Beware: Protecting Against Tax ID Theft and Avoiding Other Fraudulent Tax Schemes

In recent years, tax identity theft has impacted millions of honest taxpayers, including health care professionals. The problem keeps worsening, with no end in sight. This article provides guidance to health care professionals for preventing and remedying tax ID theft and highlights other tax schemes to avoid.

Tax ID Theft

Tax identity theft involves fraudsters filing bogus tax returns using someone else’s name and Social Security number in order to obtain a fraudulent refund. Scammers route the stolen refunds to difficult-to-trace bank accounts or have the checks sent to vacant addresses for retrieval. Often the funds are reaped before the IRS or the tax ID theft victim has any idea a return has been filed in his or her name. Honest taxpayers typically learn of the fraud when they go to electronically file their tax returns, only to have their return rejected by the IRS because a return has already been filed under their name and Social Security number. Fraudsters file the bogus tax returns often in the first few weeks of tax season, which can create major headaches for taxpayers who wait until the end of filing season to file their returns, only to learn one has already been filed.

Missourians have been hit hard by tax ID fraud in recent years. From January through early April 2015, the Missouri Attorney General’s Office reportedly received 388 complaints of tax ID theft, up from about 200 complaints the prior year.¹ In St. Louis County alone, there were 750 reports of tax ID theft in 2015.²

Targeting Health Care Professionals

While tax ID theft affects taxpayers of all types, health care professionals appear to have been especially targeted by such schemes in recent years. Physicians make good prey because they are presumed by fraudsters to have higher incomes, which can generate larger refunds. Such individuals’ personal information may also be more susceptible to compromise due to participation in government and private health insurance programs. Indeed, some suspect the epidemic among health care professionals stems from a data breach at a large health care insurer.

In addition, many health care professionals are self-employed and/or independent contractors, making them more likely to report their income on a Schedule C (Profit or Loss from Business) or as Schedule E income from a pass-through entity. Such tax forms are easier for fraudsters to manipulate and the information on these forms can be difficult for the IRS to verify before processing the refunds. Even for physicians who earn W-2 wages, the IRS does match these records to information submitted electronically until after processing the fraudulent refunds.

In 2014, the Michigan Dental Association reported receiving 350 identity theft complaints from members.³ In Washington, D.C., the Medical Society of the District of Columbia reported more than two dozen doctors were victims of tax ID theft in 2014.⁴ Similar incidents of tax ID theft have been reported by state medical associations in Indiana, Massachusetts, Maine, New Hampshire, South Dakota, Iowa, North Carolina, Colorado, Connecticut and Vermont.⁵

What is the IRS Doing about Tax ID Theft?

The IRS and the U.S. Department of Justice (“DOJ”), Tax Division, have made prosecuting individuals who use stolen identities to claim fraudulent tax refunds a top priority. Through the Stolen Identity Refund Fraud (“SIRF”) Enforcement task force, the IRS and DOJ have prosecuted hundreds of individuals for tax ID theft, resulting in long sentences for those convicted of SIRF crimes.

In July 2013, a St. Louis woman was sentenced to 144 months in prison and ordered to pay $835,883 in restitution to the IRS after pleading guilty to theft of government funds and aggravated identity theft.⁶ According to her plea agreement and other court documents, the woman stole the identities of more than 400 individuals, many of whom were deceased, and filed fraudulent tax returns using their names and Social Security account numbers.⁷ Between August and November 2012, she allegedly filed 236 fraudulent tax returns, using a network of family and friends to collect refund checks or prepaid debit cards for the refund amounts.⁸

Still, the problem persists, and the feds have yet to develop a widespread solution to the problem.

How Can You Protect Yourself from Tax ID Theft?

Filing your tax returns as early in the tax season as possible can help mitigate the risk of tax ID theft. While this may not be practical for most physicians, who likely need to wait for tax forms from financial institutions and other third party payers before they can file their returns, the sooner you file your return, the less risk you face of someone else filing a fraudulent return on your behalf.

To protect against tax ID theft, eligible taxpayers may request an Identity Protection PIN (IP PIN) from the IRS.⁹ The IP PIN is a unique six-digit number that can help prevent misuse of your Social Security on fraudulent tax returns. You must use this PIN to confirm your identity on all tax returns you file. Thus, a fraudster cannot e-file your return without this PIN. However, if you request a PIN and do not use it when e-filing your return, it will likely be rejected by the IRS. So, if you request an IP PIN, make sure you use it or provide it to your tax return preparer to use when filing your return to avoid any complications.

