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Halloween Special: Third Circuit Case Affirms Preparer’s Conviction For Aiding in Preparing False Tax Returns

Posted on Nov. 2, 2015

It comes as no surprise that IRS and DOJ pursue criminal charges against abusive preparers, especially those who view the tax system the same way that trick or treaters approach unwatched candy bowls left on the porch. We discussed one such case a month or so ago when we looked at the issue of whether it was appropriate to seek restitution from a convicted preparer. Bogus refundable credits, fake or inflated charitable deductions, Schedule C expenses and withholdings are the tricks of the trade for illicit preparers. Last month’s Third Circuit case of US v James is typical, with the court upholding the conviction of a Philadelphia-area preparer on 26 counts of preparing materially false tax returns or related documents under 26 U.S.C. § 7206(2). In US v James the preparer signed over 2000 returns in 2008 and 2009, with the DOJ’s charges stemming from 26 of those returns with bogus First Time Homebuyer’s credits and excessive meal and business travel deductions.

Friday James had previously worked at national chains before forging his own path and hanging his shingle as Frika Tax Services. His defense at trial focused largely on ignorance of the law. For example, when placing FTHBC on returns for people who never owned a house, Friday argued that he believed that those who claimed and received the credit who wound up not buying a house could repay Uncle Sam in a later year. While ignorance of the law can negate the willfulness needed to convict in offenses such as preparing materially false returns, in Friday’s case the jury found that the inferences from the evidence cut against his I didn’t understand the law defense:

Although it is theoretically possible that James misunderstood the operation of the Homebuyer Credit, other inferences from the evidence are plausible (and that carries the day, as on appeal of a conviction we review the evidence in the light most favorable to the Government). Form 5405, which was attached to the tax returns that claimed the credit, requires the taxpayer (or preparer) to list the “[a]ddress of home qualifying for the credit” and the “[d]ate acquired” and states in the instructions that people may claim the credit only if they “purchased [their] main home located in the United States after April 8, 2008, and before December 1, 2009.”

Testimony from witnesses whose returns Friday prepared did not help:

One witness testified that James told them they could claim the credit simply by entering any address in the field for the qualifying home, (testimony of Barry Thompson) (“[H]e told me to make up an address.”), another that the date listed was false (because she never acquired the house), (Rebecca Varney). Others testified that James claimed the “First-Time Homebuyer Credit” for them despite their already owning a home.[citations to record omitted]

Friday James received and the Third Circuit affirmed a 36-month conviction, which, as shown below is above the average for sentences handed down to convicted preparers. IRS Criminal investigation maintains a web page with information relating to its Abusive Return Preparer Program, including some statistics showing investigations and prosecutions, with the table below from that site:

FY 2015 FY 2014 FY 2013
Investigations Initiated 266 305 309
Prosecution Recommendations 238 261 281
Indictments/Informations 224 230 233
Sentenced 204 183 186
Incarceration Rate* 80.4% 86.3% 78.0%
Average Months to Serve 27 28 27

Given the hundreds of thousands of preparers who are at least visible in the system through PTIN registration, the relatively high error rates on issues such as the reporting of small business income and some refundable credits, and the strong sense that some preparers play an active role in tax fraud, the numbers of prosecutions seem to me to be in absolute terms pretty low but in relative terms pretty high, accounting for over 10% of prosecutions in the tax area.

More on Halloween and Tax Preparers: Masking Identity Leads to Mischief

While the threat of prosecution is a real one for preparers, and unquestionably in the last decade or so IRS has dedicated more resources to going after the really crooked ones, criminal law plays a relatively small but important part in the tax system. Interestingly, in my days of running a tax clinic lower-income taxpayers had strong fears that their tax problems could lead to criminal charges, even if the reality on the ground is that only the bigger fish get fried. I suspect, however, that if IRS and DOJ really wanted to make a dent in the error rate that stems from affirmative misconduct rather than honest mistakes it would have to go after illicit preparers who unlike Mr. Friday James do not dare sign tax returns. Consider the social science experiment I discussed a couple of years ago in one of our early posts on Procedurally Taxing where researchers peg invisibility to a greater propensity for doing the wrong thing:

Consider the following widely known social scientist experiment that is nicely summarized in an NPR story (the study is from a 1976 article in the Journal of Personality and Social Psychology by Researchers Diener, Fraser, Beaman, & Kelem, called Effects of Deindividuation Variables on Stealing Among Halloween Trick-or-Treaters). Researchers selected a group of children to visit staged homes on Halloween. The experiment involved children, dressed in costumes hiding their identity. The children went trick or treating at 27 different houses, and were greeted by different adults who showed them to a room containing two bowls, one filled with candy, and the other coins. The adults, who were in on the experiment, if asked about the money, told the kids that coins were for a charity and were going to be picked up soon. The adult then left the room. What happened next was that the kids stole. They stole candy. They stole money. They sometimes overturned the bowls and took the whole stash. It didn’t matter if an adult asked a child to act as an anonymous leader to ensure that the kids only took their fair share; the group still robbed the candy and coin bowls. The results changed dramatically if the adults knew the identity of the group of children or even the leader charged to ensure ethical behavior. When anonymity was breached, people stole less. A lot less.

As I said in my original post, building a tax system with greater visibility and accountability is the strongest way to ensure fewer dishonest taxpayers and preparers. It is the reason why information reporting often drives compliance, and the enhanced accountability that comes from oversight over unenrolled preparers is the reason why I believe IRS is justified from a policy perspective in seeking greater regulation of unlicensed preparers.

Despite the promise of oversight and its enhancing greater visibility, prosecuting bad apple preparers is an important after the fact way of ensuring that those who abuse the system know that their actions have consequences beyond bringing in fees for raiding the fisc. Finding the bad preparers is hard resource-intensive work. Ferreting out those preparers who do not even sign returns is even more challenging.

What of the taxpayers themselves who surely have culpability in signing and filing returns that are too good to be true? IRS efforts to track those taxpayers have contributed to its desire to use third-party fraud as a way to keep the statute of limitations on assessment open. That is a civil enforcement approach to the issue, as there are almost no prosecutions for tax crimes directed at lower or more moderate-income taxpayers. I am not suggesting that there should be (and sentencing would be minimal for low dollar cases) but it is interesting how in other areas such as food stamps and TANF prosecution is part of the toolkit prosecutors use to keep a lid on fraud.

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