California residents are required to file federal and California tax returns. The California state income tax is progressive. This means the rate of taxation increases by bracket as the amount of income increases. For sole filers, the current California income tax rates range from 1% to 12.3%. California residents, nonresidents, estates, trusts and others with sufficient connection to California may be required to file a California income tax return and pay all taxes due and owing.
As with any tax, many taxpayers may find temptation to hide income. Sometaxpayers may endeavor to conceal all income. Others may work to conceal only a portion of their income so as to reduce the top tax bracket they face. Regardless of the approach taken, such conduct is likely illegal tax evasion.
What is Gross Income?
Gross income is the amount a person earns before any deductions or exemptions are taken. Income in California generally follows the federal definition of income. Income can include the following:
- Compensation – Payment for services performed such as consulting fees, professional services, services such as housecleaning, or any service where the filer earns a commission or a fee. A filer may be tempted not to account for fringe benefits such as meals and employee discounts.
- Business income — Filers are supposed to include all the income they receive. Some filers just report income that is paid through credit cards, checks and other traceable methods but may avoid any income that is paid by cash. Partnership income shares must also be reported.
- Selling property — Sales or real property usually involve a fair amount of government forms so sales of real property can be difficult to hide. Sales of personal property, like a car or tools, is often done in cash and may be underreported.
- Interest — Interest paid by banks and investment companies is usually reported so filers take a great risk in not filing it. Interest on personal loans may be underreported.
- Rent collected — Whether paid by check, cash, or some other means; all rents are income.
- Passive Income — Royalties, annuities and pension are income that must be reported.
- Dividends — Dividends from stocks and investment accounts are income.
- Alimony and separate maintenance payments — These items, though they are for the benefit of spouse, must be reported as income.
- Life insurance – Proceeds from a life insurance plan are generally not tax free. The recipient needs to report the proceeds on his or her income tax.
- Discharged from a debt — Any settlement to reduce a debt in whole or part is good news for the debtor. Still, the debtor must report the settlement as income unless the debt is legitimately in dispute.
Other types of income that may need to be reported include estate income, trust income, workers compensation benefits, unemployment benefits and social security benefits. A California tax attorney will know all the types of income that must be reported and which income does not need to be reported.
Underreporting and Failing to Report Income
Employees who are issued a W-2 cannot easily conceal their income because the employer will also file the W-2 with the federal government and with the state of California. The IRS or Franchise Tax Board can then engage in form matching to identify the unreported or incorrectly reported income.
Self-employed individuals have an obligation to report all of their income and pay federal income tax, self-employment tax and California income tax. However, self-employed individuals may believe that they can get away with concealing income since they control their business’ books. In reality, those who are self-employed receive special scrutiny from the agency due to high rates of noncompliance.
Active Concealment of Income
Some taxpayers actively try to hide their income in offshore accounts or in sophisticated tax schemes. Some of these schemes are legal. Others are not. These types of maneuvers are especially suspicious and will be investigated if they are discovered.
Many filers try to claim that the failure to include the income was an honest mistake. The difference between an honest mistake and fraud can be the difference between a criminal conviction and just having to file an amended tax return and pay the fines and interest. Fraudulent acts can also result in substantial penalties, sometimes exceeding the balance contained in the original account.
Both the IRS and California Department of Revenue will review the following factors to decide if the failure to include the income was fraud or honest negligence.
- Incomplete financial records
- Failing to file timely tax returns and estimated returns
- Concealing key assets especially out of state or corporate assets
- Using a cash accounting method
- Opening and closing businesses
- Keeping multiple sets of books
If you or your business is facing an audit by the State of California or by the IRS, the stakes are too high to go through it alone. The Hoffman Law Offices are dedicated to providing on-point and strategic guidance for your tax concerns. To schedule a free and confidential initial consultation, call us at 800-897-3915 today or contact us online.