Refund Anticipation Loan (RAL) Fraud

FinCEN, working with the Internal Revenue Service Criminal Investigation?s Refund Crimes Section, undertook an in-depth review of refund anticipation loan fraud schemes and related Suspicious Activity Report filings. The Internal Revenue Service reports a significant increase in the number of fraudulent electronic tax returns that are based on bogus documents. Some fraudulent electronic tax returns have been used to obtain a refund anticipation loan. However, the limited number of Suspicious Activity Report forms reporting refund anticipation loan fraud indicates a possible lack of understanding of this crime and how financial institutions might be affected. To better assist financial institutions in identifying suspicious activity related to refund anticipation loan fraud, the following information is provided:

• A description of the legitimate process to obtain refund anticipation loans;
• A description of refund anticipation loan fraud schemes;
• Suspicious Activity Report filings and refund anticipation loan fraud case examples; and
• Examples of the types of transactions and activity, which may relate to refund anticipation loan fraud schemes.

Legitimate Refund Anticipation Loans
A refund anticipation loan is money borrowed by a taxpayer from a lender based on the taxpayer?s anticipated income tax refund.19 Other names for this type of loan are ?Rapid Refund? and ?Instant Money.? The taxpayer signs a contract with a financial institution making the taxpayer responsible for repayment of the loan. Information on the tax return instructs the Internal Revenue Service to deposit the refund into an account in the name of the filer at the lending financial institution. The deposited money is then used to pay the loan balance. When the Internal Revenue Service acknowledges acceptance of a tax return, they provide a debt indicator to inform the filer whether they have any outstanding debts that the refund will be used to offset. This information, along with other information gathered by the lender, is used to determine whether to extend the refund anticipation loan. There are numerous validity and consistency checks made by the Internal Revenue Service before an electronic return is accepted. One of those checks ensures the unique use of a valid Social Security number. The Employer Identification Number listed on the W-2 form also must be valid. However, the confirmation notice is not an agreement that the amount of the refund claimed on the tax return will be paid. The tax return must still pass through the Internal Revenue Service system, and the refund could be reduced or denied entirely. As of June 2000, the number of fraudulent electronically filed returns was one in 4,789; however, by the end of 2003, that number was one in every 966.20

How Refund Anticipation Loan Fraud Schemes Work

Fraud schemes involving income tax returns and refund anticipation loans typically entail creation of fake W-2 forms using the name and tax identifiers of real people and existing businesses. The perpetrator recruits individuals to pose as employees of a known business. These recruits could either be using their true identities or a stolen identity provided by the fraud perpetrator. When identity theft is involved, the recruit is given counterfeit identification documents, e.g., counterfeit Social Security cards and driver?s licenses, to use as proof of identity. The recruited individuals find commercial tax preparers to file fraudulent electronic tax returns and then apply for a refund anticipation loan. The loan proceeds are then split between the fraud perpetrator and the recruit.

In another scheme, an unscrupulous electronic return originator will prepare a tax return for a taxpayer where only a small refund is claimed. The electronic return originator will pay the filer the refund in cash and the filer leaves. The electronic return originator will then manipulate the figures on the return and generate a much larger refund. The electronic return originator then requests a refund anticipation loan in the name of the taxpayer for the larger refund amount and files the tax return. The electronic return originator then negotiates the refund anticipation loan check and pockets the difference between what the true taxpayer was paid and the amount of the refund anticipation loan. This requires the electronic return originator to negotiate a large number of refund anticipation loan checks payable to other individuals. The large number of refund anticipation loan checks may be an indication of an electronic return originator abusing the refund anticipation loan process. The Federal statutory violations in these fraud schemes might include 18 U.S.C. ?286, Conspiracy to defraud the United States by filing fraudulent income tax returns; 18 U.S.C. ?287, Filing false claims against the United States; and 18 U.S.C. ?1344, Bank Fraud.

