6

Say an individual earns extra money on the side by tutoring through craigslist. Moral obligations aside, why should that person report those earnings when doing taxes?

What I'm asking is how the IRS could possibly keep track of that?

I realize this sounds like a I-want-to-dodge-taxes question, but in actuality I'm looking to understand the way the system works. What's to stop people not reporting income earned in this manner?

15

My wife and I have done a good job teaching our daughter, now 15, that one does the right thing, simply because it's the right thing to do. This may not work for every child, but it did for us. Her motivation was never punishment, we explained that if she did the wrong thing, it's awful to have to live with that.

On one hand, THEAO's answer is correct, the stick the IRS wields is the audit and fines. I suppose from a legal standpoint, we comply with laws to avoid punishment. I find this to be unfortunate. To get back on topic -

  • The extra regular income counts when applying for a mortgage, I recall you asking mortgage related questions, $10,000 in extra reported income will qualify you for over $45K in incremental mortgage borrowing.
  • Depending how you file, the SE FICA contribution will add to your Social Security benefit, old Aerovistae will thank you for the extra income.
  • Earned side income will let you open a Solo 401(k), again, that old Aero will be happier if you do that now.

I started with an answer more appropriate to Parenting because I have a very precocious child for whom I addressed this question a decade ago. The latter portion of my response helps to give tangible benefits which have value even if less than the tax you might be paying.

  • 1
    I believe unemployment calculations are another benefit, just like Social Security. Unemployment checks could be higher if you report all your earnings. – MrChrister Oct 31 '13 at 5:29
12

You're asking three different questions...

Q1: What's to stop people not reporting income earned in this manner?

A: Nothing. Absolutely nothing. The IRS doesn't have the means to keep track of your cash flow and your reported taxes on the fly.

Q2: How could the IRS possibly keep track of that?

A: When you get audited. If it ever did come up that things didn't balance you would end up owing back taxes, with interest and possibly fines.

Q3: Moral obligations aside... why report?

A: Since you've dismissed 'doing your duty as a citizen' as a moral obligation, the only other real one is that it's a pain in the butt to get audited and it is expensive if you lie and get caught.

  • Isn't there a requirement for the buyer to issue a 1099misc? (technically) – Andy Jan 27 '15 at 2:20
  • You only need to issue a 1099-MISC if the total payment to the person is at least $600 USD in a year. If you pay a person less than that, you don't need to issue any paperwork. So if I hire a guy to clean my gutters every fall and pay him $200 to do it, I don't need to do any paperwork for it. – zeta-band Sep 12 '16 at 17:32
  • If you hire a guy to paint your house, and pay him $2000, you still don't issue a 1099. He's not your employee, he's still self-employed. – JTP - Apologise to Monica Jan 25 '17 at 13:57
  • @JoeTaxpayer: if he was an employee 1099 wouldn't apply at all. You are required to issue and file 1099MISC for $600 or up to an independent contractor unless it is a corporation -- which a painter or even gutter-cleaner might be for insurance or liability reasons. In fact in the 1099MISC instructions for 2015 (I haven't downloaded 2016 yet) one of the examples on page 8 for box 7 is: attorney barters business-related legal services to painter in exchange for painting work; both must report FMV of the services provided. Whether everyone always does as required is another question. – dave_thompson_085 Jan 26 '17 at 1:14
2

Because the question puts moral obligations aside, I'll answer from the practical point of view. There are two reasons for declaring side income, even cash income.

  1. If you buy a house in a year or two, the additional income will help qualify you for a mortgage.

  2. The IRS has ways to discover that you earned the money.

    a. A client might be audited. If the client deducts the cost of your services from their income, they could be asked for proof that they paid you. Suppose they saved ATM receipts that show the withdrawals of cash used to pay you, and kept records that document the dates they paid you. The IRS might want to ask you if you were paid by the client on those dates, and how much. The asking might be in the form of an audit, and you'd have to lie to the IRS to avoid penalty.

    b. A client might develop a grudge against you and report you to the IRS. Someone could do this even if they don't know for sure that you don't declare the income. If you were interviewed or audited, you'd have to lie to the IRS to avoid penalty.

    c. You could fall prey to an algorithm. There might be one that compares deductions and income. If you run a crazy-high ratio year after year, you could be flagged for audit. Once again, you'd have to lie to avoid penalty.

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