In addition, these mistakes may result in delays in processing returns and receiving any refunds. Taxpayers should carefully read all the instructions to the tax forms and schedules and review their entire return before filing. In addition, e-filing, either through the Service’s Free File Program at www.irs.gov or through a tax professional, will help reduce errors and speed refunds. Taxpayers who e-file and use direct deposit will receive their refunds in as little as two weeks.

Additional taxpayer resources, including answers to frequently asked questions, also can be found at www.irs.gov. Taxpayers can learn more about common mistakes and find an error checklist on page 60 of the Instructions to the 2003 Form 1040 Federal Income Tax Return; this information also is available at TeleTax Topic 303 on the internet at www.irs.gov and from the toll-free TeleTax number, 1–800–829–4477. 1. Choosing the wrong filing status. Taxpayers should confirm that the filing status ( i.e., single, married filing jointly, married filing separately, head of household, qualifying widower) selected on the return is correct. For example, taxpayers often incorrectly claim “head of household” filing status without meeting the requirements for that status. In addition to delaying the processing of the return and any refund, designating the wrong filing status on a return also may affect a taxpayer’s eligibility for the Earned Income Credit. The Instructions to the 2003 Form 1040 provide detailed information to assist taxpayers in choosing their correct filing status.

2. Failing to include or using incor- rect social security numbers. The names and social security numbers for the taxpayer, taxpayer’s spouse, dependents, and qualifying children for the Earned Income

Credit or Child Tax Credit must be included on the return exactly as they appear on the social security cards.

3. Failing to use the correct forms and schedules. Taxpayers should review the instructions to all applicable forms and schedules to be sure they have correctly used, and accurately completed, each form or schedule.

4. Failing to sign and date the return. Taxpayers must sign and date their return under penalties of perjury. If the return is not signed, it will not be accepted as filed by the Service. Both spouses must sign a joint return.

5. Claiming ineligible dependents. Taxpayers may claim a person as a dependent only if that person meets the legal definition of a dependent. Taxpayers should consult the Instructions to Form 1040 to confirm whether a person qualifies as a dependent. Each dependent must have a valid social security number, which must be included on the tax return. The failure to include a dependent’s name and social security number, or claiming an ineligible dependent, may result in an underpayment of tax and/or a denial of the Earned Income Credit.

6. Failing to file for the Earned In- come Credit. Taxpayers should review carefully the eligibility requirements for the Earned Income Credit, including income limits, before filing returns. For example, many military families may qualify for the Earned Income Credit because supplemental payments and combat pay are exempt from the income calculations. Detailed instructions for claiming and computing the Earned Income Credit are contained in the Instructions to the Form 1040, Fact Sheet 2004–8, in Publication 596 and through links at 1040 Central at www.irs.gov.

7. Improperly claiming the Earned In- come Credit. Taxpayers must have a qualifying amount of earned income to claim the Earned Income Credit. For example, a taxpayer whose sole income is from the receipt of disability payments does not have qualifying earned income and is ineligible for the Earned Income Credit. Detailed instructions for claiming and computing the Earned Income Credit are contained in the Instructions to the Form 1040, Fact Sheet

2004–8, and Publication 596, and through links at 1040 Central at www.irs.gov.

8. Failing to pay and report domes- tic payroll taxes. Taxpayers employing household workers, such as a house cleaner, an in-home caregiver, or a nanny, must pay and report payroll taxes for those individuals where the payments exceed certain threshold amounts. Failure to pay and report payroll taxes may result in the assessment of additional tax due, interest on the unpaid amounts, and penalties. The Instructions to the Form 1040, Publication 926 (Household Employer’s Tax Guide), and Publication 15–A (Employer’s Sup- plemental Tax Guide) contain detailed information to assist taxpayers in determining whether an individual providing household help is a household employee for whom the taxpayer must pay and report payroll taxes.

9. Failing to report income because it was not included on a Form W–2, Form 1099 or other information return. Taxpayers must report all income, even if the income was not reported on a third-party reporting statement such as a Form W–2, Form 1099, or other similar statement. Failure to report all income may result in the assessment of additional tax due, interest on the unpaid amounts, and penalties.

10. Treating employees as indepen- dent contractors. Employers may not treat an employee as an “independent contractor” to avoid paying and reporting payroll taxes. Employers who improperly treat an employee as an independent contractor may be liable for additional tax due, interest on the unpaid amounts, and penalties. Publication 15–A (Employer’s Sup- plemental Tax Guide) contains detailed information to assist taxpayers in determining whether an individual is an employee or an independent contractor.

11. Failing to file a return when due a refund. Taxpayers must file a return to claim a refund of withheld taxes when a refund is due. Taxpayers will forfeit refunds of withheld tax if a return requesting a refund is not filed within three years of the due date.

