What Exactly IS Tax Fraud?

What’s in a word? Tax terms can be confusing, but terms related to tax crimes must be clear when allegations are on the line.

"Tax fraud" is an everyday term that usually means someone is up to something with their taxes, or the company payroll taxes, or tax evasion through offshore tax accounts. People use it as a general term to refer to doing something shady with your own or someone else’s taxes.

To the Internal Revenue Service (IRS), “tax fraud” has a very specific meaning, which is worth understanding if, in fact, you are doing something shady with your own, or someone else’s taxes. Consider these specifics:

• Fraud “is deception by misrepresentation of material facts, or silence when good faith requires expression, which results in material damage to one who relies on it and has the right to rely on it. Simply stated, it is obtaining something of value from someone else through deceit.”
• Tax fraud “is often defined as an intentional wrongdoing on the part of a taxpayer, with the specific purpose of evading a tax known or believed to be owing.” 

Tax fraud is more than just a mistake; it is a willful attempt to get out of tax obligations. The key to a tax fraud claim is that the person accused of the crime willfully or intentionally committed acts to avoid paying taxes. Examples include failing to file an income tax return or preparing a false return.

Although the penalty for a simple mistake may seem severe, those that apply in cases of a tax fraud conviction are even more severe. For example, a failure to file can come with up to one year imprisonment and a monetary penalty of $100,000, while an attempt to evade taxes can come with up to five years imprisonment and a $250,000 fine. 

How Does the IRS Determine Tax Fraud?

The IRS defines tax fraud as "the willful and material submission of false statements or false documents in connection with an application and/or return." To make this determination, investigators will look for any indicators of fraud such as, but not limited to:

• Underreporting income
• Using a false Social Security number
• Falsifying documents
• Intentionally failing to pay taxes

If these common indicators are absent, the IRS typically assumes that an unintentional mistake has occurred due to negligence. Though this typically does not lead to criminal charges for tax fraud, mistakes with your taxes can lead to an accuracy-related penalty that equates to 20 percent of the underpayment. 

Anyone could be caught off guard when they are assessed this penalty, which is why it's important to make sure all tax information is accurate and truthful before submitting it to the IRS. It's also important to remember your right to an attorney as well, especially if you believe a tax fraud charge has been levied against you in error.

Understanding the Difference Between Tax Evasion and Tax Avoidance

You want to avoid paying more tax than you need to—but—you do not want to commit tax fraud. It's important to understand where the line is drawn between these two approaches. What is the difference between tax evasion and tax avoidance?

Federal and state taxes keep this country running. From federal withholding to state and federal income taxes, the U.S. Department of Treasury depends on the voluntary compliance of U.S. persons to pay their share to keep the lights on and important governmental programs and services on board. But as any good tax lawyer knows, it pays to consider strategies to legitimately reduce your tax liability. Consider these definitions from the Internal Revenue Service:

• What is criminal tax evasion? Tax evasion occurs when a taxpayer intentionally underpays or outright fails to pay a tax liability.
• What is tax avoidance? Tax avoidance measures are those taken by taxpayers that work to reduce tax liability and maximize after-tax income.

The IRS notes that the income tax system in the U.S. is based on voluntary compliance. It is a volunteer action right up to the point that you do not volunteer to pay the taxes that are required of you. Failure to file your income tax return or filing a fraudulent tax return could earn you a criminal tax charge at some point.

We talk a lot about types of tax fraud, how it occurs, and the consequences of conviction in a criminal tax matter brought by the IRS. As noted, tax fraud is one way that people evade their taxes. Before they took a criminal turn, the idea was to avoid paying taxes altogether.

Avoiding your tax burden is perfectly legal. In the U.S., there are a number of ways that assets can be held, taxes can be paid, and deductions can be used to reduce the amount of tax you pay on a quarterly or annual basis. Deferred tax plans are often used around retirement planning to shield savings and maximize wealth.

Strategies for Lowering Your Tax Bill

Most people are interested in legally lowering their tax bills. Depending on your portfolio, there are many perfectly legal tax avoidance strategies to consider, including charitable donations, tax deductions, and tax credits. Consider different types of investments, capital gains planning, estate planning, and transferring wealth through gifts, among other strategies. The key to tax avoidance is knowing what is advisable for you and what is legal.

There are grey areas, too, like offshore tax havens. While many offshore tax jurisdictions are legal, how your assets are structured and held can make the difference between tax fraud and tax avoidance.

And then there are some clear-cut activities that fall into the category of tax evasion. Inventing deductions, knowingly misstating your income and its sources, keeping two sets of books, engaging in complicated and tax-abusive corporate transactions, and pilfering employment taxes are just the tip of the iceberg when it comes to tax evasion.

Tax avoidance allows you to plan and shape your tax liability in a way that minimizes taxes. Tax evasion is an activity intended to evade and avoid the payment of taxes due.

How Tax Fraud is Reported to the IRS

While this guide focuses on helping you understand tax fraud, let’s briefly touch on how tax fraud is reported to the IRS—so you can better understand the full scope of the system.

Of course, the IRS encourages taxpayers to report tax fraud and abusive tax schemes. Taxpayers of all socioeconomic backgrounds fall victim to tax fraud—especially those with high wealth. On the flip side, business owners and high-asset individuals may also be tempted to take liberties with their own returns and regulatory obligations. Awareness of the ways and means by which the IRS learns of suspected tax fraud can help if you are a victim of a tax crime, or if you are involved in one.

It is important to understand that in addition to IRS audits and criminal tax investigations, the IRS solicits reports from the public about whether they are a victim of a tax scam or if they know someone who is profiting from a potential tax crime. 

