Earlier this year a Charlotte man was charged with tax fraud in a 20 count criminal indictment, charging him with aiding and assisting in the preparation and filing of false returns over a five year period.

According to the allegations, between 2014 and 2021 the Defendant, Tijan Mboob (“Mboob” or the “Defendant”) prepared hundreds of fraudulent returns. The indictment further alleges that the Defendant was a “Ghost Preparer,” who failed to identify himself as a paid tax preparer on the tax returns he submitted to the IRS on behalf of his clients, despite the fact he was compensated for his services.

The IRS requires paid return preparers to provide information, including name, address and phone number for the preparer, Federal Tax Identification or Social Security Number and PTIN number as well as other information.

The indictment specifically alleges that Mboob prepared tax returns on behalf of his clients which contained fabricated and fraudulent items. Some of the items included false filing status, false American Opportunity and education credits, false itemized deductions and false reforestation credits. The hundreds of fraudulent returns prepared by the Defendant resulted in the overall reduction in tax liability on behalf of his clients and their receipt of large refunds totaling $4.7 million dollars.

Finally, the indictment indicates that the Defendant failed to report any of the preparation fees he eared as income for 2017 and 2019, and in addition, failed to file returns for 2019 and 2019.

Each Year the IRS warns the public about return preparer scams.  However, there is no shortage of victims, who fall prey to these predators each year.

While the Ghost Preparer is also a paid preparer, he differs from the fraudulent return preparer who provides identifying information on the tax returns he or she prepares. The Ghost Preparer will submit a fraudulent tax return and designate the tax return as “Self-Prepared.” In doing so, he or she will deliberately omit any paid return preparer information at the bottom of the tax return. Clients are delighted to learn that they are getting a $10,000 refund, only to later discover that it was too good to be true.  How is this possible?

Its possible thanks to the illegal business practices some return preparers engage in. Most are unlicensed and not subject to Circular 230. In addition, many conduct business using a nominee as the face of the tax preparation business. These charlatans are generally are able to grow their practices based solely on their ability to generate large taxpayer refunds for their clients and by word of mouth.

The return preparer, who engages in these illegal acts, will have a federal identification number, as well as PTIN and ERO numbers. These preparers are monitored by the IRS, who, through AI and analytics is able to identify patterns in certain types of deductions, business losses, credits and withholding.  Many of these preparers have been identified and either civilly enjoined from preparing tax returns or criminally prosecuted. The ones who escape prosecution simply set up shop down the road, making use of new nominee.

A Client who receives a large tax refund to which he or she is not entitled may be thrilled and think he or she hit the jackpot.  That joy quickly gives way to fear and anxiety when the Taxpayer receives a notice from the IRS. In certain cases, it can involve multiple years.

The morale of the story is choose your return preparer wisely and asks lots of questions.  It is always best when selecting a return preparer to select an attorney, certified accountant or enrolled agent, all of whom are subject to Circular 230, which governs the conduct of return preparers.   Further, if a friend or relative recommends a return preparer based on the fact that they systematically receive large refunds, I would be suspicious.

If you have been receiving large refunds, it would be wise to have a tax attorney, certified public account or enrolled agent review your tax return.

Fraudulent Conveyances in Employment Taxes

TFR and Fraudulent conveyancesEmployers who willfully fail to remit an employee’s withholding to the IRS are liable to the IRS for the “trust fund recovery penalty” (TFRP). Generally, the IRS will assess the Penalty against any responsible person who fails to collect and pay these taxes to the IRS. A responsible person can include a business owner, a corporate officer, director or office manager and a trustee or executor as well other individuals and entities.

Those who are subject to the TFRP may attempt to impede IRS collection efforts by conveying their personal or corporate assets to relatives or to nominee entities, without fully considering the civil and criminal tax consequences associated with making such transfers.  A fraudulent conveyance can be as simple as transferring an asset to a spouse or child, or may involve multiple entities and other devices. While there may be legitimate reasons for transferring an asset to a third party, making a fraudulent conveyance is not one of them.

IRS Lawsuit on a Fraudulent Transfer Scheme

An excellent illustration of an elaborate fraudulent transfer scheme is United States v. William Planes,et al (8:18-cv-02726) where  William  Planes (“William”) and his wife, Regina Planes (“Regina”), failed to pay employment taxes exceeding $9 million on behalf of  at least ten entities over a 12 year period. The following is a partial summary of what happened. I would, however, recommend reading the case in its entirety.

The IRS filed a lawsuit in the U.S. District Court, for the Middle District of Florida against William. In its complaint, the Government alleged that while employment taxes continued to accrue, but prior to the lawsuit being filed, the defendant, William Planes (William),  fraudulently transferred almost $600,000 to his wife Regina (Regina) Planes.

In furtherance of the scheme, Regina lied to the IRS by maintaining that she was not a financially responsible person of South Capital Construction, Inc. The Court subsequently entered a judgment against Regina finding that William made the transfer to Regina in order to prevent the IRS from collecting the penalty from him.

On November 5th 2018, the Government filed a second lawsuit seeking to:

  1. Reduce a separate trust fund penalty of $529,000 assessed against William Planes in 2003 to a judgment.
  2. Disregard the corporate entities that the defendants were using to impede IRS collections.
  3. Apply the entities’ assets to the judgment.

A day after the IRS assessed $529,000 penalty against William, the defendant created the William Planes 2003 Irrevocable Trust and the Regina Planes 2003 Irrevocable Trust. These two trusts, in turn, owned six limited liability companies which William and Regina either owned or controlled.

The Government also requested and secured a temporary restraining order (TRO) on November 6th 2018, enjoining the defendants or anyone acting on their behalf or in concert with from transferring any entity asset.

On November 7, 2018 Regina was served with the TRO. Less than two hours later William transferred the sum of $160,000 from three of the entities bound by the TRO to Coast to Coast, an entity in which William is a director.  A contempt hearing followed. The Court subsequently found the defendants in contempt and converted the TRO to a preliminary injunction.

While this case has yet to be referred to the IRS Criminal Investigation Division, I suspect it will be given the dollar amount.

Trust Fund Recovery Penalty and Prosecution

The amount of the TFRP is for the most part irrelevant in the Government’s decision to prosecute an individual. Taxpayers have been prosecuted where the TFRP was far less. The following cases illustrate the dollar range in TFRP cases that have resulted in criminal prosecution:

  1. On August 27, 2019, a North Carolina woman was sentenced to 14 months in prison for employment tax fraud for withholding and failing to pay over $78,937 in employment taxes deducted from the employees of a Pediatrician where she worked as an office manager, as well as the failure to pay over $35,472 representing the employer’s share of taxes. Instead, the defendant used the money to pay her credit card bills, go on personal vacations and fund a business venture. She also helped herself to $1.4 million from the Pediatrician’s bank account.
  2. In June of 2019 a Long Island business man pleaded guilty to failure to pay over employment taxes to the IRS. According to the documents filed by the DOJ, the defendant owned and operated several steel erection businesses on Long Island. Over a four year period the defendant owed almost $500k in employment taxes. In May of 2011, the defendant changed the name of his business to BR Teck Enterprises Inc. and transferred ownership of the corporation to another individual. Despite transferring ownership of the business to a third party, the defendant continued to operate the business ad continued to pay over employment taxes. From January 2012 through June 2017, the defendant racked up an additional $950K in unpaid employment tax liability.

An Individual who owns or controls a business or is considered a responsible person who has a fiduciary obligation to accurately collect, account for and pay over to the Internal Revenue Service, all federal employment taxes withheld from its employees as well as the employer’s portion of any payroll taxes. Failure to remit such payments will invariably lead to assessment of the TFRP against an individual or entity that is considered responsible.

The above examples make clear that the transfer of corporate or individual assets to another person or an entity as a strategy to defeat or impede IRS collection efforts will seldom, if ever, work. This strategy is viewed by the Government as a deliberative process and has served as strong evidence in criminal prosecutions of intent to defraud the U.S. Government.

Alternatives other than the fraudulent transfer of assets are available when dealing with payroll tax issues. These issues can sometimes be mitigated, when an experienced tax attorney becomes involved at an early stage in the process. Conducting a Google search and handling the problem yourself is no strategy at all. Perhaps, it is time to stop digging.

