Tax Preparers are a Key Target for the Criminal Division of the IRS
The Enormity of the United States Tax System
The Internal Revenue Service (IRS) is responsible for ensuring U.S. citizens and corporations are paying the taxes required under the Internal Revenue Code (IRC). The scope of this duty is enormous. In 2021, the IRS received over 220 million tax returns. The United States Treasury received over $4.1 trillion in gross tax revenue and issued over $600 million in refunds to tax payers. The tax system in the United States handles billions of documents and trillions of dollars on an annual basis. That figure balloons when late filings, late payments, and other activity related to stale accounts, is taken under consideration.
To manage this system, the IRS is broken into multiple divisions. Each division has a unique focus within the enforcement structure. The collections division handles collection actions for backed taxes. The revenue division handles routine audits and tax disputes. The criminal division handles matters where the tax payers actions may run afoul of Title 26 of the federal code. These Title 26 violations usually involve failing to disclose accounts, failing to file returns, filing false statements within returns (tax fraud), or moving money to avoid collection (tax evasion).
Every year, the Treasury loses billions of dollars due to mistake or intentional action on the part of taxpayers and filers. There is little doubt the IRS would vastly increase their revenue if they could police the entire system effectively. However, efficient enforcement is not realistic. The system is too large to attain that goal.
CIDs Role in Enforcement
The Criminal Division (CID) of the IRS is only responsible for ferreting out Title 26 violations and a small number of alternative financial crimes (ie, money laundering and other Title 31 violations). Their agents do not focus on tax mistakes, collecting backed taxes, or negotiating payments. Even within this isolated world, the task is large and a plan of action is required to efficiently police the structure.
CID’s answer to the scope problem above is to rely on a referral system. CID operates almost exclusively through referrals from other IRS branches, banks, other federal agencies, and private citizens. A criminal tax investigation nearly always has a source disconnected from CID’s day to day operations.
The revenue division of the IRS is a main source of referrals for CID investigations. The revenue division is responsible for conducting routine audits and reviewing returns for accuracy. Their job suffers from the same scope problem present for every division of the IRS. There is no way they can review each of the 220 million plus returns filed each year. To combat this problem, the revenue division has chosen to isolate certain problem areas for review. These areas have historically included business filers with substantial income, filers whose tax situation changes drastically from year to year, filers in a business where fraud is more common, and business sectors where cash sales are dominant. These areas, and others like them, allow the IRS to focus their energy on sectors where they have a good chance of recouping material losses to the United States Treasury. It would be foolish for the IRS to expend limited resources reviewing W-2 based returns for employees making $30,000.
Tax Preparers a Key Target of the IRS
Tax preparation businesses have become one of the key sectors for scrutiny within the IRS. The IRS believes there is a high potential for fraud within this area. Based on the high volume of returns, the potential for recouping large losses is likewise present. Not all tax preparation businesses fall under this umbrella. Let’s review the general layout of tax professional businesses for a better understanding of the IRS’ focus.
Generally speaking, tax preparation firms can be broken down into three categories: 1) CPA firms (large and small), 2) franchised tax preparation businesses (Turbotax, H & R Block), and 3) tax preparation firms with limited CPA or tax professional involvement.
CPA Based Firms
Most large businesses and corporations hire accounting firms to handle their yearly tax filings. These accounting firms normally employ various CPAs to handle client files. These CPAs normally file accurate returns that benefit the client as much as the IRC will allow. Having a legitimate CPA/firm tied to the return can normally help avoid interactions with the IRS.
Less Expensive Options
For smaller business owners and employees, hiring a legitimate CPA firm may not be affordable or necessary. Depending on the complexity of the returns, the tax payer may file their own numbers through Turbotax or hire a cheaper option like H & R Block. There is nothing wrong with that route if the returns are straight forward.
Alongside these big named options, there are smaller companies that are not tied to a larger franchise. These companies normally operate out of small office fronts around cities and rural towns. Most do not employ CPAs or other tax professionals. Their employees deal with simple tax filings for a small fee. Their business model requires large volume every year to meet overhead costs.
This latter category of tax preparation businesses make up the main focus of the IRS. Some of these businesses are entirely legitimate. They serve large numbers in a local community whose populace is not comfortable with filing their own returns. Having someone facilitate the process of filing a W-2 or 1099, and setting up a direct deposit for a refund, is worth the nominal fee for the service.