Using an Informational Referral, people can report a multitude of tax crimes, just some of which include:

• Failure to report income figures accurately, including income from illegal drug sales or gambling.
• Tax crimes involving organized crimes, corruption schemes, and abusive tax avoidance schemes.
• Failure to file returns, filing false documents, scams involving filing multiple returns, or those involving identity theft.
• Taxpayers taking fake deductions, exemptions, or taking advantage of tax credits.

 You can also tick the box “Other” on the Information Referral to report activities you believe to be illegal. The IRS reviews each submission for potential follow-up, like an audit or a tax investigation. You can also report other persons and entities engaged in illegal tax behavior, including tax preparers, marketers of tax schemes, and tax-exempt organizations that are coloring outside of the lines.

Indicators of Tax Fraud

If you receive a letter from the IRS notifying you of an audit, you may not be too worried. If you did a good job on your taxes and have a pretty good idea of your reporting, there is not an enormous reason to sweat. If you know there is potential evidence of tax fraud in your returns, it is a different story altogether.

We talked earlier about eggshell audits. These are audits where you know you have something to lose if the agent or auditor does a dot-to-dot between what you have reported and what was left off the table. If an auditor or an algorithm reviews your return, math or other errors are noted.  Also of interest are any “indicators of tax fraud.” These would be overt or covert behaviors that may, intentionally or not, skew the overall results of a return.

To the IRS, an indicator of fraud is also called a “badge of fraud.” These behaviors may be an action—a deliberate misstatement, or omission—or a less obvious lack of action. While these behaviors may appear to form a pattern of fraud or a tax crime, these are only “indicators” and not outright proof.  Some behaviors that are considered potential indicators of fraud include:

• Understatement of an actual tax liability
• Statements or actions that make an outcome appear different than it would be if accurate
• A potential indicator of fraud can be made by a taxpayer, tax preparer, or other entity

In practice, indicators of fraud may look like: 

• Problems with your tax returns: Failure to file tax returns, underreporting income, or overstating expenses can be associated with tax fraud. Adding completely fraudulent deductions is fast tip-off.
• Record keeping: Inability to provide clear, accurate, complete records is not an indicator of fraud, but the lack of records can be a red flag. Lack of documentation or deposit records is a problem, and so is an inability to prove sources of income. Efforts to unravel missing accounting records sometimes leads to a second, and problematic, set of books.
• Opaque accounting: Loans, suspicious account ownership, missing documents, complex but poorly documented ownership structures, and anything that smacks of concealment can lead an auditor to question your motives and business practices.

If you made a mistake on a return and receive a letter from the IRS concerning an audit, carefully review your documents and follow up with the IRS, unless there is a significant vulnerability. If your return or documents bear some resemblance to a badge of fraud—speak with a good criminal tax attorney first.

Terms of Art When Proving Fraud

Involvement in tax fraud can lead to serious financial penalties and prison. The IRS uses specific terms to discuss and investigate fraud which are worth understanding from a compliance and litigation perspective.

Just as an IRS auditor or agent understands indicators of fraud and the meaning of willfulness, the agency uses terms of the trade to discuss evidence and evidence types needed for conviction. Understanding how the agency uses legal terms can give you insight during an audit or tax investigation. Consider the following:

1. Evidence: 

One of the most important things a taxpayer should know is the type of evidence used and needed by the IRS. While we all generally understand evidence as material, data, or testimony that can serve to make a point or convict a defendant, the IRS considers whether evidence is direct or circumstantial. Of highest value is direct evidence, which can directly prove an allegation. This could be a fact witness involved in a fraud. Circumstantial evidence is that upon which something can be inferred, rather than directly proven. That said, an inference is a reasonable, logical conclusion that can be drawn from the facts of a matter

2. Presumption of Law: 

This concept is that the rule of law will generally be inferred by a jury or judge unless that inference can be proven otherwise or disputed.

3. Burden of Proof: 

The distinctions between these terms can make the difference in a trial for tax fraud or the determination of an auditor to recommend that an audit be transitioned from a civil to criminal tax investigation.

Willful Failure to Pay Income Taxes

The Internal Revenue Service claims that about 1 out of every 6 taxpayers fails in one way or another to comply with the tax code. If the federal agency’s estimate is accurate, you might reasonably expect the number of tax-related arrests to be significantly higher than they are now.

The reason why not every sixth person you know is facing criminal charges is that the IRS distinguishes between income tax fraud and negligence.

Tax fraud is a deliberate attempt to evade taxes or to defraud the IRS. Tax fraud takes place when a person or company willfully does one of the following:

• Intentionally fails to pay taxes owed
• Willfully fails to file a federal income tax return
• Fails to report all income
• Makes false or fraudulent claims

People Make Mistakes

It goes without saying that the tax codes are long and dense and sometimes nearly indecipherable—even for accountants paid to make sense of them. In that regard, the IRS acknowledges that sometimes mistakes happen and people will assume A about the code when B actually applies.

Without evidence of fraud or other criminal activity, the IRS will typically assume you have made an honest mistake on your returns. That’s about the extent of the agency’s willingness to forgive, however, as even unintentional mistakes can result in a 20 percent penalty to the taxpayer.

There are certainly circumstances in which the IRS assumes an unintentional error is actually a deliberate attempt to defraud. In these situations, the taxpayer can face serious consequences, including prison time. Many will then turn to experienced tax law attorneys to help them resolve disputes with the IRS. In some cases, negotiations can lead to the resolution of the issue without any criminal charges; in other cases, vigorous representation in court is required.

Making a Frivolous Tax Claim

One of the many things that makes the U.S. a great nation is that we have the freedom to express our opinions, even when those opinions run counter to official government policy. For instance, people are free to argue that the federal income tax is illegal and that it violates several amendments of the Constitution.

People are free to make the argument, but they are not free to refuse to pay the income tax they owe. Because some of those who argue that the income tax is illegal, immoral and unconstitutional are articulate and persuasive, sometimes people give in to temptation and file returns making "unreasonable and outlandish claims," the IRS says, "to avoid paying the taxes they owe."  

