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Tuesday, March 6, 2012

Tax scams and how is our complex and odd tax system partly to blame

On March 2, 2012, the IRS issued a news release warning people about various tax scams including one that tells people they are entitled to an education credit for the taxes paid on groceries (IR-2012-29). Some scammers are apparently using the refundable portion of the American Opportunity Tax Credit to get refunds for people who are not incurring any college costs. Some are promising stimulus payments. Scammers often get the fee from the client and then skip town.

Should taxpayers know better?  Of course. If something sounds too good to be true, it probably is.  Is it difficult to tell fact from fiction with respect to provisions of our federal tax system?  Yes, I think it often is. In 2009 when we had Economic Recovery Payments and recovery rebate credits, didn't that sound too good to be true?  The government was going to give you money?  We are still in an economic downturn. Should someone who received an economic stimulus payment a few years ago be surprised if someone tells them they can get another one? I don't think so?

If someone has claimed a $1,000 child credit or $2.500 America Opportunity Tax Credit (even if their income is too high to qualify for needs based scholarships), should they be surprised that the government wants to give them even more money?

But what about getting a college tax credit for paying taxes on groceries?  Only 7 states even impose a tax on groceries (FTA). Even in those states, that one seems a bit of a stretch. The IRS news release suggests people read a website about education tax benefits (it is 3,600 words long!) and at the end refers to a few other links including to Publication 970 which is almost 100 pages long.  Is the average taxpayer supposed to understand all of this?  Complexity like this creates a breeding ground for scammers.

The IRS offers these tips to all taxpayers:

"To avoid becoming ensnared in this scheme, the IRS says taxpayers should beware of any of the following:
  • Fictitious claims for refunds or rebates based on false statements of entitlement to tax credits.
  • Unfamiliar for-profit tax services selling refund and credit schemes to the membership of local churches.
  • Internet solicitations that direct individuals to toll-free numbers and then solicit social security numbers.
  • Homemade flyers and brochures implying credits or refunds are available without proof of eligibility.
  • Offers of free money with no documentation required.
  • Promises of refunds for “Low Income – No Documents Tax Returns.”
  • Claims for the expired Economic Recovery Credit Program or for economic stimulus payments. 
  • Unsolicited offers to prepare a return and split the refund. 
  • Unfamiliar return preparation firms soliciting business from cities outside of the normal business or commuting area."
Will the new paid return preparer oversight program help?  I don't think so. If someone wants to break the law, they will continue to do so and either not sign the returns they prepare or use a bogus name and PTIN.

Scammers will only become less of an issue when;
  • The tax law is simpler so more people can understand it without having to read a 100 page publication that is only about higher education expenses.
  • The tax law is not used for economic recovery payments. When people get "free money" from IRS or Treasury, why not just tell yourself anything is possible in our tax law?
  • Greater taxpayer education that needs to start in high school. Students should learn about local, state and federal taxes - why these jurisdictions have taxes, types of taxes, basic tax concepts, how to prepare a state and federal income tax return by hand and with software, how to get information, how to get qualified help, etc.
  • The IRS needs to have a website where people can go and phone numbers people can call to verify someone's name and PTIN (sounds like a photo would also be a good idea - perhaps for a future PTIN renewal requirement).
  • Individuals need to be subject to a fine if they file a return for which they paid someone to prepare but that person does not sign it and put their PTIN on it.
What do you think?

3 comments:

Anonymous said...

I strongly agree with your suggestion regarding tax education during high school. There's more to civics than just voting!

If everyone were more educated about economics and the systems of taxation, I think it would improve our society. Specifically, I think that there would be fewer ignorant people who demand lower taxes at the same time that they are consuming government benefits.
All while they are complaining about high taxes and insufficient benefits.

Also, just to be clear, in your last bullet point, I assume you mean that the paid preparer should be fined if he/she did not sign the tax return as the paid preparer.

Lindsay W. said...

It's no wonder that scammers are attracted to the tax preparation business when as of 2005, U.S. individuals spent $111 billion on compliance costs annually (www.taxfoundation.org/files/sr138.pdf). Adding insult to injury, these high costs that attract scammers are mostly due to an unnecessarily complex tax system.

Although I agree that a basic tax course should be taught in high school, this alone won't deter people from falling into tax scams. The US tax code is about as complex as calculus and even though I took calculus in high school, I definitely don't remember how to find the derivative of a function now (six years later). I think it is only through the combination of a drastic simplification of the federal tax system and a basic knowledge of taxes that the incidence of faulty returns will be lowered.

Also, although I applaud the IRS for taking steps in the right direction with their Registered Return Preparer program, I don't think a hotline or collection of photos will help deter taxpayers from paying tax scammers. Those people who accept the help of unsolicited preparers who offer bogus deals are most likely the same people who don't have much time to spend on their taxes in the first place so even if a hotline or website was in place, it's doubtful these people will use or even know about those resources.

As a MS Taxation student myself, I find taxes (and the way they are intertwined with economics and politics) simply fascinating. However, the only time I hear "love" and "taxes" in the same sentence is when people get a refund. I think until the government finds a way to make the tax system better understood and respected by the public, the IRS will continue to have problems with tax scams and evasion.

Professor Nellen said...

Dear Anonymous,

Thanks for the comment. In my last bullet point where I suggest a penalty on the taxpayer if they file a return prepared by a paid preparer who does not sign the return and include their PTIN, I do mean on the taxpayer. Existing law already imposes a penalty on the preparer for this, but how will the IRS know? I think the new PTIN system will only work if IRS also educates taxpayers on their obligations and enlists their help, which should also help the taxpayer in ensuring that they go to a registered return preparer.