Combs v. Commissioner Case

constructive dividentsTaxpayers who operate small closely held businesses using a corporate entity need to be mindful that personal expenses, paid from a corporate bank account or the use of a corporate credit card for personal reasons may constitute a constructive dividend that is taxable. When a corporation pays expenses on behalf of a shareholder, it is conferring a benefit upon the shareholder. Depending upon the shareholder’s basis in the corporation, that benefit may be deemed a dividend distribution to the shareholder. It may also be considered a return of capital, which is non-taxable, or a gain.

In a recent decision, the Tax Court held that the payment of personal expenses from a corporate bank account constituted a constructive dividend that was taxable to the shareholder (Combs v. Commissioner -T.C. Memo. 2019-96). The case involved the assessment against a corporate owner of tax deficiency accuracy related penalties under 26 USC § 6662(a) as well as failure to file penalties under 26 U.S.C. § 6651 (a) (1) for the tax years 2010, 2011 and 2012.

The taxpayer, Patrick Combs (Combs), was an author, performer and motivational speaker who performed one person comedy shows and also had speaking engagements. The compensation he received for these engagements was deposited into a corporate bank account of an entity in which the taxpayer was the sole owner, officer and director. The taxpayer and his significant other were the only signors on the Bank of America account and were also authorized users of a corporate American Express Card.

Combs and his girlfriend utilized the corporate funds as well as the Corporate American Express card for the taxpayer’s personal expenses during the tax years under examination. The personal expenses were detected during an IRS audit of the taxpayer’s corporate tax returns for the years 2010-2012. During the examination of the corporate returns, the IRS also conducted an audit of the taxpayer’s Form 1040 for the same tax years.

The examiner disallowed most of the corporate deductions, based upon the absence of any proof that the deductions were legitimate business expenses, resulting in a notice of tax deficiency to the corporation.

In  addition, the IRS  determined that the payment of the taxpayer’s personal expenses that were disallowed as deductions for the corporate entity, constituted  constructive dividends and that such dividends were taxable to Combs. In this regard, the IRS issued an individual notice of deficiency to Combs for additional tax, penalties and interest.

Constructive dividend reporting

26 U.S.C. § 301 (c) (1) provides that a constructive dividend must be reported as income. When a corporation has sufficient earnings and profits, and distribution of property to a shareholder is made, the distribution is deemed to be a dividend. To the extent distributions to a shareholder exceed a corporation’s earnings and profits; the excess is treated as return of capital, and considered nontaxable, subject to the shareholder’s basis in the corporation. Where a distribution exceeds a taxpayer’s basis in a corporation, the excess is treated as a gain under Sections 301 (c) (2) and (3). Truesdell v. Commissioner, 89 T.C. 1280, 1295-1298 (1987).

In Combs, the Court citing Boulware v. United States, 552 U.S. 421 (2008), pointed out that:

“Characterization of a distribution as a dividend does not depend upon a formal dividend declaration.” Id.

The Court also pointed out that when an individual receives a distribution of property without any expectation of repayment, that distribution confers a benefit to the shareholder, and as such, constitutes a constructive dividend.

Small business owners who conduct business as a corporate entity are particularly vulnerable. The practice of paying personal expenses from corporate funds is more widespread than reported and prevalent in virtually every business sector. Factors contributing to this practice include lack of formal policies and procedures in the business, ignorance as to what constitutes an ordinary and necessary business expense, direct or indirect control over disbursements from the business, and in certain cases, greed on the part of the business owner.

The lesson here is clear. Establishing a business entity through Legal Zoom and securing a federal EIN, in and of itself, does not constitute good corporate tax governance. Business owners who engage in the practice of paying their personal expenses out of corporate funds will invariably find themselves at odds with the IRS, and could face the assessment of additional tax, substantial penalties and interest. In extreme cases, they may also face criminal prosecution.

Taxpayers currently engaged in these practices, who have yet to come under examination, should seriously consider taking remedial steps to come into compliance. Consultation with an experienced tax attorney and painstaking honesty by the taxpayer will generally yield the best solutions.

Fraudulent IRS tax refunds

Fraudulent tax refundsEach year thousands of individuals flock to tax return preparation centers in anticipation of receiving a large income tax refund from Uncle Sam. For most, the money is already earmarked for a down payment on a new car, home improvement or a vacation with most of the refund spent within 90 days of its receipt. The problem arises when the taxpayer receives a tax bill years later from the IRS and is required to repay the refund plus additional tax, interest and, in certain cases, penalties. In many cases, the bill the taxpayer receives from the IRS will cover multiple years since it takes a long time for the IRS to catch up with and prosecute crooked return preparers. While there are taxpayers who are complicit and aware that they are not entitled to those large refunds, most taxpayers are totally taken by surprise, when the IRS contacts them.

The statute of limitation for the assessment of income tax is generally 3 years from the date the return is filed. However, in the case of a false or fraudulent return, the tax may be assessed at any time under IRC Section 6501(c) (1) Id. The question of whether a return preparer’s fraudulent conduct (related to a taxpayer’s return) extends the statute of limitation for the taxpayer, has been the subject of debate among the courts. In addition, a taxpayer’s negligence in failing to review his or her tax return, can serve as a basis for imposition of the 20 % accuracy related penalty.  In 2007 the Tax Court held that a third party preparer’s fraud extended a taxpayer’s statute of limitations (Allen v. Commissioner, (128 T.C. 37 (T.C. 2007)).  However, in 2015 the Court of Appeals, in BASR Partnership v. United States, (113 Fed Cl 181 (2013) aff’d, 795 F.3rd 1338 (Fed, Cir. 2015)), rejected the Tax Court’ holding in Allen. The issue was presented once again in a 2016 Tax Court Decision styled as Finnegan v. Commissioner  (T.C. Memo. 2016-118) where the Court held that in the case of a false or fraudulent return, the income tax may be assessed at any time. This case involved the tax years 1994-2001.

The Court in Finnegan also held that the taxpayers were liable for the 20% accuracy related penalty. The Court held that the taxpayers did not meet their burden of production under I.R.C. Section 7491(c). Quoting from Treas (Reg. Sec. 1.662-3(b) (1) (ii)), the Court stated that the taxpayers failed to “make a reasonable attempt to ascertain the correctness of a deduction, credit or exclusion on a return which would seem too a reasonable prudent person to be too good to be true under the circumstances” (Id. at Pg. 29).

In addition, the Tax Court, in  rejecting the Court of Appeals decision in BASR noted that there was a persuasive dissent filed in BASR and also that a concurring opinion was filed that relied upon I.R.C. Section 6229, an inapplicable provision. Furthermore, the Tax Court pointed out that there is no jurisdiction for the appeal of any decision of the Tax Court to the Court of Appeals. In view of these decisions, it is important to point out that the Tax Court is the only forum, other than IRS Appeals, where a taxpayer can challenge a tax assessment without first paying the deficiency. In BASR, the taxpayer paid the outstanding deficiency and thereafter made a claim for a refund.

Tax return preparers

Individuals who have their Federal and State Income tax returns completed by an outside third party have many alternatives including using a licensed attorney, certified public accountant or enrolled agent, who has the knowledge and experience to ethically prepare tax returns in accordance with the tax laws. All things being equal, the cost to have your tax returns prepared by a licensed professional are commensurate with the fees charged by tax preparation services and other individuals. Given the repeated warnings from the IRS to stay clear of sleazy return preparers and information that is available on the internet, one would assume that consumers who have their returns prepared by outsiders would be somewhat circumspect in the selection process. After all, we review doctors, mechanics and other professionals prior to hiring them, right?

Inexplicably, many individuals spend very little time, if any, scrutinizing those who are tasked with the preparation of their income tax returns despite repeated warnings from the IRS. Nor is much time spent discerning the differences between a licensed professional, who is subject to professional standards, such as Circular 230, State Bar Ethics Rules and State Professional Regulations related to Certified Public Accountants and the impostors who operate illegally in the shadows.

