Income tax fraud: A crime with significant harm

Defining it, the rate of occurrence, and a look at several startling cases

by Abigail Grenfell, president, Internal Control & Anti-Fraud Experts, LLC

Tax fraud, whether perpetrated by the taxpayer, tax return preparer, or by collusion between the taxpayer and tax return preparer, is a crime and could be criminally charged as a series of crimes. But what exactly is tax fraud? How prevalent is it, and who is perpetrating it?

What is tax fraud?

Tax fraud is “… the actual intentional wrongdoing, and the intent required … to evade a tax believed to be owing. Fraud implies bad faith, intentional wrongdoing, and a sinister motive. It is never imputed or presumed and the courts will not sustain findings of fraud upon circumstances which at most create only suspicion.”1

Tax fraud cases can be brought both civilly and criminally.

Civil cases have a lower burden of proof (preponderance of the evidence), are generally less expensive to litigate, and often arise when “intent” cannot be proven or is not ripe for a criminal action. A case is not ripe for court action when a dispute has not happened yet, and a court therefore cannot resolve it.

On the other hand, criminal cases have the highest burden of proof (beyond a reasonable doubt), are time consuming and are very expensive to prosecute. They are also a large drain on personnel and financial resources for the government. Criminal cases often arise out of a taxpayer’s failure to cooperate in civil proceedings, or in an audit where demonstration of the required “willful intent” is demonstrated.

Tax fraud costs to American taxpayers

In May 2012, Forbes published an outstanding article, “Billions in Tax Refund Fraud — and How to Stop Most of It,”2 that certainly raises questions about the lack of proper process and internal control within the federal government to protect taxpayers from the blatant tax fraud occurring under the nose of the IRS.

According to Forbes, the U.S. Treasury “may be losing as much as $5 billion a year from fraudulent tax fraud claims — and most of that fraud is entirely preventable.” Citing the New York Times, Forbes exposed a severe weakness in the IRS’s refund process — identity theft. Criminals simply obtain the taxpayer’s name and Social Security number, file an electronic tax return containing a few deductions and tax credits, and have the refunds electronically deposited to bank accounts or applied to debit cards. In its July 2012 report , the Inspector General (IG) projected $21 billion in tax dollars lost to fraudulent returns related to identity theft in the next five years. In addition, the IG previously noted in 2008: “The IRS was not in compliance with direct deposit regulations that require tax refunds to be deposited into an account only in the name of the individual listed on the tax return.” A couple of examples of tax fraud that slipped through the IRS included:

  • “4,157 ‘potentially fraudulent tax refunds … totaling $6.7 million … deposited into one of 10 bank accounts. Each … account had direct deposits of more than 300 refunds.’”4
  • During their audit, the IG identified nearly 1.5 million tax returns where the IRS issued more than $5.2 billion in potentially fraudulent tax refunds.

Statistical data – abusive tax schemes4

The IRS publishes annual statistics related to abusive tax schemes. Although the number of new investigations initiated appears small, one must remember that criminal cases consume significant resources to investigate and prosecute and often involve multi-million dollar tax loss.

  FY 2013 FY 2012 FY 2011
Investigations initiated 119 149 166
Prosecution recommendations 88 111 140
Indictments/informations 80 85 86
Sentenced 64 75 95
Incarceration rate* 68.8% 74.7% 76.8%
Average months to serve 31 25 30

Note: Federal fiscal year runs from Oct. 1 - Sept. 30

*Incarceration includes confinement to federal prison, halfway house, home detention or some combination thereof.

Data source: IRS, Criminal Investigation Management Information System, as of Oct. 23, 2013

businessman in handcuffs

What were they thinking?

Shakopee tax preparer 5

“If two or more persons conspire either to commit any offense against the U.S., or to defraud the U.S., or any agency thereof in any manner or for any purpose, and one or more such persons do any act to effect the object of the conspiracy.”

According to an IRS agent’s sworn statement, the IRS alleged the Hammerschmidts acting in and through their business entity, submitted more than 700 tax returns, filed by illegal immigrants, with invalid claims and deductions such as dependents and education expenses resulting in invalid refunds in excess of $2.5 million. The agent also alleged in the affidavit that the address of a UPS store in Shakopee was listed as the illegal immigrants’ residence while nearly all resided (without authorization to be in the U.S.) in Florida.

Both Hammerschmidts previously pleaded guilty to a single count of fraud and misuse of a visa in Florida in 2009 after being indicted on charges of conspiracy to obstruct justice, witness tampering, and destruction of evidence for arranging sham marriages for illegal immigrants so they could collect government benefits unlawfully.

The case is still under investigation. No information is available on whether the IRS referred the 700 illegal immigrants to the U.S. Immigration and Customs Enforcement (ICE) for deportation or if Americans remain vulnerable to a repeat of this tax fraud scheme.

