By Compiled annually by the IRS, the “Dirty Dozen” is a list of common scams taxpayers may encounter. While many of these scams peak during the tax filing season, they may be encountered at any time during the year. Here is this year’s list:
1. Phishing
Scam artists continue to victimize taxpayers during filing season using a steady onslaught of new and evolving phishing schemes. Email phishing schemes target payroll professionals, human resources personnel, schools as well as individual taxpayers and even tax professionals, deploying various types of phishing emails in an attempt to access client data. Thieves may use this data to impersonate taxpayers and file fraudulent tax returns for refunds.
In the most recent scam, thousands of taxpayers have been victimized by an unusual scheme that involves their own bank accounts. After stealing client data from tax professionals and filing fraudulent tax returns, the criminals use taxpayers’ real bank accounts to direct deposit refunds. Thieves are then using various tactics to reclaim the refund from the taxpayers, including falsely claiming to be from a collection agency or representing the IRS.
Fake emails and websites also can infect a taxpayer’s computer with malware without the user knowing it. The malware gives the criminal access to the device, enabling them to access all sensitive files or even track keyboard strokes, exposing login information.
2. Phone Scams
Aggressive and threatening phone calls by criminals impersonating IRS agents remain a major threat to taxpayers. Many phone scams use threats to intimidate and bully a victim into paying. They may even threaten to arrest, deport or revoke the license of their victim if they don’t get the money. Since October 2013, the Treasury Inspector General for Tax Administration (TIGTA) reports they have become aware of over 12,716 victims who have collectively paid over $63 million as a result of phone scams.
Con artists claiming to be IRS officials call unsuspecting taxpayers and demand they pay a bogus tax bill. Scammers often alter caller ID numbers to make it look like the IRS or another agency is calling. The callers use IRS titles and fake badge numbers to appear legitimate. They may use the victim’s name, address and other personal information to make the call sound official. They convince the victim to send cash, usually through a wire transfer or a prepaid debit card or gift card. They may also leave “urgent” callback requests through phone “robocalls,” or send a phishing email (see above for more information about phishing).
3. Identity Theft
Tax-related identity theft occurs when someone uses your stolen Social Security number to file a tax return claiming a fraudulent refund. While the IRS has made significant progress in deterring tax-related identity theft (from 2016 to 2017 identity theft decreased by 40 percent), criminals continue to devise creative ways to steal even more in-depth personal information to impersonate taxpayers. As such, taxpayers and tax professionals must remain vigilant to the various scams and schemes used for data thefts. Business filers should also be aware that cybercriminals file fraudulent Forms 1120 using stolen business identities as well.
Always use security software with firewall and anti-virus protection and make sure security software is always turned on and set to automatically update. Encrypt sensitive files such as tax records stored on the computer. Use strong passwords. Do not click on links or download attachments from unknown or suspicious emails. Protect personal data. Treat personal information like cash; don’t leave it lying around. Don’t routinely carry a Social Security card, and make sure tax records are secure.
4. Tax Return Preparer Fraud
About 60 percent of taxpayers use tax professionals to prepare their returns. The vast majority of tax professionals provide honest, high-quality service, but there are some dishonest tax preparers who set up shop each filing season. Well-intentioned taxpayers can be misled by tax preparers who don’t understand taxes or who mislead people into taking credits or deductions they aren’t entitled to in order to increase their fee. Avoid tax preparers who base fees on a percentage of their client’s refund or boast bigger refunds than their competition.
Illegal scams can lead to significant penalties and interest and possible criminal prosecution. IRS Criminal Investigation works closely with the Department of Justice (DOJ) to shutdown scams and prosecute the criminals behind them.
5. Fake Charities
Taxpayers should be aware that phony charities use names or websites that sound or look like those of respected, legitimate organizations. For instance, following major disasters, it’s common for scam artists to impersonate charities to get money or private information from well-intentioned taxpayers. Scam artists use a variety of tactics including contacting people by telephone or email to solicit money or financial information. They may even directly contact disaster victims and claim to be working for or on behalf of the IRS to help the victims file casualty loss claims and get tax refunds. They may also attempt to get personal financial information or Social Security numbers that can be used to steal the victims’ identities or financial resources.
