United States. Congress. House. Committee on Ways.

IRS filing systems vulnerable to tax refund fraud : hearing before the Subcommittee on Oversight of the Committee on Ways and Means, House of Representatives, One Hundred Third Congress, second session, February 10, 1994 online

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IRS nUNG SYSTEMS VULNERABLE TO TAX
REFU ND FKAUD

Y 4. U 36: 103-52

IRS Filing Systens Uulnerable to Ta...

HEARING

BEFORE THE

SUBCOMMITTEE ON OVERSIGHT

OF THE

COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES

ONE HUNDRED THIRD CONGRESS

SECOND SESSION



FEBRUARY 10, 1994



Serial 103-52



Printed for the use of the Committee on Ways and Means




JON 2 7 J994



U.S. GOVERNMENT PRINTING OFFICE
77-603 CC WASHINGTON : 1994

For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
ISBN 0-16-044068-8




IRS nUNG SYSTEMS VULNERABLE TO TAX
REFU ND FKAUD

Y 4. W 36; 103-52

IRS Filing Sgstens Uulnerable to Ta. . .

HEARING

BEFORE THE

SUBCOMMITTEE ON OVERSIGHT

OF THE

COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES

ONE HUNDRED THIRD CONGRESS

SECOND SESSION



FEBRUARY 10, 1994



Serial 103-52



Printed for the use of the Committee on Ways and Means



'^^ff^itmmaHuii^,,^^




JUn 2 7 1934



U.S. GOVERNMENT PRINTING OFFICE
77-603 CC WASHINGTON : 1994



For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
ISBN 0-16-044068-8



COMMITTEE ON WAYS AND MEANS
DAN ROSTENKOWSKI. Illinois. Chairman



SAM M. GIBBONS, Florida
J.J. PICKLE, Texas
CHARLES B. RANGEL, New York
FORTNEY PETE STARK, California
ANDY JACOBS, Jr., Indiana
HAROLD E. FORD, Tennessee
ROBERT T. MATSUI, California
BARBARA B. KENNELLY, Connecticut
WILLIAM J. COYNE, Pennsylvania
MICHAEL A. ANDREWS, Texas
SANDER M. LEVIN, Michigan
BENJAMIN L. CARDIN, Maryland
JIM McDERMOTT, Washington
GERALD D. KLEC?;KA, Wisconsin
JOHN LEWIS, Georgia
L.F. PAYNE, Virginia
RICHARD E. NEAL, Massachusetts
PETER HOAGLAND, Nebraska
MICHAEL R. McNULTY, New York
MIKE KOPETSKI, Oregon
WILLIAM J. JEFFERSON, Louisiana
BILL K. BREWSTER. Oklahoma
MEL REYNOLDS, Illinois



BILL ARCHER, Texas
PHILIP M. CRANE, Illinois
BILL THOMAS, California
E. CLAY SHAW, Jr., Florida
DON SUNDQUIST, Tennessee
NANCY L. JOHNSON, Connecticut
JIM BUNNING, Kentucky
FRED GRANDY. Iowa
AMO HOUGHTON. New York
WALLY HERGER, California
JIM MCCRERY. Louisiana
MEL HANCOCK, Missouri
RICK SANTORUM. Pennsylvania
DAVE CAMP. Michigan



Janice Mays, Chief Counsel and Staff Director
Charles M. Brain, Assistant Staff Director
Phillip D. MoselEY, Minority Chief of Staff



Subcommittee on Oversight

J.J. PICKLE, Texas, Chairman



HAROLD E. FORD, Tennessee
CHARLES B. RANGEL. New York
WILLIAM J. JEFFERSON, Louisiana
BILL K. BREWSTER, Oklahoma
GERALD D. KLECZKA, Wisconsin
JOHN LEWIS, Geoiigia



AMO HOUGHTON, New York
WALLY HERGER, California
MEL HANCOCK, Missouri
RICK SANTORUM. Pennsylvania



