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JUNE 2013 / THE CPA JOURNAL 48

By Mark Lee Levine


T
he IRSs Dirty Dozen report lists
tax scams that have plagued the pub-
lic, the IRS, and many other entities
or parties in order to alert professionals
and taxpayers of the common techniques
that con artists use to take advantage of the
public. The goal of these scams is normal-
ly the theft of funds via some tax position
that seemed to be too good to be true. Tax
professionals need to be aware of the scams
that exist in the marketplace in order to
counsel taxpayers on them. (This is akin to
the many web warnings advising about new
phishing approaches, which tempt recipients
to click on a link in order to gain the ben-
efits that are often touted.)
One might think that the IRS would
detect many of these improper actions dur-
ing its audit of tax returns; however, audits
often fail to discover many common forms
of tax fraudand if the scam is detected,
it is usually discovered after much of the
damage has already been done, whether the
victim is the IRS, an individual taxpayer, or
another entity. (For an examination of the
most recent statistics compiled by the IRS
with respect to audits, see the IRSs 2012
Data Book; for more information, see
Internal Revenue Code [IRC] section 6108.)
According to the 2012 Data Book, the IRS
collected approximately $2.5 trillion in tax
revenues during the 2012 fiscal year; but
of the 146 million individual tax returns filed
for that year, the IRS examined less than
1% of them.
The IRSs Dirty Dozen list is derived
from its examination of returns filed. The
following sections analyze a few of the
tricks used to steal funds, as well as offer
suggestions for taxpayers and their advisors.
Identity Theft
Some of the scams noted in the IRSs
Dirty Dozen report included what many
have come to regard as quite common,
such as identity theft (including the theft
of key information, such as individuals
names and Social Security numbers).
Identity theft has become of such great
importance that the IRSs website fea-
tures a special section devoted to examin-
ing such cases in an attempt to lessen
their frequency and number. (For additional
information on identity theft, see the IRS
website, at http://www.irs.gov/uac/
Taxpayer-Guide-to-Identity-Theft, or call
the IRS scam unit, at 800-908-4490.)
What can tax preparers do to help tax-
payers avoid this attempt to gain and mis-
use their identity? They should remain vig-
ilant and recognize that in order to gain
confidential information, a potential thief
usually needs taxpayers to make a mistake
first. Thus, responding to an e-mail
received from someone that the recipient
doesnt know and providing important
financial and other information (e.g., Social
Security number, key addresses) can poten-
tially open the door for this type of theft.
Return Preparer Fraud
Taxpayers might assume that they are
protected from tax fraud with respect to the
tax return that they file each year because
a tax preparer aided in its preparation. This
can certainly help protect against fraud. The
IRS noted in its report that 60% of tax-
payers rely on some form of professional
helpwhether it was an individual, a firm,
or tax preparation softwarebut that some
unscrupulous tax return preparer compa-
nies actually encouraged taxpayers to act
improperly, in many instances to gain
illegal tax refunds or obtain tax credits that
were not proper for the given taxpayer.
Taxpayers should be supported in their
efforts to avoid the improper actions
encouraged by such return preparer com-
The IRSs Dirty Dozen Tax Scams
T A X A T I O N
c o mp l i a n c e & e n f o r c e me n t
A Guide for Tax Professionals and Taxpayers
panies; they should insist on checking the
background of a preparer, reviewing a
firms credentials, ensuring that a prepar-
er signs the tax return as preparer and
enters an IRS preparer tax identification
number (PTIN). If taxpayers suspect that
tax preparers are acting improperly, they
can file a complaint on the IRSs website
or complete Form 14157, Complaint: Tax
Return Preparer. In addition, tax profes-
sionals should work to build trust with
the taxpayers whom they advise.
Refund Claims
The IRS has cautioned that, in many tax
scams, taxpayers are directed to file for
refunds or rebates, such as in the follow-
ing scenarios.
Social Security. Taxpayers might be
instructed to use a Social Security claim
for a rebate or refund, even if such a rebate
or refund doesnt actually exist. (Often a
refund is promised by a perpetrator
claiming to represent the government, and
improper action is only discovered after the
taxpayer has submitted personal informa-
tionlong after the scam artist has col-
lected monies and is no longer around.)
One of the best precautions that taxpayers
can take to avoid this problem with
Social Securityrelated schemes is to
engage a reputable tax professional, such
as a CPA or tax attorney, to guide them.
Such tax advisors should provide appro-
priate professional guidance; for taxpayers,
this advice is often well worth the cost of
a consultation.