6. Inflated Refund Claims
Taxpayers should be on the lookout for unscrupulous tax return preparers pushing inflated tax refund claims. Scam artists routinely pose as tax preparers during tax time, luring victims in by promising large federal tax refunds or refunds that people never dreamed they were due in the first place. They might, for example, promise inflated refunds based on fictitious Social Security benefits and false claims for education credits, the Earned Income Tax Credit (EITC), the Additional Child Tax Credit (ACTC) or the American Opportunity Tax Credit (AOTC), among others. They may also file a false return in their client’s name, and the client never knows that a refund was paid.
Filing a phony information return, such as a Form 1099 or W-2, is an illegal way to lower the amount of taxes owed. The use of self-prepared, “corrected” or otherwise bogus forms that improperly report taxable income as zero is illegal. So is an attempt to submit a statement rebutting wages and taxes reported by a third-party payer to the IRS. In some cases, individuals have made refund claims based on the bogus theory that the federal government maintains secret accounts for U.S. citizens and that taxpayers can gain access to the accounts by issuing 1099-OID forms to the IRS.
Because taxpayers are legally responsible for what is on their returns (even if it was prepared by someone else), those who buy into such schemes can end up being penalized for filing false claims or receiving fraudulent refunds.
7. Excessive Claims for Business Credits
Improper claims for business credits such as the fuel tax credit and the research credit are also on the IRS “Dirty Dozen” list this year. The fuel tax credit is generally limited to off-highway business use or use in farming. Consequently, the credit is not available to most taxpayers. Still, the IRS routinely finds unscrupulous tax preparers who have enticed sizable groups of taxpayers to erroneously claim the credit to inflate their refunds.
Fraud involving the fuel tax credit is considered a frivolous tax claim and can result in a penalty of $5,000. Improper claims for the fuel tax credit generally come in two forms. An individual or business may make an erroneous claim on their otherwise legitimate tax return. It is also possible for an identity thief to claim the credit as part of a broader fraudulent scheme.
Improper claims for the research credit generally involve a failure to participate in or substantiate qualified research activities and/or a failure to satisfy the requirements related to qualified research expenses. In addition, qualified research expenses include only in-house wages and supply expenses and 65 percent (typically) of payments to contractors. Qualified research expenses do not include expenses without a proven nexus between the claimed expenses and the qualified research activity.
To qualify for the credit, a taxpayer’s research activities must, among other things, involve a process of experimentation using science with a goal of improving a product or process the taxpayer uses in its business or holds for sale or lease. Certain activities specifically excluded from the credit including research after commercial production, adaptation of an existing business product or process, foreign research and research funded by the customer. Qualified activities also do not include activities where there is no uncertainty about the taxpayer’s method or capability to achieve a desired result.
8. Falsely Padding Deductions on Tax Returns
The vast majority of taxpayers file honest and accurate tax returns on time every year. However, each year some taxpayers fail to resist the temptation of fudging their information. That’s why falsely claiming deductions, expenses or credits on tax returns is on the “Dirty Dozen” tax scams list for the 2018 filing season. The IRS warns taxpayers that they should think twice before overstating deductions such as charitable contributions, padding their claimed business expenses or including credits that they are not entitled to receive.
Avoid the temptation of falsely inflating deductions or expenses on your return to underpay what you owe and possibly receive larger refunds. Taxpayers may be subject to criminal prosecution and be brought to trial for actions such as willful failure to file a return, supply information, or pay any tax due; fraud and false statements, preparing and filing a fraudulent return and identity theft.
9. Falsifying Income to Claim Credits
This scam involves inflating or including income on a tax return that was never earned, either as wages or as self-employment income, usually in order to maximize refundable credits. Falsely claiming an expense or deduction you did not pay, claiming income you did not earn could have serious repercussions. Con artists often argue that the proper way to redeem or draw on a fictitious “held-aside” account is to use some form of made-up financial instrument, such as a bonded promissory note, that purports to be a debt payment method for credit cards or mortgage debt. Scammers provide fraudulent Form(s) 1099-MISC that appear to be issued by a large bank, loan service and/or mortgage company with which the taxpayer may have had a prior relationship.
