As Benjamin Franklin noted, the truths of life include death and taxes. No one is exempt, not even prisoners. The United States is known for having the highest incarceration rate in the world: close to 1% of U.S. residents 18 years or older are incarcerated. According to a 2019 report issued by the not-for-profit organization Prison Policy Initiative (PPI), 2.3 million people are confined in U.S. prisons and jails (Wendy Sawyer and Peter Wagner, “Mass Incarceration: The Whole Pie 2019,” Mar. 9, 2019, https://tinyurl.com/y2mnl2xb). Exhibit 1 reproduces the PPI’s data on this topic.
Tax preparers may have many questions with respect to incarcerated individuals. For example, are inmates exempt from taxes? If not, how do they file tax returns while in prison? Are inmates able to hire a tax professional to prepare their taxes? Are there any additional responsibilities for tax preparers when the client is an inmate? If the client is incarcerated and sends a representative to the tax preparer, are there additional responsibilities the professional must be aware of if a tax return is prepared? This article will address these and other questions, with a focus on situations where inmates wish to engage a tax professional to assist with the preparation of required tax returns.
Do Inmates Need to File?
It might not cross one’s mind that an incarcerated person has to file a tax return, but many of these individuals do meet the requirements to file. Inmates may earn income for work in prison, such as kitchen and laundry duties, although their earnings are a fraction of those of their unincarcerated counterparts. Correctional institutions may also employ an inmate due to their participation in a “correctional industry,” such as manufacturing license plates. Average hourly wages for inmates range from $0.14 to $1.41 for these types of arrangements. Inmates may also earn income on work release assignments, which allow them to leave the facility for “off-campus” employment.
In addition to earned income opportunities, an inmate may have held a paying job before incarceration, have unearned income, or have a spouse with reportable income that requires a joint filing. Exhibit 2 shows the 2019 Filing Requirements Chart for Most Taxpayers at the minimum gross income for each filing status (U.S. Department of the Treasury, “Dependents, Standard Deduction, and Filing Information for Use in Preparing 2019 Returns,” IRS Publication 501, 2019).
2019 Filing Requirements Chart for Most Taxpayers
Most prisons supply basic tax forms to prisoners, but such forms can also be obtained electronically from the IRS website. Inmates with Internet access can also “free file” their tax returns on the IRS website. The IRS’s Free File Software guides taxpayers through the process of preparing an individual income tax return. The program does not, however, have extensive error checking and will only perform basic calculations.
Inmates may also file their state income tax returns online, although fees may be incurred. If the inmate’s adjusted gross income (AGI) was below $66,000 for 2019, there may be no cost for use of the software for the federal income tax return only. The complexity of the return, however (e.g., reporting itemized deductions), may result in a fee to use the software, regardless of AGI.
Prisons may also provide access to volunteer tax programs. The IRS-sponsored Volunteer Income Tax Assistance (VITA) program offers free tax help to people who make $54,000 or less, persons with disabilities, and those with limited English language ability. Another volunteer program is the Tax Counseling for the Elderly (TCE) program, which offers free tax help for all taxpayers but focuses on individuals age 60 and older. These programs also include the ability to file tax returns electronically.
Note that when filing a joint return, inmates can rely on their spouses to gather information and prepare the return; however, those spouses will need to obtain the inmate’s signature, which could result in a logistics problem. Issues related to power of attorney are addressed below.
Engaging a Tax Professional
Inmates can always file their tax returns with the help of a professional tax preparer, but how does this actually happen? When a tax return is ready to be filed electronically, a preparer will prepare Form 8879, along with the individual income tax return. This form provides the electronic return originator (ERO)—an authorized e-file provider with the IRS—authorization to remit the tax return to the IRS electronically. Form 8879 indicates whether the individual allows the ERO to generate a personal identification number (PIN) for the taxpayer to signify approval for electronic filing or elects to personally input a PIN created in a previous tax year. If an inmate has filed electronically in a previous year, the inmate would have an established PIN that can be reused in the current year. Taxpayers must, however, have access to the Internet to personally enter a PIN to authorize release; if there is limited access to the inmate and the inmate has limited access to the Internet, it would be more efficient for the inmate to authorize the ERO to generate and enter a randomly generated PIN or enter the previously established taxpayer PIN. The ERO is required to maintain the Form 8879 for three years from the due date of the return or the date it is received by the IRS, whichever is later. The ERO’s tax preparation software can generally receive a confirmation of receipt of the tax return by the IRS, which should be kept with the Form 8879.
Form 8879 does not have to be provided to the ERO in original format; it can be received through a fax or e-mail. This is useful because sometimes a tax preparer may only be able to communicate with the inmate through a spouse or the postal system. This process of exchanging information, forms, and signatures requires sufficient time. The inmate may also have financial privacy concerns, because prison officials can inspect inmates’ incoming and outgoing mail for security or other correctional purposes without a warrant.