(II)



CONTENTS



Page

Press release of Monday, January 31, 1994, announcing the hearing 2

WITNESSES

U.S. Department of the Treasury, Internal Revenue Service, Hon. Margaret
M. Richardson, Commissioner, Michael Dolan, Deputy Commissioner, and
Ted F. Brown, Refund Fraud Executive 22

U.S. General Accounting Office, Jennie S. Stathis, Director, Tax Policy and
Administration Issues, and David J. Attianese, Assistant Director, Tax
Policy and Administration Issues 38

Becht, Barry, Goldsboro, N.C 5

Todd, Frazier B., Jr., Atlanta, Ga 8

SUBMISSION FOR THE RECORD
Electronic Filing Coalition, statement and attachment 72

(III)



IRS FILING SYSTEMS VULNERABLE TO TAX
REFUND FRAUD



THURSDAY, FEBRUARY 10, 1994

House of Representatives,
Committee on Ways and Means,

Subcommittee on Oversight,

Washington, D.C.
The subcommittee met, pursuant to call, at 10 a.m., in room
B-318, Raybum House Office Building, Hon. J.J. Pickle (chairman
of the subcommittee) presiding.

[The press release announcing the hearing follows:]



(1)



FOR IMMEDIATE RELEASE PRESS RELEASE #19

MONDAY, JANUARY 31, 1994 SUBCOMMITTEE ON OVERSIGHT

COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
1135 LONGWORTH HOUSE OFFICE BLDG.
WASHINGTON, D.C. 20515
TELEPHONE: (202) 225-5522

THE HONORABLE J. J. PICKLE (D., TEXAS), CHAIRMAN,

SUBCOMMITTEE ON OVERSIGHT, COMMITTEE ON WAYS AND MEANS,

U.S. HOUSE OF REPRESENTATIVES,

ANNOUNCES A HEARING ON TAX REFUND FRAUD



The Honorable J. J. Pickle (D., Texas), Chairman, Subcommittee on
Oversight, Committee on Ways and Means, U.S. House of Representatives,
announced today that the Subcommittee will hold a hearing on Internal
Revenue Service (IRS) efforts to identify ctnd prevent touc refund fraud,
particularly with regard to electronically filed returns. The hearing
will be held on Thursday, Febiruary 10, 1994, beginning at 10:00 a.m.,
in room B-318 Raybum House Office Building. IRS Commissioner
Margaret Milner Richardson and individuals involved in tax refund
schemes will appear as witnesses at the hearing.

In announcing the hearing. Chairman Pic)cle stated, "IRS continues
to be challenged by taxpayer schemes to defraud the tax system for
refunds that they are not entitled to. Each year, individuals and tax
preparers are becoming more sophisticated in devising ways to cheat the
system. While IRS is taking steps to detect fraud, the agency also, to
a large degree, is playing "catch-up."

"The Subcommittee needs to assess what IRS is doing up- front to
prevent tax refund fraud and what actions are being taken against
parties who defraud the teix system. While criminal action against
abusers is important, tax refund fraud is not an issue that can be
'prosecuted away.' IRS must be more diligent in implementing
procedures to eliminate fraud before refunds are issued. Further, with
IRS's goal of having 80 million taxpayers file electronically by year
2000, the agency must deal with this type of growing fraud now, before
it's too late. Electronic-filing fraud is a serious enforcement
problem for IRS because of the speed with which electronically filed
returns are processed and refunds issued."

BACKGROUND :

In 1993, IRS identified about twice as many paper and electronic
tax returns involving fraudulent refund claims than were identified in
1992. IRS detected approximately 36,000 fraudulent refund claims on
paper returns involving about $61 million in refunds, and about 25,000
fraudulent refund claims made through electronically filed returns
involving about $53 million in refunds. In 1992, IRS identified about
12,000 fraudulent refund claims on paper returns involving about
$33 million in refunds, and about 15,000 fraudulent refund claims made
through electronically filed returns involving about $34 million in
refunds.

