A taxing perspective on fraud

About that headline above: we're just kidding, of course, about the "taxing perspective" part. In fact, we've written this column to help those of you who aren't "tax types" to see how an educator can easily provide a different, yet important, perspective on fraud to students.

Incorporating tax fraud ("tax evasion" for you attorneys) into a fraud examination class provides many benefits to students. First, it gives them a different perspective about the pressure leg of the fraud triangle by shedding light on a possible motive to commit fraud, such as keeping assets due to federal, state and local governments. It's important to tell students that even if tax fraud wasn't the primary motivation for fraud in a case, a perpetrator's desire (and pressure) to not be prosecuted for tax fraud is one more reason for him or her to evade law enforcement.

Secondly, students will learn how perpetrators commit tax fraud and the applicable laws. This will be important knowledge when they become CFEs and might have to spot the telltale signs of tax fraud and understand its relationship to money laundering. (Tax fraud is money laundering's first cousin.)

Thirdly, students will become more aware of further employment opportunities, which include working for the Internal Revenue Service (IRS) and, on the other side of the table, assisting lawyers who defend those charged with tax fraud.

INCORPORATING TAX FRAUD COMPONENTS

How can educators incorporate tax fraud components into their classrooms? One approach is to engage in either the daylong or three-hour version of IRS' hands-on, role-playing tax fraud examination adventure, "The Adrian Project." Contact your local IRS office to see if it offers this fun educational endeavor.

You can incorporate tax fraud into your fraud examination class by requiring each student to choose a case that has been adjudicated in court or has been reported in the media that does not contain a discussion of the tax implications of the fraud. The student will submit a one-page paper that summarizes the facts of the case and, in a separate section, state the law (by title and section number) that the fraudsters most likely violated with reasons why they violated the law. Each student's paper should also include a listing of all elements of the law or laws the fraudsters violated.

Before you give this assignment, do two things: 1) provide students the major ways tax fraud is committed, and 2) briefly lecture on the major statutory sections of which the student should be aware.

Here are the few ways most tax fraud is committed: 1) underreporting income (including not reporting income at all) 2) overstating deductions and/or credits and 3) providing false information other than amounts on returns. The first two ways are probably obvious. Two examples of the third way of committing tax fraud include the situations in which tax evaders either lie about having signatory authority over a foreign bank account, such as not checking the correct boxes at the bottom of Schedule B (Interest and Ordinary Dividends), or mischaracterize income, such as calling the sale of illicit drugs on Schedule C (Profit or Loss from Business) sales of nutritional supplements.

ELEVEN FRAUD-RELATED SECTIONS  

We recommend teaching just 11 sections of the tax (and related criminal) code. Seven of the sections are Title 26 (Internal Revenue Code) sections: 7201, 7203, 7206(1), 7206(2), 7207, 7202 and 7212(A). Other sections are in Title 18: 371, 1001, 1341 and 1343. Because the purpose of the assignment is to familiarize the students with the sections, rather than transforming them into tax experts, we usually ask the students to focus on these sections. (See the accompanying sidebar at bottom that shows the information we expect students to know about these sections.)

You can tell students that, in addition to the criminal penalties, a civil fraud penalty (26 USC 6663) of 75 percent of the underpayment due to fraud can be added to the underpayment and a 20 percent civil accuracy-related penalty (26 USC 6662) because of negligence can be applied to the portion of the underpayment that isn't due to fraud. (In other words, both penalties can't be assessed against the same dollar of underpayment.)  

The code sections associated with tax fraud are relatively stable unlike the more familiar tax code sections that seem to change every year. Even if you don't know much about taxes, students can easily understand your rudimentary overview. Just tell them that the level of knowledge you expect them to achieve can be helpful when assisting defendants or helping to prosecute guilty parties.

Another way to have students view fraud from the IRS' perspective is to read the red flags of tax fraud codified in the agency's manual. Those interested in further reading about investigating criminal tax fraud can visit the IRS' page on criminal investigation and the Department of Justice Criminal Tax Manual.  

If you have time, discuss IRS information-gathering techniques, such as the IRS administrative summons (as contrasted with the general summons), John Doe summons, third-party summons and grand jury subpoena. 

You can also briefly mention vehicles through which perpetrators can commit tax fraud, such as placing money offshore and money laundering. You can teach them that the recent interest in confronting terrorism means that offshore tax havens are coming under increasing scrutiny as the demonic tools of terrorist finance. You also can cover money laundering's role as the "cousin of tax fraud" because of its significant role in providing asset-cloaking techniques that make it difficult to follow the money.

CONSIDER THIS INTEGRAL COMPONENT

Educators often don't include tax fraud as a significant topic in fraud examination courses. However, each year tax evaders deprive federal and state governments of hundreds of billions of dollars in revenues. Many CPAs and CFEs will encounter tax fraud either as part of a larger fraud case or as a stand-alone case. Tax fraud basics can be a vital and exciting topic area for any fraud examination course.