Taxpayers often select a return preparer based upon a recommendation from a friend, relative or co-worker who in many cases has received a sizable tax refund. Unable to contain their joy, they naturally tell their friends, relatives, co-workers and anyone that will listen to them that: “I got a great tax guy.”

In the case of those who are new to the United States many will select a tax preparer that is from their home country and speaks their language. In most cases, the criterion for selecting a tax preparer comes down to the size of the refund.

Fraudulent tax return preparer business model

The fraudulent return preparer business model can be divided into three categories and many variations thereof. The First category constitutes return preparers who prepare fraudulent returns generating refunds to which taxpayers are not entitled. These preparers use fraudulent refunds as a means to build their tax preparation practices. They are also generally new to the game and unaware of the IRS use of analytics as a tool to detect patterns of fraud in the tax preparation industry. These return preparers may or may not charge higher fees than their licensed counterparts and sometimes may take a percentage of the refund, which, by that way, is illegal. This first category of fraudulent return preparer is fabricating returns and large refunds as part of marketing strategy designed to build a robust tax practice.

The second category of fraudulent return preparers is less concerned with building a large practice or longevity and more focused on the immediate financial gain. In many cases, the business is set up naming individuals other than the true owner as the principals for the business. For many scammers this is not their first rodeo. They are savvy enough to recruit preparers who have their own IRS identification numbers so that fraudsters’ identities remain anonymous. This also enables them to blame other preparers when the IRS uncovers the scam.

The fraud is perpetrated in the following manner. The return preparer prepares two tax returns; one that the taxpayer is shown and one that is actually filed with the IRS. In virtually every case, the client’s copy of the return reflects a much smaller refund, if any, than the refund reflected on the actual return filed with the IRS, which the client never sees. In addition, the client usually authorizes the refund to be deposited into an account controlled by the return preparer. Once the return is filed and the refund deposited, the return preparer pockets the difference between the refunds reflected on the client’s copy of the return and the higher refund received.

The third category of unethical return preparer known as the “ghost tax return preparer” has emerged over the years and was the subject of a recent IRS warning. Ghost tax return preparers are return preparers who are paid to prepare income tax returns by the public. Even though the law provides that anyone who is paid to prepare or assist in the preparation of a tax return must have a valid Preparer Tax Identification Number (PTIN), ghost return preparers are able to avoid IRS detection by not signing the tax returns they prepare. Instead, they print the returns and instruct their clients to sign and mail in the return to the IRS. In the case of e-filed returns, they prepare but refuse to digitally sign it as a paid preparer.

Fraudulent return preparers have a total disregard for their clients or the damage done to the public trust. In many cases, taxpayers are left to pick up the pieces. If a taxpayer received a tax refund to which he was not entitled; he will be required to pay the IRS back. The problem is exacerbated in situations where the IRS does not uncover the fraud and the taxpayer has received refunds for multiple tax years.

Taxpayers may first become aware that they received a tax refund to which they were not entitled to when they receive a notice from the IRS adjusting their tax liability. In many cases, the Taxpayer will receive notices for multiple tax years. In other cases, a Taxpayer may first learn of the fraud when they are contacted by either an examiner from the IRS or a special agent from Criminal Investigation, both of whom may be investigating patterns of fraud by a return preparer.

IRS crackdown on fraudulent income tax preparers

The parade of return preparers and tax preparation services that have come under investigation by the Internal Revenue Service and Department of Justice illustrates how pervasive tax preparer fraud is. In 2016, federal prosecutors shut down more than 70 Liberty Tax Franchises for improprieties related to filing fraudulent returns and over inflating refunds. Prior to this time, another 60 locations which were subject of multiple federal lawsuits shut down or were enjoined by a federal court from further operation. In December of 2018, the Department of Justice and Internal Revenue Service launched an investigation into the Franchise, Liberty Tax Company, who is responsible for the sale and operation of its franchise locations throughout the United States. The investigation is ongoing. In addition, civil lawsuits have been filed in an attempt to deal with unethical return preparer practices.

In April of 2017, a class action lawsuit was filed in the United District Court for the Central District of California against Jackson Hewett, Inc. and a number of its franchisees alleging that the Defendants obtained thousands of dollars from the IRS in the name of the Plaintiffs. In order to carry out the fraudulent scheme, the Defendants would provide its customers with a copy of a tax return that differed from the return that was actually filed. The returns that were filed with the IRS artificially reduced the clients’ federal tax liability, resulting in tax refunds being generated.  The clients were unaware of the scam, since the defendants instructed the IRS to deposit the tax refunds into accounts the defendants controlled, all without the clients consent.

Attempts by the IRS and Department of Justice to curb these abuses have resulted in both criminal prosecutions and civil actions designed to enjoin the fraudulent return preparer.

On March 20, 2019 a Charlotte, North Carolina return preparer was sentenced to 24 month in prison for assisting in filing false tax returns. According to the Court documents, the return preparer was able to increase the tax refunds her clients received by claiming false refunds and reported income and expenses for fictitious businesses in order to claim the Earned Income Tax Credit. The fraudulent returns filed by the defendant resulted in a tax loss to the IRS in excess of $500,000.  In a separate prosecution, a Raleigh man was indicted and charged with conspiracy to defraud the United States and 14 counts of aiding and assisting in the preparation of fraudulent returns. Among the illegitimate items claimed as deductions, the defendant claimed false education credits.

In another case, Pennsylvania man was sentenced to 12 months in prison for filing false returns and conspiring to defraud the U.S. Government. The defendant, together with a co-conspirator was convicted of preparing fraudulent tax returns during the 2007 and 2010 tax years by falsely claiming employee business expenses and other nondeductible expenses. The false deductions resulted in claims for inflated refunds. The court noted that the refunds were specifically inflated as a means to grow the defendant’s tax practice.

In March of 2019 a Texas Federal Court permanently enjoined Jhane Broadway, a Dallas Texas return preparer individually and doing business as Jeprofessionalz (aka MaxTaxPros) from preparing federal income tax returns for others. In this particular case, the Government was able to establish that the tax return preparer prepared false returns that understated the tax liabilities of her clients by claiming false, improper or inflated deductions, including fabricated itemized deductions and Schedule C business losses. On the same day, a Federal Court in Beaumont, Texas entered a permanent injunction against another female return preparer, barring her from preparing federal tax returns for others. In entering the order, the Court found that the return preparer made fraudulent claims for the Earned Income Tax Credit, the fuel tax credit and the American Opportunity Credit. In addition, the Court found that the return preparer reported fictitious business and inflated federal income tax withholdings on her client’s tax returns.

Based upon the tax court rulings in Allen and Finnegan, a taxpayer who used a fraudulent return preparer could be in for trouble, particularly if the taxpayer used the same preparer for a number of years, since the statute of limitation for assessments is likely to remain open. Moreover, if you used a fraudulent preparer, there is a good chance you will be subject to the accuracy related penalty. For those sophisticated taxpayers who participated in the fraud you may be subject to the civil fraud penalty and possible criminal prosecution.

The takeaway here is that as a consumer, you need to conduct some due diligence prior to selecting a return preparer. You should never engage an unlicensed individual, since there is little recourse available in the event of a problem. Finally, if you have been caught up in an IRS investigation related to your returns, it is time to contact an experienced and knowledgeable tax lawyer. If ever there was an appropriate term then it is “Caveat Emptor,” which means “Let the Buyer Beware.”




Reporting personal expenses as businesses expenses on a tax return

business tax deductions 2The justification for purchasing that $75,000 Mercedes, Rolex watch or other luxury item, paying for an expensive vacation, making monthly mortgage payments on one’s personal residence, and paying for home improvements then deducting these expenditures as ordinary and necessary business expenses is sometimes based upon  a sense of entitlement.  In other instances, a business owner who claims deductions for personal expenses may feel justified in financially ingratiating himself based upon a mistaken belief that the sole predicate for tax evasion is the under-reporting of gross income. Nevertheless,  a misunderstanding of the tax rules pertaining to reporting of income and expenses in connection with the operation of a trade or a business or the IRS definition of “Income Tax Evasion”  does not justify cheating the U.S. Government.