In 1993, IRS was able to stop payment of only 86 percent of the
$61 million in fraudulent refunds claimed on paper returns, and only
54 percent of the $53 million in fraudulent refunds claimed on
electronically filed returns. As a result, IRS lost at least
$33 million due to refund fraud. Furthermore, IRS has no way of
assessing whether the agency is catching all, most, or only a small
amount of tax refund fraud.

In 1994, IRS plans to use a variety of existing and new procedures
to detect fraud involving both paper and electronically filed returns.
IRS will continue to use: computer criteria to screen potentially
fraudulent refund claims; the box known as the "funny box" for flagging
paper returns filed at the Service Center that look suspicious; and
checks in the electronic filing program such as rejecting returns with
invalid Social

(MORE)



Security numbers rejecting returns from first-time filers, and delaying
issuance of refunds for certain "high-risk" returns. In addition,
several new concepts will be used by IRS, such as: artificial
intelligence to detect broad -reaching and sometimes national refund
fraud schemes, and "tiger teams," which are groups of IRS experts
responsible for developing possible fraud schemes and testing IRS's
systems to insure the schemes are detected.

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS :

Persons submitting written comments for the printed record of the
hearing should submit six (6) copies by the close of business,
Wednesday, March 2, 1994, to Janice Mays, Chief Counsel and Staff
Director, Committee on Ways and Means, U.S. House of Representatives,
room 1102 Longworth House Office Building, Washington, D.C. 20515.

FORMATTING REOUIREMENTS :

Each statamsnl presented for printing to ttw CommiSee by ■ witneu. any written statement or exhbit sutHnitted for tht pnnted record or any
written comments in response to a request tor wnoen comments must confonri to the guidelirtes listed below Any statement or exhibit not in
complance with these guOalines will not be pmied. but win be mantaned n the Committee fUes for revnw and use by the Committee

1 . All statements and any accompanyng exhibia for pnnting must be typed in single space on legalize paper and may not exceed a total
of 10 pages.

2. Copies of \i>hols documents submMad as exhM material «•■ not be acceplad tor printing Instead, axhM material ahould be leiaranoad
and quoted or paraphrased AI exh(b< mateiial not meet i ng these apadficalions wfl be maintaned in the Cocnniltee tiles tor re«ew and
use by the Commaiee

3 Statements rrtust contain ttie name and capacity in which the i«ritness will appear or. for written comments. tt>e name and capacity of ttie
person submtbrig the statement as wel as any dMnts or persons, or any organization for whom the w^ess appears or for whom the
statement » submitted

4 A supptementai sheet must accompany each staterrient listing ttw name, ful address, a telephone numtier wtiere tt>e witness or ttie
designated representative may be reached and a topcal outsr^e or summary of the comments and recofTimendsbons in the fol statement
Ths supptementai stieet iiril not be ndixJed vi tt>e pmied record

The above restndions and Ifnistions apply only to material bang submoed for pnnling Staterrwnts and eihib<s or supplementary matenal
submitted solely tor datrtiution to the Me m bers, the press and the pubtc dunng the course of a publK heanng may be submitted in other fomis



Chairman PiCKLE. We will ask the subcommittee to please come
to order and also ask our guests to please take their seats.

I have an opening statement and Mr. Houghton has an opening
statement and other members of the committee, as they arrive,
may also, but we have a reasonably lengthy session today and we
want to get with it.

Today the subcommittee will examine the vulnerability of IRS's
filing system to tax refund fraud and what the IRS is doing to ad-
dress this fraud. The Oversight subcommittee has long been con-
cerned that the IRS is being ripped-oflf by criminals taking advan-
tage of weaknesses in the IRS' filing system.

In 1991, subcommittee members personally visited the IRS'
Questionable Refund Fraud Team at the Memphis Service Center.
At that time, we reviewed IRS' process for identifying and pros-
ecuting tax refund fraud, and urged the IRS to do more and tell
us what we could do to help. This problem, particularly in the area
of EITC, was brought to our attention by members of the Memphis
Service Center, who said there was a serious fraud problem in-
volved here.

