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Tax Day Arrives, But is Everyone Playing By the Rules?

Aired April 16, 2001 - 12:30   ET


ROGER COSSACK, CO-HOST: Today is the day, the deadline to file your taxes. People all around the country are compiling their financial records, checking their bank books and triple checking their W-2 forms. But does everyone play by the IRS' rules?


DANA GAWLEY, DENTIST: To find out three years after being involved in these trusts that it might be illegal and I might have some part of it was extremely disheartening and I was very, very scared.


COSSACK: Today on BURDEN OF PROOF, how to legally defend yourself from an IRS audit. And how much legal responsibility do you have when you sign your name on the dotted line?

ANNOUNCER: This is BURDEN OF PROOF with Roger Cossack and Greta Van Susteren.

COSSACK: Hello and welcome to BURDEN OF PROOF.

For many of you, there are less than 12 hours to file your 2000 taxes. Well, today we'll look into your rights as a taxpayer with the former IRS Commissioner Don Alexander, CNN correspondent Brooks Jackson and tax attorney and CPA Cheryl Frank. In the back, Andrew Stevens (ph) and Christie Turner (ph).

Now, tax experts estimate as many as 20 percent of Americans have not yet filed their 1040s, forcing logjams at the post office, banks and libraries. Amid today's supposed kinder and gentler Internal Revenue Service, some taxpayers are taking greater risks on generous write-offs.

But as our own CNN's Brooks Jackson reports, Americans shouldn't assume their tax returns won't face the scrutiny of an IRS auditor.


BROOKS JACKSON, CNN CORRESPONDENT (voice-over): He could be your dentist, your neighbor. Dana Gawley is an example of a growing national problem, high income Americans using illegal tax scams, schemes literally too good to be true. GAWLEY: Maybe looking back, you know, I was naive and maybe a little bit greedy, I don't know.

JACKSON: In one year alone, Gawley had income of half a million dollars and says he paid practically zero federal income tax. And he was just one among dozens of dentists, doctors and business owners who bought and abused trusts peddled by a California promoter.

DOROTHY HENDERSON: Hello, my name is Dorothy Henderson.

JACKSON: A high school dropout with a convincing sales pitch, Henderson claimed her trusts were completely legal.

HENDERSON: This is not something to avoid legitimate taxes.

JACKSON: But just look at how they worked. IRS criminal investigator Chris Gerhart explains.

CHRIS GERHART, IRS SPECIAL AGENT: This is now a entity called the Dana R. Gawley DDS trust, OK?

JACKSON: Gawley's business income went into one trust. Another trust owned Gawley office equipment. And yet another owned his home, cars, vacation home. And each trust took big deductions before passing on money to the explosion.

GERHART: And so in their theory you can then deduct your landscaping and your pool cleaning and your cars and food.

JACKSON: And if that wasn't enough, Gawley and other Henderson clients shipped money to trusts overseas, passing it through as many as five different countries.

GERHART: But once it gets to a foreign trust that is going to be located in a tax haven country such as the Netherlands Antilles or Belize or the Turks & Cacois or Costa Rica, once it gets there, we can't trace it.

JACKSON: The money came back to Gawley and other Henderson clients untaxed, minus only a five percent fee to Henderson for what she called "privacy." For three years, the trusts seemed to work like tax magic.

GAWLEY: Before that I had been paying anywhere from $30,000 to $80,000 a year in income tax. And all of a sudden that went from $30,000 to $80,000 down to basically nothing.

JACKSON: Now, Gawley's accountant, Ron Chappell (ph), has been convicted of tax fraud and sentenced to seven years in prison. He steered Gawley and others into Dorothy Henderson's abusive trusts and Henderson herself was convicted and sentenced to more than 11 years in prison. Her husband and partner drew a six year sentence. All are appealing their convictions.

The IRS admits it has a hard time catching abusive trusts.

DWIGHT SPARLIN, IRS SPECIAL AGENT IN CHARGE: Basically, their goal is to hide information from the Internal Revenue Service.

