Robert Goulder of Tax Notes and William Stone III of Morris, Manning & Martin LLP discuss the IRS’s focus on fraud in the employee retention credit claims and syndicated conservation easement transactions.
This transcript has been edited for length and clarity.
Robert Goulder: Hello, I’m Bob Goulder, contributing editor with Tax Notes. Welcome to In the Pages, the video series where we take a closer look at commentary from our print and online publications.
Our featured article for the month forces us to ask some tough questions about the prevalence of fraud in our federal tax system — specifically, whether some of the common allegations that we hear about have really been overblown. The article is titled, “Crying Wolf: The IRS’s Tax Fraud Allegations.” The author is William A. Stone III. He is an associate with the law firm of Morris, Manning & Martin LLP in Atlanta, Georgia.
William, thank you for joining us.
William A. Stone III: Thanks for having me.
Robert Goulder: So, let’s get started. First, we should distinguish between the various types of fraud that are out there. Of course, there’s civil and criminal, but can you break us down the difference, in your mind, in terms of the judicial venues, the punishments, the statutory authorizations, whether this is common-law fraud or not? Help us work through some of that first.
William A. Stone III: Yeah, so when people think of fraud, they think of criminal fraud. You think of Al Capone, you think of — [Shohei] Ohtani’s been recently in the news, Hunter Biden’s been in the news. If you’re my age, maybe Mike “The Situation” [Sorrentino] from the Jersey Shore, that’s the fraud people typically think of. So criminal fraud [trials] typically happen in a district court in front of a jury of your peers. The punishment is monetary, and potentially jail time.
Civil fraud, the type that’s not as sexy — you don’t see it in the news as much, it’s not going to be on the TV — is a penalty under section 6663, and it is in front of a bench trial at the U.S. Tax Court, typically. A bench trial just means, it’s just a judge, there is no jury, and it is typically going to take place in the Tax Court, and it’s just a monetary penalty.
Robert Goulder: Now, your article mentions two practice areas that are often called out for being rife with tax fraud, either by the government or by people outside the government. But I want to get your sense about those takes — whether they’re accurate or inaccurate, how valid they are. The first area is the syndicated conservation easement transaction. Can you work us through that, what the transactions involve and why some people think those transactions are problematic?
William A. Stone III: So a conservation easement is a voluntary legal agreement to place restrictions on real property. So the easy way to describe it is, if you put a conservation easement on a piece of land, you won’t be able to develop it. So there won’t be any high rises. If you’re from an area that’s developed quickly, there won’t be a neighborhood there. It’s going to stay what it is in perpetuity — forever. The syndication of that is the pooling of resources with investors, and from there, with a partnership, you have the flow-through of the deductions that Congress passed decades ago, 1980, and that was to incentivize conservation.
So they were seeking to have people conserve their property because, as you know, people need to be incentivized to give things away. So they looked through that, through deductions. As time went on, these deals became syndicated. Under the former commissioner, [Charles] Rettig, it became a hot-button issue: The cornerstone of his enforcement policy was syndicated conservation easements. They were accused as an abusive tax shelter, and he really made that a big part of his commissionership, if you will.
Robert Goulder: All right. Now the second area is the employee retention credit (ERC). It’s a regime that’ll be familiar to many listeners. It’s not that old, it came about as a COVID relief program. Passed, I think, as part of the CARES Act. Just briefly, how is that supposed to work, and again, why do people think that there’s fraud associated with that?
William A. Stone III: So ERC was passed during the pandemic. So unprecedented times — there’s a pandemic, businesses were struggling due to government shutdowns and other reasons, supply chain. So Congress sought ways to keep businesses afloat so they could pay their employees. They passed the ERC, and the claims there are that there’s a lot of fraud in the program, but it’s a little misleading, it’s a little different. It’s in its infancy stages; you can still claim an ERC.
It’s not easements, it’s not decades old, obviously, but the allegations in ERCs have actually been way more prevalent than even conservation easements have been, with a whistleblower coming out saying, potentially, there’s 95 percent fraud. Senator [Ron] Wyden (D-Ore.) says there’s rampant fraud. I think he uses the term “gushing fire hose.” Senator [Ron] Johnson (R-Wis.) — so it is bipartisan, Republican, Democrat — he also says, “It’s almost universal fraud.”
So there’s a lot of fraud allegation in ERCs, but at the same time — and I think we’ll talk about this a little more in depth later — not all ERCs have been processed; they haven’t all been claimed. So the fraud claims there are a little premature, I think.
Robert Goulder: Yeah, because it’s a new program, and I’m not even sure that they’re taking new enrollees. I think there was a moratorium last year, and I’m not sure whether that’s still in effect, but that program’s going to cast a long shadow. These allegations of fraud, I mean, are we coming from a small sample size?
William A. Stone III: It seems that way. So you can still claim the ERC; the moratorium is on processing claims. So if you claim it now, you’re going to send your claim in, it’s not going to get processed. But you can — some periods are still open. The moratorium just stopped the processing, but there’s been a lot of activity around it. So you’ve had a withdrawal program, a disclosure program. So it appears that the IRS is trying get taxpayers to maybe self-assess themselves without having to go through it, but it’s going to be around for a while. I think last I saw there was 1.2 million unprocessed claims, with more coming in. The allegations of fraud — it seems to be, like you said, a small sample size. If you have a million unprocessed claims, you’ve got 20, 30 percent of your claims not even processed. So claiming there’s 95 percent fraud when you haven’t processed 70 percent, 75 percent, that’s disingenuous, I think.