When you file that return, trouble can begin. No matter how reasonable the argument sounded in the book you read or website you visited, the IRS has very likely heard the argument before, taken it to court and prevailed. In fact, penalties levied against those who take up the court's time with "frivolous arguments" are getting harsher.

You can argue that only employees of the federal government are subject to the income tax, or that filing a return is voluntary, or that Federal Reserve notes are not income--the anti-tax arguments go on and on--but at the end of the day, you must send in an accurate income tax return.

Other Common Tax Fraud Crimes

Within the IRS, the Criminal Investigation (CI) unit takes a hard look at tax fraud, tax-associated money laundering, and illegal proceeds earned by legitimate companies through a variety of fraudulent methods. Some of the crimes pursued by CI include:

• Employment and payroll tax fraud: Payroll tax issues are common. Underreporting workforce numbers, collecting payroll taxes (federal unemployment, social security, and withholding taxes) and failing to pay them over to the IRS, or paying employees in cash under the table are just a few of the schemes pursued by the IRS. 
• Refund fraud: Most people know that filing a false income tax return could turn into tax litigation. Individuals and tax preparers engage in refund fraud and sometimes identity theft in order to obtain an unearned tax refund. This is also the realm where fake deductions, exemptions, and business expenses come into play.
• Abusive tax schemes: U.S. taxpayers who avoid filing regulatory reports like FBAR and FATCA could find themselves facing an IRS criminal tax investigation. With the proliferation of secrecy jurisdictions, individuals with significant wealth may seek the greater privacy available through offshore tax havens. There is often a fine line between an abusive tax scheme and a tax option used by an unwitting taxpayer trying to make legitimate use of offshore tax resources.

Committing tax fraud or tax evasion could provoke the interest of the IRS. But remember, the IRS is both underfunded and short-staffed these days. An important aspect of any tax crime is intent. It takes less time and money to work out a civil arrangement with a delinquent taxpayer than it does to try and convict that same taxpayer of a criminal offense. 

Employee Tax Fraud Explained

Criminal tax investigations are often aimed at business owners or C-suite executives. Just as often, it is the rank-and-file who perpetrate tax fraud. Monies gained from tax crime often go to pay debt or pay for personal comforts.

When an employee embezzles, it is important for an employer to obtain experienced legal advice about reporting the loss to the IRS, and properly classifying repayments on those embezzled funds should they occur. At the outset of discovery of the theft, employers can provide the IRS with information about the loss. That said, the report and steps to deal with the embezzlement should be reviewed with general counsel or a qualified tax attorney before contacting the IRS.

Common Employment Tax Fraud Scams

While failure to properly remit or pay over employment taxes may not seem the most serious crime, it is a hardball issue for the IRS. Conviction on one count of employment tax fraud can earn five years in prison. The IRS routinely identifies and investigates employment tax scams that take a number of forms, including:

• Employment leasing: When an employer outsources their personnel and payroll responsibilities, it is called “employment leasing.” While an employer contracts help from the outsourcing company, the outsourcer is responsible for collecting and paying over employment taxes. Sometimes these middleman organizations pocket employment taxes, close up shop, and disappear when notified of an impending IRS civil audit—leaving a significant tax liability.
• Pyramiding: A common employment tax scam is the practice of “pyramiding,” which is the IRS term for business owners who withhold payroll taxes and pocket the money with no intention of turning it over to the IRS.
• Cashing out: When employers or outsource employment agencies pay employees in cash, the opportunity for tax crime rises across the board. In addition to skirting Workers’ Compensation laws, employers can falsify payroll records, underreport the number of employees on the books, or underreport the amount of payroll taxes owed.

Tax Preparer Fraud

The IRS routinely brings criminal tax charges against preparers. Tax fraud is serious for the accused and for their clients, especially if the client had knowledge, or should have known that a false tax return was filed on their behalf. Here are a couple of recent IRS prosecutions:

• A Charlotte, North Carolina woman pled guilty to “aiding and assisting the preparation of a false tax return.” The woman admitted to the most common forms of tax preparer fraud, enhancing expenses, creating fake deductions, and claiming education credits that were non-existent. The amount of tax lost to the IRS from her conduct amount to approximately $500,000 and she faces up the three years in prison, probation, restitution, and penalties.
• Facing similar consequences, a Rhode Island man also faced the long arm of the law for his habit of filing fraudulent tax returns between the years of 2011 and 2015. Like the North Carolina tax preparer, the accused sought to boost refund checks for his client by creating false deductions, and inflating expenses. He also amplified charitable donations and falsified home mortgage and home energy improvement deductions. 
• On a larger scale, a pair of Southern Florida tax preparers were shut down by the IRS and face injunctions and the permanent loss of the livelihoods for their part in scamming the IRS and their clients. Using the same sorts of tactics described above, a tax preparation business inflated deductions and expenses on the tax returns of their client to increase the amount of the refund their client would receive. When the refund returned, the tax preparers pocketed the excess without the knowledge of their victims.
  
  

Avoid Tax Fraud: Know Who is Preparing Your Return

Whether a business or individual, many people use a tax preparer to handle their taxes. While oftentimes a trusted accountant or other individual, many people simply assume the tax preparer working on their taxes is on the up-and-up.

The Taxpayer Advocate Service (TAS) advises you to steer clear of these red flags when choosing or working with a tax preparer:

• You are asked to sign a blank or incomplete tax return with the guarantee that the tax preparer will file it for you.
• The tax preparer operates by collecting your refund from the IRS and then transferring it from their bank account to yours.
• You are asked to pay cash without receiving a receipt, or you are charged based on the size of your refund.
• Ask for the qualifications and experience of anyone you are considering using for your taxes. Be aware that anyone can prepare taxes—no special credential or education is required. The only requirement to prepare taxes is an IRS Preparer Tax Identification number (PTIN), which can be obtained online from the IRS for $19.75 in about 15 minutes.
• Your tax preparer guarantees a refund larger than you normally receive.