Power of Attorney, Conservatorship, and Dependency
In situations where an inmate is unable to complete the required tax returns online or is unable to provide all of the required information to a tax preparer, the inmate can appoint someone to have power of attorney for tax matters. In this case, the inmate must file IRS Form 2848, which authorizes an individual to represent the inmate before the IRS. Form 2848 must identify the specific information that the representative is requesting access to (i.e., Forms 1040, W-2, 1099), as well as the years that the representative is given power to have access to the information, and provide the specific authority to sign the tax return. With a properly signed Form 2848, the representative can prepare and sign the inmate’s tax returns.
Inmates may also work with their local judicial systems to have a conservator appointed during their incarceration. This is the most extreme option, because the conservator would have full control over all financial assets and decision making authority over the inmate’s financial matters. If this relationship is established, the conservator would have to notify the IRS of the relationship by filing Form 56, Notice Concerning Fiduciary Relationship, and attach legal documentation such as a judiciary appointment as conservator by the inmate’s jurisdiction. The IRS will recognize the conservator for all of the inmate’s tax matters. The inmate will not have authority to communicate with the IRS on personal tax matters until the conservator relationship is terminated judicially.
An inmate can also be claimed as a dependent. In the case of a child claimed as a dependent, juvenile incarceration is considered an exception to the residency rule for qualifying dependents. The residency and support rules for claiming an inmate older than age 19 may be more difficult to defend as to the dependent’s eligibility.
A tax preparer may encounter nonincarcerated clients who need help with tax returns involving inmates. The requests can come from the spouse of an inmate, the parents of an inmate, a court-appointed conservator, or even a third party claiming—legitimately or illegitimately—to be associated with the inmate. The tax preparer will need to determine the relationship of the individual to the inmate and how information will be transmitted or received. Appropriate documentation should be obtained to legally discuss the matter with the individual representing the inmate, including formally prepared power of attorney documents.
All tax preparers must prepare the tax return in conformance with IRS Circular 230, which is discussed below. They should also be aware of potential fraud risks when preparing returns for clients with whom they have limited or no communication. Furthermore, the tax preparer for a prisoner may have the additional burden of establishing and verifying that the individual with whom they are communicating is the actual taxpayer.
Recent Incidents of Tax Frauds Involving Prisoners
The IRS identified more than 24,000 fraudulent tax returns that used a prisoner’s Social Security number in 2015. The refunds claimed on those tax returns totaled more than $1.3 billion [Treasury Inspector General for Tax Administration (TIGTA), “Actions Need to Be Taken to Ensure Compliance with Prisoner Reporting Requirements and Improve Identification of Prisoner Returns,” 2017, https://tinyurl.com/yxhb5ze8]. Knowledge of commonly employed tricks should help reduce fraud risks faced by a tax preparer. The more common scams that have been employed include the following:
- Identity theft. According to a press release from the Department of Justice (“Phenix City Resident and Ringleader of Multi-Million Dollar Stolen Identity Tax Refund Fraud Schemes Sentenced to Prison,” Mar. 28, 2018, https://tinyurl.com/yd2w2aee), William Anthony Gosha III of Alabama and his coconspirators stole the identities, including SSNs, of inmates and other people, including soldiers who were deployed to Afghanistan. They used the stolen IDs to file over 8,800 tax returns with the IRS and sought more than $22 million in fraudulent refunds.
- False power of attorney. Shermaine German used false powers of attorney to deceive the IRS (U.S. Department of Justice, “Federal Agents Arrest Six People Across Alabama Charged with State Inmate in Tax Refund Scheme,” June 6, 2013, https://tinyurl.com/y4vlnzgo). When he was an inmate at Donaldson Correctional Facility in Bessemer, Alabama, German created false power of attorney forms that he mailed out of the prison along with the false income tax returns he fabricated.
- Fictitious income. Arnold Tobias Gervais was sentenced in 2013 for defrauding the IRS of more than $3.4 million in federal income tax refunds while he was in state custody. Gervais filed or caused to file seven fraudulent tax returns, all of which falsely claimed that the taxpayer had earned significant wages from a fictitious company that had withheld from those wages a significant amount of federal income tax (Federal Bureau of Investigation, “Marietta Man Sentenced to Federal Prison for Filing False Claims with the IRS,” August 19, 2013, https://tinyurl.com/y6l4hk9s).
On July 20, 2017, TIGTA submitted its audit report addressing the effectiveness of IRS corrective action efforts to detect fraudulent returns produced by the prison population (https://tinyurl.com/yxhb5ze8). The report determined that there continued to be concerning deficiencies. The IRS had implemented a process to match prisoners in the Federal Bureau of Prisons and the State Department of Corrections to reported tax data utilizing a “matching” program; unfortunately, the tests were performed on an incomplete population. TIGTA found that 272,931 prisoners were not reported to the IRS; of the unidentified prisoners, 16,742 prisoners reported more than $48 million in refunds. The IRS indicated that it did review 3,474 of the unidentified prisoners’ returns and found that 60.4% (2,098) were confirmed to be fraudulent, and the returns that were identified as fraudulent issued total refunds of approximately $6.4 million. The IRS did not run the remaining 13,268 untested returns, and TIGTA did not extend its audit scope to determine if the refunds reported on the remaining 13,268 prisoner returns were fraudulent.
