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CRACKING THE CODE, OR SMOKING THE CRACK?

June 12, 2006

A reporter from Tax Analysts e-mailed me last week asking if I had ever dealt with clients who filed returns based on a book called "Cracking the Code." I hadn't heard of the book, so I googled the book title. After getting a page full of responses about the Catholic Church and Opus Dei, I refined the search by adding the name of the author, Alan Hendrickson.

Based on the Google results, Mr. Hendrickson's book looks like the usual delusional tax protestor stuff - wages aren't income unless their earned by government employees or on federal reservations or territories, etc. I said as much to the reporter, and said I was glad I had no clients who had filed based on Mr. Hendrickson's theories.

The reporter then asked why the IRS seems to issue refunds based on these returns. That is an interesting question. The IRS clearly does issue refunds based on bogus tax theories on occasion, and some people no doubt get it. Why?

ROLLING THE ACORNS PAST THE BLIND SQUIRRELS

Mr. Hendrickson would argue that the IRS issues refunds because he's "cracked the code," discovering the magic set of filings to get you out of paying taxes. That is, of course, absurd. And no, it's not a conspiracy to keep me doing what I'm doing for a living; if this stuff actually worked, I would take it to my highest-income clients, crack the code for them, and get them to pay me an annuity of 5% of their tax-free income for the rest of my life; they'd do it gladly, if it worked, and I'd spend my springs watching baseball games in Arizona instead of doing tax returns in Des Moines.

The refunds come through, when they come through, because of the ponderous nature of the IRS bureaucracy. I don't think the IRS has ever really figured out how to cope with tax protestors. It will inevitably fail to recognize some of the tax protest returns out of the 160 million or so annual 1040s, and some of the bogus filers will get their refunds. Any refund claim is likely to get paid if it isn't done in crayon, if it foots, if it doesn't use some obvious tax-protest trigger words (and maybe even then), and if the refunds are relatively small.

The Tax Analysts piece on Mr. Hendrickson's book came out today ($link). It quotes Dennis Parizek, "an IRS operations manager who heads the agency's "frivolous filer" unit based in Ogden, Utah." The piece says:

Parizek estimated that this year the IRS has stopped roughly 90 percent of zero wage refund claims, and he expressed confidence that more would be recovered after his agents start examining the returns filed this year. He speculated that most of the zero wage refunds that had been issued this year were for relatively small amounts -- less than $2,000.

The numbers are vague enough to make me suspicious. I wonder where they get the 90% figure? It's reassuring to know that the service centers do have teams dedicated to tax protest issues, but the words "estimated" and "speculated" sound like somebody guessing, rather than somebody with solid figures.

THE MAGICAL FORM 4852

Unfortunately for Mr. Hendrickson's readers, the method the book seems to advocate is one the IRS is likely to catch. Apparently Mr. Hendrickson's adherents file Form 4852, which is used by people who never get a W-2 from their employer, or who find errors on the W-2. The code-crackers file a 4852 showing no income.

This is likely to generate an IRS notice. The IRS does computer routines to match employer W-2 reports with the 1040s that are supposed to show the income. This routine will normally flag the code-crackers returns for further review. The IRS matching runs for 2004 filings are probably underway about now, and a lot of 2004 crackers who weren't identified on their initial filings can expect unhappy tidings from the IRS over the summer.

WHY SO SLOW?

Still, I have always thought the IRS response to tax protest arguments was puzzlingly slow. Tax protest promotors should be hit hard, and quickly, with maximum publicity to set an example. In fact, though, many continue to operate for months or years while the slow IRS injunction process grinds on - giving the gullible the impression that the promotors have really "cracked the code." And then they brag to their neighbors or on Mr. Hendrickson's website, making honest filers feel like chumps, at least for awhile.

I wonder whether the IRS has a central unit devoted full-time to tax-protest schemes? A few lawyers and agents devoted full-time to tax protestors and scam preparers should be able to pay for their keep by shutting down scams before they get traction.

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