2016’s Dirty Dozen Tax Scams

Every year, the IRS releases a list of what it calls the worst tax scams of the year. Beginning Feb. 1 and ending on Feb. 17, the IRS issued a news release each day highlighting a scam. These “dirty dozen” scams can be encountered at any time of year, but the IRS reports that they peak during tax season.

1. Identity theft

According to the IRS, the No. 1 scam this year is tax-related identity theft, which the IRS defines as when someone uses a taxpayer’s stolen Social Security number to file a tax return claiming a fraudulent refund (IR-2016-12). Although the IRS has introduced more effective screening and detection systems that are designed to detect identity theft before it issues a refund, the Service admitted that it is still a major problem. To fight the problem more effectively, over the past year, the IRS has participated in a Security Summit initiative in partnership with states and the tax-preparation industry to try to improve security for taxpayers. The participants share information of fraudulent schemes that have been detected this filing season to provide increased protection. More than 20 data elements are used, unknown to taxpayers, to verify tax return information.

In addition, the IRS urged taxpayers to protect their own information so it is harder for thieves to breach the IRS’s security systems. These efforts at taxpayer education include the Taxes. Security. Together. campaign to help taxpayers avoid the data breaches that make it easier for them to become victims.

2. Phone scams

The second scam this year is phone scams, in which criminals call, impersonating the IRS (IR-2016-14). Many times, they disguise the number they are calling from so it appears to be the IRS or another agency calling, and they may threaten arrest, deportation, or license revocation. The scammers sometimes use IRS titles and fake badge numbers to appear legitimate and use the victim’s name, address, and other personal information, which makes the call sound official.

To protect themselves, the IRS says, taxpayers should be aware the IRS will never call to demand immediate payment, call about taxes owed without first having mailed a bill, call to demand payment without the opportunity to question or appeal, require use of a specific payment method, such as a prepaid debit card or wire transfer, ask for credit or debit card numbers over the phone, or threaten to bring in local police or other law enforcement to arrest a taxpayer for not paying.

3. Phishing

Another scam that continues to appear high on the list is “phishing,” in which taxpayers get unsolicited emails seeking financial or personal information. A taxpayer who receives a suspicious email should send it to phishing@irs.gov. “The IRS won’t send you an email about a bill or refund out of the blue,” said IRS Commissioner John Koskinen (IR-2016-15). Scam emails can also infect a computer with malware without the taxpayer’s knowing it, often enabling the criminals to access sensitive files or track keyboard strokes, exposing login information.

4. Return preparer fraud

Return preparer fraud involves “dishonest preparers who set up shop each filing season to perpetrate refund fraud, identity theft and other scams that hurt taxpayers” (IR-2016-16). The IRS warned taxpayers to be wary of “unscrupulous preparers who prey on unsuspecting taxpayers with outlandish promises of overly large refunds,” which is why the IRS says this scam makes it onto the list every year.

“Choose your tax return preparer carefully because you entrust them with your private financial information that needs to be protected,” Koskinen said. The IRS provides a number of tips for taxpayers to choose competent preparers, including checking what the preparer’s credentials are, making sure the preparer will be available after filing season, and ensuring that the taxpayer’s refund is deposited into the taxpayer’s account, not the preparer’s. The IRS recommends avoiding preparers who base their fees on a percentage of the refund or promise larger refunds than other preparers.

5. Hiding money or income offshore

Hiding money or income offshore, which is a major focus of IRS enforcement efforts, is the next tax scam the IRS addressed (IR-2016-17). “Our continued enforcement actions should discourage anyone from trying to illegally hide money and income offshore,” Koskinen said. As the IRS explained, there are legitimate reasons that taxpayers have foreign accounts, but these accounts trigger reporting requirements. The IRS offers a number of programs, including the Offshore Voluntary Disclosure Program, for taxpayers to come into compliance with these requirements. The IRS noted that the heightened reporting required under the Foreign Account Tax Compliance Act, P.L. 111-147, which went into effect in 2015, makes it even harder for taxpayers to conceal assets overseas.