The IRS is well aware that business owners and those who are self-employed are in a unique position. Unlike a salaried employee who receives a W-2 or a retiree who is issued a Form 1099R in connection with a pension distribution, business owners have the ability to determine their income tax liability. The absence of third party reporting to the IRS makes this possible.  Although the U.S. Tax System is a voluntary system, the IRS is aware that business owners routinely pay personal expenses from their business accounts and thereafter deduct those expenses as if they were associated with the operation of a trade or a business.

While a  criminal tax prosecution of a business owner can include the failure to file returns or the under-reporting of income and the overstatement of business deductions, many business owners assume that tax evasion is only associated with  income side of the ledger. Nothing could be further from the truth. I.R.C. Section 7201 defines income tax evasion, in pertinent part, as the willful attempt “in any manner to evade or defeat any tax imposed by this title or the payment thereof. . . .” Id.

In addition to tax evasion, business owners, who are caught cheating on their business and/or personal tax returns are oftentimes charged with other crimes  such as Conspiracy to Defraud the United States, money laundering, filing a fraudulent tax return, or theft of government funds.

In an effort the promote compliance, the IRS provides qualifying business owners who have routinely deducted their personal expenses or otherwise cheated their returns with an opportunity to come clean. While there is no guarantee of non-prosecution, a business owner who makes a complete and honest disclosure is more likely to avoid jail time than if he waits for the IRS to discover his nefarious conduct. The IRS Voluntary Disclosure Practice is not suited for everyone. Each case must be carefully evaluated based upon the facts, the taxpayer’s history with the IRS and whether other non-tax laws have been violated.  A taxpayer who has otherwise had a clean tax history may be looked upon more favorably than someone, who had prior problems with the IRS or was under criminal investigation for a non-tax crime (i.e. securities fraud).

Detection of fraudulent business deductions by IRS

The IRS detection of fraudulent business deductions can occur in a number of ways:

  • The first and most obvious way is when a business or an individual is selected for examination by the IRS. Detection can also occur in cases where there are unpaid payroll taxes by a business and the IRS is conducting an investigation to determine whether to assess the Trust Fund Penalty against an individual considered to be a “responsible person.”
  • Where a business is owned by multiple parties, the examination of one principal can potentially lead to the examination of other principals in the business. In other cases, a disgruntled employee, who was passed over for a promotion or a bitter ex may serve as the catalyst for an IRS examination of a business owner’s questionable business practices.
  • On occasion, the IRS has been able to detect illegal deductions of personal expenses by a business through an outside tax preparer. In this case, an outside tax preparer involved in the preparation of the business owners’ business and personal income tax returns is identified by the IRS to be engaged in systematic and pervasive pattern of preparing false returns for business and individual taxpayers.
  • Another way in which the IRS may discover illegal business deductions is through court filings, such as a bankruptcy, divorce, business litigation or post judgment liquidity determination.
  • Nondeductible personal expenses are sometimes discovered as a result of a companion investigation related to mortgage or bank fraud. It is not uncommon to find that a business owner has submitted fabricated and unfiled personal and business income tax returns inflating the bottom line for his business as a basis for securing a business or personal loan, while at the same time, either failing to file or filing false returns with the IRS reflecting tax losses.
  • Finally, social media, statements contained on a business website, the use of analytics by the IRS and cyber security breaches have provided the IRS with a treasure trove of evidence that business owners routinely deduct personal expenditures as business expenses.

Criminal cases

The landscape is littered with those who have tried to game the system and paid dearly. The recent criminal charges  filed in Los Angeles against attorney, Michael Avenatti, illustrate the point. Avenatti’s meteoric rise in notoriety was due, in part, to his representation of porn star, Stormy Daniels, his 147 appearances on CNN and MSNBC as well as his announcement of a possible Presidential bid in 2020. Avenatti’s current legal problems originated, in part, from unpaid employment and personal taxes, submitting fabricated business and income tax returns in connection with bank financing and his lavish lifestyle. In fact, Avenatti failed to file personal and business income tax returns for multiple years. Specifically, Avenatti provided a false 2012 business return for his law firm, reflecting approximately $11.5m in gross revenues and net income of $5.8m (Id. at Page 184). In sharp contrast, the actual business return filed with the IRS for 2012 reflected approximately $6.2m in gross revenue and a $2.1m loss. The tax loss was generated, in part, by significant personal expenses that were deducted as ordinary and necessary business expenses on the law firm tax return.

During the past 25 years, I have been tasked by various clients who were a party to business, matrimonial and bankruptcy proceedings to review business and personal tax returns where fraud was suspected. I have also represented dozens of business owners who have been subject to IRS scrutiny with respect to the deduction of personal expenses as business expenses.

In this regard, my office has reviewed hundreds of business and personal income tax returns of litigants and clients who were self-employed. In many cases, I concluded that the business owner engaged in a rampant and systematic pattern of deducting expenditures for personal expenses as ordinary and necessary business expenses. I have also encountered this pervasive practice during the due diligence phase involving the valuation and sale of a business.

Personal expenses deducted as business expenses

Personal expenses that have been deducted as ordinary and necessary business expenses by business owners have included, but are not limited to:

  • A business owner who was engaged in an oil and gas drilling business constructed a garage at his home at a cost of $350,000. The garage which included a two bedroom upstairs apartment, auto lifts and service bays, was used for servicing and storing the business owner’s collection of vintage automobiles and motorcycles. The proceeds to build the garage came from the corporate business account. The cost of the building was recorded on the books of the business, as if the business owned the garage. The business capitalized the cost of the building over the useful life of the building, reflecting depreciation expense on the business income tax returns. In addition all the costs associated with maintenance of the garage as well as the salary of a full time service mechanic were deducted by the business. Finally, the individual’s automobile and motorcycle collection and related costs were all carried on the corporate books and written off, despite the fact that these assets were titled in the owner’s name, individually.
  • A beach front condominium was purchased for $1.2m by a prominent personal injury lawyer. He and his family used the condominium exclusively as a vacation home. The cost of the condominium was depreciated by the business. In addition, the business owner deducted all of the carrying cost including mortgage, taxes, insurance and HOA fees as ordinary and business expenses for his law practice.
  • A South Florida Certified Public Accountant, who was engaged in the business of providing financial expert testimony during court proceedings, used the funds from his practice to finance a long term extramarital affair. The expenditures included regular trips to Las Vegas, and the Bahamas, the purchase of a $65,000 BMW for the business owner’s girlfriend, multiple shopping trips and the purchase of luxury personal items, as well as the expenses associated with the rental of a penthouse apartment on Brickell Avenue in Miami. All of these personal expenditures were deducted by the business as ordinary and necessary business expenses. Subsequently, the business owner’s wife discovered the affair and filed for divorce. Her divorce attorney retained my office to review the husband’s finances. As part of the divorce proceedings, the business owner was required to provide his business and personal tax returns as attachments to his financial affidavit as well as copies of his business and personal bank statements. These documents were relevant in the context of equitable distribution, alimony and child support.
  • In the early nineties, a South Carolina Real Estate Developer and its principals were sued for bank fraud by a New Jersey lender in connection with a failed real estate project in Atlantic City. A judgment in excess of $18m was entered in favor of the bank. As part of its collection efforts, my office was retained to evaluate the potential for recovery against the developer and its principals. In this regard I reviewed the business and personal income tax returns as well as the business financial statements and bank records, which were submitted to the bank as part of the loan approval process. The returns submitted to the bank reflected robust earnings and substantial liquidity, including cash, trading accounts and work in process. Pursuant to a court order, my office secured the actual business returns submitted to the IRS. In sharp contrast to the information submitted to the lender, the business returns filed with the IRS reflected significant operating losses. The losses were created in part due to the inordinate number of personal expenses that were paid from and deducted by the business as ordinary and necessary business expenses. During my examination of the business returns, my office was able to determine that one of the principals had a son at Cornell Medical School and a daughter who was attending college in Lucerne, Switzerland. In addition, the son had full time use of a luxury company car. The tuition and all expenses were being funded by the corporate entity with the costs deducted on the corporate returns as continuing education, professional conferences and other professional fees. In addition, two of the other business principals, who happened to be brothers, paid all of their personal expenses out of the business and had full time use of luxury automobiles leased by the business. Perhaps the most outrageous expenditure involved cosmetic surgery for the brothers’ wives, which were deducted as “consultant’s fees” on the business return.
  • A Brownsville, Texas couple, who jointly owned a lucrative internal medicine practice, routinely deducted annual business losses associated with a cattle breeding business operated from their home. The losses were generated in part based upon personal expenses that were paid from the cattle breeding business, and thereafter, deducted as ordinary and necessary business expenses on Schedule F of the taxpayers’ personal income tax returns. The initial IRS examination resulted in the disallowance of the losses associated with the cattle breeding business and the imposition of the 75% civil fraud penalty for a period of three years. However, the taxpayers’ problems did not end there. At the conclusion of the IRS examination a referral to criminal investigation was made. While the taxpayers were successful in avoiding criminal prosecution, the time spent aware from their medical practice and the costs associated with their choices resulted in their filing personal bankruptcy as well as a bankruptcy for their medical practice. Ultimately, the couple separated and divorced.

