SPECIAL TO THE WEB
By Kevin Berry, Ph.D., CFE and H. Charles Sparks, Ph.D., CPA
The home of former U.S. vice presidential candidate Sarah Palin now has another claim to fame. In spring 2012, the U.S. Internal Revenue Service (IRS) charged a Wasilla, Alaska, tax preparer with six counts of preparing false tax returns. Two factors make this scheme particularly interesting: 1) the tax preparer laundered illegal drug profits by setting up a fake company to mask the true source of income and profits and 2) even though the preparer had little professional and technical training and limited experience, the deception was innovative and complex.
Normally, authorities charge tax evaders when the criminals either underreport illegal activities or don’t report them at all. Interestingly, in this case, the tax preparer went one step further: The false business she created for her client allowed him to obtain credit through local financial institutions.
This fraud scheme will be relevant especially to small- and medium-size banks and credit unions, auto finance companies and even mortgage companies because they often don’t have expert in-house fraud groups that can detect questionable clients or customers. These financial institutions, when vetting self-employed individuals and small businesses for creditworthiness, normally rely heavily — if not exclusively — on federal income tax returns. (A coauthor of this article serves on the board of a local credit union with assets of $125 million. Its loan policy explicitly requires the most recent two years of federal tax returns for small business and self-employed borrowers.) Firms that examine potential borrowers seldom investigate tax return information beyond obtaining and comparing IRS copies. This is poor procedure as we show in this case.
Beginning in the spring of 2007, Jamie Powell (not her real name) began preparing false tax returns for a local drug dealer we’ll call BJ, and his wife. The returns reported a portion of BJ’s illegal income as legitimate construction company profits. Powell, who also apparently bought drugs from BJ, worked hard to make his income look legitimate even though she lacked accounting education or extensive professional experience. (Powell billed DJ and his wife tax preparation fees that were 20 times greater than those she charged her legitimate clients.)
The elaborate scheme included fake sales receipts, purchase invoices and bills of sale and other supporting source documents just in case the IRS audited BJ. The reported income omitted enough of BJ and his wife’s true income so they could also qualify, and receive, the earned income credit. Eventually, Powell prepared and filed prior year false income tax returns back to 2003 for BJ and his wife. They used these false returns to apply for and obtain loans to purchase vehicles and obtain credit cards.