- The Washington Times - Wednesday, November 23, 2011

A federal tax break designed to help those burned by financial fraud is itself being abused, with most of those who claimed the deduction cheating the IRS and costing the government tens of millions of dollars in a single year, according to a new report.

The findings released Wednesday by the Treasury Department’s inspector general for tax administration studied the effects of a surge in fraud claims in 2008, the year of the global financial meltdown.

Faced with Ponzi schemes such as that of disgraced Wall Street financier Bernard Madoff, who pleaded guilty to 11 counts of fraud in a $65 billion scam, the IRS issued guidance to investors to alert them to tax breaks available to those who lost money in such illegal schemes.

The inspector general’s office went back to look at some of the claims on tax returns filed electronically and found a high error rate among those claiming the breaks.

“We estimate that 1,788 (82.14 percent) of 2,177 tax returns may have erroneously claimed deductions totaling more than $697 million, resulting in revenue losses totaling approximately $41 million,” the investigators concluded.

They said those losses are conservative estimates because they only include erroneous claims from electronic filings in a single tax year.

The inspector general said even though the IRS itself had identified this area as ripe for fraud, it didn’t put in place the kinds of extra compliance checks it should have on fraud-loss claims.

The investigators said the tax agency might not have enough time to go back and audit all of the potentially erroneous claims before the statute of limitations runs out.

The financial collapse in 2008 and 2009 was punctuated by reports of massive fraud. In the case of Madoff, who pleaded guilty in 2009, authorities say the loss to investors was $18 billion.

In the investigation, the inspector general actually used a list of Madoff’s victims to try to identify taxpayers who were claiming a theft deduction but who may not have been eligible.

The report was heavily redacted, with the inspector general saying much of the information risked providing a road map for others seeking to circumvent IRS regulations.

Investigators said the IRS agreed with the recommendations, but nearly all of the responses were redacted so it’s unclear what action will follow.

Government tax breaks have come under scrutiny this year as Congress tries to trim the federal budget. Democrats, in particular, have argued that the government can no longer afford many of the deductions and credits allowed in the current tax code, which amount to hundreds of billions of dollars that taxpayers keep each year rather than ceding them to the IRS.

The inspector general has found the government has erroneously paid out billions of dollars to illegal immigrants, prisoners and others who, investigators say, wrongly claimed credits for everything from new home purchases to college education expenses.