The above examples illustrate that business owners, who engage in the illegal practice of deducting personal expenses as a means of under-reporting their federal tax liability, paid the price for their actions. Deducting personal expenditures as business expenses, at least circumstantially, is probative evidence that a business owner willfully intended to cheat the government and can result in substantial civil and criminal penalties as well as the possible loss of freedom. Even in cases where a business owner reports all of his gross receipts on his business or personal return, claiming personal expenses as ordinary and necessary business deductions can result in more than merely the IRS disallowing the deductions.

Today, we are subject to heightened scrutiny due to social media, the legal and illegal exchange of financial information and cyber security threats. In addition, rarely if ever, do business owners engage in this unlawful practice without knowledge by a third party, such as a partner, employee, spouse or girlfriend, who may be able to corroborate the fraud.

In the past, business owners were able to enjoy the benefits of deducting personal expenses as business expenses in order to defeat the assessment and collection of income taxes. That is no longer the case. If you are concerned about your potential exposure, now is the time to consider coming forward. In some, but not all cases, there is a potential to right the ship by making a complete and honest disclosure. Depending upon your circumstances and particular facts of the case, utilizing the IRS Voluntary Disclosure Practice may be an alternative to jail time. While some taxpayers cite the low number of Department of Justice criminal tax prosecutions as justification for rolling the dice, any business owner who has been prosecuted and convicted for tax and other related crimes will tell you that it was not worth it. IRS tax prosecutions can result in financial ruin, loss of earnings, divorce, family break-up, bankruptcy and, in extreme cases, suicide.

In the 25 plus years I have been representing taxpayers, I have yet to find one that has since departed this earth who was able to take it with him. Ultimately, it is about the choices we make in life.



©April 5, 2019


Promises Too Good To Be True

Fraudulent Tax Resolution Co.In 1931, the famous jurist, Benjamin Nathan Cardozo, in discussing fraud stated that: “Fraud is the pretense of knowledge when knowledge there is none.” Ultramares Corp. v. Touche, 255 N.Y. 170, 179, 174 N.E. 441, 444 (1931). This famous quote has withstood the test of time and is particularly relevant to the tax resolution industry and the rampant fraud perpetrated upon the public each day.

Tax resolution or tax settlement firms are firms that advertise that they have tax experts who are capable of negotiating a settlement with the IRS for pennies on the dollar.  In all but limited circumstances, the IRS will insist on full payment. The IRS offers Installment Agreements and Partial Payment Arrangements. In addition, a taxpayer who is in financial dire straits may qualify as being “noncollectable” thereby suspending IRS collection efforts. In rare circumstances, a taxpayer may be able to reduce the amount that he or she has to pay in order to settle up with the IRS.

False claims are repeated on late night TV, the radio, print ads and the internet. The constant barrage of advertising usually includes assertions that tax attorneys, certified public accountants and former IRS employees are on staff and are prepared to lead the charge on your behalf. In reality, most of these charlatans are merely sales people reading from a script designed to separate you and your hard earned money. Make no mistake, these enterprises are “boiler room” operations engaged in the unauthorized practice of law and operate in violation of federal and state consumer protection laws

Every year, I receive inquiries from taxpayers who have been scammed by one of the many tax resolution companies out there. In each case, the taxpayer paid a tax resolution company anywhere from $3,000 to $10,000 and received nothing in return. Consequently, the taxpayer’s tax problem was not resolved.

Offer in Compromise (OIC)

When a tax resolution company claims that they can settle IRS debt for pennies on the dollar, they are referring to what is known as an Offer in Compromise (OIC). Offers are rarely successful for a number of reasons. First, the documentation is substantial. Second, there is a high level of IRS scrutiny when reviewing an Offer. Finally, whether an Offer is accepted is based upon objective criteria including income and expenses, assets and liabilities and the time remaining under the statute of limitations for collections.  The notion that a representative from a tax resolution company is going to march into an IRS and negotiate face to face is nothing less than absurd and conjures up the vision of a personal injury attorney negotiating the settlement of a slip and fall case with an insurance carrier.

Tax liens & Levies

These Companies utilize aggressive sales tactics and typically represent that they can have tax liens removed from public record and also remove levies. While it is possible to have a tax lien withdrawn in certain cases, the IRS will generally not subordinate its claims against a taxpayer. Nevertheless, tax resolution companies boast that they have the ability to magically have liens and levies released.

Many Taxpayers have told me that when they asked for a refund, the Company told them to go pound salt or engaged in dilatory tactics, thus avoiding having to refund the client fees.  The most extreme case I handled involved an offshore disclosure where the Taxpayer paid a Tax Resolution Company over $45,000. The Company did nothing, except obtain the Taxpayer’s transcripts from the IRS exposing the Taxpayer to significantly greater penalties than would have been assessed had the Company taken appropriate action.

Tax resolution companies’ business model

The tax resolution business model compensates most of its employees based upon commission, which is an invitation for misrepresentations to the public, since the goal is to sign as many individuals as possible, irrespective of the facts surrounding a particular tax case. The sales people are well trained to tell anyone who calls that their case can be settled for a fraction of the outstanding tax debt. These assurances are generally made without ever reviewing a document or interviewing the client. Consequently, false advertising and representations are the order of the day.

 Standards of practice

Since most of these scammers are unlicensed they operate outside the State Bar Ethics Rules, State Regulations governing Certified Public Accountants or Circular 230 all of which proscribe standards of practice, ethics and continuing professional education. The Department of the Treasury, Office of Professional Responsibility handles consumer complaints, as they relate to those subject to Circular 230, which includes attorneys, certified public accountants and those enrolled to practice before the IRS.

There has been ongoing debate in terms of who is subject to Circular 230 particularly in light of Loving v. Internal Revenue Service, a 2014 decision. In Loving the U.S. Court of Appeals held that a Department of Treasury rule governing a “tax return preparer,” (which is defined as a person who prepares tax returns for compensation) exceeded IRS rule making authority. The 2011 regulations required a tax return preparer to register with the IRS, pay a fee and pass a qualifying exam.

Karen Hawkins, former Director of the Office of Professional Responsibility, asserted that

“there is no doubt that OPR has jurisdiction over the tax debt resolution industry and those working in it.” OPR Targets Debt Resolution Industry in Campaign Against Sanctionable Practices. Since OPR only reports the names and professional designation of those who are disciplined by the OPR, it is difficult to assess the number of individuals who are engaged in the tax resolution business who have been sanctioned.  In addition, an integral part of tax resolution involves tax return preparation including original and amended tax returns. As such, the OPR’s assertion that they have jurisdiction over the tax resolution industry is suspect.

