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IRS '99-ing' fraud probe ensnarls 80 state workers

BY Gregory Seay

8/17/2015
PHOTO | lucadp, shutterstock.com
PHOTO | lucadp, shutterstock.com

Editor's Note: This story updates a state worker's sentencing that occurred after it went to press.

An ongoing Internal Revenue Service income-tax withholding probe has exposed payroll-deduction abuses among dozens of Connecticut state workers, leading to convictions of several of the worst scofflaws and a withholding-compliance crackdown by the state.

Officials with the IRS's New England regional office in Boston, the Connecticut U.S. Attorney's Office, the state Department of Revenue Services, plus several other state agencies, recently confirmed the probe's existence following the high-profile indictments and convictions of at least three current or former state workers by the Connecticut U.S. Attorney's office.

One, a nurse at Middletown's Connecticut Valley Hospital, claimed "99" personal exemptions — the maximum — on her IRS Form W-4, with no federal tax withheld from her combined $515,239 in salary from 2007 to 2012, according to court papers. She also failed to file federal tax returns for the same six-year period in which her tax bill totaled $73,599.

As a result, the state Department of Mental Health and Addiction Services (DMHAS) employee, Stephanie Elliott, was sentenced Friday in federal court to 16 months in prison and ordered to pay IRS what she owes. She also forfeits her state job.

Two other DMHAS workers indicted for income-tax related fraud have since quit their jobs, a state agency spokeswoman said. In all, Connecticut has about 60,000 full- and part-time workers on its payroll.

William Offord, IRS's Boston special agent in charge of the New England region, says findings from that probe have spurred similar IRS withholding and tax-filing investigations into state workers in other parts of New England and the U.S. He declined to specify where.

"This particular scheme is so egregious we just couldn't ignore it," Offord said. "Because they're state employees, we kind of see it as a public-corruption thing.''

Elliott, the nurse convicted of tax evasion, claimed she learned to pad her take-home pay by loading up her W-4 form with fake deductions from hospital co-workers, according to prosecutors' May 2015 presentencing memo.

That cluster of workers even coined a verb — "99-ing'' — one Offord says he had never heard of in all of his 27 years as an IRS investigator, to describe their withholding scheme.

Elliott also claimed, the memo states, that previous tax returns she did file were prepared by a man named "Buddhu,'' whom the government says was ultimately arrested for preparing fraudulent returns. Under her plea, Elliott will repay Uncle Sam $105,697.22 in unpaid federal taxes and interest.

Tax-filing misdeeds for most of the remaining state workers did not rise to the level of prosecution, Offord said. Many have been resolved through negotiations as to the amount of tax, penalties and interest due, he said.

IRS-New England region spokeswoman Amy Hosney said the probe into Connecticut state workers' withholding began when an enterprising IRS field agent conducted a "deep data dive,'' cross-indexing filers' W-4 exemption claims with their yearly income-tax filings. Hosney declined to specify the date the probe launched, but she and court papers say it has been underway since at least early 2014.

Those with discrepant W-4s and unfiled tax returns were flagged for further investigation, yielding at least 80 Connecticut state workers whose withholdings and tax filings were a mismatch, according to the same pre-sentencing memorandum that prosecutors filed in nurse Elliott's case. The number of W-4 "exemptions" claimed impact the portion of a filer's pay held aside to cover state and federal income taxes, effectively raising or lowering a filer's net paycheck.

"We do these kinds of probes to check on compliance, to see where there's no compliance,'' Hosney said.

Such probes, Offord said, enable the IRS to fulfill its mission of trying to obtain 100 percent voluntary compliance by taxpayers regardless of whether the economy is up or down, or filers are wealthy businessmen, executives, professionals, or blue-collar workers.

The investigations also serve to reassure taxpayers, he said, that no matter one's income or socio-economic status, everyone is being held accountable to pay what they owe.

"This is a scheme that a lot of people can relate to,'' the IRS special agent said. "Who wouldn't want their full amount of their paycheck without any withholding?"

Public warning

The probe's existence and the IRS's pursuit of the worst offenders, officials say, also reminds taxpayers to think twice before committing withholding and tax-filing abuses.

"If people think they're not going to get caught, the more likely people will cheat on their taxes," said Connecticut U.S. Attorney Deirdre M. Daly, whose office is spearheading the tax-evasion prosecutions.

Elliott's attorney, Deborah Stevenson of Southbury, says her client has accepted responsibility for her incorrect W-4. But Stevenson contends that beyond that, the state was legally bound to withhold the proper sum from Elliott's pay. Stevenson also wonders why the IRS hasn't held the state accountable for its role.

However, DMHAS, the state Comptroller's Office, and IRS argue that ultimately the responsibility is the employee/taxpayer's.

According to comptroller's office spokeswoman Tara Downes, each state worker is individually responsible for her/his compliance with federal withholding statutes. The comptroller's office, Downes said, is only responsible for providing state agencies and employees with "the most current information to ensure they understand the federal rules and regulations."

Not surprisingly, few of the state workers caught up in the IRS federal withholding probe breached their responsibilities as state taxpayers. Whether or not they had legitimate federal withholding declarations, most apparently still managed to promptly file their state tax returns, according to state Revenue Services spokeswoman Sarah Kaufman.

The simple reason: Being current on state income taxes is one of the conditions at least for state revenue-services workers to keep their jobs, Kaufman said. Along with failing to file federal returns from 2007 to 2012, Elliott lapsed in filing state returns for the same period, court papers show.

DMHAS, which oversees Connecticut Valley Hospital and the state's other mental-health facilities and services, said that it notified mid-probe all its workers about the state's standards for withholding compliance.

Last December, Shawn Kuhn, DMHAS's human resources director for payroll, workers' compensation and benefits, sent out an agencywide memo reaffirming the state's and the agency's standards for documenting withholding declarations, or for claiming exemptions.

It also spells out what to do if employees don't file an updated W-4.

"Pursuant to IRS Publication 15, an employee claiming exemption from federal withholding can do so only by filing Form W-4 with their employer,'' according to a copy of Kuhn's memo provided by a DHMAS spokeswoman.

"This filing is only effective for the calendar year for which it is filed. To continue exempt filing status, each impacted employee must have filed a new Form W-4 by Feb. 15, 2015. If one is not available [not filed], then taxes should be withheld on the basis of 'single with zero withholding allowances'. If an employee provides a new Form W-4 after Feb. 15, 2015 it will apply to future wages only. No refund of taxes previously withheld will be made."

Outside perspective

Dan Gottfried is a Hartford tax partner with law firm Hinckley Allen who regularly represents clients in IRS tax matters, though none are involved in the "99-ing" probe.

Gottfried said underwithholding by itself usually won't trigger a criminal indictment, unless it's tied to some other misconduct, like failing to file a return.

However, IRS special agent Offord says filing a false W-4 is a criminal offense, because a clause on the form above the line where filers sign warns that, at the risk of perjury, they are certifying that they have honestly filled out the document.

But even then, Gottfried said, scofflaws often can correct their misdeeds and avoid major sanctions — if they fess up first to the IRS.

"If you come in with your hat in hand and try to clean up your problems in good faith, prosecution is very rare,'' he said.