Over the past several years, the subcommittee has commissioned
the U.S. General Accounting Office to review IRS' tax refund fraud
problem for which reports were issued to this subcommittee in May
1989 and in December 1993. In both instances, GAO warned us
that close attention should be given to tax refund fraud and rec-
ommended improvements to IRS' systems. Some of these rec-
ommendations have been implemented by the IRS.

Most recently, the subcommittee reviewed several internal IRS
reports prepared in 1993 by the IRS Office of Internal Audit and
an individual under contract. That is the report of an individual
under contract with IRS concerning IRS' fraud detection efforts. I
think we will all agree that tax refund fraud is not a new phenome-
non nor is it likely to disappear overnight or disappear altogether.
However, it is critical that the public know: (1) whether the IRS
clearly knows and understands the scope, magnitude and nature of
the problem; (2) whether the IRS has a comprehensive fraud con-
trol program in place; and (3) whether the IRS is able to effectively
adjust its fraud controls as the world changes to quickly deal with
criminals' continuing efforts to circumvent the traps.

In my judgment, the IRS has almost perfected the art of using
its computers to give out tax refunds quickly without making a cor-
responding effort in the area of fraud controls. It seems that to
some degree the IRS is speeding down the highway at night with
its headlights off hoping to avoid oncoming traffic. Perhaps the IRS
needs to pull into a rest stop and pull out a map.

The IRS Commissioner today will present detailed testimony con-
cerning the IRS' recent efforts to deal with tax refund fraud and
IRS' future plans to be more aggressive. I applaud her for leading
the agency in the right direction and commitment to addressing
this problem. At the same time, as a result of the subcommittee's
investigation and review of IRS reports leading up to this hearing,
I have concluded that the situation is worse than originally
thought.

The fact of the matter is that fraud exists and it is a serious
problem. It is not my intent today to use this hearing to expose



specific IRS weaknesses or to provide a road map for would be
crooks. Rather, my goal is to make sure that the IRS is in full gear
in stopping fraud, that it is accountable to the public, and where
IRS is unable to act because of resources or other restraints, to tell
the Congress so that we can act and help.

The tax return filing program is not a Federal Government pro-
gram that comes and goes depending on priorities of the adminis-
tration. The tax return filing system is here to stay and affects the
pocketbook of every American. Consequently, when it falls short, I
think we should know about it.

In conclusion, I expect that the IRS Commissioner will tell it all
at today's hearing and in doing so, I believe together we can quick-
ly address any remaining system vulnerabilities during the 1994
filing season and aggressively chart out and implement additional
safeguards for the filing seasons to come.

I will ask Mr. Houghton if he wants to make an opening state-
ment.

Mr. Houghton. Thank you, Mr. Chairman. I join you in opening
our hearing on the income tax firaud issue. I appreciate your doing
it. It is timely and I believe it is important that we understand
what is going on, in the light of the IRS statistics and the increase
in fraudulent income tax refunds.

The question for us is why is this happening? It seems to me
there are two basic issues. One is the refundable nature of the
earned income tax credit, and the second is the expansion of elec-
tronic filing. We are here to find out. We are here to probe. I hope
we will shine a light on something which is of great concern to
most American citizens. Thank you.

Chairman Pickle. Thank you, Mr. Houghton.

Now, we have two witnesses to begin with. One is Frazier B.
Todd, Jr. and the other is Barry Becht. Do you gentlemen — first,
I want to swear you in as a procedure that the committee always
does.

[Witnesses sworn.]

Chairman Pickle. Let the record show that the witnesses have
said, yes.

Do either of you gentlemen want to make an opening statement
about your participation in this program or do you want us just to
ask questions?

Mr. Becht. I have an opening statement I have prepared here.

