What US Congress giveth, the IRS may taketh away:  Detecting and prosecuting tax fraud under the CARES Act

What US Congress giveth, the IRS may taketh away: Avoiding tax fraud risks under the CARES Act

United States Publication April 14, 2020

As the United States continues its efforts to control the COVID-19 pandemic, the federal government has taken a number of steps to provide immediate financial relief for taxpayers. These efforts culminated last month when Congress passed the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”). This US$2 trillion aid package offers financial assistance to businesses, families, and individuals in hopes of stimulating the economy and providing much needed liquidity for businesses struggling to stay afloat. Although the government will likely apply the CARES Act liberally upfront to get cash into the economy quickly, the fine print contains a warning for taxpayers rushing to claim lucrative benefits: the IRS is watching. Once the IRS begins to examine the records of a taxpayer, all of its financial dealings are fair game and subject to critical scrutiny.

Oversight and enforcement mechanisms of the CARES Act

While Congress understood the immediate need to get cash into the hands of taxpayers, it was also acutely aware of the potential for fraudulent claims under the CARES Act. To combat this, the CARES Act creates three separate bodies to monitor the disbursement of funds to taxpayers for coronavirus-related relief: 

  1. Pandemic Response Accountability Committee: This Committee is designed to prevent and detect fraud, waste, abuse and mismanagement. Among other functions, the Committee may conduct its own independent investigations, audits and reviews related to disbursed funds. The Committee, along with the Congressional Oversight Commission discussed below, has general oversight over all three phases of the COVID-19 legislation, namely the Coronavirus Preparedness and Response Supplemental Appropriations Act (Phase 1), the Families First Coronavirus Response Act (Phase 2), and the CARES Act (Phase 3). 
  2. Congressional Oversight Commission: As an establishment of the legislative branch, the Commission will monitor the implementation of Phases 1, 2, and 3 by the Department of the Treasury and the Board of Governors of the Federal Reserve System. The Commission will prepare and present reports to Congress regarding loans, loan guarantees and investments made under the CARES Act.
  3. Office of the Special Inspector General for Pandemic Recovery: As part of the Department of Treasury, the special inspector general will monitor the disbursement of funds under the CARES Act. Armed with US$25 million in appropriations, the special inspector general will conduct, supervise and coordinate audits and investigations of the making, purchase, management, and sale of loans, loan guarantees, and other investments made by the Secretary of the Treasury pursuant to the CARES Act.

In addition to the oversight committees discussed above, the CARES Act appropriates an additional US$37.2 million to the IRS for enforcement activities. This provides significant  funding for IRS Criminal Investigation (CI). As one of the top investigators of financial crimes and tax fraud in the world, IRS CI is now mobilizing to help investigate potential criminal violations of the CARES Act. In a recent interview with Law360, Don Fort, the chief of IRS CI, acknowledged the government’s concerns regarding fraudulent claims for small business loans and other tax benefits under the CARES Act. Among other things, Mr. Fort noted that IRS CI is “spending this time doing liaison with the Department of Justice, with our federal law enforcement partners. There are a number of task forces forming in judicial districts.” Therefore, as the pandemic subsides and businesses take advantage of the programs and benefits under the CARES Act, there is certain to be an uptick in the number of IRS CI investigations and criminal prosecutions being conducted. If the IRS determines that an issue exists regarding the receipt of these funds, they will certainly look further into the taxpayer’s financial dealings for other potential issues.

Fraud foreshadowing: the CARES Act and the troubled Assets Relief Program

Besides the oversight and enforcement mechanisms created by Congress, the tax relief provisions set forth in the CARES Act are riddled with good faith requirements and anti-fraud language. Among these relief options is the US$350 billion Paycheck Protection Program (“PPP” or the “Program”), as implemented by the Small Business Administration. Under the Program, small businesses can receive loans to cover up to eight weeks of payroll, rent, and certain other expenses. If the funds are properly used, the PPP loans are forgiven from repayment. There is currently ambiguity in the law whether the use of the funds to pay the specified expenses qualify for a tax deduction like those expenses normally do. In addition to certain good faith certifications required by each applicant under the Program, the PPP loan application expressly warns that the government may pursue criminal fraud charges if the applicant uses PPP funds for unauthorized purposes or knowingly makes a false statement to obtain a  loan. So, while taxpayers may view these forgivable loans as free money, the government is making its intentions clear: if taxpayers abuse the Program, those taxpayers will be audited and/or criminally prosecuted.Although the PPP loan requirements address fraud directly, other provisions of the CARES Act take a more subtle approach. For example, the CARES Act offers payroll tax deferral and an employee retention credit to most businesses. More specifically, employers and self-employed taxpayers may defer payment of certain employer-side employment taxes for up to two years. Eligible employers are also allowed a refundable credit against certain employment taxes for 50 percent of the qualified wages paid by the employer to its employees. Although this deferral and credit are available to most employers, a closer look reveals that a taxpayer receiving a forgivable PPP loan is no longer eligible for the deferral or the credit. If a taxpayer couples a PPP loan with either the deferral or the credit, then the taxpayer has inadvertently exposed the business to a potential audit or criminal charges.
As businesses continue to cope with the economic effects of the pandemic and explore their relief options, lessons can be learned from the Troubled Assets Relief Program (TARP) under the Emergency Economic Stabilization Act. Following the 2008 financial crisis, the Department of Treasury implemented TARP in an effort to stabilize the economy. In the short-term, businesses acted quickly to save their companies, and the government freely disbursed funds. However, like the CARES Act, the TARP legislation created a Special Inspector General (SIGTARP) to help monitor the disbursement of funds and investigate applications for relief. Failures to adequately maintain records led to numerous allegations of fraud. Since 2008, SIGTARP has criminally charged over 400 people, imprisoned 300 people, and recovered US$11 billion from businesses with criminal investigations still being brought today.

With this in mind, businesses should seek advice from counsel on how to best utilize the relief measures under the CARES Act and how to best protect themselves from the future threat of an audit or a criminal investigation. If a taxpayer incorrectly double-dips on tax benefits, this mistake, at best, could lead to a time-consuming and expensive civil investigation and audit. It could also open the door for a broader examination of their financial dealings if a problem is discovered. At worst, the mistake could lead to a criminal investigation and prosecution for fraud. While taxpayers should feel encouraged to apply for benefits under the CARES Act, they should do so with the understanding that what Congress has giveth with one hand, the IRS has the power to taketh away from those abusing the system. 

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