Inmates Scam IRS Big Time

By Dennis Wagner The Arizona Republic -- 12/27/05

The Arizona Republic via NewsEdge Corporation:

Daniel G. Johnson was serving time at the Marana Community Correctional Treatment Facility near Tucson when he found a new way to make money from behind bars: He started ripping off Uncle Sam.

The 28-year-old forger, who worked in the private prison's library, sent fraudulent tax forms to the Internal Revenue Service seeking refunds of more than $200,000. Although tax schemes are rampant in Arizona's correctional systems, Johnson's case was exceptional because he was caught and prosecuted by the federal government.

This year, IRS officials detected $68 million in false tax refund applications filed by 18,000 U.S. prisoners for the 2004 tax year. That accounted for more than one-seventh of all phony refunds nationwide.

In Arizona, convicts were responsible for roughly half of the $600,000 in fraudulent claims detected by Department of Revenue investigators this year. Tax-scamming is a longtime pursuit of America's prison denizens. But it has proliferated behind bars so much recently that congressional hearings were conducted during the summer to figure out how the system can be fixed.

Nancy Jardini, chief of IRS criminal investigations, told a House subcommittee that inmate fraud has increased 700 percent in three years.

"There is no question that prisoner refund fraud is on the rise," she said. "Even though prisoner returns comprised less than 1 percent of all individual federal income tax returns filed in 2004, more than 15 percent of false refund returns used prisoner names and taxpayer identification numbers."

By all accounts, the crime is exacerbated by a simple fact: Inmates have little incentive to stop because they seldom face punishment, from the justice system or prison administrators, when they are caught. Law enforcement authorities say they just don't have the resources to investigate criminals who are behind bars. So Daniel Johnson is the only inmate in Arizona to be convicted of tax fraud during the past two years.

The damage is not measured merely in dollars stolen from the U.S. Treasury. Tax fraud also represents a perennial headache for penal institutions, where the crime spreads like a virus from inmate to inmate, bringing money, contraband and violence into already volatile cellblocks.

"Any actual cash in an inmate's possession is dangerous in a prison environment," said Joe Profiri, a criminal investigations manager for the Arizona Department of Corrections. "It's a potential tick up for crime." During the House subcommittee hearings, an anonymous inmate drove home that point by saying he had filed 700 false returns for $3.5 million worth of refunds. "The money and drugs eventually led to beatings," he said. It was unclear how much money he received.

Afterward, Rep. J.D. Hayworth, R-Ariz., dubbed the practice "Operation H & R (Cell)Block," adding, "It's time we put it out of business."

How it works

By any measure, the government's tax-collecting job seems Herculean: IRS workers processed 130 million tax statements last year, and caught $2.2 billion worth of false refund claims.

About 455,000 of those filings came from a U.S. population of 2.1 million people doing time in state, federal, county and private correctional centers. The typical scheme begins with a convict who has access to the Internet or prison library for IRS forms and to a photocopy machine where papers can be duplicated. The inmate fills out fictitious revenue statements, claiming overpayment of taxes or seeking rebates, then sends the fraudulent papers to the IRS.

"You'll get some that are handwritten and the guys can barely spell," said Sandy Schwartz, an investigations supervisor for the state Revenue Department. "And there are some where it's typed out and really pretty, and they've used a software system."

State and federal revenue agents employ all sorts of firewalls to prevent tax graft. Correctional guards and mailroom workers are trained to watch for bogus tax papers, including a high volume of mail to or from the IRS.

Prisons provide the tax collectors with inmate rosters that can be red-flagged in databases. Government computers are programmed to detect specific addresses and scam techniques, as are processors who handle the paperwork.

But the screening is imperfect and, as Schwartz pointed out, fraudulent filings that go undetected represent a "great unknown."

In fact, inmates have devised dozens of schemes. When one succeeds, it is likely to proliferate within a cellblock, then spread to other correctional centers. Sometimes, ringleaders work out profit-sharing deals with cellmates, using their names and Social Security numbers to file more tax returns. Or they may just steal the information.

Either way, completed forms are sent to an outside accomplice who forwards them to the IRS, often using a post office box as a return address. When refunds arrive, the middleman cashes each check, takes a cut and distributes the rest to inmate prison accounts or associates on the outside. Some of the most sophisticated operations launder money through offshore accounts.