Tax preparers who scam their clients are common. To increase the size of your refund (and their fee), they may create false deductions, fake tax credits, and underreport your actual income. When your refund is deposited into their account, they claim their “fee” before they provide your refund.

When the height of the tax season has passed, disreputable tax preparers often pack up and leave town. By the time you receive a notice from the IRS that there is something wrong with your tax return, they are nowhere to be found. Regardless, the tax preparer is responsible for the accuracy of the tax return. You will be financially liable for penalties, interest, and any tax fraud that may have occurred when you signed without reviewing your return first.

The IRS encourages taxpayers to file a complaint regarding their tax preparer if they experience the following:

• Your 1040 was filed without your consent or knowledge, or your status was incorrectly reported to influence the size of your refund.
• The preparer falsified the tax return by creating deductions, exemptions, or inaccurately reporting income.
• You failed to receive your refund.

Questions to Ask to Avoid Tax Preparer Fraud

The IRS cautions individuals and businesses to scrutinize their tax preparer on an ongoing basis. If you can answer “yes,” to any of the following questions, proceed with caution:

• Does your tax preparer ask you to sign a blank return or are you expected to file your return or other regulatory filings without careful review?
• Are the fees you pay your accountant or tax preparer based on how much of a refund they claim to be able to provide for you?
• Do you have concerns that your accountant or preparer may not have credentials or contemporary knowledge of recent legislative and tax changes?

You’re Charged with Tax Fraud. Now What?

Here are straightforward tips to avoid headlines and resolve the charges of tax fraud:

• Respond immediately: Take quick action if you receive notice or become aware of interest by the Internal Revenue Service (IRS). When significant wealth, complicated tax avenues, or criminal charges could be involved, contact a tax attorney experienced with IRS investigations. Connecting with knowledgeable legal counsel straight away could be your strongest move for avoiding tax litigation.
• Preserve your records: Locate and preserve all records that you feel could be of interest to the IRS. Do not tamper with evidence, destroy records, or make phone calls to potential witnesses about what they should or should not say. If you destroy evidence or try to tamper with witnesses, it could make things worse.
• Engage the process: Your tax lawyer will spearhead and guide you through interactions and meetings with the IRS. Be honest and cooperate. Although it is a stressful process, little is gained by defensive posturing. Work with your attorney to ensure that your explanations are consistent across venues and align with the overall situation.
• Work toward a solution—not litigation: Even if it is found you have significant tax liability, your attorney can work toward options that may not involve trial, but allow you to repay monies you are found to owe. Prosecution takes time and resources for the IRS, and you may be able to avoid a criminal charge or face a lesser charge depending on the seriousness of the allegations.

Of course, the best way to avoid a tax controversy is to ensure that you meet FBAR and foreign bank account reporting guidelines, pay your taxes, and work with best-in-class accountants and tax preparers. When there are issues or a tax crime allegation is pending—contact a tax attorney with the defense experience you need to keep you from career or reputational damage, financial loss, or prison.

Understanding the Difference Between Civil and Criminal Tax Fraud

We talked earlier about the importance of willfulness when the IRS is considering prosecution. It may be difficult to convince the IRS that you did not intend to dramatically underreport your income. Yet, if there is true margin for error that you did not understand how a bonus applies, the IRS may find you made a mistake—rather than committing civil or criminal tax fraud.

When the IRS can establish that a fraud occurred—and have reason to believe it is not a mistake—the agency may consider charges of tax fraud, either civil or criminal. The distinction between the two is critical, and it is the responsibility of the IRS to prove allegations they bring against a taxpayer.

Civil and criminal tax crime charges are different legal measures. Both civil and criminal allegations can be brought against a taxpayer at the same time, but the charges play out in different ways. One big difference is the level of proof required to prove the charges. Consider:

• Criminal tax crime matters must be proven “beyond a reasonable doubt” by the IRS.
• Civil tax fraud crimes must be proven with “clear and convincing” evidence.

A standard of proof “beyond a reasonable doubt” is the higher standard and, if proven, also carries consequences beyond that of a civil tax fraud. Differences between the penalties carried by each charge include:

• Criminal tax crimes: Criminal allegations are pursued “to punish” the individual for commission of the tax fraud. Criminal tax fraud is prosecuted to deter the individual and others going forward. The defendant faces fines, restitution, and imprisonment as possible consequences of conviction.
• Civil tax crimes: Civil fraud is an administrative correction usually taken after an audit. The penalties are often proposed by the auditor in their report. The appropriate tax will be assessed, along with monetary penalties. If assets are involved, they may be recovered as part of the action.

Will I Be Charged with Criminal Tax Fraud?

Statistically speaking, the chances of any given taxpayer being charged with criminal tax fraud or evasion by the IRS are minimal. The IRS initiates criminal investigations against fewer than 2 percent of all American taxpayers. Of that number, only about 20 percent face criminal tax charges or fines. In a recent year, only less than 2,500 Americans were convicted of tax crimes – approximately .0022% of all taxpayers. Additionally, the “unofficial” minimum amount of taxes owed before the IRS will choose to file criminal charges is around $70,000, in cases involving multiple years of fraud.

The term tax fraud is a general one that can refer to a number of different laws found in Title 26 (the Internal Revenue Code) and Title 18 of the United States Code (or “USC”). The main distinguishing feature of tax fraud is the taxpayer’s intent to defraud the government by not paying taxes that he knows are lawfully due. Tax fraud can be punishable by civil (i.e. money), criminal (i.e. jail time and money) penalties, or both. For example, a taxpayer can commit tax fraud and be punished under 26 USC § 6663 with civil penalties, without actually being charged with criminal tax evasion under Title 26 USC § 7201.