Legal actions against tax resolution companies

In addition to the OPR, some states have taken legal action against tax resolution companies. In September of 2017 the State Attorney General for the Commonwealth of Virginia filed a lawsuit against Wall & Associates, Inc. (“Wall”) alleging that the Company misrepresented its tax debt settlement services, while at the same time they collected large retainers and monthly payment from their victims. The lawsuit alleges that Wall violated Virginia’s Consumer Protection Act by deceiving consumers by claiming that Wall’s average client settled his or her IRS debt for 10% of the total amount. The complaint further alleges that the Company made false claims concerning the tax related experience, qualifications and abilities of its employees, including characterizing sales people as “tax consultants” or “tax experts” and claiming that Wall’s employees were authorized, qualified or certified to practice before the Internal Revenue Service or state tax authorities when they were not. Id.

In December of 2018, the Attorney General for the State of Minnesota sued Wall alleging that the Company  violated Minnesota’s consumer protection laws by failing to register with the state and collecting large advance payments, while remaining unresponsive to customers.

Other honorable mentions include the television “Tax Lady” Roni Deutch, who was sued in 2010 by the State of California for swindling thousands of consumers who were facing serious IRS problems. Other Companies such as JK Harris and Tax Masters were subject to multiple suits for deceptive practices and elected to file for Bankruptcy.  Needless to say, these firms are no longer in business. In fact it is estimated that some 109 tax resolution companies have gone out of business from 2001-2011.

If you are contemplating retaining a professional in order to resolve your tax debt, you should only hire a duly licensed tax attorney who has the requisite training and experience to assist you in achieving closure with the IRS.  If you do your homework, you can find a tax attorney whose fees are commensurate with the fees charged by the scammers.


By: Anthony N. Verni, Attorney at Law, Certified Public Accountant

© March 29, 2019.

Electronic Filing For Businesses

E File form8300In an effort to promote compliance, on February 19, 2019 the IRS urged businesses that are required to file reports of large cash transactions to take advantage of the electronic filing option that was announced on September 19, 2012 by The Financial Crimes Enforcement Network (FinCEN). Under federal law a person who is engaged in a trade or business must file Form 8300 (Report of Cash Payments Over $10,000 Received in a Trade or Business) within 15 days after a transaction (IRC 6050I; 26 CFR 1.6050I-1(e); 31 USC 5331;  31  CFR 1010.330). Although businesses still have the option of filing Form 8300 on paper, electronic filing has several benefits. One of the benefits is that electronic filing is convenient and cost effective. It is also a secure way of transmitting sensitive financial information. Similarly, by filing Form 8300 electronically, businesses are able to receive immediate acknowledgement of receipt when filing is completed.

The filing requirement for Form 8300 authorized under Internal Revenue Code Section 6050I pre-dates the enactment of Section 5331 under the Bank Secrecy Act (BSA). Section 5331 enacted in 2001 requires non-financial trades or businesses to file Form 8300. In 2001 Treasury Regulations were issued permitting a single Form 8300 to satisfy both the Title 26 and Title 31 filing requirements.

Who is required to file?

Although the term “person” is defined differently under Titles 26 ad 31, the regulations under both titles expressly incorporate the definition of “person” under Section 7701 of the Internal Revenue Code to include an individual, trust, estate, partnership, association, company or corporation.  The term “trade or business” generally includes any activity carried on for the production of income from selling goods or performing services. It is not limited to integrated aggregates of assets, activities, and goodwill that comprise businesses for purposes of certain other provisions of the Internal Revenue Code. Activities of producing or distributing goods or performing services from which gross income is derived do not lose their identity as trades or businesses merely because they are carried on within a larger framework of other activities that may, or may not, be related to the organization’s exempt purposes.

What payments need to be reported?

While the Internal Revenue Code requires reporting cash receipts, Section 5331 of the BSA requires the reporting of receipts of coins or currency. The definition of “cash” under Treasury Regulation 26 CFR 1.6050l-1 (c) (1) is similar to the definition of “currency” under Title 31.

Under the Treasury Regulations the term “cash” includes:

  • Coin and currency of the United States or any other country which circulates and is accepted as money in the country in which it is issued
  • A cashier’s check, bank draft, traveler’s check or money order having a face amount of not more than $10,000 that is (1) received in a designated reporting transaction, or (2) received in any transaction in the which the recipient knows that the instrument is being used in an attempt to avoid the reporting of the transaction

Under Title 31 the term “currency” is defined to include foreign currency and to the extent provided in the regulations proscribed by the Secretary, any monetary instrument with a face amount of not more than $10,000, except a check drawn on the account of the writer in most financial institutions. 31 CFR 1010.330(c)(1).

While there are stiff civil and, in some cases, criminal penalties associated with failing to file Form 8300, a report issued by the Treasury Inspector General for Tax Administration (“TIGTA”) on September 24, 2018 concluded that the BSA Program has had a minimal impact on compliance. Nevertheless, if you are required to file Form 8300 you should be concerned and take action.

The takeaway here is that the IRS has streamlined the filing process for Form 8300 by permitting electronic filing. By doing so, businesses should take advantage of this process in lieu of paper filing, which remains an option. Those who fail to file Form 8300 may find it difficult to explain the reason for non-compliance in light of the electronic filing option. Failing to file Form 8300 may also create risk particularly where a financial institution has filed a Suspicious Activity Report (“SAR”) in connection with a transaction which should have been reported on Form 8300.  In the event an SAR is filed there is a possibility that you will be identified by the IRS and be subject to their scrutiny. The impetus behind requiring the filing of a cash transaction report is to promote compliance and establish money trails and expose hidden criminal trends and patterns that include money laundering and terrorist financing.



Large Tax Refunds: Are they too good to be true?Ghost tax preparers

The IRS has long cautioned taxpayers against using disreputable tax return preparers. In a recent announcement, the IRS warned taxpayers against using “Ghost Preparers” to prepare their tax returns. A Ghost Preparer is a variation of a disreputable tax preparer. These preparers target mostly immigrants who have just arrived in the U.S. and low to moderate wage earners, who often rely upon a referral from a friend or relative who previously received a large tax refund. Unbeknownst to the taxpayers, they are unwittingly committing tax fraud. Taxpayers who are unfamiliar with the U.S. system of taxation may not understand that they are responsible for the content of their tax returns, which they sign under penalty of perjury. Consequently, any false statement contained in a tax return is the ultimate responsibility of the taxpayer and can lead to unintended results including the assessment of additional tax, interest and penalties, as well as a referral to Criminal Investigation of the Internal Revenue Service.

The following discussion reinforces the point that you should stay clear of those who promise unusually large tax refunds and only hire a licensed Attorney, CPA or Enrolled Agent.

Ways Ghost tax return preparers defraud the IRS

Return preparer fraud and inflated refund claims are two of the IRS “Dirty Dozen” tax scams and have been the focus of the Internal Revenue Service for the past several decades. While technological advancements and the use of analytics have enabled the IRS to identify patterns of fraud associated with the fraudulent preparation of federal income tax returns, fraudulent return preparers continue to prey upon innocent taxpayers.

A disreputable tax preparer is a tax return preparer that promises and typically generates large tax refunds on behalf of its clients by fraudulently preparing income tax returns. The scheme involves making up deductions such as employee business expenses, investment advisory expenses, and other miscellaneous Schedule-A deductions.

They also fabricate medical expenses, charitable contributions and other itemized deductions. In certain cases, an unscrupulous return preparer will claim fictitious dependents to take advantage of or increase the refundable portion of the Child Tax Credit. In other instances, these fraudsters will create a fake taxpayer business and include made up income and expenses on Schedule C in order to maximize the Earned Income Credit. In extreme cases, these return preparers will create fictitious W-2’s utilizing phony federal taxes withheld in order to increase the tax refund.

Often times, the fraudulent return preparer will have the client’s tax refund deposited into an account over which the return preparer has control over. The return preparer will then retain a percentage of the refund or a pre-agreed upon flat fee and thereafter remit the balance to the client. In other cases the fraudulent return preparer will give the client a refund based upon the correct tax liability and pocket the difference generated by refund from the fraudulent return.

The traditional fraudulent return business will generally operate in the form of a corporation or limited liability company with a nominee named as the principal in order to mask the identity of the true owner. More often than not the True Owner is on the IRS radar for past transgressions and may be the subject of an injunction or prior criminal prosecution.