Sidebar:

All the U.S. tax code sections on fraud your students will ever need

26 USC 7201 — Any person who willfully attempts to evade or defeat any tax or the payment of any tax is guilty of a felony. Penalties include:

• Imprisonment of not more than five years,
• Fines of not more than $250,000 ($500,000 for corporations)* or
• Both, together with the costs of prosecution.

This section defines two distinct crimes: the attempt to defeat or evade a tax and the attempt to defeat or evade the payment of any tax. The former is prosecuted more often than the latter. A person other than the taxpayer can commit this offense.

26 USC 7203 — Any person who willfully fails to file any return, keep any records or supply any information required by the Internal Revenue Service is guilty of a misdemeanor. Penalties include:

• Imprisonment of not more than one year,
• Fines of not more than $100,000 ($200,000 for corporations) or
• Both, together with the costs of prosecution. 

A person other than the taxpayer can commit this offense.

26 USC 7206(1) — Any person who willfully makes and subscribes (or signs) any return, statement or other document under written declaration under penalties of perjury and that doesn't believe every material matter true and correct is guilty of a felony. Penalties include:

• Imprisonment of not more than three years,
• Fines of not more than $250,000 ($500,000 for corporations)* or
• Both, together with the costs of prosecution

26 USC 7206(2) — Any person who aids or assists in or procures, counsels or advises in the preparation or presentation of a return, affidavit, claim or other document that's fraudulent or false as to any material matter, whether or not such fraud or falsity is with knowledge or consent of the person authorized or required to present such return is guilty of a felony. Penalties include:

• Imprisonment of not more than three years,
• Fines of not more than $250,000 ($500,000 for corporations)* or
• Both, together with the costs of prosecution.

The IRS uses this provision mostly to prosecute tax practitioners. It has prosecuted violators for such actions as backdating documents and using inflated appraisals to increase those taxpayers' write-offs.

26 USC 7202 — Any person who's required to collect, account for and pay over any tax imposed by the Internal Revenue Code and willfully fails to collect or truthfully account for and pay over this tax is guilty of a felony. Penalties include:

• Imprisonment of not more than five years,
• Fines of not more than $250,000 ($500,000 for corps)* or
• Both, together with the costs of prosecution.

This section pertains to fraud involving trust-fund taxes such as payroll taxes.

26 USC 7207 — Any person who willfully delivers to the IRS any list, return, account, statement or other document known to be fraudulent or false as to any material matter is guilty of a misdemeanor. Penalties include:

• Imprisonment of not more than one year,
• Fines of not more than $100,000 ($200,000 for corporations) or
• Both, together with the costs of prosecution.

26 USC 7212(A) — Any person who corruptly or by force endeavors to intimidate or impede any officer or employee of the U.S. acting in an official capacity under the Internal Revenue Code or in any other way corruptly or by force obstructs or impedes or endeavors to obstruct or impede is guilty of a felony. Penalties include:

• Imprisonment of not more than three years,
• Fines of not more than $250,000 ($500,000 for corps)* or
• Both, together with the costs of prosecution. 

This section applies to efforts to hide income and supply false information to the IRS.

18 USC 371 — If two or more persons conspire either to commit any offense against the U.S. or to defraud the U.S. or any agency thereof in any manner or for any purpose and one or more persons commit any act to achieve the objective of the conspiracy, each person is guilty of a felony. Penalties include:

• Imprisonment of not more than five years,
• Fines of not more than $250,000 ($500,000 for corps)* or
• Both, together with the costs of prosecution.

18 USC 1001 — Any person who knowingly and falsely conceals or covers up any material fact by any scheme or trick or makes or uses any false writing in connection with any matter within the jurisdiction of the U.S. is guilty of a felony. Penalties include:

• Imprisonment of not more than three years,
• Fines of not more than $250,000 ($500,000 for corporations)* or
• Both, together with the costs of prosecution.

Taxpayers and their advisors who attempt to cover up a problem during an audit or investigation can be convicted under this section.

18 USC 1341, 1343 — The federal mail fraud statute (1341) applies to anyone who devises or intends to devise a scheme to defraud for the purpose of obtaining money or property by false pretense or uses the mail to execute the scheme. Wire fraud (1343) applies to anyone who transmits across state lines by wire, radio, television or the Internet any pictures, writings or sounds for the purpose of executing a fraudulent scheme. Violation of either statute is a felony carrying maximum imprisonment of five years. Courts have upheld convictions of mail fraud in cases involving false income tax returns using fictitious names to obtain refunds.

*As modified by 18 USC 3571

Carl Pacini, Ph.D., J.D., CPA, is an associate professor of accounting at the University of South Florida-St. Petersburg. He also teaches as an adjunct professor of forensic accounting at Florida Atlantic University. Pacini has published more than 75 articles in accounting and law journals and is a member of the ACFE Higher Education Advisory Committee. 

George R. Young, Ph.D., CFE, CPA, Educator Associate, is an associate professor at Florida Atlantic University and the academic director of the forensic concentration in the Masters of Accounting program at the university. He is chair of the ACFE Higher Education Advisory Committee and co-author of "Forensic Accounting and Fraud Examination," a textbook published by McGraw-Hill. 

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