If you have concerns or fear you may be facing criminal tax charges, this eBook will help to educate you on the basics criminal tax fraud and your personal rights. We invite you to download our eBook and as always, please contact the experienced tax attorneys at Robert J. Fedor, Esq., L.L.C. with any questions.

Good to Know: Penalties for Criminal Tax Fraud and Civil Tax Fraud

Civil tax fraud penalties are limited to monetary consequences and do not result in a criminal prosecution. Common civil infractions and their associated penalties include:

• Fraudulent failure to file a tax return: 15% of the net tax due for each month up to five months with a maximum penalty of 75% of the unpaid tax
• Filing a fraudulent tax return: 75% of the underpayment amount

Criminal tax fraud can result in a significant period of imprisonment, among other penalties. For criminal tax fraud, the potential penalty is directly tied to the specific criminal charge you face. For example, some common crimes and punishments related to criminal tax fraud include:

• Tax evasion: This crime carries a maximum sentence of five years imprisonment and a fine up to $100,000 for individuals or $500,000 for corporations.
• Willful failure to pay tax, failure to file or failure to keep sufficient records: This crime carries a maximum term of imprisonment of one year, accompanied with a potential fine up to $25,000 for individuals or $100,000 for corporations.

Heads Up: IRS Announces CI-FIRST

Taking a more collaborative approach to fighting financial crime, the IRS announced a new initiative for working with banking institutions to fight tax crime.

Enforcement under the Bank Secrecy Act (BSA) has been a high priority for the IRS. Under the BSA, banking and financial entities provide reports, known as Suspicious Activity Reports (SARs), to the IRS that can help to identify activities like money laundering, offshore tax evasion, or tax fraud. While announcing its new initiative, the IRS highlighted stats from 2022-2024 that demonstrate its use of BSA data as it conducts criminal tax investigations. Some of those statistics include:

• Using BSA data, IRS-Criminal Investigations (CI) uncovered tax fraud of $21.1 billion associated with financial crimes.
• The agency seized $8.2 billion in holdings and assets related to tax and other crime, and it collected $1.4 billion in restitution from defendants on behalf of victims.
• During the 2022-2024 time frame, more than 87% of criminal investigations referred for prosecution related to the BSA filing. Prosecution of those cases resulted in a 97.3% conviction rate, which returned average sentences of 37 months in prison.

Agency and institutions collaborate to identify money laundering

With this headwind from 2024, IRS: CI the implementation of CI-Feedback in Response 5o Strategic Threats (FIRST) aims at improving communication to financial institutions around the use of SARs. Along with improving the subpoena process, IRS-CI will discuss how SARs are used along with how banks might boost the effectiveness of SARs. 

Lauren Kohr, strategic engagement officer for IRS: CI, said, “Behind all of these metrics are real crimes with real victims. A lot of times people look at BSA data or the Bank Secrecy Act as a regulatory requirement, but it’s really one of the sharpest tools law enforcement has as whole has to trace fraud illicit money and dismantle these criminal networks.”

During the 2022-2024 timeframe, IRS-CI agents ran almost one million searches on SARs per year for the last three years. Interestingly, approximately 70% of cases opened by IRS:CI included a SAR reporting a currency transaction under $40,000. About 50% of SARs received during that time were for transaction amounts less than $22,230.00.

The IRS also notes information provided through the BSA is used by IRS: CI to identify tax fraud related to pandemic-era relief, as well as drug trafficking.

Guy Ficco, IRS: CI Chief, said, “public-private partnerships thrive when everyone mutually benefits, and to enhance our partnership with the financial industry, we plan to launch CI-FIRST which will promote information-sharing, streamline processes, and demonstrate how valuable BSA data is to criminal investigations.”

Filing a False Tax Return

The owner of a Deerfield accounting firm drew a prison term for preparing false tax returns—after he had already been tapped by the Department of Justice (DOJ) for the same thing in 2018.

53-year-old Gary Sandiego owned G. Sandiego and Associates in Deerfield. Unlike ghost preparers, Mr. Sandiego had been in business for some time. Though he likely had an established clientele who trusted him, he created and filed false tax returns on their behalf, creatively adding deductions, manipulating expenses, and even energy credits. In 2018, the DOJ took him to court for tax fraud going back to 2011. He was fined $358,000, and ordered to cease conducting business as a tax preparer. 

While that might seem like the end of the story—it is not. In February of 2023, Mr. Sandiego was indicted by a federal grand jury in Chicago and charged with 17 counts of tax fraud and making false statements. The charges relate to his activities as a tax preparer from the years 2014 through 2017. An IRS criminal tax investigation found that Mr. Sandiego ignored the documents provided by his clients and falsified their tax returns without their knowledge. As a result, the IRS failed to collect $4,586,154 in due tax from his clients. In April of 2023, Mr. Sandiego pled guilty to the charges.

In October of 2024, Mr. Sandiego was sentenced to 16 months in prison, along with restitution of $2,910,442 and supervised release following his term of incarceration.

And what of the other $2 million owed to the IRS? Regardless of whether a tax preparer deceives a client about the amount of tax they owe, or the amount of a refund they received—when the tax fraud comes to light, the taxpayer may be responsible for correcting their return, paying the correct tax, or reimbursing the IRS for an inappropriate refund.

Initially, the IRS fines tax preparers who prepare and file fraudulent tax returns. The first sign of IRS involvement is a notice letter identifying the problem and setting out a penalty. Penalties are carefully calculated on the span of tax years, the inflation rate, the number of violations, and the particular violations committed.

Tax Evasion

Tax fraud did not work out for an Ohio man who came up short in front of a federal jury.