In many respects, the business may appear to be legitimate and will include a store front, phone number and website. As part of the scheme, the business will also have a Federal Employer Identification Number, Preparer Tax Identification Number (PTIN) as well as an Electronic Return Originator Number.  Unfortunately, these identification numbers are in the name of someone other than the true principal and, in some cases, have been stolen.

In response to the recent criminal prosecutions of and civil injunctions issued against unethical return preparers, the Ghost Preparer has emerged as the business model of choice for fraudsters. The Ghost Preparer is similar in many respects to the traditional fraudulent return preparer. The Ghost Preparer makes up deductions, claim credits and create fictitious income in order to maximize the client’s tax refund.  However, the Ghost Preparer differs in several respects.

The Law

Under the law, anyone who receives compensation for preparing a tax return, must have a valid (PTIN) and must sign the return. Unlike his unscrupulous colleagues, a Ghost Preparer does not sign the tax return and   omits any information which could provide the IRS with an audit trail. He will generally instruct the client to sign and mail the return to the IRS. In cases where the return is submitted electronically, the Ghost Preparer will submit the return as “self-prepared.”

The Ghost Preparer insists on cash payment for his services. In other cases, he may have the client authorize the IRS directly deposit the client’s tax refund into an account the Ghost Preparer has control over. Once the refund is received, the Ghost Preparer deducts his fee and remits the balance to the client.

Initially, clients are delighted with the huge refund they are receiving and are quick to the relay their good fortune to their friends and relatives. In turn, friends and relatives flock to the Ghost Preparer in hopes of also receiving a large tax refund.  The process is generally repeated for a period of three or four years before the IRS identifies the irregularities and contacts the taxpayer.

What happens next?

Long after the tax refunds have been spent on a home theater system, vacation and down payment on a new automobile, the taxpayer receives a Notice of Adjustment from the IRS advising him that he now owes $48,745.68 in additional tax, penalties and interest for a three year period. After the taxpayer picks himself off the floor, he contacts the Ghost Preparer only to find that the Ghost Preparer has moved on to greener pastures. Further inquiry reveals that the Ghost Preparer used a fictitious name. Since the tax return was deemed “self-prepared” the taxpayer is left holding the bag.

The taxpayer’s problems are often exacerbated where multiple years are involved and the total additional tax, penalties and interest exceeds $50,000.  A permanent lawful resident of the United States who has recently filed for Naturalization may suddenly find their application denied or subject to an indefinite delay in processing. In addition, a taxpayer may find his or her passport has been revoked or the subject of a Notice of Federal Tax Lien. In extreme cases, a taxpayer may also become the subject of an IRS criminal investigation and subject to deportation.

The fraudulent tax return industry has been able to flourish, in part, due to lack of oversight. Practice before the Internal Revenue Service is limited to Attorneys, Certified Public Accountants and Enrolled Agents who are governed by Circular 230. Unfortunately, tax return preparation is not limited to those who are subject to Circular 230. Consequently, anyone can prepare income tax returns including those intended on defrauding the IRS without having to adhere to the professional guidelines.

Financial and emotional cost related to being scammed by a Ghost Preparer, can be devastating and life changing.  If you have been receiving unusually large refunds, it may be advisable to have a professional take a second look to determine if you are the victim of a fraudulent return preparer. There are steps that can be taken to mitigate the impact of filing such returns.

The takeaway here is that you should only hire an Attorney, CPA or enrolled agent to prepare your federal tax return. In most cases, the preparation fees are no more than the fees charged by those not subject to Circular 230.



The Trust Fund Recovery Penalty: Are You At Risk?


Trust fund recovery penalty

The assessment of the § 6672 penalty can be devastating, and in some cases, life changing. Individuals who are subject to the penalty usually state that they were unaware that failure to collect and pay employment taxes to the IRS could result in personal liability for unpaid payroll taxes. The § 6672 penalty, commonly known as the “Trust Fund Recovery Penalty” (“TFRP”) imposes personal liability on individuals who are required to collect, account for, and pay over employment taxes and who willfully fail to collect such tax, or truthfully account for and pay over such tax.The requirements for imposition of the penalty are:

  1.  The penalized person is deemed to be a “responsible person” or someone responsible for having collected and paid the tax in the first place; and
  2. The penalized person must have willfully failed to collect and pay that tax (Godfrey v. United States, 748 F.2d 1568, 1574 (Fed. Cir. 1984)).

The TFRP provides the IRS with an alternate means of collecting unpaid employment taxes, when the employer is unable to do so, by permitting the IRS to pierce the corporate veil and hold those responsible for the employer’s failure to pay the outstanding taxes (White v. United States, 372 F.2d 513, 516, 178 Ct.Cl. 765 (1967)).

The TFRP usually comes into play when a business is experiencing a financial crisis. The disruption to an employer’s cash flow requires making tough decisions by those in charge of deciding which creditors get paid. The list of creditors usually involves the IRS. Employers are required to withhold income and FICA taxes from employee salaries and must also contribute the employer’s share of FICA taxes. The withheld funds are to be placed in trust with the government designated as the beneficiary. Often times employers will utilize trust funds, which are a ready source of cash, in order to satisfy operating expenses with the justification that the business is merely receiving a loan from the government. In more egregious cases, trust funds have been used to continue to pay for the personal expenses and lavish lifestyle of those who are in charge of paying the bills. These individuals are usually, but not always, the corporate officers, directors or managers of a business, but also include others. Suffice it to say, the IRS views the dissipation of trust funds by those in charge as stealing.

The IRS commitment to pursue those who have failed to account and deposit payroll taxes on behalf of their employees is underscored by the remarks made by the Assistant Attorney General at a Federal Bar Association Conference:

“Since January 2015, the Tax Division has sharpened its focus on civil and criminal employment tax enforcement. As most of you know, these cases involve employers who fail to collect, account for, and deposit tax withheld from employee wages. These withholdings represent 70 percent of all revenue collected by the IRS, and as of September 2015, more than$59 billion of tax reported on Forms 941 remained unpaid. These employers are literally stealing money, knowing that their employees will receive full credit for those amounts when they file their returns. The employers gain an unfair advantage over their competitors and the U.S. Treasury is left holding the bag.”

Acting Assistant Attorney General Remarks at Federal Bar Association Tax Law Conference (March 4, 2016). The 26 U.S.C § 6672 (a) provides in part that:

“Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.

The following discussion identifies persons who may be at risk, the common mistakes made during an IRS examination and the assessment process as well as procedural options that may be utilized to contest the assessment of the TRFP.

Who Is Responsible For The Collection, Accounting And Payment Of Payroll Taxes?

The assessment of the TRFP requires that the IRS establish that the person against whom enforcement is sought had a duty to collect, account and pay over employment taxes. The term “person” is defined in 26 U.S.C. § 6671(b) and includes:

“an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee, or member is under a duty to perform the act in respect of which the violation occurs.”

The courts use the term “person” and “responsible person” interchangeably. While the term “person” is statutorily defined, the latter is not. Rather, the term “responsible person” is a creation of the courts (Slodov v United States, 436 U.S. 238 – Supreme Court 1978). In order to be considered a responsible person, the taxpayer must be “under a duty” to collect, truthfully account for, and pay over” any taxes.
The inquiry will always focus on whether the person has “significant control over the enterprise’s
finances” ((Fiataruolo v. United States, 8 F.3d 930, 939 (2d Cir. 1993), (quoting Hochstein v. United States, 900 F.2d 543, 547 (2d Cir. 1990)).

While many of the cases involve officers, directors and shareholders, the courts have expanded who qualifies as a responsible person to include creditors, employees, accountants and attorneys. If the responsible person could have impeded the cash flow of the business to prevent the trust funds from being squandered, then he or she will be held liable (Thomas v. United States, 41 F.3d 1109, 1113 (7th Cir. 1994)). Furthermore, the TFRP can be assessed against more than one person (Thibodeau v. United States 828 F.2d 1499, 1503 (11th Cir. 1987)). Consequently, each person found liable can be held responsible for the full amount of unpaid trust fund taxes.

