Hold the Phone! Tax Cheats Ripping Off the IRS

April 14, 2007 — -- Wars are expensive. They are now and they were more than a century ago.

Hard pressed to pay for the Spanish-American War in 1898, the government imposed an excise tax on long distance calls from those new-fangled telephones. It was considered a tax on the well-to-do, since they were the ones able to afford such luxuries.

The war ended quickly, but the tax remained.

Last year, Washington finally killed the tax, and offered refunds for all taxes collected after February 2003. But tax cheats figured a way to get more than they should.

"Eleven percent are requesting refunds that would have required them to pay their entire annual income in telephone service," J. Russell George, the Treasury Department's inspector general for tax administration, told ABC News. "And it's simply outrageous."

George said his auditors looked at 23,000 refunds that have already been paid.

"Over 66 percent have requested amounts that would have required the person to have paid at least a quarter of their total annual income in order to achieve the amount they're requesting for a refund," he said. "So, for example, someone with a $40,000 annual income, they're asking for $10,000 in refunds."

Cheats are getting away with that and other tax scams, according to the inspector general, because the Internal Revenue Service says it does not have enough agents to audit the returns.

"The IRS is knowingly paying out highly suspicious tax refunds," George said. "The IRS had made a decision that it is cheaper for them, or more efficient for them, to allow certain levels of fraud to occur so that they could focus on bigger items."

George sharply disagrees with the IRS' reasoning, and said so in testimony sent to Congress. He said the cost so far to the Treasury is more than $30 million.

"But that," he said, "is just at the outset."

No one knows how much the refund frauds will eventually cost. Many people are only now filing their tax returns and requesting refunds.

The IRS says even when it finds tax frauds, the Justice Department, overburdened with other cases, often refuses to prosecute.

On Thursday, IRS Commissioner Mark Everson told Congress, "In most districts across the country, you will not get prosecuted for a $40,000 refund crime."

The government has not only failed to crack down on many tax cheats. In some cases, it has hired them.

A few years ago investigators discovered 27,000 defense contractors who owed back taxes on big profits they made on everything from catering food to providing services at military funerals.

One contractor had not paid taxes for 10 years. He moved to a comfortable life in the Caribbean where he cannot be extradited.

Gregory Kutz, who directs investigations at the Government Accountability Office, told Congress in 2004, "He sucked the money out of the company, left the country, and the IRS was left with $10 million unpaid tax."

The Pentagon says it now checks with the IRS to find out whether contractors owe back taxes. But just when the IRS thought that problem was solved, more tax cheats turned up -- physicians and medical companies who get paid by Medicare.

"One ambulance company received more than $1 million from Medicare in just the first nine months of 2005," Sen. Norm Coleman, R-Minn., said at a Senate hearing, "and it owed more than $10 million in back taxes."

Congressional investigators found that 21,000 doctors and companies paid by Medicare failed to pay $1.3 billion in taxes.

And who has to make up for the taxes lost?

As Russell George told ABC News: "Tax cheaters cheat everyone, not just the IRS, because if everyone paid what they owed, tax rates, in theory, could go down."