Chairman PiCKLE. All right. Do you have a statement to make
also, Mr. Todd?

Mr. Todd. Yes, sir, I do.

Mr. Becht. Good morning.

Chairman Pickle. Mr. Jefferson, do you have an opening state-
ment?

Mr. Jefferson. No, sir.

TESTIMONY OF BARRY BECHT

Mr. Becht. Good morning, Hon. Chairman Pickle, and members
of the Subcommittee on Oversight. It is an honor and a privilege
to be able to speak before you on tax refund schemes.

My name is Barry Becht, a Federal inmate, serving an 18-month
sentence at Seymour Johnson, a minimum security Federal prison



camp in Goldsboro, N.C. I am charged with aiding and assisting in
the preparation of false Federal income tax returns from the east-
ern district of Virginia in the Alexandria Federal Courthouse.

I have been incarcerated for 7 months, since July 1993, and my
release date is scheduled for August of this year. I am 36 years old.
I have been married for 10 years with four daughters, ages 8 to IV2
years old. Prior to my incarceration, I have resided in Falls
Church, Va. I have considerable experience in all phases of ac-
counting and taxation.

I have generated payroll taxes, issued W-2s, filed W-4s, 940s,
941s, sales tax returns and fixed asset schedules with depreciation.
I have had 2 years of college courses primarily in accounting, busi-
ness and Federal taxation. I have also taken the advanced income
tax preparation course offered by the H&R Block Tax Training
School.

I began preparing income taxes for friends and relatives of my
wife, who is Vietnamese, within the metro D.C. area. Through word
of mouth, our business opened in 1987 as T&B Tax Services in Ar-
lington, Va. I felt that I was using my Grod-given talents in math
and working with figures helping these clients get a tax refund.

I charged tax fees based on tne forms that I used. The average
fee per return was around $50. In the beginning, I prepared their
returns based on information they supplied. However, many clients
had not retained receipts. As the business grew and through the
clients' greed, as well as my wanting to keep their business, I
began inflating deductions, overstating expenses and getting the
clients more of a refund than they had a legal right to receive.

I had only a very small percentage of audits, so I continued doing
returns this way, from the IRS. I realized the seriousness of my ac-
tions when in September 1990 there was a search and seizure done
on my office to take all the records out and essentially close the
business. I knew that I had made a big mistake in my life for
which I am deeply sorry. I thought I was Helping clients with their
taxes, but I caused hundreds of clients a financial tax burden, and
I caused great embarrassment for my wife and family within the
community, as well as having a husband and father away in pris-
on.

I also caused the IRS headaches and for all I have done I am
deeply sorry and ask forgiveness for that.

Mr. Chairman, I have spent 7 long, difficult months in prison,
another 2^2 years under investigation from the IRS, and I have
tried to think of ways to improve myself Then, this opportunity
came up to assist and perhaps prevent tax fraud schemes. And I
feel I can be valuable to help deter preparers from going through
what I have.

If tax preparers and individuals know that they will be crimi-
nally prosecuted and that they will be detected up front for devis-
ing these tax fraud schemes, then we can begin to eliminate the
tax refund fraud. There is much work to do as there are so many
schemes developed over the years and dangerously so for electronic
returns.

I personally have signed and prepared over 4,000 tax returns
from 1987 to 1990. Through the 2-year investigation of the IRS,
they sampled 475 returns, of which 472 were fraudulent with a tax



deficiency of right around $750,000. This is what I have personally
done and that is what I have been charged with in my case. They
found this on concluding the investigation in June 1992. That
means refunds were issued to my clients and that those returns
passed through their computer criteria and what they call the
"funny box" for suspicious or conspicuous fraud.

Briefly, those returns passed because of so many different areas
used to reduce tax liabilities, child and dependent care, moving ex-
penses, employee business expenses, rental and common loss, char-
itable contributions, depreciation, business use of the home, other
taxes paid, medical expenses, all of these areas received some at-
tention but spread out so the computer red flag on criteria was able
to be passed.