Suspicious Activity Report Filings

A search of FinCEN?s SAR Query System revealed two Suspicious Activity Reports referencing refund anticipation loan fraud schemes.

While conducting a routine review of its refund anticipation loans, a bank discovered similarities in multiple loan applications that indicated possible fraud. The bank found multiple W-2 forms that had unusually high withholding amounts (20 percent as opposed to the more typical 10 percent). Most of the suspicious loans included W-2 forms from well-known businesses. All of the W-2 forms had similar wages and withholding amounts. The tax returns on which the loans were based listed refundable credits (e.g., education credits, child care credits, and/or low income credits). Upon contacting the borrowers, the bank discovered that the income tax returns, which were the basis for these loans, were fraudulent. The names and Social Security numbers on the tax returns and loan applications had been obtained through identity theft. The employers listed on the W-2 forms did not employ the individuals named on the forms. The bank identified 41 fraudulent loans. The average refund on the fraudulent tax returns was $5,000.
A bank filed a Suspicious Activity Report on loan fraud involving refund anticipation loans after the Internal Revenue Service failed to forward the refund checks for approximately 500 loans. The bank reported that it suspected the possibility of insider involvement on the part of the tax preparer because of a higher than normal charge for their service on the affected loans. (Note: After a subsequent law enforcement investigation and the issuance of Federal indictments, two subjects entered guilty pleas.)

No additional Suspicious Activity Reports describing fraudulent loans based on sham tax returns were located. However, there were nine reports of suspicious deposits of ?Rapid Refund? or ?Refund Anticipation Loan? checks. Each of these Suspicious Activity Reports related multiple deposits of this type of check into a customer?s account. The checks were payable to individuals who endorsed them over to a third party. These Suspicious Activity Reports could be incidents of fraud perpetrators redeeming fraudulently obtained checks.

Refund Anticipation Loan Fraud Cases

The Internal Revenue Service named theft of personal and financial information used to file fraudulent tax returns as the second most common method of tax fraud. The combination of refund anticipation loan with a fraudulent tax return allows the perpetrator to take advantage of a source of funds that lenders advertise as instant money. To make this type of loan appealing to the public, funds are made immediately available, leaving little time for the lender to perform due diligence to prevent fraud. The following are examples of fraud schemes that used false income tax returns and refund anticipation loans.

• A February 2003 press release by the United States Attorney for the Southern District of New York announced the arrest of 17 defendants in connection with a tax and identity fraud scheme that allegedly netted more than $7 million.21 The criminal Complaint charged the defendants with engaging in a scheme from 1997 through January 2003 to file thousands of false and fraudulent federal income tax returns. The defendants were accused of filing fraudulent returns for persons who were not entitled to the refunds. The defendants were also accused of committing identity theft to file tax returns on behalf of individuals without their knowledge. The fraudulent tax returns claimed Earned Income Credits and listed fake dependents. The tax returns were electronically filed and used to obtain refund anticipation loans.
• In 1998, a Federal court in the Western District of Tennessee convicted a man for bank fraud and filing false claims. The defendant was an accountant who prepared tax returns. The defendant created fictitious W-2 earnings statements using the names and Social Security numbers of low-income housing residents and individuals who were unemployed or receiving public assistance. He then electronically filed fraudulent tax returns and applied for rapid refund loans.
• Frequently, the tax preparer is an unwitting participant in these fraud schemes. In a court case filed in the United States District Court for Eastern District of Michigan, the defendant was convicted of conspiracy to defraud the government and submission of false claims to the government. The defendant prepared fake W-2 forms and caused a nationally known tax service provider to unwittingly electronically file the fraudulent tax returns. The defendant then received bank loans on the expected refund.

