Introduction
There is no such thing as a free lunch. There is a vein of gold in that old saying. And yet, that doesn't stop many from trying to get something for nothing. Entire generations have grown up now trained to depend on the government for support whether it be through food stamps, skewed tax credit laws or welfare. The price they pay in dignity, respect and freedom is barely noticed by many of them. And yet, even with those who are truly in need or who truly deserve the help there are many more who look for ways to scam the government for funds.
Each one of them is convinced they have found the fool-proof way to scheme Uncle Sam and in many cases they get away with it temporarily. Though there are many variations on the overall themes, each will generally fall within one of five categories.
The Top Five Ways to Cheat the Government -and How They Will Catch You Doing It
1. EIC Fraud
2. "Under the Table" Payroll
3. Falsifying of W-2 or 1099 information
4. Clustered Nest
5. Multi-Level Marketing Tax Evasion Methods
EIC FRAUD
Earned Income Credit is a refundable tax credit meant to help working single parents. Normally, the way a tax credit works (nonrefundable) is that if an individual has paid 00 in taxes for the year and qualifies for the ,000 tax credit, they can only receive the 00 they paid in taxes. If the individual paid in taxes, the tax credit could be as much as ,000 or more and they would get . With the refundable tax credit, the individual isn't required to have paid taxes to get the earned income credit added to his or her refund amount.
It works on a sliding scale where the EIC climbs up to it's maximum (usually around 000 in earned income) and as the income climbs above ,000 the EIC slides down. Maximum EIC is usually around 00. Finally at about ,000, the EIC has decreased to . As someone who spent several years preparing taxes in the lower income bracket neighborhoods, let me tell you that there are those whose whole year is planned around receiving this huge check of taxes taken from those who pay them and given to those who won't. EIC is given only for your first two children from birth to age 17.
The 'married or unmarried' couple with four kids will go in to a tax prep office, separate ones if they are experienced at this. And though each lives in the same house, each one claims the Head of Household status, which increases the amount they can deduct off of their taxable income and with each of them claiming EIC they can receive a checks totaling up to ,000 for end of year tax filing season. The Head of Household is supposed to be for those who are receiving no other support from anywhere else. The Head of Household must be providing for that Household, so if there is a boyfriend, girlfriend, spouse, parent etc living there, they cannot claim that designation.
These cheats will do this for years before they are caught, but having been caught, they are not allowed to claim EIC for ten years following a fraud investigation. They will then have to pay back incorrectly paid EIC and pay penalties for fraudulent returns on top of that of up to 75% of the amount that the IRS was defrauded.
How They Get Caught
Every time an individual opens a bank account, purchases a car, or rents or buys a home there is a little note made that identifies their Social Security number with that transaction. Obviously someone whose earned income doesn't reach over ,500 isn't going to go buy a ,000 vehicle, or a 0,000 home. These cheats do not realize that they are putting a huge target on their back that screams, "Audit Me!" to the trained IRS auditors. You can't have it both ways and claim to make enough income to pay off your purchase on credit and then on another form claim that you didn't make enough money to pay taxes.
There is a storehouse of this information, and the IRS does take note of logical errors. Example; A man came into my office and told us proudly that he was the father of nine children with seven different women and that his total income for the year was under 00 and he wanted to claim half of his kids before their mothers did so he could get the refund first. There is no way on this earth that a man on his own can pay for food, rent and gas on 00 annual income. And he wanted to claim that he supported these children too? He went to prison a year and a half later, but I hear his kids are doing just fine without him.
Under the Table Payroll
Whether it be because the worker is illegally living here in this country or because the employer doesn't want to bother with payroll taxes, a growing number of small businesses are paying in cash. And since their employer isn't reporting it, the individual employee sees an opportunity to cheat the government. (In some of these cases, these individuals are engaging in illegal activity through which they make all their cash. Drug dealing, prostitution, etc.)
The first caution here is that this arrangement is illegal. The second is that it is dangerous. Illegal because there are certain state requirements for employment that cannot be met or measured without records. And, dangerous because this is how most employers get around paying worker's compensation insurance. An injury on a jobsite where all is done 'under the table' will usually receive sub-standard care for fear of reporting the injury to a hospital or qualified doctor.
How They Get Caught
In much the same way that those who are cheating EIC, every legal transaction they make puts one more flag on a case that would not have one otherwise. If they are making money they are not reporting, they will have a hard time explaining how they are making 0 a month in mortgage payments when they only claim to earn 0 and that they are the sole provider of support for that household. As the Zen Master would say, 'all things are connected, and yet not all things are the same.'
