New York Sting Nabs Tax Preparers

WSJ Tax article
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New York Sting Nabs Tax Preparers

NOVEMBER 26, 2008, 12:06 A.M. ET

By TOM HERMAN

New York State tax officials say they have uncovered evidence of significant fraud among professional tax-return preparers in a statewide sting operation in which undercover agents posed as clients.

Officials say they're startled not only by the unexpectedly large amounts of tax evasion they witnessed -- such as hiding taxable income and inflating deductions -- but also by the brazen nature of the cheating, which was caught on secret recordings. In one case, for example, a preparer told an undercover investigator: "I did not declare your full gross income from your business because you will pay a lot of taxes," according to a criminal complaint filed recently against a Queens, N.Y., preparer.

In another case, a tax preparer said he is going to report only $13,188 as taxable income, instead of the $131,884 the undercover agent had said was the correct amount, says an official at the New York Department of Taxation and Finance. Another preparer, referring to records given to him by the undercover agent, said: "This one and this one, I never saw this. It's going into the shredder."

Officials have already begun prosecuting some preparers on criminal charges, and they expect additional criminal prosecutions against other preparers -- as well as some clients, says William Comiskey, the tax department's deputy commissioner, office of tax enforcement. Officials will also be seeking civil fraud penalties against preparers. Mr. Comiskey says some preparers have agreed to cooperate and go undercover to show that their clients knew of the fraud and build evidence against those clients -- and, in some instances, against other preparers.

"They are cooperating against their former clients in other ways as well," such as sharing client lists and identifying fraudulent returns, Mr. Comiskey says. He says the state hasn't yet investigated tax-preparation chains, and that most of the preparers "were sole practitioners or were in small group practices."

Officials say they found evidence of fraud among about 40% of the 85 professional tax-return preparers they visited. If all the phony returns that were prepared had actually been filed, "it would have cost the federal, state and local governments approximately $4 million" in taxes, says Mr. Comiskey.

The sting operation, which began in fall 2007 and is continuing today, is part of New York's greatly increased crackdown on tax cheating. In the seven months through October, New York's tax department opened 1,378 criminal fraud investigations -- more than in any prior year and more than twice as many as the 581 cases opened in all of fiscal 2007. The department referred 329 cases to prosecutors in the past seven months, up from 271 in the entire prior fiscal year and 198 the year before that. The department also has increased the number of staffers devoted to fraud enforcement to about 125, up from 25 in early 2007, and hopes to expand further.

"We are trying to project a decidedly different persona" than in the past, Mr. Comiskey says. "We're trying to make it clear we are becoming much more aggressive" in the battle against tax fraud.

With state and local budget woes mounting rapidly, more revenue-hungry states are likely to follow New York's example and beef up tax-enforcement efforts. Although state-tax officials acknowledge today's bloated budget deficits can't be eliminated solely by tougher enforcement, they say increased enforcement can help close the gap -- and also help reassure honest taxpayers that they aren't chumps. Moreover, cracking down on fraud is considered smarter and politically safer than raising taxes on law-abiding voters, especially during this grim economic slump.

The results of the New York sting operation could bolster congressional efforts to expand regulation of paid preparers -- such as requiring certain training and competency standards and imposing stiffer punishment on wrongdoers -- as a key ingredient in government efforts to combat cheating. Lawmakers have been leaning hard on the Internal Revenue Service to do a better job of closing the nation's $290 billion-a-year "tax gap," the difference between what's actually collected and what the IRS estimates should be. Already, IRS and Justice Department officials have begun stepping up their efforts to nab tax cheating by preparers.

In recent years, growing numbers of taxpayers have hired someone else to do their returns. Some 60% of all individual taxpayers now hire a preparer to do their returns, up from 46% in the mid-1980s, according to IRS data. While nobody knows exactly how many preparers there are, estimates generally have ranged as high as 1.6 million. That list includes many highly trained pros -- such as tax lawyers, certified public accountants and enrolled agents -- who already face stiff professional regulation. But it also includes hundreds of thousands of other preparers, such as sole practitioners in storefront operations who have little or no training or credentials and face little or no regulation.

In New York, tax-department officials say the results of their sting operation and their beefed-up enforcement efforts have convinced them that the tax-cheating problem is significantly greater than they previously had thought.

In almost all the cases, tax-department staffers posed as people who worked in all-cash businesses. In some cases, they sought help with sales-tax returns and brought books and records of their "business."

In one case, a preparer told an undercover agent to step outside his office and return with a different set of records. When he returned, the preparer told him: "You know why I asked you to do that? Because if I have to swear it, I can say I swear to God that these are the papers you brought to me."

IRS studies have demonstrated that people tend to be far more honest in reporting their income when that income is subject to tax withholding and when the taxpayer reports the income to the IRS. Income that isn't subject to tax withholding or to separate reporting is far more likely to be misreported.

New York officials have opened criminal investigations against dozens of clients and also sent out some 1,570 letters to other former clients who used the preparers. "Returns prepared by your tax preparer are being examined for potential misstatements," the letter says, adding that the preparer "has admitted to assisting taxpayers in the filing of fraudulent and inaccurate" returns.

It goes on to warn taxpayers that their returns may be audited and urges them to act now to avoid possible penalties by participating in the state's new voluntary-disclosure and compliance program.
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