February 2008

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1. Offshore credit card users.

2. High-risk, high-income taxpayers.

3. Abusive schemes and promoter investigations.

4. High-income non-filers.

5. Unreported income.

6. The National Research Program.

The use of offshore credit cards is not illegal, but from a taxation standpoint, they are considered high-risk because they can hide income not reported to federal authorities.

High-income taxpayers typically have more complex returns than middle and lower income filers. They have the ability to invest in pass-through entities like partnerships, trusts and corporations. Upper income taxpayers also have the ability to engage in sophisticated tax mitigation schemes. Because of the resources available to higher-income taxpayers, the potential for errors and outright fraud to occur in their returns exceeds the risks inherent in tax returns of lower-income filers.

The IRS continually updates it's listing of transactions and schemes that it considers abusive and fraudulent. Using any of these schemes could signal your return for audit. For more information on such schemes, check out the IRS Compliance and Enforcement page.
www.irs.gov/compliance/index.html

High-income non-filers - and those who fail to report income - should be aware that the IRS has developed, and constantly improves upon, a sophisticated computer model to catch them. As time goes on and more data is collected through the National Research Program, the accuracy of these models will only increase. Even without the use of the model, the IRS's 1099 matching program has greatly enhanced collections from returns that omit income.

As a final note on where the IRS is headed, be aware that certain returns are automatically screened by IRS personnel. From an individual standpoint, all returns with total positive income items that total $50,000 or more will be screened. This does not mean the returns will be audited, only that there is a higher chance for them to be chosen in the long run.

The strategy articulated in 2002 is still applicable today. As the IRS continues to develop its computer models, you can expect to see greater accuracy in the returns it chooses for audit. With greater accuracy comes the likelihood that the IRS will increase the numbers of returns it audits and finds additional taxes. For this reason, it is important for you to make certain that what you report to the IRS is accurate. If you have any questions of how this might affect your tax returns, please give us a call.

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General Business News

The High Cost of Fraud

The latest Report to the Nation on Occupational Fraud & Abuse (the Study) prepared by the Association of Certified Fraud Examiners is, to say the least, bone chilling for business managers. If its conclusions are right, businesses in the United States lose 5% of their revenue to fraud each year. This equates to over $600 billion a year, some of which could be occurring at your company.

The Study was based on information provided by well over 1,000 Certified Fraud Examiners plus over 1,000 cases of occupational fraud investigated in 2006. By far, the most prevalent form of fraud included some type of asset misappropriation, with corruption the second leading cause and financial statement fraud coming in third. As a business owner, it is imperative that you know the basics of how fraudsters operate and how to protect yourself from a potentially devastating loss.

Asset Misappropriation

Asset misappropriation is exactly what it sounds like - the use of your assets for an unauthorized purpose. Depending on the scheme used by the perpetrator, the median loss can be anywhere from $25,000 to $500,000 when dealing with misappropriation of cash. The median loss for non-cash asset misappropriation is anywhere from $55,000 (inventory) to $1.85 million (securities).

Skimming and larceny are the primary avenues of misappropriation of cash receipts. Skimming schemes are those where cash is stolen prior to being recorded on an organization's books. Taking a customer's cash and failing to ring up a sale on the register is one example of skimming. Larceny, on the other hand, occurs after the receipt has been recorded on the books. For example, an employee properly records a customer's check on the books, then deposits in his or her own account. The median loss for misappropriation of cash receipts is $73,000 to $76,000.

To most of us, the cost of misappropriation of cash receipts is staggering, but the real dollars are in schemes involving cash disbursements. For example, fraud involving payment of fictitious bills carries a median cost of $130,000 and fraud involving wire transfers costs a median $500,000. Schemes can also involve fraudulent expense reimbursements and false payroll checks.

If your business carries inventory, control is essential, particularly if the inventory is in high demand. Naturally, food and other items used daily are susceptible, but so are just about any inventory items that have a ready market. Electrical supply houses, foundries, office supply stores, and many other companies can suffer inventory "shrinkage."

The high ticket item (in the non-cash area) is theft involving securities. The median loss is $1.85 million and typically involves transfer of company investments to personal accounts.


Corruption

While most of us would think misappropriating assets is a pretty corrupt thing to do, the Study defines corruption differently. Corruption occurs whenever someone uses his or her influence to obtain a benefit contrary to the interests of the company. Bribery, extortion, engaging in transactions where there is a clear conflict of interest (undisclosed), and similar acts fall within this category. By far, undisclosed conflicts of interest were the most prevalent at 61.6%, while bribery came in second at 42.7%

Financial Statement Fraud

Financial statements are relied heavily upon by vendors, lenders, and the investing public. Failure to fully account for and properly disclose the financial status of a company has caused suppliers and vendors to lose billions of dollars. Most fraud comes from the failure to record all liabilities and falsely record revenue and value assets. Even transactions that have substance may be fraudulent if reported in the wrong period.

While all forms of fraud are heinous, financial statement fraud can be the most destructive. Consider, for example, the losses incurred by investors in WorldCom and Enron. Not only did heavy hitters lose millions of dollars, but small investors whose life savings were tied up in the stocks lost their retirement. The sheer magnitude of financial fraud can be astounding.


The Cure For Fraud

No system ever designed by man has been able to fully limit fraudulent activity. In the end, the best cure for the common fraud is the common sense of a business' owner(s). Constant vigilance and instituting proper oversight of the activities and assets of a business will always be the best protection against fraud. Next month, we will discuss some controls and policies you can put in place to protect your company, your assets, and your employees.
 

2008 Strothman & Company Seminar Series - Confessions of an Embezzler

Join Strothman & Company on April 23, 2008 as we host Barry J. Webne, a convicted embezzler as he shares his insight on the second most costly white collar crime in the United States. He will reveal the secrets and early warning signs of financial fraud and provide prevention measures. You will leave knowing how to protect your organization from schemes that could rob it of its reputation and financial security.

Seminars are held at Owl Creek Country Club. Registration: 7:30 AM. Seminar: 8:00 - 10:00 AM.
Call 585.1600 for reservations.
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If you have any questions, please call us at 502.585.1600 or email info@strothman.com

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