Brad Palmer, an IRS agent, described tax-scamming in Arizona as a "huge" prison enterprise that has infected every type of correctional facility in the state. "There are a lot of inmates involved. The difficult part is knowing how many of the schemes are all connected," Palmer said. "Once we catch a scheme, they adapt it and find a new system."

Crime goes unpunished

In Johnson's case, the scheme involved claims that he had overpaid taxes on gambling winnings. He apparently was charged because the total refund request of $207,686 was so huge. He admitted guilt as part of a plea agreement, and could add up to five years to his 2 1/2-year prison term.

Profiri, the DOC investigator, said most prison-based tax fraud goes unpunished because of flaws in the system. When prison officials learn of a scam, Profiri said, they interview inmates, conduct cell searches and do other investigative work. Often, they discover photocopied tax forms, lists of Social Security numbers and large amounts of cash entering inmate accounts.

With that evidence, Profiri said, corrections officials notify the IRS, but that's usually the end of the story.

"Sometimes they show an interest, but with the financial disclosure laws the IRS can't share information with us," he explained. "I am unaware of any cases (involving Department of Corrections inmates) that resulted in an arrest or prosecution."

Palmer, the IRS agent, confirmed that, under federal law, he is banned from disclosing taxpayer information to anyone, including prison investigators. When inmates are caught, he said, the IRS blocks them from collecting false refunds. But agents cannot pass on details to prison officials.

Meanwhile, neither the IRS nor the U.S. attorney is likely to pursue charges because the perpetrators are behind bars, and they'll likely get sentences of less than two years. Even when key players are identified, prosecution involves witnesses with low credibility and the challenge of distinguishing conspirators from cellmates who may be victims of identity theft.

"Usually in tax fraud cases, we know who did it and we have to prove the crime," Palmer noted. "Here, we know the crime but we don't know who did it."

Patrick Schneider, chief of criminal prosecutions at the U.S. Attorney's Office in Arizona, said he has been forced to cut back on prosecuting white-collar crimes in general, so it hardly makes sense to go after offenders who are incarcerated.

"We just don't have the manpower to do every fraud case we would do otherwise," Schneider said.

The same is true on the state level, where no convict has been indicted for tax fraud in at least two years. "If someone is in prison and spending years there anyway, what's the point of spending time and resources? said Schwartz, the state investigator. "Are we going to prosecute? No."

Rules not enforced

Back in prison, possession of contraband items, including multiple IRS forms and lists of Social Security numbers, is a breach of conduct. Violators may lose visitation privileges, get transferred or face other penalties.

But, because of another kink in the system, that rule is seldom enforced. Profiri said DOC officials do not want to interfere with IRS criminal investigations, so they hold off on disciplinary sanctions while federal tax agents investigate inmates for fraud. Because the IRS seldom presses charges and cannot tell prison officials anything about inmate tax investigations, prisoners almost never get punished.

The upshot: No criminal prosecution. No prison sanctions. No reason for felons to think twice about continuing to defraud the government. As Profiri put it, "If you're able to steal and get away with it, you continue to steal."

This month, IRS officials began considering measures that would allow tax agents to disclose information on inmate scammers to correctional authorities. But the proposal has no formal status.

In the meantime, Palmer agreed that convicts have little incentive to stop violating tax laws. "It's a problem. I'm not going to sit here and deny that there's a hole in the system," Palmer said.

He added that the IRS moved to fill that hole this year by assigning him specifically to prison refund scams, the first time a special agent in Arizona has been given that duty. He said he is working with prison officials, focusing on ringleaders and outside accomplices.

"We're trying to fix it," Palmer said.

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By the numbers:

• 130 million: Total tax returns filed with the IRS in 2004.
• 455,000: Returns filed by prisoners.
• 118,000: Total fraudulent returns filed last year.
• 18,000: Phony returns submitted by inmates.
• $2.2 billion: Total value of false refund claims prevented by IRS in 2004.
• Unknown: Value of false refunds paid out because they were not detected.
• 361: The total number of people convicted of refund scams against the IRS during the past three years.
• 700%: The increase in tax fraud by prisoners during that period.