12. Failing to check liability for the al- ternative minimum tax. Taxpayers should determine whether the alternative minimum tax, or AMT, applies. If the taxpayer

2004-12 I.R.B. 631 March 22, 2004

by putting assets in an offshore bank account.” A citizen or resident of the United States cannot use an offshore arrangement (such as a foreign bank or brokerage account, or a credit card issued by a foreign bank) to avoid his tax obligations. In addition, taxpayers are required to disclose foreign financial accounts to the Treasury Department and may face civil and criminal penalties if they fail to do so.

tablishing a ‘corporation sole.’” A taxpayer cannot avoid income tax by establishing a corporation sole for the purpose of avoiding tax on the taxpayer’s income. A corporation sole may be used only by a bona fide religious leader for specific, limited purposes relating to the religious leader’s office.

sets in a trust to escape income tax while still retaining control over those assets.” A taxpayer who places assets in a trust but retains certain powers or interests over the assets, including the power to control the beneficial enjoyment of the assets, is treated as the owner of the assets and is subject to tax on the income from those assets.

paid to maintain his household by es- tablishing a home business.” Business expenses, including expenses related to a home-based business, are not deductible unless the expenses relate to a bona fide, profit-seeking business. Promoters of home-based business schemes improperly encourage taxpayers to claim household expenses as business deductions although the purported home-business used in these schemes is not a bona fide trade or business.

Code section imposes a requirement to file a return.” Section 6011 expressly authorizes the Service to require, by Treasury regulation, the filing of returns. Section 6012 identifies persons who are required to file income tax returns. Under Treasury regulations, taxpayers who receive more

is liable for AMT, the Service may reduce or deny a requested refund or may assess any additional tax due, interest on the unpaid amounts and penalties.

This notice was authored by the Office of Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. For further information regarding this notice, contact that office at (202) 622–7800 (not a toll-free call).

Frivolous Arguments to Avoid

Notice 2004–22

SECTION 1 INTRODUCTION

As April 15 approaches, taxpayers are reminded to steer clear of tax-avoidance schemes that purportedly reduce or eliminate taxes. If an idea to save on taxes seems too good to be true, it probably is.

Tax-avoidance schemes are based on frivolous arguments that the Service and the federal courts have repeatedly rejected. These schemes typically are sold by promoters for a substantial fee, and may be sold over the Internet, through advertisements in newspapers and magazines, at conferences and seminars (including conferences for professional groups such as doctors or dentists), and through recommendations of friends or acquaintances who have learned about these schemes.

Section 2 of this notice sets out many of the most common frivolous arguments used by these tax-avoidance schemes. The Service is committed to identifying taxpayers who attempt to avoid their tax obligations by using schemes based on these and other frivolous arguments. Frivolous returns and other similar documents submitted to the Service are processed through its Frivolous Return Program. The Service also reviews other non-return documents making frivolous arguments submitted by taxpayers, such as correspondence, to determine whether these individuals have filed required tax returns and paid all taxes due for previous years.

Section 3 of this notice identifies potential civil and criminal penalties. Taxpayers who engage in tax-avoidance schemes will be liable for unpaid taxes and interest. In addition, the Service will impose civil and criminal penalties against taxpayers

where appropriate. The Service also will determine appropriate penalties against persons who promote these schemes and who prepare frivolous returns based these schemes.

SECTION 2 COMMON FRIVOLOUS ARGUMENTS

This section sets out many common frivolous arguments used by taxpayers to avoid or evade tax.

cause it contradicts the original Con- stitution, and it was not properly rati- fied.” The 16 ^th Amendment, which authorizes the income tax, was properly ratified and is valid.

right’ to exclude the cost of his labor from income.” There is no “claim of right” doctrine under any federal law, including the Internal Revenue Code, that permits a taxpayer to deduct or exclude the value of his labor.

is taxable under section 861.” Sections 861–865 do not exclude income from tax. In particular, nothing in these sections or the Treasury regulations provides that only income earned from certain foreign sources is subject to U.S. tax.

within the meaning of the Internal Revenue Code.” A citizen of each of the 50 States ( e.g., New York or California) of the United States and the District of Columbia is also a citizen of the United States.

are citizens of a foreign country and therefore not subject to tax.” Section 911 permits a taxpayer to elect to exclude income from U.S. income tax only when the taxpayer earns income and resides outside the United States under the conditions and limitations set forth in that section. For purposes of section 911, States ( e.g., New York or California), Commonwealths, and Territories ( e.g., Johnston Atoll) of the United States are not foreign countries.

March 22, 2004 632 2004-12 I.R.B.

the right to use dependents in order to increase the amount of EIC claimed.” A taxpayer may not purchase or sell the right to use additional dependents for purposes of the Earned Income Credit. To be claimed as a dependant, a child must be a qualifying child under the Earned Income Credit rules.

The Service and the federal courts also have repeatedly rejected variations of these arguments as well as numerous other tax avoidance schemes and frivolous arguments used by taxpayers to avoid or evade taxes.