TIGTA also found that the IRS system did not run the matching tests on all identified prisoner returns. TIGTA identified 4,072 prisoner returns that did not have matching supporting documentation from third parties for income and withholding; these filers received $7.3 million in refunds that may have been fraudulent. Although TIGTA did not extend the scope of work to determine whether the untested returns resulted in fraudulent reporting, the deficiencies identified resulted in more than $48.9 million in potentially fraudulent refunds claimed.
These frauds highlight the importance of the due diligence that a tax preparer must perform when preparing returns for clients who are imprisoned.
What Are Tax Preparers’ Responsibilities?
According to the IRS, approximately 56% of taxpayers use tax professionals to prepare their returns (John A. Koskinen, Written Testimony before the Senate Finance Committee on Regulation of Tax Return Preparers, Apr. 8, 2014, https://tinyurl.com/qwqatcn). These tax professionals are responsible for preparing and submitting an accurate income tax return to the IRS. If the return contains mistakes, the taxpayer can incur late fees and penalties. In the case of fraudulent refunds, honest taxpayers are hurt. Tax preparers must keep up with the continually changing tax laws and follow best practices required by the IRS and relevant professional associations.
The AICPA has developed enforceable tax practice standards for its CPA members known as the Statements on Standards for Tax Services (SSTS). SSTS 2, Answers to Questions on Returns, by referencing the declaration made by a tax preparer that the tax return prepared “is true, correct, and complete,” places a significant burden on tax preparers to gather information from an incarcerated (or any other) taxpayer. The term “question” in this standard is not limited to an actual question on the tax return, but also includes questioning the accuracy of information reported on the return, such as income and deductions. Though allowed “reasonable grounds … for omitting an answer to a question,” tax preparers should always exercise “reasonable effort” to obtain the information necessary to prepare the tax return.
SSTS 3, Certain Procedural Aspects of Preparing Returns, sets forth the applicable standards concerning the obligation to examine or verify certain supporting data or to consider information related to another taxpayer when preparing a tax return. Preparers should—
- make reasonable inquiries if the information furnished appears to be incorrect, incomplete, or inconsistent;
- refer to the taxpayer’s returns for one or more prior years; and
- make appropriate inquiries to determine whether tax requirements have been met (e.g., documentation of travel and entertainment expenses).
SSTS 3 also expands on the scope of the preparer declaration to “include information furnished by the taxpayer or by third parties.” This inclusion of documentation from third parties increases the significance for tax preparers to ensure that they have sufficient communication with inmates when preparing their income tax returns.
The AICPA Statements adhere to Treasury Department Circular 230, which lays out rules governing practice before the IRS for all tax preparers. Circular 230 stipulates preparer duties with regard to any knowledge of clients’ error and diligence as to accuracy of the return:
- Section 10.21 – Knowledge of client’s omission. If a preparer knows the client has made an error or omission in any return submitted to the IRS, the preparer must advise the client of the nature and the potential consequences of the error or omission.
- Section 10.22 – Diligence as to accuracy. A preparer must exercise due diligence in preparing the tax returns and in determining the correctness of any representations made to the IRS and to the client.
- Section 10.34 – Standards with respect to tax returns and documents, affidavits, and other papers. A preparer may not sign a tax return or claim for refund that the preparer knows, or reasonably should know, contains a position that lacks a reasonable basis. A preparer may generally rely in good faith upon information furnished by the client, without verification; the preparer, however, must make reasonable inquiries if the information received appears incorrect or incomplete.
Tax preparers involved in a prisoner income tax fraud scheme who intentionally disregard the rules and regulations put forth by the AICPA and the Treasury Department could face severe consequences as a result of their actions. The argument that communication with an inmate was “too difficult” is an unacceptable explanation for not following the rules and regulations. The relevant state board of accountancy and the AICPA may also impose corrective actions on violating CPAs, including suspension or revocation of their licenses and termination of AICPA membership. Moreover, under Internal Revenue Code (IRC) section 6694(b), the IRS can fine the tax preparer the greater of $5,000 or 75% of fees collected from preparing the tax returns.
Per Circular 230 and the SSTSs, tax preparers should check the supporting documentation, such as income and expense statements, to determine the accuracy of information reported by the taxpayer. If they are uncertain of anything provided to them, tax preparers must investigate by making appropriate inquiries. Finally, referring to the taxpayer’s prior-year returns should help them ascertain whether errors or omissions have been made.