Return Changed by Preparer Prior to E-Filing

Courtesy of David & Mary Mellem, EAs

A PMTA is a document that contains legal advice signed by attorneys in the National Office of the Office of Chief Counsel and issued to IRS personnel who are national program executives and managers.  They are useful for taxpayers since they explain what the rules are in certain given situations. 

This is a story about a tax preparer who did dastardly things without his clients’ knowledge.

This situation involved an individual who prepared individual income tax returns.  IRS uses the fictitious name of Horsefor the preparer’s name.   Horse prepared approximately 700 returns for tax year 2002 of which approximately 450 were e-filed.  He prepared the returns based on information the taxpayers furnished and printed out a copy of the completed return to give to the client.  Horse also established a refund anticipation loan (RAL) account at a financial institution for that client that allowed him to issue a bank check prior to the refund being received from IRS.  Prior to transmitting the returns to the Service, Horse increased the charitable contributions without the clients’ knowledge in order to increase the refund.  He also claimed various fraudulent Schedule C business expenses for several clients, but it appears the clients were aware of these fraudulent expenses.  Horse gave the clients the returns printed earlier that did not contain the higher deductions, and a bank check for the amount of the refund less his $50 preparation fee. 

Once IRS processed the e-filed return, it wired the refund to the financial institution.  The institution paid off the RAL account, deducted the RAL and bank fees, and as instructed by Horse, placed the rest of the refund into Horse’s preparer account as preparer fees. 

In those cases where IRS froze the refunds, the institution made demand to the taxpayers for the refund amounts.  Many paid the financial institution the amount of the check they received while others paid the entire amount of the RAL including the fraudulent portion that Horse received without their knowledge.  The taxpayers were completely unaware they were receiving RALs and that their refunds were routed through the financial institution.  

In PMTA-2011-013 the Chief Counsel was asked the following questions and provided the related answers related to these returns prepared by Horse: 

Issue 1) Is a return a nullity if a return preparer increased the charitable contribution amount on a taxpayer’s return to inflate the refund, and the taxpayer was unaware of the increased charitable contribution and did not benefit from that part of the refund? 

Answer 1) Yes, the return is a nullity because the electronic file submitted to the Service is a document unknown and unverified by the taxpayer.  The Courts have identified a four-part test, known as the “Beard” test, for determining whether a defective or incomplete document is a valid return.  These tests are: a) there must be sufficient data to calculate the tax liability, b) the document must purport to be a return, c) there must be an honest and reasonable attempt to satisfy the requirements of the tax law, and d) the taxpayer must execute the return under penalties of perjury.  Since the signed Form 8453 (now Form 8879) was not for the return submitted to IRS, the return fails the Beard test and the return has no status under the Internal Revenue Code.  Also no accuracy related or civil fraud penalties can be imposed against the taxpayer. 

Issue 2) If the return is a nullity but the taxpayer received a RAL for the correct amount of his refund (minus normal preparation fees), does the taxpayer receive another refund when his true return is filed? 

Answer 2) The taxpayer should not be entitled to a refund from the Service when he has received through the preparer the amount to which he was in fact entitled.  This is because there is no overpayment.  No refund can be made unless it has first been determined that the taxpayer has made an overpayment in tax for the year.  Since the taxpayer received the correct overpayment through the RAL, the taxpayer has no overpayment.  However where the Service has frozen the refund, there is an overpayment and the Service should issue the correct amount of refund accordingly.  In this case the Service should send the check directly to the taxpayer. 

Issue 3) If a taxpayer is aware of the fraudulent expenses on Schedule C and not aware of the inflated charitable contributions, is the return a nullity?  

Answer 3) Even though the taxpayer was aware of part, the taxpayer was not aware of the rest, therefore the return is a nullity as described in Issue 1).  Although the taxpayer is not subject to civil penalties, the taxpayer could be subject to criminal penalties. 

Issue 4) Should the taxpayers correct their account by filing new returns or amended returns? 

Answer 4) The taxpayer’s Master File account should be corrected by having the taxpayer file an accurate Form 1040 series return from which Criminal Investigation or the SBSE Division can adjust the Master File account.  The taxpayer should not file a Form 1040X because the electronic return filed by the preparer is a nullity and no return has been filed by the taxpayer. 

[Editor’s note:  This PMTA does not address how to file the accurate Form 1040 in this type of case.  If the Criminal Investigation or SBSE Division of IRS is already on the taxpayer’s case, filing the accurate return with them would appear to be the best route to go.  If there is no case yet, and you are trying to file an accurate return for a taxpayer fitting the description above, it may be beneficial to file the return by hand delivery to the local IRS office with an note explaining the nullity of the original return.] [TaxMama Note: Or file the tax return on paper, with a cover letter explaining the circumstances, and if you have any written correspondence from CID, include a copy.]

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This text has been shared with you courtesy of:  David & Mary Mellem, EAs & Ashwaubenon Tax Professionals, 920-496-1065 (920-496-9111).,,,

©2011 Ashwaubenon Tax Professionals.  No reproduction of this article is permitted without the express written consent of Ashwaubenon Tax Professionals, 2140 Holmgren Way, Suite 1040, Green Bay, WI  54304.
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