John Everson of Liberty Center, Ohio, is a successful electrical engineer who owned his business. As any business entrepreneur knows, it can be difficult to maintain the bottom line, keeping up with tax reporting, and a myriad of other responsibilities that come from heading up your own business.

By all accounts, Mr. Everson ran a going concern. Between 2009 and 2016, he earned over $2.3 million. The narrative pauses here to consider the criminal tipping point—that space and time when an individual decides that a ploy or scheme to avoid taxes might suit their interests better than remaining compliant. Some people are driven to tax fraud by circumstance—it may seem the only way to rescue a sinking business. Or—simple proximity to the levers of business makes tax crime easy. In both scenarios, warning flags about ground-level consequences are ignored.

For Mr. Everson, the aim was to conceal income to avoid paying taxes—a common goal carried out across the U.S. every year. The mode in his case was a trust. The IRS takes a hard line on abusive trust schemes. The IRS notes scammers use abusive trusts for reasons that include:

• Reduce or eliminate income, gift and estate, and self-employment taxes
• Increase deductions for personal expenses paid out by the trust
• Ability to boost deductions for depreciation on expenses, homes, and other property

As noted by the IRS, “Abusive trust arrangements often use trusts to hide the true ownership of assets and income or to disguise the substance of transactions.” Trusts are intended to separate the control of trust funds from those who benefit from the trust. In abusive trust set-ups, the owner continues to control and direct funds in the trust.

For his part, Mr. Everson directed his clients to pay invoices to his trust. He then transferred the money into financial accounts created for non-profit organizations he had created which were owned by his family members. According to the IRS, Mr. Everson registered his home and airplane as owned by a non-profit entity.

It is unclear how the IRS criminal investigation into the business of Mr. Everson began. But, in the end, he owed $658,487 via his actions. Mr. Everson was so sure of his scheme that he took his case before a federal jury—rather than negotiating a potentially more favorable resolution to his dilemma. He was convicted and sentenced to over two years in prison, along with restitution, and supervised release. It comes down to—was it worth it? Only Mr. Everson, headed for prison, can say.

International Tax Fraud

A complicated tax crime earned a hedge fund trader about $1.3 billion in ill-gotten goods. It also earned him the next 12 years in prison.

A longtime tax fraud in the European Union (EU) caught up with one player recently. Sanjay Shah is a hedge fund trader who operated a complex tax operation in Denmark from 2012 to 2015. Shah’s involvement in Denmark is only one part of a much larger financial pile-on that occurred in the EU starting in about 2001.

The scheme took advantage of dividend arbitrage stock transactions called "Cum-ex", which is Latin for “with without.” In this scheme, international financial firms, insurance companies, traders, and lawyers took advantage of a tax loophole that allowed multiple parties to collect a tax refund for a dividend payout without identifying the actual owner.

Sanjay targeted Danish banks for a four-year period, garnering more than one billion in tax refunds from the Danish treasury. Referring to the loophole as a “defect,” tax crime attorneys for Sanjay claim the loophole he used was legal. That said, media reports note that Sanjay referred to himself as a “greedy bastard” during an interview for Danish television. Sanjay remarked that he likened the trading scam to playing “Space Invaders,” working to better his score with each round.

Across the EU, different banks, traders, and entities played out the Cum-ex trade in other countries. Just some of the banks that were allegedly involved include Morgan Stanley, Bank of America, Deutsche Bank, Warburg Bank, JP Morgan, and many more.

According to Tax Justice Network, the total cost (so far) to the treasuries of these countries is about $55 billion, including hits taken by Switzerland, Poland, Germany, Denmark, Italy Belgium, Norway, and Austria. Possibly the largest tax theft in European history, impacted countries did little to warn each other about the scam. Litigation is ongoing in Germany, with over 1000 investigations open into people who engaged in Cum-ex trades.

As for Shah, he removed himself to Dubai in 2009 from where he was finally extradited in 2024. Shah lived in style in Dubai, residing near the beach with both a yacht and a 10,000 square foot villa. According to media, Shah attended his sentencing wearing a red Christmas hat. His legal team quickly filed an appeal to the Danish High Court.

Employee Embezzlement

Criminal tax investigations are often aimed at business owners or C-suite executives. Just as often, it is the rank-and-file who perpetrate tax fraud.

In March 2019, Alabama resident Alita Edeker was sentenced to almost four years in prison for stealing from her employer and filing false income tax returns. According to the Department of Justice, Ms. Edeker was an accounts manager at a science technologies company based in Auburn, Alabama, between 2005 and 2014.

Like many individuals who embezzle from their employer, Ms. Edeker was in a position that enabled her to route and reroute monies coming into the company for the payment of goods and services. Ms. Edeker processed credit and debit card product purchases for the company. Between 2007 and 2014, Ms. Edeker transferred more than $700,000 into accounts that she controlled.

Monies gained from tax crime often go to pay debt or pay for personal comforts. Ms. Edeker used the illicit funds to pay for her car, home utilities, and mortgage. As with many types of criminal endeavors, Ms. Edeker was pursued for filing fraudulent tax returns. In addition to the embezzlement and making false statements about the money she diverted, the IRS found she filed inaccurate income tax returns between 2011 and 2013. 

Ultimately, Ms. Edeker will serve her prison time, plus three years of probation. She is required to repay her employer $819,497.29 and owes the IRS another $101,604. As an accounts manager and felon, Ms. Edeker will be hard-pressed to repay her debts in her lifetime.

Payroll Tax Fraud

Payroll tax crimes are common and usually avoidable. The plight of one business owner highlights the federal obligation to pay over employment taxes to the IRS.