Now, there is the fraud claim where people have created fictitious entities and claimed the ERC under that. I think that’s clear-cut fraud, but I would find it hard to believe that that’s 95 percent of the claims. So as time goes on, I think we’ll really see how fraudulent was the ERC program. And I do think we need to talk about fraud versus a mistake. So you can claim the ERC and maybe a government shutdown or a supply chain issue and be wrong about that, but genuinely had thought that. That’s not fraud; that’s a mistake. Now, filing under fictitious entities that don’t exist, I think most people would say, “Well, that’s fraud.”
So I think there’s a difference in, well, was the claim valid? Aka, should you receive the money? Did you receive the money vs. was it fraudulent — those are two different questions.
Robert Goulder: All right, now we need to circle around to the headline of your article, which got my attention because I’m a big fan of the Aesop’s fables, and everybody knows the story “The Boy Who Cried Wolf.” So the part of your article that really shines is where you tie that together. Explain the metaphor.
What is the long-term risk to the IRS — or anybody else in government who’s making all these claims — that these programs, both the conservation easements and the ERC, saying that they’re gushing with fraud? How could this all backfire and go horribly wrong for the IRS?
William A. Stone III: Well, so we’ll start at the claims. So in easements, you’ve had — the IRS has lost on the civil side in court recently in most recent easements. So the fraud’s not there. Saying that all of them are fraudulent and they’re all abusive — I wrote an article in Tax Notes showing that’s not true. A lot of the valuations have been good for easements. And again, there is a difference between misvaluing something and committing fraud. When it comes to the ERC, you have — and this really isn’t the IRS as much as it is Congress, honestly, and the irony is not lost on me, they passed the bill that now they’re claiming is rampant of fraud. But there, you’re just eroding taxpayer trust.
So at the end of the day, the taxpayer is the village here. And when you look at fraud, you say, “Well, all these things are rampant with fraud, there’s fraud everywhere.” Well, that hurts the taxpayer in different ways. If you’ve invested in a conservation easement, you possibly think, “Oh, I need to go get counsel. Am I going to be in trouble for fraud? What’s the problem here?” And then it turns out, well, this went to trial. Yeah, it lost, but it wasn’t fraudulent. Well, that has real consequences for you.
And the ERC even more so, right? You have the withdrawal program. Maybe I have a small business and I have a totally valid claim for an ERC, but I’ve been scared because I keep seeing Senator Wyden, Senator Johnson, members of the House come out and say, “Man, there’s so much fraud. There’s fraud everywhere.” And fraud’s a scary word. I think when most people receive any tax notice, they’re scared, but especially fraud. And maybe I withdraw a valid claim. That’s not good; that’s not congressional intent happening.
Maybe I don’t submit a claim because I think, “Oh well, I keep hearing everything’s fraud. So can I really trust that this is a valid claim? How valid are any claims?” So you erode trust. I think you’re in the infancy stages when it comes, like I said earlier, with conservation easements, where the boy is saying, “There’s a wolf, there’s a wolf!” Well, right now we’re saying, “Well, there’s fraud everywhere.” And I know I’ve said it multiple times, but it bears repeating.
Alleging 95 percent fraud, or anywhere near that, when you haven’t processed 95 percent of claims — it’s just disingenuous. So at the same time, at the end of the day, 10 years from now, maybe we find out, “Well, the ERC program wasn’t as fraudulent as we thought it was. Yeah, there was fraud, but it wasn’t rampant. It wasn’t a gushing fire hose of fraud.” Just like conservation easements, you’re seeing fraud — it’s getting alleged a lot, but it’s not winning at the courts. And that hurts taxpayers, and they also have to defend against these. So I think it just erodes trust the way that the boy eroded trust with this village. And in this, I think the village is the United States taxpayer.
Robert Goulder: Do you have any sense that people might be conflating a criticism of these programs that they’re overgenerous and maybe need to be scaled back and sort of improperly mixing that with an allegation of fraud? I mean, let’s just say, for the sake of argument, if you’re a lawmaker and you think the ERC has served its purpose, think it should be phased out. There’s a way to do that, right? You legislatively limit it or you wind it down, am I correct? You don’t go around saying, “Gee, it’s fraudulent.” That’s not the way to curtail government spending. Am I right?
William A. Stone III: Well, exactly. And with ERC, it was always going to be costly.
Robert Goulder: They knew it. Yeah.
William A. Stone III: The idea that we’re worried about spending — it was a stimulus package. It was always going to be costly. So now that we’re saying, “Well, there’s tons of fraud.” Well, you’re Congress, you are exactly right. You can legislate ERCs out, if you wanted to do that. With conservation easements, for example, they passed new legislation that put more restrictions on easements. They didn’t do away with conservation easements, but they added restrictions.
So at the end of the day, it’s on Congress to act. And that’s the unfortunate part for the IRS. So I don’t necessarily blame them with the moratorium, and they are being overburdened with this, but it is their job as a tax enforcement agency. With the moratorium, I think the IRS’s place is, “Hey, you’ve got to start processing claims. Congress passed this, you’ve got to process the claims and determine, are they valid claims? Are they invalid claims? And then after that, an invalid claim, was it a fraudulent claim?” So I think you have to do those things if you’re the IRS. But from Congress’s standpoint, yeah, I think if you really think there’s this much fraud, if Senator Wyden and the Senate Finance [Committee] and all [think there’s] this much fraud, you need to pass legislation to curtail that. And I don’t have the answer, I’m not in Congress, but that seems the likely path.
Robert Goulder: There you have it. It is an exceptional article. It is entitled, “Crying Wolf: The IRS’s Tax Fraud Allegations,” and you can read it in Tax Notes. William A. Stone III, thank you very much for joining us.
William A. Stone III: Yeah, thanks for having me.
Read the full article here
