Dishonest Preparers : Fat Refunds Lure Many to Tax Scams

Taxpayers love fat tax refunds. No wonder, then, that many were attracted to the services of Vernon Morris.

Morris, a Los Angeles tax preparer, would get refunds of as much as $4,000 for clients, often low-income blacks who could use the cash. Problem was, state Franchise Tax Board investigators say, he got these refunds by putting clients into fictitious businesses and generating false business deductions. Women clients often were made out to be fashion designers, while male clients were set up with their own building-maintenance businesses.

To support the deductions, Morris supplied clients with phony money orders, receipts and other documents, investigators say. His fee usually ran between 10% and 20% of clients’ refunds.

Time in Prison

Unfortunately for Morris, state tax officials caught on to his scheme. Earlier this month, after his plea of no contest to a felony charge of supplying fraudulent information on tax returns, he was sentenced to two years in state prison, where he is already serving time on a check-kiting conviction.

Unscrupulous tax preparers like Morris--who pocket exorbitant fees in exchange for generating illegal refunds--are a growing problem in the Los Angeles area, more so than in other parts of the nation, federal tax officials contend.

These preparers find Southern California a fertile ground in part because its large populations of minorities and recent immigrants--often hungry for cash and less sophisticated about tax laws--provide an eager client base.

Their activities, authorities say, are costing tens of millions of dollars in tax revenue while subjecting thousands of taxpayers to potential penalties and payment of back taxes that some cannot afford to pay.

“The preparers are in it to line their pockets, but they put their clients in jeopardy,” says C. Philip Xanthos, branch chief of the Internal Revenue Service’s criminal investigation division in Los Angeles.

Threat of an Audit

As part of a crackdown on this problem, the IRS in the next year plans to audit at least 50,000 taxpayers in the Los Angeles area who are believed to be clients of fraudulent preparers, Xanthos says. About 45 local preparers are currently subjects of IRS undercover investigations out of the Los Angeles office, up from about 14 last year, he says.

Indictments against as many as five alleged fraudulent preparers and two of their clients are expected to be issued today in what may be the largest-ever single issuance of indictments against preparers in the Los Angeles area. Meanwhile, IRS employees at the agency’s return-processing center in Fresno are pulling returns and freezing refunds of clients of four preparers suspected of filing fraudulent returns, says Alphonse V. Ristuccia, an IRS special agent.

But, some state and federal tax officials concede, their efforts may still not be enough. Some fraudulent preparers still escape undetected or unprosecuted because of the limited resources of the IRS, state Franchise Tax Board and prosecutors. And while California is one of the few states nationwide that requires preparers to be registered, the law is poorly publicized and does not do enough to deter dishonest preparers, some critics say.

Other critics say the problem will persist as long as the tax laws and forms are so complicated, forcing taxpayers to seek help from preparers who sometimes are poorly qualified and prone to deception.

Hesitant to Inform

Clients also are unlikely to inform on their preparers, as many willingly participate in deceptive practices, often ignorant of potential penalties and all too happy to pocket fat refunds, investigators say.

Other taxpayers figure that because of the low percentage of individual tax returns audited by the IRS--less than 2%--they are willing to take their chances. Tax officials admit that thousands and possibly millions of taxpayers cheat in a less blatant fashion on their returns, under-reporting income or inflating deductions by a few dollars here and there.

“They (taxpayers) play the odds,” says Edward Wilson, a special agent for the Franchise Tax Board who has investigated many fraudulent tax preparer cases in recent years.

“There’s a little larceny in everyone’s heart,” says John D. Berdis, administrator of the Franchise Tax Board’s criminal investigation unit in Los Angeles.

The local IRS crackdown comes as it appears the agency is making progress against tax cheating nationwide, thanks largely to improved computer cross-checking of tax documents, increased numbers of examiners and new tax laws that curb loopholes and tax shelters. A new IRS study contends that the “tax gap”--the difference between what taxpayers owe and what they actually pay--may have shrunk to between $80 billion and $90 billion in 1987, from an earlier estimate of $100 billion.

Seasonal Effect

The crackdown and new indictments also come during the heart of this year’s tax-filing season, when the IRS usually seeks to publicize its efforts against fraudulent tax practices to encourage taxpayer compliance.

To be sure, the problem of unscrupulous preparers is not new. And at first glance, it doesn’t seem all that big. In the last two years, for example, the IRS has identified about 80 unscrupulous preparers in the Los Angeles area--a fraction of the more than 7,000 legitimate preparers operating in the Los Angeles area, according to the state Department of Consumer Affairs.

The state Franchise Tax Board handles even fewer cases, investigating an average of only about 12 questionable preparers each year statewide and about six in the Los Angeles area.

But the small number of unscrupulous preparers is deceptive, authorities argue, because they generate an inordinate amount of returns.

Some prepare as many as 3,000 returns a year, far more than the average preparer, who may do only a few hundred. Seven of the 80 preparers under IRS scrutiny generated 16,300 returns for the 1986 tax year, an average of more than 2,300 each. The amount of tax revenue owed on those returns alone is estimated to total about $8.9 million, or $546 per return.

Simple Returns

These preparers can do so many returns largely because most of their clients have uncomplicated tax situations and otherwise would need to file only the simple 1040EZ or 1040A forms, the IRS’ Xanthos says.

