Federal prosecutors are asking the court to shut down a Liberty Tax Service franchise in South Carolina, alleging that these locations have deliberately prepared false and inflated federal tax refunds by giving them income from fictional jobs and claiming children that don’t exist.

Virginia-based Liberty licenses its brand out to some 4,000 tax prep franchises around the country. Christopher Paul Haynes, the franchisee in Justice Department lawsuit operates a trio of franchises in Columbia, SC, area. According to the complaint [PDF] filed this week in a U.S. District Court, these offices “routinely prepare and file fraudulent income tax returns for customers.”

“The tax return preparers at Haynes’s tax preparation offices fabricate expenses, deductions, credits and other adjustments on customers’ federal income tax returns to illegally generate a tax refund or a refundable credit from the Internal Revenue Service,” reads the lawsuit, which accuses the franchises’ approximately 35-40 preparers of, among other things, reporting false or inflated business income, expenses, and bogus dependents.

High Rate Of Success

Customers at Haynes’ franchises almost invariably ended up claiming a refund. According to the complaint, 99% of the nearly 1,500 tax returns filed between Jan.-April 2015 calculated that the taxpayer was owed a refund. From 2011 through 2015, an average of 93% of returns filed at these locations sought refunds.

The IRS took a look at 202 federal tax returns prepared by these offices between 2011 and 2014. Nearly all of them (96%) contained deficiencies requiring IRS adjustments.

“The IRS calculated the average tax deficiency per return to be approximately $3,834 per tax return,” notes the complaint, which says that Haynes and his employees continued to prepare problematic returns even though he knew that customers were being audited and he was under investigation.

In spite of the fact that many of the customers had no idea their returns had allegedly been falsified or inflated, preparers frequently asked them to sign, without explanation, a Return Information Verification form indicating that they had reviewed the documentation.

Hitting The Sweet Spot

One of the ways that Haynes’ preparers frequently managed to claim that they were owed large refunds was through a combination of claiming false income and inflating or falsely claiming an Earned Income Tax Credit.

The EITC allows lower-income people to claim a tax refund even if they have no tax liability and have made no withholding payments. The amount of the credit increases as annual income approaches $13,650 but begins to decreases once it gets beyond $17,830. EITC also increases, within limits, as the claimant adds more dependents.

So if, in tax year 2014, you had three dependent kids and earned between $13,650 and $17,830, you were entitled the maximum EITC of $6,143.

In order to hit that sweet spot, the DOJ says that Haynes and his preparers would create fictional income for customers who earned less than $13,650 and/or claim fake dependents to get up to three.

Over a five-year period, some 62% of returns filed at these locations claimed the EITC.

More Forms, More Money

To create these nonexistent businesses, the DOJ says that preparers would ask customers about their hobbies and base their fictional employment on their answers. You say you like to cut hair? You’re a freelance hairstylist. Enjoy arts and crafts? That’s a business too, of sorts.

The lawsuit cites examples of fake housekeeping businesses, janitorial services, caregivers, stylists, babysitters, and home health care operations resulting in thousands of dollars in unearned tax credits being falsely included on these returns.

And doing so didn’t just get the customer a refund they may not have deserved. It also benefited the franchises, which charged for preparation on a “per form” basis. So by filling out the Schedule C for the fake income and then claiming the EITC on yet another form, Haynes’ franchises were allegedly making even more money from the deception, contends the lawsuit.

Likewise, preparers would allegedly file false Schedule A deductions for bogus business expenses, resulting in a larger refund for the customer and another form to pay for.

“No Walkouts”

The DOJ claims that preparers at Haynes’ franchises are paid near minimum-wage levels. They do, notes the lawsuit, receive an end-of-season bonus “based on the total number of tax returns that the employee prepares and files during the tax season.”

By paying his preparers so little for their time, but rewarding them for working expeditiously, the DOJ alleges that “Haynes financially incentivizes his tax return preparers via this bonus system to prepare as many tax returns as possible, for the highest possible preparation fee.”

Employees are also, according to the DOJ, taught to abide by a “no walkout” policy, meaning that preparers should do everything they can to justify the “exorbitant” fees charged by the service and to make sure that a return is prepared for every customer who comes through the door.

Thus, prosecutors say that even though the preparers do receive some training on tax preparation before the season starts, “many employees do not uniformly adhere to the pre-tax-season tax preparation training when preparing customers’ tax returns.”

Federal law requires that tax preparers “furnish a completed copy” of a customer’s return “not later than the time such return or claim is presented for such taxpayer’s signature.” But the lawsuit contends that these Liberty franchises frequently failed to do so, and that sometimes they charged upwards of $50 to customers just to get copies of their returns.

The DOJ is asking the court to block Haynes — who had no tax-related experience (other than doing his own personal taxes) before becoming a Liberty franchisee in 2005 — and his employees from preparing tax returns, or assisting in any way with the preparation of tax returns.

Liberty HQ Responds

When reached for comment by Consumerist, Liberty’s Chief Compliance Officer Jim Wheaton stated that the company “has a robust compliance program, and we expect our franchisees to make sure that their offices comply with all federal and state tax requirements.”

Noting that the lawsuit only applies to a small number of the company’s total franchises and that the corporate office had not been made aware of any investigation, Wheaton nonetheless said that the Liberty “will take appropriate action after completing a review of both current year and prior operations at these offices.”

“There is no place in the Liberty Tax system for franchisees or preparers who commit fraud or who take other shortcuts,” said John T. Hewitt, President, CEO and Founder of Liberty Tax, in a statement. “We created a separate compliance group, and named a Chief Compliance Officer last year, in order to be able to respond quickly to compliance concerns.”

Hewitt says that he hopes that the situation at the Haynes franchises isn’t as dire as the lawsuit makes it out to be, but acknowledges that “In a system that includes thousands of offices and 35,000 tax preparers hired by our franchisees each year, it may be inevitable that some franchisees and preparers, or their customers, will engage in behavior that Liberty does not condone and will not tolerate.”

It’s been a not-great 2016 so far for Liberty. In January, Maryland Comptroller Peter Franchot stopped accepting returns from seven different Baltimore-area Liberty locations. Then last week, Franchot suspended processing tax returns from 16 additional Liberty franchises because of the high volume of questionable returns.

What The Schedule F Is Going On?

Problems with untrained and greedy tax preparers is not limited to the few Liberty franchises mentioned here. It’s an industry-wide issue, as shown in a recent undercover study by the National Consumer Law Center.

In 2011, the IRS created a system that would require all 700,000 non-CPA tax-preparers in the U.S. to register and demonstrate their mastery of the topic through testing and continuing education courses.
However, the tax-prep industry immediately challenged the IRS’s authority to enact these sort of rules and in 2014 a federal appeals court sided against the IRS.

An 1884 law gives the IRS the authority to “regulate the practice of representatives of persons before the Department of the Treasury,” but the appeals court ruled that tax preparers only assist taxpayers and “do not possess legal authority to act on the taxpayer’s behalf. They cannot legally bind the taxpayer by acting on the taxpayer’s behalf.”

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