SECTION 3 CIVIL AND CRIMINAL PENALTIES

Civil and criminal penalties may apply to taxpayers who make frivolous arguments. Potentially applicable civil penalties include: (1) the section 6651 additions to tax for failure to file a return, failure to pay the tax owed, and fraudulent failure to file a return; (2) the section 6662 accuracy-related penalty, which is equal to 20 percent of the amount of taxes the taxpayer should have paid; (3) the section 6663 penalty for civil fraud, which is equal to 75 percent of the amount of taxes the taxpayer should have paid; (4) a $500 penalty under section 6702 for filing a frivolous return; and (5) a penalty of up to $25,000 under section 6673 if the taxpayer makes frivolous arguments in the United States Tax Court.

Taxpayers who engage in tax-avoidance schemes also may face criminal prosecution for: (1) attempting to evade or defeat tax under section 7201 for which the penalty is a fine of up to $100,000 and imprisonment for up to 5 years; and (2) willful failure to file a return under section 7203 for which the penalty is a fine of up to $25,000 and imprisonment of up to one year; and (3) making false statements on a return under section 7206 for which the penalty is a fine of up to $100,000 and imprisonment for up to 3 years.

Persons who promote tax-avoidance schemes and those who assist taxpayers in claiming tax benefits based on a tax-avoidance scheme also may face penalties. Potential penalties include: (1) a $250 penalty for each return prepared by an income tax return preparer who knew

than the statutory minimum amount of gross income must file returns. Taxpayers also are required to pay any tax owed.

Some people mistake the word “voluntary” for “optional” - but filing a tax return is not optional for those who meet the law’s requirements. The word “voluntary,” as used in IRS publications, refers to the fact that the U.S. tax system is a voluntary compliance system, which means that taxpayers themselves determine the correct amount of tax and complete the appropriate returns, rather than have the government determine tax for them. For those who do not comply with their tax obligations, the tax law authorizes various compliance measures.

employer, I don’t have to withhold in- come or employment taxes from my employees.” Every taxpayer is responsible for completing and filing required returns and paying the correct amount of tax. An employer is required by law to withhold income and employment taxes from salary and wages paid to employees. Employers also must deposit the amounts withheld with the IRS.

the taxpayer disagrees with the gov- ernment’s use of the taxes it collects.” No law, including the Internal Revenue Code, permits a taxpayer to avoid or evade tax obligations on grounds that the taxpayer does not agree with the Government’s past or possible future use of the taxes collected.

return that reports zero income and zero tax liability.” All taxpayers who receive more than the statutory minimum amount of gross income must file returns and pay tax. No law, including the Internal Revenue Code, permits a taxpayer who has received wage and other income to file a return with zero income and zero tax liability.

or the tax system by filing a set of doc- uments in lieu of a tax return.” Tax

payers must file income tax returns using the forms prescribed by the Service. No law, including the Internal Revenue Code, permits a taxpayer to file a document or series of documents to remove himself from the income tax system.

a return with an attachment that dis- claims tax liability.” A return with an attached disclaimer of tax liability is not a valid tax return under the law. Filing a disclaimer of tax may result in penalties for failure to file in addition to other applicable civil and criminal penalties.

altered penalties of perjury statement to generate a tax refund.” Alterations to an income tax return or to the penalties of perjury statement may nullify a return. Filing an altered document may result in penalties for failure to file in addition to other applicable civil and criminal penalties.

rations tax credit’ to right wrongs done in the past.” No law, including the Internal Revenue Code, permits a “reparations tax credit.”

vices for an inflated price, a taxpayer can use the Disabled Access Credit to reduce tax or generate a refund.” The Disabled Access Credit, which is limited to specific medical equipment, may only be claimed for amounts actually paid by a taxpayer. Promoters of this scheme improperly offer to sell equipment or services at highly inflated prices in order to generate a large credit. Taxpayers participating in this scheme, however, ultimately are not required to pay, and do not pay, the entire price stated in the sales contract.

of Social Security taxes under section 3121 that he paid and get a refund of those taxes.” Section 3121 does not exclude wages from taxation and does not authorize a refund of Social Security taxes paid.

2004-12 I.R.B. 633 March 22, 2004

Provisions and Judicial Practice Division. For further information regarding this notice, contact that office at (202) 622–7800 (not a toll-free call).

or should have known that the taxpayer’s argument was frivolous (or $1,000 for each return where the return preparer’s actions were willful, intentional or reckless); (2) a $1,000 penalty under section 6701 for aiding and abetting the understatement of tax; and (3) criminal prosecution under section 7206 for which the penalty is a fine of up to $100,000 and imprisonment for up to 3 years for assisting or advising about the preparation of a false return or other document under the internal revenue laws. Promoters and others who assist

taxpayers in engaging in these schemes also may be enjoined from doing so under section 7408.

SECTION 4 ADDITIONAL INFORMATION

Other information about frivolous tax positions is available on the Service website at www.irs.gov .

This notice was authored by the Office of Associate Chief Counsel (Procedure and Administration), Administrative

March 22, 2004 634 2004-12 I.R.B.