The IRS’ ‘Dirty Dozen’ part 2: The worst tax scams

The Dirty Dozen for 2013

Last week we gave you the first six scams of the IRS's "Dirty Dozen." This week's column presents the second half of 2013's "Dirty Dozen". Don't fall prey to these schemes.

7. False/Inflated Income and Expenses

Including income that was never earned, either as wages or as self-employment income in order to maximize refundable credits, is a popular scam. Claiming income on your tax return that you did not earn or expenses you did not pay in order to secure larger refundable credits such as the Earned Income Tax Credit (EITC) could result in repaying the erroneous refunds, including interest and penalties and, in some cases, even prosecution.

To many of us it is counter-intuitive to think that if you have more income, you get a bigger refund - but with some refundable credits that is exactly the case. Unlike most deductions and credits, the EITC is refundable -- taxpayers can get it even if they owe no tax.

Because it is refundable, the Earned Income Tax Credit is a magnet for tax fraud. Edwin Rubenstein, president of ESR Research issued a report in 2009 documenting abuse of the EITC. Rubinstein found that, "Year after year about one-third of all EITC returns are based on illegal multiple returns, phony Social Security numbers or claims of nonexistent children or spouses."

The General Accounting Office has reported that the IRS estimates between 27 and 32 percent of EITC dollars are paid erroneously.

8. False Form 1099 Refund Claims

In some cases, individuals have made refund claims based on the bogus theory that the federal government maintains secret accounts for U.S. citizens and that taxpayers can gain access to the accounts by issuing 1099-OID forms to the IRS. In this ongoing scam, the perpetrator files a fake information return, such as a Form 1099 Original Issue Discount (OID), to justify a false refund claim on a corresponding tax return.

On June 22, 2012, Ronald L. Brekke, of Orange County, California, was sentenced to 144 months in prison, three years of supervised release and ordered to pay $6,206,998 in restitution. Brekke promoted a tax fraud scheme known as "1099 OID" fraud. Promoters of this scheme claim that the U.S. Treasury will pay out tax refunds equal to the value of a person's personal debt. Brekke assisted nearly 1,000 people in three countries to claim over $763 million in fraudulent tax refunds.

9. Frivolous Arguments

Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish claims to avoid paying the taxes they owe. Just a few examples of bogus arguments are: wages received for personal services are not income, the federal income tax is unconstitutional because the Sixteenth Amendment wasn't properly ratified, and the IRS is not an agency of the United States.

10. Falsely Claiming Zero Wages

Filing a phony information return is an illegal way to lower the amount of taxes an individual owes. Typically, a Form 4852 (Substitute Form W-2) or a "corrected" Form 1099 is used as a way to improperly reduce taxable income to zero. The taxpayer may also submit a statement rebutting wages and taxes reported by a payer to the IRS.

11. Disguised Corporate Ownership

Third parties are improperly used to request employer identification numbers and form corporations that obscure the true ownership of the business.

These entities can be used to under-report income, claim fictitious deductions, avoid filing tax returns, participate in listed transactions and facilitate money laundering and financial crimes. The IRS is working with state authorities to identify these entities and bring the owners into compliance with the law.

12. Misuse of Trusts

For years, unscrupulous promoters have urged taxpayers to transfer assets into trusts. While there are legitimate uses of trusts in tax and estate planning, some highly questionable transactions promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. Such trusts rarely deliver the tax benefits promised and are used primarily as a means of avoiding income tax liability and hiding assets from creditors, including the IRS.