Amended returns I did were done similarly, but only selected
areas were explained and used, child care, employee business ex-
penses. Schedule C for self-employment, business expenses, espe-
cially depreciation and Section 179 expense. There has to be an im-
plementation to look at supplemental forms within the tax return
much more carefully. Schedule C, Schedule E for rental, rental
losses claimed through abuses of expenses many times are totally
fabricated. Schedule Ks for corporations; that is an extremely
abused area to be able to write off personal losses, to be able to
transfer those to the taxpayer.

Form 2106, employee business expenses is greatly exaggerated
and unsupported without proper records. Form 2441, child and de-
pendent care. Even though they have changed the laws to include
the name, address and Social Security number of the recipient, it
is still an area that is abused.

Schedule A for itemized deductions, charitable contributions,
miscellaneous deductions. These forms have various schemes and
I am identifying the problems and the solutions have to come from
more selective computer criteria and these "tiger teams" that was
mentioned in the press release of experts, to be able to test the sys-
tem against these schemes.

Mr. Chairman and subcommittee members, in concluding, I
would very much like to be a part of this team because it will be
a team effort. Of course, as you know I am still incarcerated in
prison, on the last 6 months of my sentence. If the remainder of
my sentence could be under a home confinement arrangement, I
could devote these months to community service. I would devote
my time with proper supervision in helping to develop detection of
tax refund fraud schemes.

I am here to cooperate and answer any questions that you may
have, and I thank you, Mr. Chairman and subcommittee members.

Chairman PlCKLE. Thank you for a very forthright statement and
it will be a helpful statement, I think, to all of us.

I have some questions, but let me ask, Mr. Todd, do you have a
statement to make?

Mr. Todd. Yes, I do.

Chairman PiCKLE. Is it a relatively brief statement?

Mr. Todd. Yes.

Chairman Pickle. Go ahead.



TESTIMONY OF FRAZIER B. TODD, JR.

Mr. Todd. Grood morning, Mr. Chairman and members of the
Subcommittee on Oversight. My name is Frazier Todd, Jr. I am 35
years of age, divorced, with four children and my home is Atlanta,
Ga. I have been incarcerated since April 1, 1992, for the charges
of conspiracy to file false claims with the Government.

These charges involved a fraudulent tax refund scheme with elec-
tronically filed returns. I was sentenced to 30 months incarceration
followed by a period of 3 years supervised release. I am presently
serving my sentence at Federal Prison Camp Seymour Johnson, lo-
cated in Goldsboro, N.C.

I was originally scheduled to be released on February 3, 1994,
which was last week, to serve the last 4 months of my sentence in
a halfway house, but due to overcrowding of halfway houses my in-
carceration has been prolonged an additional 2 months and I am
now scheduled to be released April 4 of this year to serve the last
2 months of my sentence at a halfway house.

I attended high school in San Francisco, graduated from Wood-
row Wilson. I attended the Computer Learning Center and received
a computer operations certificate in San Francisco. I moved to At-
lanta, Ga., in 1983 and attended Massey Business College and re-
ceived an associate degree in business administration and later at-
tended St. Leo's College located on the Army Base at Fort McPher-
son in Atlanta, Ga., and completed my bachelor of science degree
there in 1988.

I worked for a CPA firm in Atlanta during the summer months
in 1985 and 1986 while attending college. I opened Todd & Associ-
ates in 1988 and maintained an office in Atlanta, Ga., for the pur-
poses of providing accounting and tax services.

I remained sel^emploved up until the time my business was shut
down August 16, 1991 by the IRS Criminal Investigation Division
pending an investigation of fraudulent activities involving the elec-
tronic filing of false income tax returns through that business. The
conduct of the scheme involved the recruiting of real persons to
provide me with their real names and their correct Social Security
numbers.

Criteria for selecting these people recruited were individuals who
did not work or were not required to file returns, individuals who
were not in default of student loans guaranteed by the U.S. Grov-


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