The tax preparation industry is big business. Each year around $20 billion is paid to software companies and preparers of individual tax returns and well over $3 TRILLION flows between Uncle Sam and taxpayers in the form of refunds and taxes owed. With this much money at stake, it shouldn’t be a surprise that there is some fraud involved. However, most people don’t realize how prevalent it is. Let’s look at three of the most widespread and despicable forms of tax fraud and tax preparation scams.
The amount of identity theft committed via tax preparation is staggering. IRS has identified 14.6 million false returns and stopped $50 billion in fraudulent refunds from 2012 to 2014 alone. Investigations of tax-related identity theft are up 66 percent during this same period, indicating this is a growing problem.
How does it work? The criminal simply files a tax return with the victim’s social security number and has the tax refund delivered to them instead of the taxpayer. This is a nightmare for the victim, of course. They must file their taxes by mail, but more importantly they must call the IRS to get the refund they’re owed and get the fraudulent return corrected. The victim will get their money—eventually, but it could be delayed for months. The IRS says a typical case can take about 180 days to resolve.
What can you do to minimize the chance of falling victim to this type of identity theft?
- File your taxes early. The IRS only allows one tax return per social security number per year, so if you file in January instead of April, you reduce the amount of time the bad guys can hijack your identity.
- Check your credit report every 12 months.
- Don’t carry your Social Security card or any document(s) containing your SSN Don’t give a business your SSN just because they ask, give it only when required.
- Protect your computers by using antivirus software, downloading recommended security patches, and frequently changing passwords for online accounts.
- Don’t give personal information over the phone, through the mail, or on the Internet unless you’ve initiated contact yourself, or you’re sure you know who you’re dealing with.
- Do not respond to an unexpected email or text message that claims to be from the IRS. The IRS always initiates contact with taxpayers by mail.
Tax Preparer Fraud
Sometimes the wolf is in sheep’s clothes. In this type of fraud, a tax preparer creates big refunds by lying on the tax return, giving both the preparer and taxpayer a nice payday, usually without the taxpayer’s knowledge. The preparer increases the refund by claiming false deductions, excessive exemptions, and manipulating income figures to obtain tax credits, such as the Earned Income Tax Credit, fraudulently. The preparer then uses the large refund amount to justify a higher fee to their unsuspecting clients.
When the IRS detects the false return, the taxpayer — not the return preparer — must pay the additional taxes and interest and may be subject to penalties.
What can you do to avoid being defrauded by a tax preparer?
- Be careful with preparers who claim they can obtain larger refunds than other preparers. This is a warning sign they may be up to something.
- Do your homework to find a qualified, professional preparer – read reviews online, ask your friends and family for recommendations, and ask the preparer for references.
- Find out the person’s credentials. At a minimum the preparer must have a PTIN (Preparer Tax Identification Number). Many preparers are Enrolled Agents (EAs) or CPAs as well.
- No matter who prepares your tax return, you are ultimately responsible for all of the information on your tax return, so review your return before you sign it and ask questions on anything you don’t understand. Never sign a blank form.
- Be sure the preparer signs your tax return and provides you with a copy for your records.
- Avoid the problem altogether by doing your taxes yourself with software. Be sure to choose a software company that is part of the IRS e-file program, as IRS does background checks on the company and executives before they’re accepted into the program.
The average refund is around $2,500 and is the largest single check many Americans get all year. Unscrupulous preparers take advantage of this fact and overcharge consumers, cloaking it in the shadow of a large refund check.
For years, the most common method of predatory pricing was the Refund Anticipation Loan (RAL). Similar to a payday loan, this is a short term loan that uses a forthcoming check as collateral. In this case it’s the taxpayer’s refund check. After fees and interest, the APR often is in the triple digits! Thankfully, the government is pressuring lenders to stop such usury and most major US banks ceased making RALs in 2013. However tax preparers and cash advance businesses are still offering similarly expensive financial products with hard to decipher interest rates to vulnerable consumers.
Another form of predatory pricing is the lack of pricing transparency by many tax preparers. Some do this by charging customers a percentage of their refund rather than a fixed dollar amount. 20% sounds like a bargain until you realize you’re getting a $2,000 refund and you unknowingly agreed to pay $400 for tax prep. Other shops assert that they charge by the form and cannot predict which forms will be generated until they actually finish the tax preparation. Thus, consumers cannot comparison shop or predict how much they will actually be charged. Preparers trick taxpayers into overpaying by hundreds of dollars by disguising the actual cost of their services using these and other shady tactics.
How can you avoid being price gouged?
- Ask for a quote up front, and don’t do business with anyone that won’t provide one.
- Don’t pay until you see the final return and fee structure. Don’t sign the return if you aren’t happy with the service and price.
- If you get any sort of loan or cash advance for your refund, be sure you understand the fee structure, including the annualized interest (APR).
- Know what you should be charged. Software typically costs around $50 all-in, and retail tax stores charge around $200 on average.
By following the tips above, you can avoid becoming a victim of the three biggest tax scams in America.
Bill Hendricks is the CEO and co-founder of Common Form, which helps people with simple finances file taxes in 5 minutes from their phone or computer.