False government forms. Posing as
experts, perpetrators of tax scams often
encourage taxpayers to file government
forms in order to seek credits or refunds,
even though they know that the claim is
improper. Of course, it is illegal to know-
ingly make claims for refunds or credits
that the taxpayer is not entitled to; how-
ever, because many taxpayers do not know
if they are entitled to a given refund, they
rely on the advice of this expert.
This scam often occurs with respect to
false Forms 1099 that attempt to claim a
right to a refund. If taxpayers know that
they have not paid the given amount of
money on the Form 1099, then they should
know that they are not entitled to a refund.
For example, if a taxpayer pays money that
is withheld from their wages earned, it
might be argued that the taxpayer thought
that the refund claim was for some such
funds; however, if the amount was never
paid to the government in the first place,
then certainly the claim would not normally
exist. Taxpayers should seek out and retain
a professional advisor; tax advisors
should review available refunds and cred-
its with taxpayers in order to increase their
awareness of potential scams.
Claiming Zero Wages
Related to false refund claims are situ-
ations where taxpayers claim that the
amount of wages that they earned was less
than the actual amount earned; thus, a
refund is claimed as owing money to the
taxpayer. This position is often supported
by false W-2 forms, corrections for a W- 2,
or corrected Forms 1099. Given the preva-
lence of such fraud scams, taxpayers
making claims for a refund must properly
support them; in addition, they should be
undertaken with the advice of a trusted pro-
fessional, thereby avoiding many of the pit-
falls noted earlier.
Use and Misuse of Trusts
In addition to refunds and zero wages, tax-
payers have claimedoften because of direc-
tion from improperly acting return prepar-
ersthat they are entitled to a refund because
they do not have taxable income. Often, the
claim is related to an argument that taxpay-
ers set up a trust to earn the income that
was owed to them, whereupon they contend
that the income should not be taxed because
it was not received. Of course, if a taxpayer
creates a shell trust or entity that is effectively
the incorporated pocketbook of the taxpayer
and the trust has no viability, the taxpayer
should pay tax on the income earned. In
this setting, the taxpayer cannot successfully
contend that the income is in the trust and
the taxpayer is not subject to tax against the
income. (For more information on such form
over substance fraud, see Mark Lee
Levine and Libbi Segev, Real Estate
Transactions, Tax Planning, ch. 40,
Thomson/West, 2013.)
Use and Misuse of Corporations
Along the same lines as the discussion
of trusts above, some taxpayers have
employed corporations or other entities to
avoid filing tax returns, to transfer money
to other interests, and to gain other deduc-
tions. This does not mean that corpora-
tions or other entities cannot be used
properly, but the IRS reported many scams
in which such entities have been used to
try to avoid proper reporting of income. As
noted earlier, tax advisors should provide
taxpayers with professional advice and
guidance.
Frivolous Arguments to Avoid Paying Tax
The IRS, the courts, and others are
plagued each year with outlandish argu-
ments by taxpayers trying to escape the
obligation to pay taxes. Sometimes there
is an argument that the taxes are unconsti-
tutional, that there is a lack of due pro-
cess, or that there was a violation of the
equal protection clause of the federal and
or state constitutions. These frivolous
positions are quite common; as such, the
government has devoted a good deal of
attention to this issue. (For a grouping of
the many types of fallacious arguments
made by taxpayers, see the IRS website
[http://www.irs.gov/pub/irs-utl/friv_
tax.pdf].) For example, the IRS noted that
taxpayers contend that they do not have
to pay taxes because the filing of a tax
return is voluntary. Along with this con-
tention on the voluntary nature of the fed-
eral income tax system, the IRS listed the
following fallacious taxpayer arguments
under the voluntary category:
n Payment of a federal income tax is
voluntary.
n Taxpayers can reduce their federal income
tax liability by filing a zero return.
n The IRS must prepare federal tax returns
for a person who fails to file.
n Compliance with an administrative sum-
mons by the IRS is voluntary.
Arguments not in the voluntary catego-
ry included claims that the taxpayer is not
a citizen of the United States and thus owes
no taxes, that Federal Reserve Notes are
not income, and that military retirement
pay does not constitute income. When
these and similar arguments are being
made, tax advisors and taxpayers must con-
sider whether the position sounds too good
to be true. Taxpayers should obtain pro-
fessional advice in order to avoid the
costly problems that are generated by these
scams and misinformation.
Income and Expenses
Another area of abuse in the Dirty
Dozen report involves the common issue
49 JUNE 2013 / THE CPA JOURNAL
of income and expenses. Two major
approaches exist for reducing taxable
income: reduce the amount of income
reported and increase the amount of
expenses claimed. This approach to eva-
sion of taxes has been in use almost since
the inception of the tax law. This approach
is certainly not limited to actions on the
federal level; states and other countries face
these same problems. With this type of
abuse, taxpayers often forget to report
some income, such as in the case of lot-
tery winnings.