6. Inflated refund claims

Another scam that is closely related to return preparer fraud is inflated refund claims, in which unscrupulous preparers set up shop to lure unsuspecting taxpayers (IR-2016-18). “Be wary of tax preparers that tout outlandish refunds based on federal benefits or tax credits you’ve never heard of or weren’t eligible to claim in the past,” Koskinen said.

Inflated refund claims often involve claims for tax credits that taxpayers are not entitled to, such as education credits, the earned income tax credit (EITC), or the American opportunity tax credit. The IRS reminds taxpayers that they are responsible for what is on their return, even if someone else prepares it, and they can be assessed penalties and interest as well as additional tax.

7. Fake charities

Next on the list is fake charities. Taxpayers are cautioned to check the Exempt Organizations Select Check on the IRS’s website to determine whether a charity is bona fide and qualifies for deductible contributions (IR-2016-20). Legitimate charities should be willing to give donors their employer identification numbers, which can then be used to check whether the charities are qualified on the IRS website. Fake charities often use names similar to well-known organizations and may set up fake websites. They also can be used for identity theft purposes. When large-scale natural disasters occur, these fraudulent organizations tend to increase, the IRS reports, and it warns that taxpayers should not make any contributions without checking first.

8. Falsely padding deductions

No. 8 on the list is falsely padding deductions (IR-2016-21), which consists of deceitfully inflating deductions or expenses on the return to pay less tax or receive a bigger refund. This item is new to the dirty dozen list this year. The IRS warns taxpayers that they should “think twice” before overstating their charitable contribution expenses or padding their business expenses, as well as avoid claiming credits they are not entitled to, such as the EITC and the child tax credit. Taxpayers who do this may be subject to substantial penalties and may, in some cases, face criminal prosecution.

9. Excessive claims for business credits

The next item on the list, excessive claims for business credits, expands on last year’s “excessive claims for fuel credits” (IR-2016-22). This scam involves two specific false claims for credits: fraudulent claims for refunds of fuel excise tax and bogus claims for the research tax credit. The IRS says that its refund fraud filters are stopping a number of fraudulent fuel excise tax refunds this year.

10. Falsifying income to claim tax credits

Tenth on the list is falsifying income to claim tax credits (IR-2016-23). This usually involves falsely claiming higher earned income to qualify for the EITC, which is a refundable credit. Unscrupulous preparers often do this to get taxpayers larger refunds than they are entitled to. Even when taxpayers are unaware of these false claims, they are, as the IRS reminds again, responsible for what is on their tax return. They can be subject to significant penalties, interest, and possibly prosecution.

11. Abusive tax shelters

No. 11 is participating in abusive tax shelters (IR-2016-25). Abusive tax shelters are defined as schemes using multiple flowthrough entities to evade taxes. They often use limited liability companies, limited liability partnerships, international business companies, foreign financial accounts, offshore credit or debit cards, and multilayer transactions to conceal who owns the income or assets.

The IRS also mentions the misuse of trusts and captive insurance companies among the types of transactions taxpayers should avoid. As in some of the other scams, the IRS warns that participating in these transactions can result in significant penalties and interest and “possible criminal prosecution.” According to Koskinen, “These schemes can end up costing taxpayers more in back taxes, penalties, and interest than they saved in the first place.”

12. Frivolous tax arguments

The final “scam” is frivolous tax arguments, which the IRS warns taxpayers not to be talked into (IR-2016-27). Announcing the release today of the 2016 version of its webpage, “The Truth About Frivolous Tax Arguments,” the IRS explained how the courts and the IRS have treated these arguments, which involve claims such as that the only employees subject to income tax are employees of the federal government or that only foreign income is taxable. “Taxpayers should avoid unscrupulous promoters of false tax-avoidance arguments because taxpayers end up paying what they owe plus potential penalties and interest mandated by law,” Koskinen said. The IRS reminded taxpayers that they would automatically be subject to the $5,000 penalty for frivolous tax positions.

—Sally P. Schreiber (sschreiber@aicpa.org) is a Tax Adviser senior editor.