Most tax preparers are ethical and help ensure their clients file timely and accurate tax returns, but a small percentage abuse their position of trust. They may, for example, engage in fraudulent activities that harm taxpayers.
The IRS has warned about tax “promoters,” which the agency defines as entities that “undermine voluntary compliance by marketing improper methods to reduce the amount of taxes legally owed.” Such promoters can expose businesses and individuals to financial and legal risk.
Wide Variety of Schemes
Some shady tax preparers and promoters encourage clients to submit fraudulent returns and engage in aggressive tax-avoidance schemes. Some tax schemes that you should be aware of include:
Employee Retention Credit (ERC) claims. In September, the IRS announced an immediate moratorium through at least the end of 2023 on processing new ERC claims due to scams. The ERC is a refundable tax credit designed for businesses that continued paying employees during the COVID-19 pandemic. It was also available to businesses that experienced a significant decline in gross receipts. Many taxpayers fell victim to promoters who told them they could qualify for the ERC and now face IRS enforcement actions. So the tax agency has announced a special withdrawal process for those that filed potentially inaccurate ERC claims.
Fuel tax credit claims. The fuel tax credit generally supports off-highway and farming fuel use and encourages businesses to choose renewable resources. To inflate returns, dishonest tax preparers and promoters might encourage taxpayers to claim the credit, reduce their taxable income and receive an inflated refund. Taxpayers told by preparers to claim a credit that isn’t applicable should just say “no.”
Compromise mills. When taxpayers can’t pay their tax debt, they’re allowed to submit an “Offer in Compromise,” to the IRS. This is a request to settle the outstanding amount for less than the stated amount due. Some tax promoters market their ability to secure Offers in Compromise — and charge high fees to “determine” whether a taxpayer qualifies for an offer. Paying such fees to a third party is unnecessary because the IRS provides a free online tool (irs.gov, search for “Offer in Compromise”) that any taxpayer can use to determine eligibility. However, the IRS charges a $205 application fee.
Charitable Remainder Annuity Trust fraud. Charitable Remainder Annuity Trusts (CRATs) enable individuals to donate assets to charity as well as pay income to at least one living beneficiary. After 20 years of payments, or when a beneficiary dies, leftover funds are passed to a qualified charity. Some promoters try to convince taxpayers to establish a CRAT to avoid capital gains on property allocated to the trust account. But incorrect usage of CRATs can expose taxpayers to IRS scrutiny and legal trouble.
In addition to watching out for these schemes, taxpayers should be wary if a preparer charges a fee contingent on the size of a refund. After all, this fee structure provides the preparer with an incentive to artificially inflate tax credits and deductions and underreport income. Tax preparers who don’t want to sign a return or appear to sign with someone else’s information also merit concern.
Choose the Right Advisor
Some preparers and promoters use the tax code’s complexity to perpetrate scams and charge exaggerated fees. If a tax preparer produces a return that generates a significant refund, includes questionable credits or is overly complex and difficult to understand, clients should question it — and the preparer. The existence of these dishonest tax preparers makes it that much more important to engage honest and experienced ones.