Small Business Tax Scams: 10 Ways to Protect Yourself

Is your tax preparer ripping you off? Here are the ways it can happen, and the signs to watch for.
Freelance Writer, Self-employed
April 03, 2013

Clients of a Virginia tax return preparer unknowingly signed returns that used phony Schedule C forms to claim business losses. The resulting refunds were deposited directly to a bank account controlled by the preparer, who would then write a check for a fraction of that amount to the taxpayer, and keep the rest.

The scam is one of hundreds of tax preparer ripoffs investigated by the Internal Revenue Service last year. Perpetrators of that particular swindle pled guilty in January to fraud and identity theft and were sentenced to federal prison terms. But more fraudsters are out there, waiting to cheat honest taxpayers of their refunds and even expose them to criminal liability.

The Scams and Scammers

Filing false refunds without their clients’ knowledge and skimming the refunds is perhaps the most popular scamming technique. Fraudulent tax preparers have also been known to file one return to the tax collectors and another to lenders showing a higher income so a borrower could qualify for a loan.

Tax preparer swindlers don’t necessarily look like crooks. In one case settled by the IRS this year, a Certified Public Accountant admitted using false Schedule Cs to get unwarranted refunds. Another was a former judge.

The cost to taxpayers is significant. Perpetrators of one tax filing scam were ordered to pay nearly $2 million in restitution. The cost to a taxpayer can be as high or higher. The IRS reminds that, even when using a paid tax preparer, the taxpayer is the one legally responsible for making sure the return filed is complete and accurate.

Protect Yourself

While increased use of e-filing and more computerized tracking of suspicious returns by the IRS is making it trickier to file fraudulent returns, cases of tax preparation scam are not declining. From 2010 to 2012, the number of convictions of tax return preparers rose from 132 to 176, a 33 percent increase.

One thing hasn’t changed much: the chance of receiving jail time if you get caught. In 2010, 89 percent of tax return preparer convictions resulted in prison terms, for an average time behind bars of two years. By 2012, the incarceration rate slid slightly, to 84 percent, while the average time in jail rose to 29 months.

The Internal Revenue Service and other tax experts suggest these ways to protect yourself from a dishonest tax preparer:

1. Check for a "Preparer Tax Identification Number." The IRS issues these numbers to all paid tax preparers. Lack of a PTIN is an indicator of a shady operator.

2. Check history. The Better Business Bureau and other organizations maintain records of complaints received about tax preparation firms as well as others. Look at your local BBB to see how others feel about working with the preparer.

3. Don’t sign a blank return. This may seem obvious, but many frauds are based on having taxpayers sign blank returns that are then filled out with false information.

RELATED: Small Business Taxes: Is Your Company Giving Up Free Money?

4. Read the return before signing it. Obvious? Maybe. But some scammers assume you won’t and, often enough, they’re right.

5. Get a copy of the return for your records. You may need it if, as sometimes happens, the preparer files another, false return in your name.

6. E-file. Electronically filing a digital return rather than having the preparer mail a paper return reduces the chances that false paperwork will be submitted under your name. Any preparer who does more than 10 returns is required to use e-filing.

7. Don’t work with a preparer who asks to be paid a percentage of any refund. Negotiate a flat fee or other payment method. Don’t pay the preparer based on the size of the refund.

8. Don’t agree to have any refund deposited to the preparer’s account. Preparers sometimes write checks to taxpayers before filing returns, ostensibly pre-paying them the expected refund. Then the preparer will submit an altered return claiming a bigger refund and pocket the difference.

RELATED: 3 Common Mistakes That Lead to a Tax Audit

9. Don’t agree to inflated or false deductions. While some preparers cheat without taxpayers’ knowledge, often taxpayers agree to making entries they know are incorrect in order to pay less taxes or get bigger refunds. In these cases, taxpayers are as liable as preparers.

10. Make sure the preparer asks for paperwork. A preparer who fills out tax forms without seeing documentation in the form of pay stubs, expense receipts, invoices and the like may be operating on the shady side of the law. Legitimate preparers will ask to see at least a sampling of your paperwork.

Read more articles on small business taxes.

Photo: iStockphoto

Freelance Writer, Self-employed