OID Scam Still Claiming Victims

[The Observer]

From the Columbus Dispatch:

So, with his 2008 federal income-tax return, David A. Woodard Sr. filed the forms and information he had been told about and received a $900,000 refund.

Yesterday, the 75-year-old Woodward was ordered to repay the government $450,511 and sentenced to two years of probation.

[Mider]

So for a couple of years on probation, he gets to keep almost 1/2? No wonder people attempt to do this.

[The Observer]

The article points out that the scammer received a third of the refund amount (S300,000 est.) meaning our senior citizen was left with approximately $600K. I am assuming that the court has verified that he spent $150,00 of it and that because he is elderly, the chances of him repaying anything other than what is left is unrealistic.

[operabuff]

The restitution amount ordered in a criminal tax case is intended to be reflective of the amount of damage to the government, but is not determinative of the civil tax liability. If the IRS chose to do so, they could assess the full $900,000. The article says the taxpayer is paying $900 a month out of his Social Security. At that rate, it would take him 80+ years to pay off $900,000 and a mere 40 or so to pay off the restitution amount.

Section 6201(a)(4) was recently added to the IRC to allow the IRS to assess and collect restitution amounts as though they were taxes, but the statute is clear that criminal restitution is not the same as tax.

The IRS is required to credit the restitution amount against civil tax liability, however.

For a more thorough discussion of the topic, see this Chief Counsel Notice issued last year:

http://www.irs.gov/pub/irs-ccdm/cc_2013_012.pdf

[Judge Roy Bean]

So for a couple of years on probation, he gets to keep almost 1/2? No wonder people attempt to do this.

An interesting twist - he paid off debts with some of it.

Just wondering, under what circumstances could the IRS seek to recover from the creditors?

[The Observer]

Just wondering, under what circumstances could the IRS seek to recover from the creditors?

Circumstances would have to be a situation where the IRS could prove that the government was a secured senior lienholder over the creditor and that the creditor was aware of the IRS lien at the time they received the proceeds. But if the creditor is considered a superpriority creditor under IRC 6323, all bets are off.

The likelihood of the IRS having a perfected lien in this situation that had priority over the taxpayer's paid creditors is small.

Edit: Upon further reflection, the above is not relevant to the refund situation. In order for the statutory tax lien to arise, there has to be an assessment. That does not exist in this situation, nor does it exist in any case where the IRS has erroneously issued refunds; refund amounts are not assessments. In that instance, the IRS has to pursue securing a judgement after filing suit. I presume that it would be even harder to recover monies from paid creditors since it would difficult to prove that the creditor was in cahoots with the taxpayer to effect the fraudulent refund, especially if the creditor was innocent and bona fide bystander in this situation. It would be unreasonable to expect creditors to research the source of funds everytime their receivables were paid, especially if they are unsecured creditors.

[operabuff]

But the IRS certainly could make assessments after it has erroneously issued a refund. It would most likely require a notice of deficiency. In this situation, where the Service chose to proceed against the taxpayer criminally, the civil examination would have been put on hold and there would be no assessment as yet.

[The Observer]

But the IRS certainly could make assessments after it has erroneously issued a refund. It would most likely require a notice of deficiency.

Are you saying a notice of deficiency based on the erroneous refund amount? Under what IRC statute would that be based? I have never seen such a creature. My experience in this are has been that any erroneous refund amount is pursued by filing a suit in federal court to recover.

[operabuff]

I don't think you're really thinking this through. The taxpayer here filed a return, understating the amount of tax due. That's a deficiency. The newspaper article doesn't contain much detail, but usually the OID scheme operates by the taxpayer claiming a bogus refundable credit. This happens all the time. Most returns filed by taxpayers are refund returns. You can't really be saying that the only time the Service can use deficiency procedures is when the return shows a balance due or is fully paid.

Some variations of the OID scheme involve using the 1099-OID as a basis for an overstated withholding claim. In that case deficiency procedures would not be required and the Service could simply assess the overstated amount under the authority of section 6201(a)(3). This would allow the Service to use its administrative collection procedures without resort to suit.

The statute that allows for an erroneous refund suit serves as a backup in these types of refunds, if for example, the assessment statute is blown. Some courts describe these as "rebate" erroneous refunds.

On a different set of facts, though, the erroneous refund suit becomes the Service's primary recourse. Say the taxpayer files a return claiming a $500 refund and the Service personnel make a mistake in data entry and the taxpayer gets a $50,000 refund. Here the erroneous refund is not based on the amounts actually shown on the tax return, so there is no deficiency. If the taxpayer does not voluntarily return the money, an erroneous refund suit will be necessary. These are sometimes described as "nonrebate" erroneous refunds.

[The Observer]

I don't think you're really thinking this through.

I think that I am more likely overthinking it. I now understand the point you are making, that regardless of whether the taxpayer claimed to have a taxable amount of income or not, as long as the Service did not contribute error to the return resulting in refund, the assessment of that return (even for zero taxes due) would allow recovery under deficiency procedures, thereby resulting in the reversal of the bogus credits. I should have stuck with my first answer.

[Judge Roy Bean]

I'm still confused.

The convicted has paid off debts with fraudulently obtained funds from the Treasury.

So, if someone conceives of a scam and uses the proceeds to pay off debts, where do the creditors stand when the scheme collapses?

[operabuff]

The short answer is that unless the creditors took their payments knowing that the payor owed them as taxes, they're probably going to keep the money. The IRC gives the government some recourse against 3rd parties via what's called transferee liability (section 6901) but an unrelated 3rd party creditor is unlikely to fall afoul of that unless they're in on the scheme or have somehow assumed the liabilities of the original taxpayer.

A book could be written (and probably has been) on the intricacies of how and when the IRS can collect from 3rd parties.