Tax Preparation Fraud

As each year ends and a new year begins, everyone needs to start thinking about their impending tax obligations. Whether you are filing single, married filing jointly, married filing separately, or head of household each individual’s goal is often to pay as little taxes as possible while still meeting their fair share of their required tax burden. The United States tax law is extremely complex and the majority of American citizens are not familiar with the exact rules and regulations of the Internal Revenue Service (IRS) tax code that is codified in United States Code title 26. Given the vast intricacies, elaborate stipulations, and lengthy guidelines of the tax code (which is literally thousands of pages long), it is no surprise that a large portion of the public seeks professional assistance when filing their tax returns each year.

With the taxpayer’s permission virtually anyone can prepare a tax return on an individual’s behalf, but ultimately it is you the taxpayer who is responsible for any discrepancies (either accidental or intentional) that are declared on your return. Professional tax preparers who charge for their services are required to have a Preparer Tax Identification Number (PTIN) authorized by the IRS. A good course of practice when selecting a tax preparer is to verify the tax preparer’s PTIN by utilizing the PTIN Directory which is a free searchable online database that releases pertinent information regarding tax preparers’ qualifications including whether the preparers are Certified Public Accountants, Enrolled Agents, or tax lawyers (https://www.ptindirectory.com/). 

Tax preparation fraud can ensue when an individual selects a dishonest tax preparer, but can also occur if the taxpayer intends to prepare and submit their own return. With the myriad of tax software available to the public along with the ease of electronic filing, many individuals choose to file their returns themselves instead of hiring a tax professional. Individuals who decide to file their own returns face challenges as they attempt to lower their tax liability because most individuals are not up to date with the ever changing tax code. Mistakes whether intentional or not, are not taken lightly by the IRS and you could be penalized. Hiring a tax professional does not always ensure your tax return is without errors especially if you hire an untrustworthy tax preparer.   

A common tax fraud scheme involves so called ghost tax preparers who prepare your tax return and deliberately do not sign the return as the preparer leaving no trace of their involvement. Beware of these dishonest tax preparers who entice you by promising or guaranteeing substantial tax refunds. Other common red flags for unscrupulous tax preparers include being compensated based on a percentage of your upcoming tax refund; insisting upon directly receiving your refund and paying you the difference; tax preparers who either do not have or refuse to provide you with their respective PTIN; and tax preparers who request that you endorse a blank return or do not allow you to check the final return before filing.

Crooked tax preparers have a wide array of tools available at their fingertips in order to inflate your tax refund, however the bottom line is many of these techniques represent flat out tax evasion. The two main methods for guaranteeing a higher tax refund consist of either decreasing your actual earned income or declaring excessive and / or falsified tax exemptions thereby reducing your overall tax liability and increasing your refund.

Since the majority of people include an employer tax form when filing their returns, there are legitimate methods of reducing your earned income. The most common technique to lower taxable income is to take advantage of retirement savings accounts whether that entails contributing to your employer’s 401(k) for example or by contributing to an Individual Retirement Account (IRA) such as a Roth IRA if your company does not offer employer-sponsored retirement plans. These are pretax deferrals that can greatly lower your tax liability. Another method is to set up a Health Savings Account (HSA) or a Flexible Spending Account (FSA) which again utilizes pretax earnings to reduce your earned income. Although these are credible ways to decrease your taxable income, they require tax planning throughout the year to reap the benefits while a dishonest tax preparer can claim falsified amounts on your W-2 Wage and Tax Statement form. The fictitious contributions will not match your employer provided W-2 form and once you sign and submit your return, the numbers are set in stone and you are at risk of tax fraud.       

Dishonest tax preparers frequently utilize methods to reduce your tax burden that involve the use of fraudulent tax deductions / expenses that can include falsified business expenses, fabricated donations / charitable contributions, overstated medical expenses, or even blatantly not reporting earned income altogether. A huge area of tax preparation fraud relates to these fictitious business expenses for self-employed individuals on your Schedule C, such as claiming personal expenses as business deductions, declaring ordinary miles as business travel, and deducting personal dining and entertainment as business expenditures. Fraudulent tax preparers can take advantage of these Schedule C expenses and you may not even own a business.      

Whether you were aware of it or not, claiming phony expenses, exemptions, deductions, credits, and / or not reporting income on your tax return is a crime; and the IRS will pursue the taxpayer not the tax preparer. According to the Internal Revenue Code §7201, tax evasion is a felony criminal offense and if found guilty of tax evasion you can go to jail for up to five years, pay a hefty fine of up to $250,000 for individuals, and face tax liens on your property including legal seizure of your house or car (https://www.irs.gov/pub/irs-utl/tax_crimes_handbook.pdf). Even if you honestly did not know your tax preparer submitted a fraudulent tax return, pleading ignorance is not a legitimate defense in the eyes of the IRS and it is your name on the line.

In addition, a big concern for you and the IRS in terms of tax preparation fraud is identity theft with the electronic filing of false tax returns on both the state and federal tax agencies. The tax preparer only needs your social security number and a few other personal identification information such as your home address or telephone number; these items are readily available through a public records search or open source research via internet search engines. The fraudsters will create bogus W-2 withholdings to generate fictitious refunds under your name and directly receive the funds into a bank account. The funds are then quickly withdrawn in cash or transferred to other bank accounts to conceal the theft. Watch out for tax preparers who demand to know the social security numbers of your close family relatives. If these individuals are not claimed on your return, your tax preparer has no reason to need their social security numbers in order to file your return.

From an AML perspective, a common warning sign that a bank account is being used to conduct tax preparation fraud is the identification of numerous tax refunds that are followed by significant outgoing transfers and / or cash withdrawals.  Tax preparation fraudsters will open bank accounts for the sole purpose of receiving these illicit tax refunds; with today’s ease of opening accounts online, the perpetrators never have to meet face-to-face with bank personnel.  This allows the fraudsters to open accounts online using false identification with relative ease, thereby concealing their involvement in the crime.  Because of this, banks need to ensure that they are doing effective remote account opening to make this scheme harder for the perpetrators.

Based on these factors, it is extremely important that you be very meticulous when selecting a tax preparer and always review your final tax return before signing and filing it with the IRS. Remember it is your name and your reputation that is on the line.