An Epidemic of Fake Businesses on Federal Tax Returns: The Dangers and Consequences

In recent years, my Bankruptcy Office has seen an alarming rise in fraudulent activity involving fake businesses being listed on federal income tax returns. This trend is part of a broader scheme where individuals attempt to inflate their income or deductions to secure higher refunds than they’re entitled to. At first glance, it may seem like an easy way to boost your tax refund. However, it’s crucial to understand that engaging in this kind of tax fraud can lead to severe legal consequences, including criminal charges, hefty fines, and even imprisonment.

The Mechanics of the Scam

 

Here’s how the scam works: Taxpayers – often encouraged by unscrupulous tax preparers – fabricate business entities on their tax returns, claiming deductions related to fictitious expenses such as business losses or costs associated with a non-existent operation. These “businesses” are often listed on forms like Schedule C-Profit and Loss from Business, which is used to report self-employed income and deductions.

A common strategy is to list business expenses for things like supplies, advertising, and other deductions that wouldn’t otherwise exist. These made-up deductions reduce taxable income, thereby increasing the size of the refund. Often, the business doesn’t even exist; it’s an illusion meant to exploit the tax system.

 

The Appeal: Why Do People Do This?

 

There’s no denying the temptation of a larger tax refund. After all, many people rely on their annual tax refund to cover various expenses, from paying down debt to financing vacations or making home improvements. The idea of increasing your refund with just a few lines on a form might seem too good to pass up.

But here’s the reality: While these schemes may yield short-term gains, they carry long-term risks. The IRS is highly sophisticated and uses a combination of data analytics, automated audits, and random checks to detect fraudulent returns. What seems like an easy way to boost your refund could land you in serious legal trouble if you get caught.

 

The Consequences of Tax Fraud

 

Let’s be clear: Falsifying tax returns is not just an error; it’s fraud. And tax fraud is a serious crime. If the IRS audits your return and finds that you’ve fabricated business expenses or income, you could face significant penalties.

1. Fines and Penalties – The IRS can impose steep penalties for fraud. These fines can amount to 75% of the underpayment of tax due to fraud, which can easily amount to thousands of dollars.
2. Interest – In addition to fines, interest will be charged on any unpaid tax, compounding the amount owed.
3. Criminal Prosecution – In extreme cases, tax fraud can lead to criminal charges. If convicted, you could face prison time. The penalties for criminal tax fraud are severe and can include imprisonment for up to five years, along with hefty fines.
4. Damage to Your Reputation – Beyond the financial penalties, a conviction for tax fraud can severely damage your reputation. If you’re a business owner, your ability to secure loans, work with clients, or even hire employees could be compromised.
5. Ineligibility for Future Refunds – If you’re caught committing tax fraud, you may become ineligible for future tax refunds, or the IRS may withhold them until any outstanding penalties are paid off.
6. Denial or Revocation of Bankruptcy Discharge – As stated before, The United States Department of Justice Office of the United States Trustee is the watchdog of the bankruptcy system in the US.  Their attorneys will often review suspicious tax returns and may have inquiries and ask for documentation proving large business expenses.  If these business expenses cannot be substantiated, your Discharge may be at risk of being denied or revoked.  It goes without saying that Bankruptcy Debtors should always tell the truth when questioned by the Chapter 7 Trustee or attorneys from the US Trustee’s Office.  If the business never existed, if your tax preparer made it up or advised you to show business losses, tell the truth and let them know.  It will be far easier than producing receipts that do not exist.

Red Flags the IRS (and Bankruptcy Trustee) Looks For

 

The IRS has become extremely adept at identifying fraudulent returns. They use a number of tools to detect inconsistencies or signs of fraud, such as:

• Unusually large deductions for non-existent businesses or expenses.
• Inconsistent reporting of business income from year to year.
• A sudden increase in tax refund claims without corresponding increases in legitimate income.
• Discrepancies between reported income and known business or employment history.

If any of these red flags appear on your return, it’s more likely that the IRS will scrutinize your tax filings.

 

How to Protect Yourself

 

1. Be Honest and Accurate: Never fabricate information on your tax return. Always report your income and deductions honestly. If you’re unsure about whether an expense is deductible, consult with a tax professional who can guide you in compliance with the law.
2. Hire a Reputable Tax Preparer: It’s best to hire a tax professional such as a Certified Public Accountant.  If you use a tax preparer, ensure that they are reputable and knowledgeable. A good tax professional will not encourage or engage in fraudulent behavior. If they suggest creating fake businesses or making exaggerated claims to inflate your refund, walk away immediately.
3. Keep Good Records: Maintain accurate records of your income, expenses, and any deductions you claim. This will not only help you file a proper return but also protect you if you’re ever audited.
4. File Early: The sooner you file your tax return, the less time there is for fraudsters to hijack your identity and submit false claims. Filing early also gives you more time to address any issues that arise with your return.
5. Respond Promptly to IRS Notices: If you do get audited or receive a notice from the IRS, don’t ignore it. Respond promptly and provide all requested documentation. Working with the IRS in good faith is the best way to resolve any issues.

An Epidemic of Fake Businesses on Federal Tax Returns: The Bottom Line

 

While the temptation to fabricate a fake business or claim illegitimate deductions may seem like a quick fix for a higher refund, it’s never worth the risk. The consequences of tax fraud are far-reaching and can impact not only your financial future but also your freedom.

The key takeaway here is simple: Always be honest when filing your taxes. There are no shortcuts to financial success, and playing games with the tax system only leads to trouble.

If you’re facing any uncertainty about your tax filings or have concerns that you may be caught up in fraudulent activity, don’t hesitate to reach out for legal advice. The penalties for tax fraud are far too serious to ignore.

As always, make sure you’re working with professionals who have your best interests in mind. The integrity of your tax filings is crucial, and in the long run, it’s always better to be safe than sorry.