What if You Become a Tax ID Theft Victim?

If you do fall victim to tax ID theft, there are steps you can take to remedy the situation. Start by completing an IRS Form 14039 (“Identity Theft Affidavit”), attesting that your personal information has been compromised and that you believe a fraudulent tax return was filed using your Social Security number and other personal information. In some instances, the IRS may notify you that you are a possible victim of identity theft by way of a 5071C letter. The 5071C letter may ask you to call the IRS and verify certain information and to confirm that the return electronically filed in your name was fraudulent. If you received the 5071C letter from the IRS, you should attach this to your affidavit (Form 14039).

Next, you should prepare (or have prepared) a correct paper copy of your tax return and mail it to the IRS. The IRS should eventually process your correct return and any associated refund. According to the IRS, it can take up to four months to process paper-filed returns.

Other Tax Scams to Avoid

While tax ID theft can strike unsuspecting taxpayers, other tax scams provide warnings signs and should be avoided at all costs. Given their higher incomes and associated tax brackets, physicians may fall prey to illegal tax avoidance schemes promoted by individuals claiming to possess specialized or secret knowledge of the inner-workings of the Tax Code. While the popular tax shelter schemes of the 1970s and 1980s have mostly been thwarted by IRS and DOJ enforcement efforts, promoters of illegal tax avoidance schemes still exist today. Such schemes often involve the use of multiple flow-through entities or accounts, including offshore accounts, and multi-layer transactions intended to conceal the true nature and/or ownership of taxable income or assets. Such schemes also often involve the payment of personal expenses disguised as business expenses. Misuse of trusts is another common scheme, whereby promoters encourage taxpayers to transfer their income and/or assets into trusts with promises to escape taxation. Participation in such schemes can have devastating civil consequences and could lead to criminal charges.

Some examples of health care professionals being prosecuted for participation in such schemes are highlighted here:

• In June 2014, a jury convicted a Fresno, California-based oral surgeon of tax-related offenses for his participation in a trust scheme where he claimed millions of dollars’ worth of personal expenditures as business expenses.¹⁰ The illegal trust scheme was promoted by an attorney who helped the doctor funnel business earnings into shell companies in order reduce his taxable income, according to the government.¹¹ The surgeon was ultimately sentenced to 18 months in federal prison for obstructing and impeding the IRS.¹²

• In December 2014, a Mississippi doctor was sentenced to 75 months in prison for tax evasion and obstructing IRS laws.¹³ The doctor, an orthopedic physician, “used a complex tax evasion scheme involving an entity in Utah, which claimed it was a tax exempt church, to evade his taxes,” according to the government.¹⁴ The physician had allegedly not filed any tax returns or paid tax since 2003.¹⁵

• Finally, in January 2015, a San Diego doctor and his wife were sentenced to four years in prison and ordered to pay almost half a million dollars in restitution to the IRS for their participation in various tax fraud schemes.¹⁶ Despite earning as much as $1 million a year from their osteopathic medical practice, the doctor and wife paid almost no federal income tax for a decade, according to the government.¹⁷ They also responded to the government’s investigation by making widely-rejected and frivolous tax protestor arguments as to why they owed no taxes, such as that they were not citizens of the United States and federal tax laws did not apply to them.¹⁸

You should avoid any tax arrangement that sounds too good to be true. It likely is. You should also be weary of anyone claiming to have found a “loophole” in our tax system whereby you can escape federal taxes altogether or that our nation’s tax laws somehow do not apply to you. Finally, and probably most importantly, prior to entering into any tax avoidance strategy, obtain a second opinion regarding the legitimacy of the deal or transaction from a CPA or tax attorney. The cost of doing so will pale in comparison to the tax, penalties (civil and/or criminal), and interest you may face if the transaction later proves to be a sham.

Biography

This article was written by Mark Milton, an associate in the St. Louis office of Husch Blackwell LLP and former Trial Attorney with the U.S. Department of Justice, Tax Division. Husch Blackwell serves as outside general counsel to the Association. The information contained in this article should not be construed as legal advice or a legal opinion on any specific facts or circumstances. The contents are intended for general information purposes only, and readers are urged to consult their own attorney concerning their own situation and any specific legal questions.

Contact: mark.milton@huschblackwell.com