JACKSON: When the IRS does uncover a trust scheme, it generally prosecutes only the promoter. The IRS says Dorothy Henderson help clients evade somewhere between $10 million and $20 million in federal income taxes, while she charged fees totaling more than a million.

Though he wasn't prosecuted, Dana Gawley still had to pay back taxes plus stiff penalties and interest, hundreds of thousands of dollars. His advice? Check your common sense and don't try it.

GAWLEY: I guess I should have asked more questions and, you know, if you want something to be true, you know, maybe you believe that, you know, over your best judgment that it really is when it isn't.


COSSACK: Well, Brooks, this is a sad story for that dentist but, you know, I couldn't help but thinking as, watching this, which was the point of, I mean at what point did he say, you know, what part of this, what part of free taxes is going to be OK in this world? Because, you know, I've yet to see this happen.

How widespread is something like this?

JACKSON: Well, it's getting more and more widespread, apparently. There are now actually outfits promoting these kinds of schemes on the World Wide Web. The Hendersons were selling their trust package for about $5,000 per client, doing direct marketing. Now the price is down to $895 on some Web sites I saw.

Roger, one thing I want to stress, though, the key to your question earlier, Dana Gawley, the IRS considers him kind of a stand- up guy. He testified at the trial. He relied, he says in good faith, on his accountant, who he'd been with for years. Now, his accountant went to jail. But if the IRS can prove that you as a taxpayer knew these things were illegal, you could go to jail, too, and there are -- there is a dentist, in fact, in Michigan who is now serving a long prison sentence for just this sort of thing.

COSSACK: Well, it would seem to me that in terms of proving something like this that it's always a difficult thing to prove what you know and what you don't know unless you have something in writing or something on that and normally when somebody comes in and testifies on behalf of the government, usually, the government is usually willing to make some kind of a deal with them. But it...

JACKSON: And that's why the IRS is focusing on the promoters here and, of course, for the folks who, the taxpayers, when they eventually catch up to them, they do have to pay interest and penalties and a lot more money than they would have paid if they had just been straight up in the first place.

COSSACK: I just want to say this, as both a former prosecutor and a former defense lawyer, it would have been a lot easier, I think, for me to make an argument to a jury about we don't know what this man was thinking, but what do you think he was thinking when, in fact, suddenly he just bought into this thing and never had to pay any taxes? Do you think he knew something was wrong? And I just think that that would be an easier argument to sell than gee, he had no idea.

JACKSON: Could be. And I think the IRS is now, of course, publicizing its position on these things. So they're cracking down on them. And I think as time goes on the argument that gee, I didn't know is going to be a harder one to sell to a judge or a jury.

COSSACK: Let's talk, we're going to talk later on in this program about red flag items. But let's talk about now the idea of red flag items. It would seem to me that suddenly, you know, I'm an IRS investigator and I'm looking up and suddenly here's a person not paying any taxes, the flag couldn't get any redder.

JACKSON: Well, as a taxpayer if you encounter one of these offers, probably the first thing the IRS would advise you to do is ask yourself if this is too good to be true? And if it seems too good to be true, it probably is. One of the red flags that you see a lot, they'll tell you, your own accountant and lawyer probably aren't aware of this, it's too sophisticated, trust us, don't trust your own lawyer. That's actually a red flag that this may be a fraudulent scheme.

COSSACK: And in terms of promoters, in terms of it's the promoters who are, you say, generally are going to jail, but again, that doesn't mean that the taxpayer is off the hook.

JACKSON: It does not. As I say, there are people who are serving prison time now who were just taxpayers, clients of some of these folks. It's a matter of what the IRS and the Justice Department think they can prove at trial. They're focusing on the promoters but any taxpayer who goes into this knowing that it's wrong is at risk.

COSSACK: All right, let's take a break. When we come back, how do you legally defend yourself from the IRS? Have things really changed in the auditing department? Don't go away.


COSSACK: It's a rite of spring. I don't mean baseball, I mean taxes. Today is the final day for Americans to file their tax forms for the year 2000 and for some, tax day and dealing with the IRS is a scary occasion. Not for me, of course. Especially for those facing audits.

