The Tax Scam to Worry About the Most: The Unethical Preparer

SAN FRANCISCO – The IRS recently released its annual "dirty dozen" tax scams, but many taxpayers - those eager to stay on the right side of the law — are unlikely to be embroiled in most of these complex and illegal ruses, some say.

That's because many of the 12 scams are clear attempts to sneak around current tax law. For instance, No. 2 on the list is "abusive Roth IRAs," of which one example entails a business-owner creating a shell corporation with a Roth IRA and paying undervalued property into the IRA to avoid contribution limits. That one word - "undervalued" - should set off some alarms.

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"You don't need to be a tax expert to realize that these do not appear legitimate," said Bob Scharin, a New York-based senior tax analyst with RIA, of Thomson Tax & Accounting. Most of the scams "seem to be based on greed and wishful thinking," he said.

No. 1 on the dirty dozen list - abuses related to the telephone excise tax refund — is another example. Some taxpayers are requesting amounts far in excess of the $30 to $60 standard refund amount available for this one-time tax perk.

It's true that if taxpayers don't want to claim the standard amount, they can dig out their relevant telephone bills, add up the 3 percent tax they paid on long-distance calls and claim that amount — but some taxpayers are going overboard, requesting refunds in the tens of thousands of dollars, said Nancy Mathis, an IRS spokeswoman.

It seems likely that at least some oversized refund requests are deliberate. "When people are asking for a $1,000 refund, people have to realize it's not what Congress intended," Scharin said.

Meanwhile, many taxpayers are facing another problem related to the telephone excise tax: Failing to claim it at all.

In general, the scams detailed on the dirty dozen list offer taxpayers a clear message, said Mark Luscombe, a principal analyst with CCH Inc., a Riverwoods, Ill., tax publisher.

"If you're gullible ... don't be so gullible, and if you're trying to evade (tax law), the message is the IRS is looking for you," he said.

The mother of many scams

The dirty dozen scam taxpayers really need to worry about is No. 6, "return preparer fraud." If they fall for the ploys of an unscrupulous preparer, they're likelier to file, say, a "Form 843 tax abatement" — that's No. 11 on the list - or use No. 12, a "frivolous argument." See the IRS' list of 'dirty dozen' scams.

An unethical tax preparer might convince you that you can take the American Indian Employment Credit (No. 7 on the list), for instance. It is, after all, a legitimate tax credit for employers to take, Luscombe said. But it's not available to individual filers.

"It sounds like someone trying to make money off American Indians by claiming to them they can help them avoid paying taxes ... and then taking a profit and filing the returns. Then the person finds out it's all bogus, but by then they've lost the money to the promoter," he said.

Return preparer fraud is one of two scams on the list to which even taxpayers eager to do everything above-board may fall prey. The other such scam is phishing, where fraudsters send fake "IRS" e-mails to unsuspecting victims, promising to send a missed refund if the taxpayer will simply input some personal account information. The IRS does not request such information by e-mail.

It's easy enough to deal with e-mails purporting to be from the IRS: Click "delete" immediately. Finding the right tax return preparer will take a bit more time.

One rule is easy: Avoid preparers who promise large refunds even before seeing your tax information, Scharin said. Instead, find a preparer by asking people you know for recommendations. "Probably the best thing is word-of-mouth from people who have similar types of tax situations," he said. "If you're a business owner, then you need someone who has different experience and skills than a salaried employee's return preparer."

Also, make sure the return preparer is asking questions about your situation, not simply accepting the paperwork you hand over, Scharin said. You might have forgotten something. One key question the tax pro should ask is whether you've gone through any changes over the course of the year. Some major tax-related changes include getting married, buying or selling a home, taking a retirement plan distribution, and starting to pay for college.

Finally, "everyone does not need the top tax expert to do their return," Scharin said. "Just like we all don't need the top surgeon for a minor medical procedure. Look for someone who's competent and has the time to do your return properly and on a schedule that works for you."

Also, read the National Association of Tax Professionals' brochure on how to find a tax professional - it offers a list of questions to ask when you're looking around for a tax return preparer. See the NATP brochure (PDF document).

Once you find a preparer you trust, consider asking her to review any new financial deals you're interested in - such as No. 9 on the list, "structured entity credits" - before you sign on the dotted line. If the tax savings sound too good to be true, you know that means.

IRS success

Of course, the dirty dozen list has its uses. Some scams highlighted on the list in years past are no longer a problem, the IRS' Mathis said.

"A few years ago, slavery reparations were a huge issue and some African American taxpayers were improperly trying to claim billions in refunds," Mathis said, in a follow-up e-mail.

"This was a combination of honest taxpayers making mistakes based on rumors and unscrupulous promoters touting the idea and making money off of it. But the dirty dozen list helped get the word out that this reparation did not exist." Taxpayers are no longer claiming such reparations on their tax returns, she said.

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