Falsifying of W2 or 1099 Information
It is relatively easy to purchase a pack of blank W-2's or 1099's and 'create' your own income. Usually the cheaters use a legitimate EIN number of a legitimate business that they have worked at temporarily or that a friend or relative has worked at and they create a W-2 that gives them just enough earned income to get the EIC credit. By the time the ruse is discovered, the cheaters have cashed their super fast refund checks and left town. Electronic filing prevents some fraud, but it makes others so easy.
The legitimate business owner then is left to explain why he or she didn't pay employment tax on these individuals who faked these forms. The IRS seems to move much slower when you are the one who has been wronged. It could mean paying penalties on payroll taxes that were never supposed to be filed anyway.
A lot of those people using this particular scam are illegal aliens and do not have a legitimate social security number anyway, those that are legal citizens, and yet, cheaters anyway, eventually move and forget the crime they have committed.
How They are Caught
Once this particular fraud is forgotten, one day they will have to use their social security number for a job, a loan, or college application. At that point, they are nailed even though it may be five or more years later. Offenses of this type earn prison time.
If it is an illegal that is cashing this check, it makes it more of a challenge. Typically, an illegal does not have a checking account to use to cash this check, so they must go to a check cashing store. It is there that they must produce ID, addresses of references and some employment information. What a lot of people don't realize is that all the checks you receive and cash have clearly identifiable stamps showing where and when the check was cashed, deposited and processed. If the illegal is still in the same area when the IRS does get up and start investigating, it doesn't take too much to find them.
The Clustered Nest
Using the same principle in the first EIC fraud of a couple living together in the same place and each claiming Head of Household and EIC for each of their four children, the clustered nest describes what happens when that is taken to extremes. Where there are four or more families within the same residence each claiming HOH and EIC for their group of kids. This is common in heavily Hispanic areas where the families are actually able to get along with each other in close quarters. Often the children are swapped back and forth amongst the relatives to get the maximum benefit of the tax refund.
How They are Caught
In doing background checks there are areas and addresses that are automatic 'red flags' of fraud. They are called 'high risk' areas, high turnover, a transient population, hotels, apartment complexes, etc. When an address has ever been used as a 'clustered nest' where more than one family is claiming residence at the same time, that location is flagged. Eventually the addresses are matched together with dates and times people are claiming residence and sole ownership of the Head of Household title. As long as the entire family moves every three years, they could keep this up for many years. But once an area has been 'flagged' so too are any social security numbers using that address.
Multi-Level Marketing Tax Evasion Fraud
Lately there has been a group promoting an old idea they tout as being "new". This group stems from a MLM that sells legal insurance plans and a big part of their business is in recruiting other representatives. As the steam has gone out of their engine in the past seven years, it is getting more and more difficult to recruit smart people into these pyramid schemes. So their approach has changed to deemphasize the MLM aspect and sell them on the benefits of being able to deduct expenses they already have by opening their own business.
Most W-2 earners as they call them, don't have time to work 40-60 hours a week and put in another 10 - 20 on an MLM. So the approach is this, let me show you how to deduct those expenses you have now anyway and save you money on your taxes. When you own your own business you do get to deduct losses, home office expenses and a percentage of your utility bills depending on the size of the home office.
So now they have otherwise smart people joining this pyramid MLM group, not to advance within the MLM, but to deduct all the losses they will have pushing these pre-paid legal insurance plans on their friends and family. There are several things wrong with this; First, your business needs to be in operation for the purpose of making a profit, NOT for writing off day to day personal expenses. Second, there are rules and regulations for home office and vacation deductions that these 'fake tax experts' don't bother explaining to their new recruit, which easily lead to the deductions being disallowed and the penalties and fees start rolling in. And third, these so called tax experts are the furthest from being experts that one could be. A weekend training class does not a tax expert make.
How They Get Caught
The chief inspiration behind this devious scheme deftly avoids investigations and prosecutions. The pre paid legal insurance company however, seems to attract investigations constantly. Experts in corporate fraud have cited several red flags that show a company is ripe for fraud to be committed on the corporate level and this particular company is at that point. Since it is difficult to hold the corporation liable for the outlandish claims of its' sales force, there will continue to be people sucked into this 'incorporate yourself' scheme that has been around for over 30 years. The good news is that the eyes of the corporate fraud experts are on them and soon there will be a slip up. Gee, I hope they know a good lawyer.
The Top Five Ways to Cheat the Government -and How They Will Catch You Doing It
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David Roberts, CFE, CQBPA, MBA, lives in Kissimmee, Florida with his four girls, three dogs, two snakes and one wife. He has been a member of the Association of Certified Fraud Examiners for five years and has been studying fraud for longer than that. He is the owner of Homesoon Accounting Services which specializes in Quickbooks Consultations and Fraud Prevention and Detection.
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