Refund Anticipation Loan Fraud Indicators

The IRS Restructuring and Reform Act of 1998 encouraged the Internal Revenue Service to set a goal of having 80 percent of Federal tax returns filed electronically by the year 2007. To aid in that goal, the Internal Revenue Service published a list of Free File Alliance tax preparers on its website who will electronically file income tax returns at no charge for persons who meet specified income criteria. An electronic return originator may submit either a tax return they have prepared or a return collected from a taxpayer. The Internal Revenue Service requests the electronic return originator be on the lookout for suspicious or altered income documentation (W-2 and 1099 forms), and requests (but does not require) that electronic refund originators obtain two forms of identification.22 However, the electronic return originator who receives the return via the Internet is basically only transmitting the return to the Internal Revenue Service and does not have the opportunity to examine these documents.

Extra precautions must be taken to prevent fraud associated with electronically filed income tax returns, especially when tax returns are submitted via the Internet. The Internal Revenue Service has a program that recognizes certain fraud indicators in electronically filed tax returns and prevents the issuance of some refunds based on the fraudulent returns. This program, however, will not protect the lending institution because the return is initially accepted and an electronic acknowledgement sent to the filer. It is the electronic acknowledgement that the lender uses to underwrite the loan. Electronic return originators/transmitters that accept income tax returns over the Internet also lack the advantage of personally meeting their customers.

Based on information from the review of Suspicious Activity Report narratives and criminal prosecutions, lending and financial institutions and tax preparers should be alert to the following ?red flags? of possible refund anticipation loan fraud. Taken alone, these indicators may not involve activity related to refund anticipation loan fraud, but when they occur in combination, they should arouse suspicion.

1. Multiple loan applicants in a short time period with W-2 forms from the same employer;
2. W-2 forms that differ from other W-2 forms from the same employer or appear suspicious or altered;
3. W-2 forms with unusually high withholding amounts for the reported income ? 20 percent as opposed to the more typical 10 percent;
4. Multiple W-2 forms that have identical, or nearly identical, income and withholding amounts;
5. Customers whose identification addresses do not match the address on the W-2 forms;
6. Customers using ?mail drop? addresses, e.g., United States Post Office boxes, retail postal services addresses, etc.;
7. Multiple refunds directed to the same address or post office box;
8. Loan applicants presenting identification documents that appear counterfeit;
9. Multiple direct deposits from tax refunds deposited into the same account; or
10. Individuals depositing (or cashing) multiple refund anticipation loan checks payable to third parties.

Finally, an Internal Revenue Service refund that is intended to satisfy an outstanding refund anticipation loan balance but that is not received within the typical time frame (about two weeks) could indicate the Internal Revenue Service has identified the refund as possibly fraudulent.

What to do if Suspicious Activity is Suspected

In accordance with Suspicious Activity Report regulations, financial institutions are required to report suspicious activity, including those that involve a refund anticipation loan, whenever they suspect their institution was used to facilitate criminal transactions when the amount aggregates to the applicable suspicious activity reporting thresholds. When completing a Suspicious Activity Report form to report activity indicative of refund anticipation loan fraud, a depository institution preparer should mark box 35g, Consumer Loan Fraud, and use the narrative to clearly, completely and sufficiently explain the nature of the refund anticipation loan fraud. Other types of financial institutions that know or suspect that transactions may involve proceeds from refund anticipation loan fraud should mark the ?Other? box and provide an explanation in the narrative that completely and sufficiently explains why the institution suspects or has reason to suspect the transactions.

20 Gary Bell, Director, Office of Refund Crimes, Internal Revenue Service Criminal Investigation, Tax Fraud Alert: Fraudulent e-file Returns on the Rise, http://www. Natptax.com/tax_news, last modified Feb. 23, 2004.
21 For more information, see http://www.usdoj.gov/usao/nys/Press%20Releases/Feb03/IRSIDFRAUDARRESTS.pdf
22 Handbook for Authorized IRS e-file Providers of Individual Income Tax Returns, Pub. 1345, Rev. 1/2001.
Excerpted from SAR Activity Review Issue 7, page 15