Dishonest preparers enjoy tremendous financial incentives.

First, they charge far higher fees. An unscrupulous preparer may charge $75 to $100, where an honest one would charge only $25, Xanthos says.

The dishonest ones command such high fees often because clients don’t know better and because refunds are so large. Many charge a percentage of the refund, giving them a clear incentive to concoct the biggest refund possible--whether legal or not.

Some get very creative with their fee structures. One Hawthorne preparer, when recently visited by an IRS undercover agent posing as a prospective client, charged a tiered fee structure.

According to IRS investigators, the preparer charged $50 for an accurate return. But for $70, he offered to create fictitious deductions to get the agent a $1,000 refund. (If done accurately, the agent’s return should have resulted in an additional $1,000 in tax owed.)

For $150, the preparer offered a “deluxe package,” generating a $1,500 refund by putting the client into the Amway door-to-door sales business. The preparer even supplied an Amway starter kit and phony documents to support fictitious insurance, car, advertising and inventory expenses, the IRS’Xanthos says.

The lure of giant refunds naturally attract clients, who spread the news through word of mouth or by distributing the preparer’s business cards, investigators say. Such publicity helped the Hawthorne preparer to expand his clientele from only 300 in 1985 to 1,300 last year, according to IRS investigators.

“That’s an incredible increase in clients,” Xanthos says.

Clemencia Carandang, a wheelchair-bound hospital bookkeeper who set up a sideline business as an income tax preparer working out of her home in Carson, had clients from as far north as San Francisco, contends Sam Williams, a Franchise Tax Board special agent who investigated her case. Carandang, who catered primarily to recent Filipino immigrants, was sentenced in January to five years probation, 500 hours of community service and $48,000 in fines and legal restitution for generating fraudulent tax returns.

In many cases, preparers gain clients by misleading them about the possible risk of audits and penalties, investigators say.

Misled on Penalties

Clients are often told that the worst thing that could happen if they are caught is that they will pay back taxes and interest owed, investigators say. Clients are not told, however, that they may be liable for fraud or negligence penalties that could add as much as 50% to interest owed and 75% to taxes owed.

Clients also are not told they may be subject to criminal prosecution, although cases of individual taxpayers being charged are rare, in part because authorities need their cooperation to help nail the preparers.

When clients have been audited and forced to pay taxes, interest and penalties, the consequences in some cases are quite severe. Many clients have had difficulty paying because their preparers took a big chunk of the refunds as their fees. And by the time clients are called on the carpet, many have spent the rest of their refunds.

Vernon Morris, the preparer who put clients in fictitious businesses, preyed on young, unsophisticated, low-income blacks “who really could use the refund money,” says Franchise Tax Board investigator Wilson. These clients usually were hard pressed to pay back funds to the state, Wilson says. The state attached the wages of some clients; one was forced to give up his apartment and move in with his parents, Wilson says.

Costly to the Clients

Some clients of John Cestare, a preparer who pleaded guilty to filing fraudulent returns, also were hard pressed. Cestare, who made clients fictitious partners in money-losing television productions, generated such large bogus deductions that clients got refunds not only for the current year but for the three previous years as well, according to Kendra McNally, an assistant U.S. attorney who worked on the case.

But Cestare’s fees also were hefty as he pocketed 50% of the current year’s refunds and 75% to 85% of the previous three years’ refunds, McNally says.

In not all cases, however, are clients knowing participants in fraudulent practices.

Harold Taylor, who ran a tax preparation service in Inglewood and was recently sentenced to 16 months in prison and a $10,000 fine, had clients sign legitimate returns and paid them up front what they expected to get in refunds, since the actual refund checks would go to him instead of clients, according to state investigator Wilson. But after clients signed the returns, Taylor would then doctor them, adding dependents and deductions to generate higher refunds, Wilson says. Taylor then pocketed the difference.

Authorities appear to be getting more skilled at detecting and catching dishonest preparers, thanks to increased computer matching of information from W-2s and other documents with actual returns.

But some critics and tax officials say they could do even better.

Bruce Hochman, a Beverly Hills attorney who represented Clemencia Carandang, the Carson preparer who pleaded guilty to filing fraudulent returns, contends that tax authorities would handle more cases if they pursued more civil rather than criminal remedies.

The state Department of Consumer Affairs requires all preparers in California to be registered, with the exception of certain practitioners such as attorneys and certified public accountants and anyone authorized to practice before the IRS. To be registered, a preparer must meet certain minimum training requirements and post a $2,000 bond.

But a lot of preparers don’t know about the registration requirement, admits Donald G. Procida, administrator of the program. And registration doesn’t seem to stop some unscrupulous preparers. For example, Harold Taylor, the Inglewood preparer who doctored clients’ returns after they signed them, was legally registered.

Some investigators also complain that the fines and prison sentences against fraudulent preparers are not stiff enough. Some preparers convicted of filing false returns get right back into the business, sometimes by having friends or relatives sign returns, investigators say.

Many preparers also escape detection, at least temporarily, by not signing their names to clients’ returns, investigators say.

“It is a recurring problem,” the IRS’ Xanthos admits. “There are a lot of recidivists.”