Don, let's go right to you. Is the IRS a friendlier place than it was, perhaps, when you were the commissioner?

DON ALEXANDER, FORMER IRS COMMISSIONER: Oh, it certainly is kind and friendly now, much friendlier than when I was commissioner, even though I tried to make as sure as you can in this imperfect world that taxpayers are treated fairly and with respect.

COSSACK: Cheryl, as a practicing accountant as well as attorney, and you have to represent people through, who go through audits, do you find now your relationships with the IRS agents are different or friendly or easier?

CHERYL FRANK, TAX ATTORNEY CPA: They're different. Right now we have more cases going into the criminal arena than we did in the past. There's a lot less civil cases and more criminal. So although on the civil side they might appear more friendly, they come down with a heavy stick.

COSSACK: Well, now, I always understood what got you in trouble with the IRS was that if you failed, basically, if you failed to report your income or you set up some fraudulent kinds of deductions. But if you at least told them how much money you made and you at least tried to be creative, you could always argue about it. But you're saying now that kind of talk gets you into criminal court?

FRANK: Right. We're seeing a lot of non-filer type cases of small amounts going into criminal, which we hadn't seen in the past, a lot of issues with collection and employment taxes going into criminal. So it's a whole different arena right now.

COSSACK: Now, help me out. When you, if you don't file your income tax, that's a misdemeanor, isn't that right?

FRANK: Well, failure to file over a number of years...

COSSACK: Can become...

FRANK: ... when you owe money can become...

COSSACK: A felony?

FRANK: Right.

COSSACK: But if you do it, if you fail to file one year, isn't that a misdemeanor?


COSSACK: But if you file a return that is fraudulent, that's a felony?

FRANK: Right.

COSSACK: And that's the one where people are marching off to prison?


COSSACK: So, Don, what are the red flag items? What can you tell me about red flag items?

ALEXANDER: Well, you saw a red flag in your earlier segment, the idea as a dentist who has a very large income to suddenly start reporting practically nothing. That's about the worst thing you can do. There are a lot of other bad things you can do. Some of the other bad things that you can do generally go to unreported income rather than overstated deductions. Simply forgetting about a principal part of your income is a very unwise thing to do, even now with the kinder and gentler IRS.

COSSACK: How about -- Cheryl, what about this innocent spouse change in the law? That was a dramatic change that happened a couple of years ago. What was that all about and what was the purpose?

FRANK: Well, the purpose was to allow spouses which may not have contributed to issues of liability to get out of paying. There was a lot of publicity as to that it would be a lot easier. In our experience it has not. So many innocent spouse claims have been filed that the IRS is just bogged down and nothing is being done about them. But the few that have gotten through, it's been a long and arduous process. So it's not what the IRS claims.

COSSACK: Brooks, the whole purpose of that innocent spouse change in the code was to protect husbands and wives from being liable for something that they had very little to do with. Is it working?

JACKSON: Well, I can't tell you. I think you've just heard the answer to that, that the case load certainly has gotten the IRS bogged down. The General Accounting Office has commented on this. It's also drained a lot of personnel away from traditional collection activities like audits. Audits are now down at a, the audit rate last year was at an all time low. The chances of an individual being audited are less than one half of one percent. You could go 200 years without being audited. Even for high income people it's less than one percent.

COSSACK: What about that? Is the auditing rate down? I mean are people, is there less chance that people are going to get audited unless they have one of these red flag items that we talked about, the trusts or an enormous amount of money and very little taxes?

FRANK: Yes, that's true. We've seen a significant decline in audits over the last few years.

COSSACK: And why do you think that is?

FRANK: They just don't have the personnel. They're supposed to be hiring some but it's still going to take a year or two or three to train them, especially the level of sophistication of many taxpayers in high income brackets.

COSSACK: So, Don, you know, as a former commissioner, what do you, what would you tell people who first of all get notice that they're going to be audited or second of all, are getting ready to file their tax returns, they want to do the right thing and they don't want to get audited?