Taxpayers have also been known to claim
deductions or credits where they did not actu-
ally qualify for them. For example, claiming
a business deduction in order to attend an
event with no business connection might be
an attempt by the taxpayer to assert a
deduction for the cost of the tickets, even
though this is not a bona fide business
expense (see IRC sections 162 and 274).
Clearly not every failed deduction is the result
of a Dirty Dozen scheme, but many frivolous
claims are made for deductions and credits
when taxpayers have no reasonable basis
for the claim.
If a potential scam artist suggests that
taxpayers undertake some of the afore-
mentioned steps to reduce their taxes, tax-
payers should ask that individual for the
authority, in writing, for such position.
Even if taxpayers receive a written state-
ment of authority, they should discuss the
situation with a professional tax advisor.
Claims for Deductions to Charitable
Organizations
The IRS cautions taxpayers that when
they give a gift to what is alleged to be a
qualified charity, they should confirm
that the charity does have proper status
with the IRS and is actually considered a
qualified charity. Of course, taxpayers
should not attempt to claim deductions that
are not bona fide as to the gift and the
amount. For example, taxpayers have been
known to claim large deductions for gifts
of property (e.g., paintings and other art-
work) to charity; even if the charity is bona
fide, the amount of the deductions must
still be properly supported. (See IRC sec-
tion 170 and the regulations under this
section related to gifts to charities and
valuations of the same.)
Free Money from the IRS
This scam seems so apparently farcical
on its face that one might assume it
would garner little support by scam artists,
but its inclusion in the Dirty Dozen
report represents a major problem for the
IRS. Presentations are made to many tax-
payers, especially seniors, on issues like
Social Security; in these presentations,
scam artists convince such individuals that
they are entitled to free money in the
form of a tax refund or credit because they
are in a lower social economic stratum. To
avoid falling for this type of scheme, tax-
payers should write down the statements
that are made to them and should then dis-
cuss them with their tax advisors.
Offshore Games
Another common scam is a tax device
that attempts to encourage taxpayers to avoid
paying taxes by simply hiding or placing
their income in accounts located outside the
United States. Credit and debit cards are
sometimes used in such cases to withdraw
money from the accounts. Of course, it is
not improper for taxpayers to have a foreign
bank account; however, if a taxpayer owes
taxes on income from that bank account,
failing to pay those taxes can subject the tax-
payer to large fines, interest, or criminal
charges. (The IRS has been working very
diligently to collect taxes and fines from such
accounts.) A warning sign should go off in
taxpayers minds the second that someone
suggests that they can reduce income tax
simply by engaging in foreign transactions.
Because foreign transactions also add com-
plexity to tax preparation, tax advisors should
counsel taxpayers accordingly.
Phishing
Finally, phishing is a constant concern
about scams on the web, in which scam
artists try to fish for data and use it to
con taxpayers and others. This is a seri-
ous problem for the IRS and continues to
be of concern to many law enforcement
agencies. Such scams have even relied
upon a false IRS position or a website
that appears to be affiliated with the IRS
in order to tempt taxpayers to submit per-
sonal data, which are then often used to
gain access to accounts of the taxpayer and
to otherwise steal funds from the taxpay-
er. The IRS has seen an increase in this
type of phishing as thieves attempt to
gain access to refunds owed to taxpayers.
The IRSs Dirty Dozen report provides
more information on this type of phish-
ing. Although knowing about these
schemes will not eliminate them, aware-
ness that these approaches are common
enough to appear in the Dirty Dozen
should make both taxpayers and their advi-
sors a bit more cautious.
Lessons to Learn
Because many of these scams are tied
to the use of the Internet and because the
increasing use of technology for daily com-
munications, business, banking, financial
transactions, and much more is unlikely
to change anytime soon, tax professionals
should expect that many of the Dirty
Dozen scams will appear with even
more vigor and strength, and they will
cause even more damage in years to come.
Hopefully, taxpayers and their advisors
will be more cautious and less likely to fall
for these schemes if they are armed with
knowledge of them. Once a tax profes-
sional learns that such scams have been
attempted against one client, it is impor-
tant to immediately notify other potential
victims, as well as the IRS and other appro-
priate governmental authorities, such as
consumer fraud offices and district
attorneys. q
Mark Lee Levine, PhD, JD, LLM, CCIM,
ChFC, is a professor and chair holder at
the University of Denver, Denver, Colo.
JUNE 2013 / THE CPA JOURNAL 50
Taxpayers might be
instructed to use a
Social Security claim
for a rebate or refund,
even if such a rebate
or refund doesnt
actually exist.