IRS Cracks Down on Fraudulent Tax Preparers

Karen Miller of Nashville had a good hook for attracting customers. According to government filings, she claimed that if they just filed a certain tax form, they could receive "astonishing" refunds from the Internal Revenue Service. Last year, Miller prepared and filed 41 such returns for customers, who in total claimed more than $8.3 million in refunds from federal coffers. The scam, a federal court later concluded, was based on the all too prevalent (and erroneous) belief that the Treasury Department maintains secret accounts for citizens and that taxpayers can access the money by filling out a version of Form 1099. It's called a "redemption scheme."

The number of Justice Department actions against tax-return preparers and tax-scheme promoters has skyrocketed from a single prosecution in 2001 to more than 435 injunctions and other legal actions since, according to statistics obtained by U.S. News. Last month, a federal court permanently barred Miller from preparing federal returns. On the same day, the government filed suit against six other preparers around the country who allegedly ran redemption schemes, seeking to shutter preparers who had sought a total of more than $560 million in fraudulent refunds.

The increase in enforcement, which comes primarily in the form of swift court-ordered injunctions barring preparers from submitting additional returns, has been made possible by a variety of new tactics. One key change has been an initiative to train IRS agents to spot fraudulent preparers and gather the information needed for Justice Department lawyers to win quick court action. Dozens of agents have received such training in the past few years. In addition, sophisticated computer models have been used to spot fishy trends in filed tax forms and connect them with suspect preparers, says Seth Heald, chief of the civil trial section in the Justice Department's Tax Division.

The dramatic increase in enforcement has coincided with growing calls from lawmakers and tax officials to regulate an industry that has quietly escaped oversight for decades. Currently, anyone can file a tax return and charge a fee for the service. Only three states—California, Oregon, and Maryland—impose any type of licensing or certification system on those who offer such services. In 2008, the Treasury Department sent undercover auditors to preparers around the country. They reported finding systemic errors in filing, often due to inadequate training of preparers. Only 60 percent, for instance, correctly compiled information on itemized deductions.

But as the tax code grows in complexity, more and more Americans—some 60 percent, by most estimates—are turning to preparers to guide them through the maze of paperwork. Some dishonest preparers will "trade" children, complete with Social Security numbers, between filers to maximize deductions; others will try to declare pets as children to take advantage of tax credits, investigators say. Some preparers will advertise their serv­ices only to steal their customers' personal information, like Social Security and credit information.

Last month, the IRS announced it would regulate all federal tax preparers and create a licensing and registration ­system, which would include a testing and continuing education requirement for the estimated 1 million preparers nationwide. The regulations, which will take effect in 2011, have the strong support of the big players in the tax filing industry, like H&R Block and Jackson Hewitt. The National Society of Accountants also came out in favor of the new rules, saying that they would clean up the marketplace. Lawyers, licensed enrolled agents who can represent taxpayers before the IRS, and certified public accountants are exempt from both the new competency tests and the continuing education requirements.

Tax prep experts warn customers against preparers who claim they can secure taxpayers a larger refund than others can, those who base their fee on a percentage of the refund, and those who pressure clients to take out so-called refund anticipation loans. Most important, they say, never trust a tax preparer who refuses to sign a return he or she prepares.

Preparers range from legitimate to decidedly suspect. In 2007, a federal court enjoined a Florida woman who operated her tax preparation business at a booth in a Miami flea market and, according to court documents, claimed fraudulent fuel tax credits on her customers' returns. According to the complaint, one of the woman's customers, a baby sitter, claimed using 16,451 gallons of gasoline for business-related purposes on her tax returns—the amount of gas needed to drive a car around the globe 10 times.