iThe Internal Revenue Service (IRS) has long used investigations targeting tax preparers as a tool for combating fraud and closing the tax gap. By targeting tax preparers, the IRS is able to identify individual taxpayers who may have submitted false and fraudulent returns as well. The IRS is continuing its efforts to target tax preparers in 2024; and, in many cases, these efforts are leading to criminal charges.
When conducting tax preparer investigations, the IRS looks for several “red flags” that it considers potential evidence of fraud. The IRS is also targeting specific forms of fraud in tax preparer investigations—including fraud under the Paycheck Protection Program (PPP) and Employee Retention Credit (ERC) program. For tax preparers who are facing an IRS criminal investigation, identifying the focus of the IRS’s investigation is a key first step toward building an effective defense strategy—but it is ultimately just one step of many that tax preparers must take to protect themselves to the fullest extent possible.
Here are 10 examples of common allegations against tax preparers in IRS investigations in 2024:
- Underreporting Taxable Income
The IRS regularly targets tax preparers for helping taxpayers underreport their taxable income. This includes underreporting individual and business income tax liability from all sources, including commonly underreported income sources such as:
- Cash receipts
- Cryptocurrency gains
- Gambling winnings
- Sale of appreciated assets
- Tips and commissions
Tax preparers have a duty to ensure that they are reasonably confident in the contents of the returns they prepare. This means that tax preparers cannot blindly rely on taxpayers’ representations in all cases, nor can they make assumptions or recommendations that are not based on an individual taxpayer’s specific circumstances. If a tax preparer has reason to know (or “should have known”) that a taxpayer’s return contains false income information, the tax preparer can face civil or criminal penalties in the event of an IRS investigation.
- Claiming Fraudulent Business Expenses
Assisting taxpayers with claiming fraudulent business expenses is another common allegation in IRS tax preparer investigations. Here, too, tax preparers must be extremely careful to ensure that they are not relying on their clients’ false representations or providing generalized advice that does not reflect a particular taxpayer’s income tax liability. While preparing returns that contain any type of fraudulent business expense can expose tax preparers to civil or criminal liability, some of the most commonly abused business expense deductions are:
- Home office deductions
- Business travel deductions
- Meal deductions
- Transportation expense deductions
- Depreciation on business equipment (or personal assets claimed as business property)
All business expense claims on a taxpayer’s return must be substantiated—that is, supported by reliable documentation. Even if a tax preparer relies on information provided by a client, if that information appears suspicious (i.e., if it appears that a client may be claiming luxury vacations as business travel), the tax preparer can still face liability in an IRS investigation for filing false income tax returns.
- Implementing Abusive Tax Shelters
The IRS is increasingly targeting tax preparers for assisting with the implementation of abusive tax shelters. Under Section 6694 of the Internal Revenue Code, a tax preparer can be held liable for helping a client take a position resulting in understatement of the taxpayer’s liability, “unless there is or was substantial authority for the position.” As the IRS explains:
“The substantial authority standard is less stringent than the more likely than not standard (the standard is met when there is a greater than 50 percent likelihood of the position being upheld), but more stringent than the reasonable basis standard as defined in Treas. Reg. 1.6662-3(b)(3). . . .
“Whether a tax return preparer meets this standard will be determined based upon all facts and circumstances, including the tax return preparer’s due diligence.”
The question of whether a tax planning strategy crosses the line to an abusive tax shelter is also determined based on a facts-and-circumstances analysis. Many of the arrangements that the IRS targets in abusive tax shelter investigations are not inherently unlawful, but rather become unlawful due to how they are implemented. For tax preparers targeted in these investigations, being prepared to demonstrate the “substantial authority” on which they relied can be crucial for achieving a swift and favorable resolution.
- Falsely Claiming Cash Contributions to Charities
Falsely claiming cash contributions to charities is another common form of tax fraud for which tax preparers can be—and often are—held accountable. Tax preparers are especially likely to face scrutiny if their clients (as identified by their signatures on taxpayers’ returns) are consistently and uniformly claiming cash contributions to charities at the federal limit—which is 60% of a taxpayer’s adjusted gross income (AGI) for both 2023 and 2024 (subject to certain exceptions). Here, too, tax preparers should require adequate substantiation from their clients in order to protect themselves, and tax preparers should not claim cash contributions on their clients’ returns as a matter of course.
- Falsely Claiming Earned Income Tax Credits, Education Credits, or Energy Credits
Falsely claiming credits on taxpayers’ returns is a common issue in IRS tax preparer investigations as well. This includes falsely claiming the earned income tax credit (EITC), education credits, and residential energy credits, among others.
The IRS has issued specific warnings about credit-related tax fraud to tax preparers. For example, regarding the EITC, the IRS writes:
“If you find the information provided by the client appears incomplete, inconsistent or incorrect, you should ask additional questions, document the answers and make a judgment as to whether the answers make sense. If they don't, you have a responsibility to ask more questions and possibly ask for documentation until you are confident the return you are preparing is accurate. You must also use professional judgment regarding the credibility of your client and the answers you receive. If you are not comfortable with the answers or credibility of the client, then due diligence dictates you refuse to prepare the return.”
This, once again, underscores the importance of doing your due diligence as a tax preparer. While the IRS targets tax preparers for recommending abusive tax schemes and making other affirmative recommendations that result in unlawful tax evasion, it also targets tax preparers who fail to do what is necessary to avoid facilitating their clients’ efforts to pay less than they owe.
- Employment Tax Fraud
Employment tax fraud has also been high on the IRS’s list of enforcement priorities in recent years. Tax preparers who assist their clients with submitting fraudulent employment tax returns, improperly withholding employees’ funds held in trust, or misrepresenting their payroll data to the IRS can face either civil or criminal penalties depending on their specific role in facilitating their clients’ tax fraud.
- Claiming the Same Income, Expenses, or Losses Year to Year
When a taxpayer claims the same income, expenses, or losses year after year, this is a major red flag for the IRS. When the taxpayer’s returns are signed by the same tax preparer year after year, this is a major flag as well. As a result, when preparing clients’ returns, tax preparers should be wary of reporting figures that are identical to the figures reported in prior years, as they most likely are not accurate.
- Accepting Kickbacks from Taxpayers
Evidence that a tax preparer has requested or received kickbacks in exchange for submitting fraudulent tax returns is a common trigger for IRS tax preparer investigations. While tax preparers can of course charge for their services, they cannot solicit or accept payment in exchange for assisting their clients with engaging in federal tax fraud or tax evasion. The IRS can uncover kickbacks through various means, including taxpayer audits, among others.
- Paycheck Protection Program (PPP) Fraud
The IRS has played a major role in the federal government’s efforts to uncover and prosecute PPP fraud in the wake of the COVID-19 pandemic. This has included targeting tax preparers suspected of helping their clients submit fraudulent PPP loan applications, generate fraudulent substantiating documentation, and file fraudulent loan forgiveness certifications. PPP fraud enforcement remains a top priority for the IRS (and other federal agencies) in 2024, and the success of the IRS’s efforts in targeting tax preparers to date means that these efforts will almost certainly continue well into the future.
- Employee Retention Credit (ERC) Fraud
The IRS is also continuing to aggressively target tax preparers for their role in facilitating ERC fraud both during and after the pandemic. Like the PPP, the ERC was intended as a pandemic-era relief program for struggling businesses, but it ultimately proved to be a prime target for fraud. With the total cost of ERC fraud estimated to be over $2 trillion, targeting tax preparers and taxpayers who submitted fraudulent ERC claims remains a top federal law enforcement priority as well.