The IRS considers the following factors when making a determination of whether a person is a responsible person:

  1. Does the person(s) have a duty to perform?
  2. Does the person(s) have the power to direct the act of collecting trust fund taxes?
  3. Does the person(s) have the accountability for and authority to pay trust fund taxes?
  4. Does the person(s) have the authority to determine which creditors will or will not be paid?
  5. Does the person(s) have the status, duty and authority to ensure that the trust fund taxes are paid?
  6. Is the person(s) an officer, director, or shareholder of the corporation?
  7. If the person(s) is an officer, what do the corporate by-laws state regarding the person(s) responsibilities as it relates to financial matters?
  8. Does the person(s) have the ability to sign checks?
  9. Does the person have the authority to hire and fire employees?
  10. Does the person have the authority to sign and file the excise tax or employment tax returns, such as Form 941, Employer’s Quarterly Federal Tax Return?
  11. Does the person control payroll/disbursements?
  12. Does the person control the corporation’s voting stock? and
  13. Does the person(s) make federal tax deposits?

While no one factor is dispositive, check-signing authority is considered strong indicia of responsibility, even in cases where the check signer is instructed by a superior not to pay the taxes (Howard v. United States, 711 F.2d 729, 734 (5th Cir. 1983)). The facts in each case are evaluated by the IRS when making a determination as to responsibility. As the Court of Appeals pointed out in Godfrey:

“. . . the case law makes abundantly clear, a person’s “duty” under § 6672 must be viewed in light of his power to compel or prohibit the allocation of corporate funds. It is a test of substance, not form” (Godfrey 748 F.2d at 1576).

What Constitutes Willfulness Under 26 U.S.C. § 6672?

In addition to establishing that the individual is a “responsible person”, it is necessary that the Government prove that the person acted willfully. The Internal Revenue Manual defines “willfulness” in the context of the TRFP as: “intentional, deliberate, voluntary, and knowing, as distinguished from accidental. Willfulness is the attitude of a responsible person who with free will or choice either intentionally disregards the law or is plainly indifferent to its requirements” (I.R.M. §

Some of the factors the I.R.S will consider in making a determination of whether a responsible person was willful include:

  1.  Whether the responsible person had knowledge of a pattern of noncompliance at the time the delinquencies were accruing.
  2.  Whether the responsible person had received prior IRS notices indicating that employment tax returns have not been filed, or are inaccurate, or that employment taxes have not been paid.
  3.  The actions the responsible party has taken to ensure its Federal employment tax obligations have been met after becoming aware of the tax delinquencies.
  4.  Whether fraud or deception was used to conceal the nonpayment of tax from detection by the responsible person. Id.

The courts have construed “willfulness” under § 6672 to mean the “voluntary, conscious and intentional act” of paying creditors other than the IRS when the company is financially troubled (Phillips v. IRS, 73 F.3d 939, 942 (9th Cir. 1996) (quoting Davis v. United States, 961 F.2d 867, 871 (9th Cir. 1992)); Klotz v. United States, 602 F.2d 920, 923 (9th Cir. 1979)).

While evidence of willfulness requires proof of a voluntary, intentional, and conscious decision not to collect and remit taxes thought to be owed, it does not require proof of a special intent to defraud or deprive the Government of monies withheld on its account (Godfrey 748 F.2d at 1576, citing Scott v. United States, 354 F.2d at 295). The Court of Claims has consistently rejected the view that “a finding of willfulness entails a showing of evil motive, bad purpose, or calculated malevolence” (Id. at 1576). The focus of inquiry is rather “on the deliberate nature of the individual’s election not to pay over the money and the circumstances of that refusal” (Id. at 1576). Consequently, if a person deemed a responsible party discovers that there are unpaid taxes, the responsible person has an immediate duty to use all unencumbered funds to pay taxes (United States v. Kim, 111 F.3d 1351, 1357 (7th Cir. 1997)). Failure to pay the back taxes will result in personal liability on the part of the responsible person.

The Court of Appeals in Godfrey echoed the White definition of willfulness as meaning “a deliberate choice voluntarily, consciously, and intentionally made to pay other creditors instead of paying the Government.” Godfrey 748 F.2d at 1577, citing Scott 372 F.2d at 521. The Court of Appeals citing Feist v. United States, 607 F.2d at 961 also noted that willful conduct may also include a reckless disregard of an “obvious and known risk” that taxes might not be remitted. Finally, the Godfrey Court citing Bauer v.
United States, 543 F.2d at 150; stated: “Mere negligence in failing to ascertain facts regarding a tax delinquency,” however, “is insufficient to constitute willfulness under the code” (Godfrey 748 F.2d at 1577).

Assessment of The Trust Fund Penalty

When an employer falls behind on the payment of its payroll taxes, the IRS will send out a Federal Deposit Tax Alert Notice to the business. If unanswered a Revenue Officer (“RO”) is assigned to the business to investigate the reason the business in non-compliant. The RO will attempt to bring the business into compliance by directing the business to set up a special trust account for the deposit of employment taxes. If the business fails to come into compliance, the next step will be to conduct an investigation of potentially responsible individuals against whom the § 6672 penalty can be assessed. The RO will then attempt to secure the business’s bank records and other records of the business. The RO will also issue Letter 3586 to the potentially responsible individuals setting a meeting (“Interview”). Letter 3586 is accompanied by Notice 784 “Could You Be Personally Liable for Certain Unpaid Federal Taxes.”

At this point the potentially responsible should seek the advice of a tax attorney. Most individuals are ill equipped to handle an IRS Interview and may unwittingly say something that will be used to establish responsible party status. In some cases, an individual’s statements may serve as a basis for a referral to the Criminal Investigation. Remember, the IRS is not there to help you. The RO will use Form 4180
(“Report of Interview With Individuals Relative to Trust Fund Recovery Penalty”) when conducting TFRP Interview. “The Form is intended to be used as a record of a personal interview with a potentially responsible person.” I.R.M. § 1. At the conclusion of the Interview, the individual will be asked to read and sign the Form. If you are not represented, there is a very good chance the IRS will deem you to be a responsible person. More often than not, Form 4180 is used to ensnare a person as a responsible person.

Depending upon the circumstances, and particularly where criminal exposure exists, a good tax attorney may advise the individual not to sign Form 4180. The attorney might also request that the Form be completed outside of the presence of the RO to provide the taxpayers additional time in which measured responses to the questions can be framed. Finally, if the Individual plans on attending the Interview, it is extremely important that he or she be represented by tax counsel.

Following the Interview, the RO will determine whether to proceed with the proposed assessment. If the RO decides to move forward, he or she will generate and send the responsible person a 60 day Preliminary Notice styled as “Letter 1153” together with Form 2751 (“Proposed Assessment of Trust Fund Penalty”) Thereafter, the IRS must wait 60 days after the issuance of Letter 1153 and the Proposed Assessment before issuing a notice and demand for payment. The responsible party has 60 days to respond and 75 days if the letter is addressed out of the country. In response to the Notice the Taxpayer has the following options:

  1. Panic and take no action (Can be fatal to your chances).
  2. The individual can sign Form 2751 in which he agrees with the assessment.
  3. File a protest letter and then proceed to IRS Appeals.
  4. Request mediation.
  5. If the individual disagrees with the decision from Appeals, he or she has a right to judicial review.

There are also alternatives with respect to post assessment including Offers in Compromise, Installment Agreement, Partial Pay Installment Agreements and Currently Not Collectible that may serve as a basis for minimizing the financial impact associated with being subject the assessment of the TFRP.


If you are involved in a business that is delinquent on its payroll taxes, there is a high likelihood that you will be investigated by the IRS. Those individuals responsible for management of the business are particularly vulnerable to the TFRP should the business ultimately fail to pay its employment taxes.
When looking into the issue of responsibility, the IRS will most always pick the low hanging fruit. Since the IRS considers failure to pay your employment taxes stealing, the necessity of legal representation cannot be understated. If the IRS is currently conducting an investigation into the employment taxes of your business, it is advisable to get ahead of the curve particularly if there is a risk of a referral to Criminal Investigation of the IRS. A potentially responsible person should never attend an Interview without the assistance and advice of counsel. Many individuals I have counseled simply waited too long. You cannot hide your head in the sand!

By Anthony N. Verni.