Well-intentioned individual taxpayers who don’t understand taxes or unscrupulous return preparers who mislead people into taking credits or deductions they aren’t entitled to do this to secure larger refundable credits (e.g., the Earned Income Tax Credit) to charge a higher fee; however, it can have serious repercussions. Taxpayers can face a large bill to repay the erroneous refunds, including interest and penalties. In some cases, they may even face criminal prosecution.
Remember: Taxpayers are legally responsible for what’s on their tax return whether it is prepared using tax software or a tax professional.
10. Frivolous Tax Arguments
Taxpayers are also warned against using frivolous tax arguments to avoid paying their taxes. Examples include contentions that taxpayers can refuse to pay taxes on religious or moral grounds by invoking the First Amendment or that the only “employees” subject to federal income tax are employees of the federal government, and that only foreign-source income is taxable.
Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish claims to avoid paying the taxes they owe. These arguments are wrong and have been thrown out of court. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law or disregard their responsibility to pay taxes. The penalty for filing a frivolous tax return is $5,000.
11. Abusive Tax Shelters
Abusive tax shelters, particularly those involving micro-captive insurance shelters, are on the list again for 2018. Phony tax shelters and structures to avoid paying taxes continues to be a problem and taxpayers should steer clear of these types of schemes as they can end up costing taxpayers more in back taxes, penalties, and interest than they saved in the first place.
Another tax shelter abuse involving a legitimate tax structure involves certain small or “micro” captive insurance companies. In the abusive structure, unscrupulous promoters, accountants, or wealth planners persuade the owners of closely held entities to participate in these schemes. The promoters assist the owners to create captive insurance companies onshore or offshore and cause the creation and sale of the captive “insurance” policies to the closely held entities. The promoters manage the entities’ captive insurance companies for substantial fees, assisting taxpayers unsophisticated in insurance, to continue the charade from year to year.
For example, coverages may insure implausible risks, fail to match genuine business needs or duplicate the taxpayer’s commercial coverages. Premium amounts may be unsupported by underwriting or actuarial analysis may be geared to a desired deduction amount or may be significantly higher than premiums for comparable commercial coverage. Policies may contain vague, ambiguous or deceptive terms and otherwise, fail to meet industry or regulatory standards. Claims’ administrative processes may be insufficient or altogether absent. Insureds may fail to file claims that are seemingly covered by the captive insurance.
Micro-captives may invest in illiquid or speculative assets or loans or otherwise transfer capital to or for the benefit of the insured, the captive’s owners or other related persons or entities. Captives may also be formed to advance intergenerational wealth transfer objectives and avoid estate and gift taxes. Promoters, reinsurers and captive insurance managers may share common ownership interests that result in conflicts of interest.
The bottom line: Don’t use abusive tax structures to avoid paying taxes. The IRS is committed to stopping complex tax avoidance schemes and the people who create and sell them. The vast majority of taxpayers pay their fair share, and everyone should be on the lookout for people peddling tax shelters that sound too good to be true. When in doubt, seek an independent opinion if offered complex products.
12. Unreported Offshore Accounts
Through the years, offshore accounts have been used to lure taxpayers into scams and schemes. Numerous individuals have been identified as evading U.S. taxes by hiding income in offshore banks, brokerage accounts or nominee entities and then using debit cards, credit cards or wire transfers to access the funds. Others have employed foreign trusts, employee-leasing schemes, private annuities or insurance plans for the same purpose.
While there are legitimate reasons for maintaining financial accounts abroad, there are reporting requirements that need to be fulfilled. U.S. taxpayers who maintain such accounts and who do not comply with reporting requirements are breaking the law and risk significant penalties and fines, as well as the possibility of criminal prosecution.
Since 2009, tens of thousands of individuals have come forward to voluntarily disclose their foreign financial accounts through the Offshore Voluntary Disclosure Program (OVDP), taking advantage of special opportunities to comply with the U.S. tax system and resolve their tax obligations. The IRS recently announced that this voluntary program will end on September 28, 2018.
If you think you’ve been a victim of a tax scam, please contact the office immediately.