Minnesota men sentenced in Ponzi fraud schemes6

In January 2013, both Jason Bo-Alan Beckman of Plymouth and Gerald Durand of Faribault were sentenced to 360 months and 240 months in prison, respectively, for filing false tax returns and for tax evasion, in addition to conducting a massive Ponzi scheme and other crimes. Together with Christopher Pettengill of Plymouth and Trevor Cook, convicted of non tax-related crimes, they were ordered to pay more than $155 million in restitution to their Ponzi-fraud scheme victims. Beckman and his wife owed more than $1.3 million in federal income taxes for the 2007-09 tax years.

Federal inmate in Alabama pleads guilty to tax fraud perpetrated while in prison 7

My favorite story is this astonishing case that should be featured on “Stupid Criminals.” A federal prison inmate serving 10 years for Medicare fraud pleaded guilty in December 2012 to filing a false refund claim for more than $2.7 million. David Marrero sent false documents to the IRS, including false tax returns claiming refunds based on fictitious IRS forms 1099-OID, claiming businesses withheld federal tax from his wages.

Convicted, indicted tax accountants

A recent prosecution of a tax accountant should serve as a stern warning to tax preparers that they are not beyond prosecution for tax crimes when they advise their clients to file false returns.

BDO Seidman LLP partner

This case is truly a stain on the accounting profession.8 Former BDO Seidman LLP partner Stephen Favato was sentenced to 18 months in prison for a litany of tax crimes, including “corruptly endeavoring to obstruct and impede the Internal Revenue laws and one count of aiding and assisting in the preparation and filing of a false income tax return.” For at least four years, Favato tried to obstruct the IRS and also advised his client to falsify his 2002-04 joint tax returns. Estimated tax loss was $184,000.

December 2013 indictment

On Dec. 23, 2013, the Department of Justice revealed that a 63-count superseding indictment (subsequent indictment with additional charges) charging Chatonda Khofi, Ishmael Josh, Amadou Sangaray and Francis Saygbay in a conspiracy to defraud the IRS. It is alleged that the defendants prepared and filed false federal and Minnesota individual income tax returns that included false dependents (using stolen identities), deductions, business losses and wage income.9

From two tax-evasion sentences, a lesson comes10

In April 2013, USA Today provided a great comparison of two tax-evasion cases and sentences involving offshore accounts.

In the first case, a military doctor from Florida pleaded guilty to willful failure to notify the IRS about Swiss bank accounts (holding nearly $1.5 million) that were inherited from his father. The taxpayer pleaded guilty to one felony conviction that forced him to retire from the Department of Veterans Affairs medical post after nearly 30 years of military service. The taxpayer was sentenced to six months in federal prison as a deterrent to others, paid $1 million in back taxes and penalties, was fined $100,000, and was ordered to pay $216,000 in restitution and to perform 400 hours of community service providing rehabilitative medical care.

Facts in the second case are strikingly similar. The taxpayer was a 79-year-old widowed Palm Beach, Fla., heiress and charity benefactor who also inherited an offshore account. One key difference from the prior case is that this taxpayer hired an attorney to contact the IRS when she learned the account could be subject to tax. Unfortunately, the attorney did not contact the IRS in a timely manner; the IRS learned of the account during the one-month delay, costing her an additional $13 million. The taxpayer pleaded guilty to filing two years of false tax returns, concealing up to $43 million from IRS. She was ordered to pay $21.7 million in penalties plus $667,716 in overdue taxes and interest on income. She was also sentenced to one year of probation; however, the judge terminated the punishment and recommended she file a pardon request.

Hold yourself and others to a higher standard

Certified public accountants are, and should be, held to a very high ethical standard in all facets of our work. Tax preparation is no exception. Tax clients should be vetted to ensure you are comfortable preparing, signing and filing their tax returns. Ignoring the warning signs can have devastating effects on your business and your freedom.

Abigail Grenfell is president of Internal Control & Anti-Fraud Experts, LLC, a firm specializing in fraud prevention, detection and investigation, development of anti-fraud programs, design and assessment of internal controls. You can reach her at abby.grenfell@icafemn.com.

1 14 Mertens, Law of Federal Income Taxation, sec. 55.21, page 64 (1991 Rev); Ross Glove Co. vs. Commissioner, 60 TC 569 (1973).
2 http://www.forbes.com/sites/leonardburman/2012/05/28/billions-in-tax-refund-fraud-and-how-to-stop-most-of-it/
3 http://www.treasury.gov/tigta/auditreports/2012reports/201242080fr.pdf
4 http://www.irs.gov/uac/Statistical-Data-Abusive-Tax-Schemes
5 IRS raids Shakopee tax preparer, StarTribune, February 16, 2012 http://m.startribune.com/business/?id=139448903
6 http://www.justice.gov/usao/mn/beckman.html
7 http://www.justice.gov/tax/2012/txdv121539.htm
8 http://www.justice.gov/opa/pr/2012/April/12-tax-481.html
9 http://www.justice.gov/opa/pr/2013/December/13-tax-1363.html
10 http://www.usatoday.com/story/money/business/2013/04/25/tale-of-two-tax-evasion-cases/2107003

 


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