Business owners in the U.S. are required to collect and pay employment taxes to the IRS. It is a fact of business life. There are several types of taxes for which wages are withheld. These taxes include:

• Federal income
• Social Security
• Medicare
• Unemployment

Employees depend upon employers to withhold and pay these taxes on their behalf to ensure their right to participate in federal programs like unemployment and Social Security. Federal taxes are also critical for good governance. While employment tax disputes may arise over amounts owing, it is fundamentally clear that paying over payroll taxes is the responsibility of every business owner or their designee.

There are a couple of different types of payroll tax fraud. An owner may falsify documents to under-report full-time employees. Employees may be paid in cash under the table. Workers could be classified as contractors who are performing the work of employed staff. Business owners could also collect withholding taxes from employees but fail to pay the money over to the IRS. For one Michigan business owner, this type of tax fraud recently led to a prison sentence of a year and a day.

Yigal Ziv owned and operated a software development company in Walled Lake, Michigan. Mr. Ziv himself collected and paid over employment taxes owed to the IRS—at least until 2014. Between 2014 and 2018, Mr. Ziv collected employment taxes of approximately $691,000—but kept the withheld wages for his personal use. At the same time, he failed to file employment tax returns. As many do, Mr. Ziv used the money to pay personal bills and for luxury purchases. He also made mortgage payments and lease payments on a luxury vehicle.

In a twist, Mr. Ziv became aware of an ongoing IRS criminal tax investigation into his practices in May 2018. In response, he failed to file employment tax returns from the fourth quarter of 2019 to the fourth quarter of 2020 or pay over another $199,000 in withheld taxes.

Mr. Ziv pled guilty and was sentenced in March of 2023. He will also pay a fine of $5,000 and restitution of $897,271.

Business owners are responsible for employment tax returns and paying over-associated taxes, even if they designate the duty to an accountant. In this matter, Mr. Ziv has no one to blame but himself and will spend a year in prison as a result.

Family Tax Fraud

It is a long shot to win the lottery, right? A father and his sons set out to beat the odds and ended up in serious trouble.

From the news, lottery proceeds seem to be getting larger—and they are. According to CBS, both Powerball and Mega Millions have slightly changed their rules in recent years which make it harder to win. The cost of playing these lotteries also increased. As headlines grow, so do the number of people buying one or more tickets. 

One Boston family made gaming the lottery a family enterprise between the years of 2011 and 2020. Along the way, they filed false tax returns, and laundered more than $20 million in lottery proceeds. How did they do it?

Ali Jaafar and his two sons Yousef and Mohamed made millions by purchasing winning lottery tickets from actual winners of the Massachusetts State Lottery. Over the course of the tax scam, they bought more than 14,000 tickets from the winning ticket holders. It turns out there are quite a lot of people who win lottery proceeds who prefer to stay anonymous and under the radar of the IRS. By selling their tickets to Jaafar family members, people holding winning tickets were not reported to the IRS and were able to (at a discount) receive cash under the table without reporting it to the IRS or seeing any of it withheld for taxes, prior tax liabilities, or past due child support.

The Jaafars then presented the winning tickets as their own. In Massachusetts in 2019, Ali Jaafar was the number one lottery ticket winner, and his sons were numbers three and four on that same list. Each family member reported the fake winnings on their tax returns and falsified their tax returns with equal gambling losses to null out taxes owed. The family members earned approximately $1.2 million in misguided tax returns.

Along the way, the family grew their network of complicit convenience store owners whom they paid off to provide them with information and assist with cashing their lottery tickets. The State of Massachusetts has now revoked or suspended the licenses of more than 40 lottery agents.

The curtain fell on the scheme, as it usually does. Mr. Jaafar and his son Yousef were sentenced to five and four years in prison respectively, plus they were required to turn over their profits and pay restitution of approximately $6 million. The other son, Mohamed Jafar, pleaded guilty in 2022 to one conspiracy charge which resulted in a six-month sentence, two-year lottery ban, and almost $100,000 in restitution to be paid.

Acting U.S. Attorney Joshua Levy noted, "This case is, at its core, an elaborate tax fraud. Over the course of a decade, this father-and-son team defrauded the Massachusetts State Lottery Commission and the IRS to pocket millions of hard-earned taxpayers' dollars. These defendants worked together to recruit a wide network of co-conspirators and spread their lottery scam across Massachusetts, avoiding detection by repeatedly lying to government officials.”

Bottom line? Winning the lottery remains exceedingly difficult to do.

Willful Evasion or Simple Mistake?

Can claiming you made an innocent mistake on your tax return get you out of hot water with the Internal Revenue Service (IRS)? Maybe so, maybe not.

Simple errors on tax returns are common. Individual taxpayers and business owners may forget a schedule, file a return with miscalculations, or misinterpret what is being asked. It happens. The IRS may catch it or may not. If you receive a letter from the IRS or become the focus of an IRS civil audit, it behooves you to speak with a tax attorney to review your tax profile and reporting. In some cases, there may be an opportunity to prove the miscalculation, while in other situations, it may be tough to prove it is not tax evasion.

Let’s look at the case of Mr. Jonathon Michael, a mechanic in Springfield, who worked with port operations in New Jersey. Like the rest of the working world, Mr. Michael was asked to designate his withholding allowance on an IRS W-4 form. The form allows an employer to calculate the amount of wages to withhold and pay the IRS on behalf of the employee. In 2014, Mr. Michael completed and submitted the W-4 form verifying he was exempt from federal income tax withholding.

Mr. Michael earned more than $260,000 per year and had no recognized exemption from paying employment taxes. At this point in the story, Mr. Michael appears to have made a serious mistake with regard to designating his withholding allowance. Signing on the bottom line of the form acknowledges that information is accurate and subject to charges of perjury if it is not. As a result of the W-4, his employer withheld no taxes for Mr. Michael.