Having said that, some of these companies have historically driven sales by filing inaccurate returns and increasing their client’s refund potential. Their ability to obtain larger than normal refunds can create a groundswell of new clients, and thus, increase the profitability of the company. This business model is a reoccurring theme for many small operations across the country. This common trend has led to increased oversight from the IRS and the Department of Justice. Here are a few DOJ press releases detailing tax preparer prosecutions:
https://www.justice.gov/opa/pr/texas-tax-preparer-charged-false-returns
https://www.justice.gov/usao-sdtx/pr/rgv-tax-preparer-indicted-filing-false-returns
https://www.justice.gov/opa/pr/texas-tax-preparer-charged-filing-false-returns
https://www.justice.gov/opa/pr/texas-return-preparers-indicted-false-tax-return-scheme
Both the revenue and criminal divisions actively review filings from these companies for indications of fraud. The most common indication being outrageous business expenses for a W-2 employee or small business owner.
Once the IRS flags a particular preparation company, it is common for CID to take over the investigation. CID normally reviews these cases for two separate criminal schemes – 1) assisting a tax payer in filing a false return (Title 26 § 7206(2)) and 2) filing falsities on the preparer’s personal or business returns (Title 26 § 7206).
CID Investigation into Tax Preparation Businesses
The nature of the CID investigation will depend on whether CID believes the preparer is assisting in the preparation of false returns for their clients or filing false statements within their own personal/business returns. Though both can be present together, we will break the investigation down by scheme for clarity.
Assisting in the Preparation of False Returns
If CID believes the preparation business is filing fraudulent returns for their clients, the agent will contact the clients to set up interviews. This contact is normally made by supplying clients with summonses requiring their appearance for an interview. Once received, the clients normally reach out to a criminal tax attorney to get clarification on their exposure.
We have represented numerous client’s who receive a summons under this type of investigation. In the overwhelming majority of cases, CID is not interested in targeting the client for criminal charges. CID would rather use the client as a witness to build a case against the tax preparer. Most CID agents will be honest if asked whether the person being represented is a witness or target of the investigation. If we are advised the client is merely a witness, we normally advise the client to meet with the IRS and freely discuss the filed returns. This path likely ensures the client will never become anything more than a witness. Considering the large percentage of guilty pleas in the federal system, the initial CID interview may be all that is required.
The CID interview is normally an easy process. The agent will present returns prepared by the target of the investigation. They will go line by line asking the client whether the number is accurate, and if not, whether the number was supplied to the tax preparer. Normally, the answer is no to all questions. This line of questioning establishes the tax preparer’s knowledge and intent under the false statement statute. If CID can stack enough clients together, the criminal case becomes overwhelming in short order.
Though the tax preparer is the likely target of the investigation, the clients are not without risk. In certain situations, the clients may be charged with a false statement count alongside the tax preparer. This is not the normal operating procedure on these cases, but it is a possibility if the tax payer played a role in producing the false numbers.
Aside from criminal risks, the taxpayer will certainly have civil tax issues that need attention. The client will be required to file amended, accurate returns for the years under investigation. Those accurate returns will increase the tax liability for each year. The increased tax liability will be buttressed with late payment penalties and interest. If multiple years have passed since the original return was filed the penalties and interest can be substantial. The taxpayer would be wise to hire a civil tax attorney at that stage to fight the additional accruals and settle the tax debt.
False Statement on Personal or Business Returns
If CID believes the tax preparer is filing false personal or business returns alongside their clients, their investigation will focus on the financials behind the business. CID will issue summonses for all personal and business bank accounts and the business’ books. In addition, they will begin interviewing employees within the company. In this way, the criminal tax investigation mirrors the common tactics we see in non-preparation cases. CID is attempting to recalculate the numbers and fill in the gaps with witness testimony.
Tax Preparers Play a Dangerous Game
Filing false returns on behalf of others is a dangerous game. By entering the tax preparation business, the person is subjecting themselves to increased IRS scrutiny. Criminal tax cases are built on the tax loss involved in a particular scheme. If a tax preparer has filed hundreds of false returns, the tax loss could be substantial. The increased tax loss makes their scheme an attractive target for CID investigation and raises the stakes at sentencing if convicted.
While the IRS struggles to catch everyone each year, a lengthy run of criminal activity ensures probing at some point. Tax preparation companies need to ensure they are avoiding false filings. While minor mistakes are common, and certainly not criminal, substantially overstating expenses or understating income is a recipe for disaster. The Department of Justice, through the IRS, will continue to ferret out tax preparation businesses that funnel clients through the promise of unrealistic refunds.