ALEXANDER: Let's take that second category first.

COSSACK: All right.

ALEXANDER: The second category who want to do the right thing, ought to file a complete, timely and reasonably accurate, not necessarily perfect, returns.

COSSACK: What if you don't have the money to pay the taxes?

ALEXANDER: If you don't have the money, file the return anyway. File the return anyway. Get that return on file and then work with IRS to have a payment plan or, if you don't have money at all and nothing coming in, an offer in compromise. IRS has been deluged with them lately. Congress told IRS in '98 to go easy on taxpayers that owe taxes. It gave taxpayers who owe taxes, overdue taxes, new due process rights, appeal rights. And IRS has responded to Congress.

COSSACK: All right, let me just go to Cheryl now. All right, now you're the practical person. I've come to you and I say listen, I've got to pay this income tax, I don't have it. What, in reality what's going to happen to me if I say listen, they say, OK, you owe us $1,000. I call them up and say listen, I'll tell you what, I'll give you $500? Are they going to take it?

FRANK: What most people are doing now is using the offer in compromise process. It's a long process. Usually it takes about a year or a year and a half to get through. There's appeals that you have to go through. It's not easy. You can't just file a form and pay less taxes. So it's not as the IRS says. It's hard.

COSSACK: All right, now, but what -- you say it's hard and it's difficult, but in the long run, what's the chances of the taxpayer's success?

FRANK: I think it's very good if your income is in a certain position and you don't have a lot of assets. If you're a high income taxpayer with a lot of assets, the offer of process becomes very difficult.

COSSACK: And then the IRS, what, just rejects it and says no, you owe us the full amount of money?

FRANK: Right, and you're back to square one with more interest and penalties.

COSSACK: More interest and penalties. All right, now, forget about that. Let's talk about now the person who doesn't want to get audited. What should that person be trying to do?

ALEXANDER: OK, that's still in that second category, the person that doesn't want to get audited.


ALEXANDER: That person ought to do his or her best job trying to figure out what his or her income was for the disclosed year, what the tax is, get a return on file, pay as much of the tax as you can, all of it if possible, and then try to stay even with IRS in the current year. People have to pay withholding taxes and people have to filed estimated taxes and pay the estimated taxes. That's what the person ought to do.

Whether the person will do it or not, don't know.

COSSACK: That's a different story. All right, Brooks, what happens now, you're the taxpayer or the ubiquitous taxpayer and someone comes along and says, you know, there is this new tax plan. This is what all the wealthy people are doing, you know, and they don't pay taxes. You're the only one that's paying taxes. So let me help you out. There's this new tax method, we do this, we do that, cut your tax by 50 percent? What should I...

JACKSON: Well, watch out is the answer and get good legal advice from somebody you trust. Don't take these things at face value because as the opening segment showed, you can get in trouble with these schemes, some of them.

COSSACK: All right, but are there, Cheryl, are there ways in which, legitimate ways that people can save money, or are things pretty well cut and dried?

FRANK: Well, there's always creative ways to plan transactions. But if it sounds too good to be true it usually is.

COSSACK: All right. Now, in terms of, for example, tax savings device, what's the best one, buying a house, owning a house?

FRANK: Owning a house. Taking advantage of your Schedule A deductions such as charity, medical expenses, keeping good track of those things. That's still an excellent way.

COSSACK: Now, Don, you've gotten notice that that audit's, that the auditor is about to knock on your door. What should, how do you react and what should you do?

ALEXANDER: One, don't get excited. Two, don't get mad. And three, assemble the information and have the information to back up your deductions and also to show that you've fully reported your income ready when the auditor shows up. The auditor has a tough job to do. There's no sense in trying to make it worse.

COSSACK: All right, that's all the time we have today. Thanks to our guests and thank you for watching. Today on TALK BACK LIVE, should sports teams named after Native Americans change their names? Send your e-mail to Bobbie Battista and tune in at 3:00 P.M. Eastern Time. And we'll be back tomorrow with another edition of BURDEN OF PROOF. I'll see you then.



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