Employers annually provide the IRS with a W-2 form for each employee. The W-2 alerts the IRS to the actual wages, compensation, and withheld taxes paid by each employee. It is pretty easy math for an algorithm to compare incoming W-2s and W-4’s. The difference can mean an IRS tax investigation. In this case, that is just what happened.

In 2016, the IRS stepped in and advised the employer of Mr. Michael to disregard the W-4 he provided and to begin withholding appropriate wages on his behalf. At this point, Mr. Michael was alerted to the intervention of the IRS and their focus on his tax situation. The story might have ended here had Mr. Michael acknowledged the “mistake,” and paid and filed his taxes accordingly along with arrears and penalties for the years 2014, 2015, and 2016. To this point, Mr. Michael could have argued, if pressed, he made an unintentional mistake and intended to make good on it.

But—that is not what happened. Instead, Mr. Michael wrote a letter to his employer attesting to the correctness of the prior W-4 he had provided. As a result, his employer withheld no payroll taxes on his behalf for the year 2014 through 2018. Given fair warning that the IRS could consider his choices as a tax crime, he chose to stick to his story, pretty much foreclosing the opportunity to claim he made an unintentional error.

In April 2021, Mr. Michael was indicted by a federal grand jury for tax evasion and willful failure to file individual income tax returns. Overall, he failed to pay withholding and federal income taxes on $1.6 million in income earned over the five-year period in question.

The devil is in the details between an unintended error and willful tax evasion. Mr. Michael faces approximately ten years in prison for not responding to the IRS when he had a chance. While his sentence will likely fall well short of ten years, he owes significant money to the IRS.

Ponzi Schemes

We have two memorable schemes prosecuted in 2023 both involving Ponzi schemes. So—what is a Ponzi scheme?

A Ponzi scheme is a financial fraud that involves attracting investors into an ongoing scheme. Early investors are given impressive payouts which spreads positive word-of-mouth to others looking for high returns. New investors pour money into the scheme, which may be used to pay out original investors. Incoming funds are also siphoned off for the benefit of the fraudsters. While the scam can stay afloat if there is enough money coming in, it will eventually collapse.

The scam is named for Charles Ponzi who is believed to be the first flim-flam man to cook up the scheme. In more recent history, the infamous and now-deceased Bernie Madoff earned his illicit billions from a Ponzi scheme he ran from approximately the 1960s until 2008 when he was arrested. His Ponzi scheme is acknowledged as the largest in history.

The first of two schemes we’ll explore belongs to Paulette Carpoff who earned notoriety with her husband as perpetrating the largest criminal fraud in the history of the Eastern District of California.

Inventing a company, DC Solar, the Carpoff’s claimed to be in the business of manufacturing mobile solar generators (MSGs) which were mounted on trailers and leased for emergency cellphone towers and lighting at sporting and entertainment events. Investors bought into the company and then participated in leasing the MSGs back to the company. Of course, the MSGs were not manufactured and the continued investment income fueled the scheme and the luxe lifestyle of the Carpoffs. When arrested, Ms. Carpoff had $18,000 in cash in her purse and a spare $9,000 in her car. The price of this Ponzi? Ms. Carpoff is headed to prison for 11 years, her husband for 30, and the couple owes $790.6 million to the government.

The second scheme centers around Michael DaCorta who also ran a Ponzi scheme that attracted more than 700 investors through supposed foreign-exchange trading. Claiming the investment was risk-free and backed by collateral, Mr. DaCorta and his cronies crafted a scheme that bought them expensive vehicles, multiple luxury homes, college tuition for family members, trips, and more. While his investors lost approximately $80 million, Mr. DaCorta will lose the next 23 years of his life to prison, plus a hefty penalty for this tax crime.

Easy come—not so easy go.

National Tax Fraud

Individuals and criminal crews look at mortgage tax fraud to boost or create a tax refund. The crew led by Iran Backstrom of Georgia included several co-conspirators in Florida and around the country. The scammers recruited clients through marketing seminars. Clients were advised their debt and mortgage liability entitled them to large refunds because banks and credit companies had routinely withheld income from them. These claims had no basis in fact and fraudulent tax documents were prepared and submitted with the fake tax returns to legitimatize the refunds—and it worked.

Between 2014 and 2016, Mr. Backstrom (also known as Shariyf Noble), along with his crew, prepared false income tax returns for clients and obtained fraudulent income tax returns from the IRS to the tune of $64 million dollars overall. For preparing the returns, Mr. Backstrom and the others routinely received $10,000 to $15,000 in fees and indicated the return had been prepared by the taxpayer without other assistance.

As a result of the years-long IRS criminal tax investigation, co-conspirators throughout the country were prosecuted and received prison sentences for their part in the scheme. Mr. Backstrom earned approximately $1 million as the ring leader and failed to file tax returns between 2014 and 2016. As a result, he was sentenced to more than eight years in prison. His second-hand man, Arthur Daniels (also known as Mehef Bey), was sentenced to 11 years in prison. A Florida woman, Rebecca Cyphers, was sentenced to a year in prison for preparing false income tax returns, and other crew members are also serving prison time. The final defendant to be sentenced, Yomarie Febres, will serve a four-year prison term for preparing false returns and failing to file income tax returns.

Acting Deputy Assistant Attorney General Stuart Goldbert said, “Today’s sentence represents the culmination of years of work by the Department of Justice, the U.S. Attorney’s Office, and IRS-Criminal Investigation. The main promoters of this multimillion-dollar tax fraud conspiracy now have been identified, convicted, and sentenced to a substantial prison term. The message to other would-be tax cheats is clear:  no matter how sophisticated or complicated your scheme, we will uncover it, obtain your conviction, and seek sentences that hold you fully responsible for your criminal conduct.”

Committing a tax crime can be costly to your life and liberty. If you are involved in personal tax fraud—or a tax scheme on a larger scale—speak with an attorney experienced with criminal tax defense as soon as possible.