Why widespread fear of the IRS opens the door for scams

In an undated handout photo, a sample 1040 income tax return. (Handout via The New York Times)

Lisa Bennett was at home when she received a call from Officer Jason Dean of the Investigative Office of the Treasury. He told her that an arrest warrant had been issued for failing to respond to three IRS CP503 notices, that her phone lines were being traced and that she should not try to leave the city.

When she protested that she had received no such notices, he responded with the high-handed disinterest of a powerful bureaucrat: “We’re only calling you as a courtesy to inform you that you will be arrested and charged with failure to meet federal taxation requirements, malicious conduct, and theft by deception. You will be arrested within the next two hours and held in custody for six months pending an investigation.”

Then he softened: There was someone who might be able to help her, but he could make no guarantees. He transferred her to another agent, who said that if he could get a 1099-C form for out-of-court restitution for cancellation of debt, he might be able to call off the police, whose calls were already showing up on her cell phone. But there was not much time. Soon she was racing to the bank with her son in tow, afraid to hang up the phone lest the arrest team descend.

It was a scam, of course. These were not IRS agents. Form 1099-C is not for cancelling your debts, but for reporting debts you’ve had cancelled by others (which the IRS quite properly regards as income). And while there are people who go to jail for tax evasion, you have to work pretty hard at defiant non-payment to actually get sent to the pokey. Also, agents of the IRS won’t make it hard to verify that they are agents of the IRS — for instance, if you want to call them back at an official number.

Bennett ultimately didn’t fall for it. She came to her senses when she was asked for money. But these tricks are successful often enough to continue. What’s interesting about this scam is its departure from classic confidence schemes.

Think about something like the Nigerian email scams, and how they draw their victims in: greed for a lucrative finder’s fee in exchange for doing something that sounds maybe a little bit shady, but maybe sort of noble too.

The IRS scam, on the other hand, works entirely by fear. It makes people who have done nothing wrong afraid that they have. That’s a pretty hefty achievement. Imagine trying to extort money from someone by claiming that they had murdered someone. You might elicit laughter or bewilderment, but you’d rarely elicit cash.

Why is it so easy for people to believe that the IRS is about to arrest them for a crime they weren’t even aware of having committed?

You guessed it: The IRS is incredibly powerful, and the tax code is incredibly opaque. Filling out taxes is not a matter of being good at math or accounting, or even knowing how various provisions of the tax code interact in revenue projections. It is entirely a matter of knowing what can be deducted, and how. And because our tax code is so complex, that doesn’t mean “read the statute”; it means “read the statute and the case law, and develop a sense over long experience of how agents are likely to interpret this or that during an audit.” Only tax professionals can do that; the rest of us are too busy earning a living.

Legal complexity does not accumulate linearly; it accumulates exponentially. When you have one law on the books and you add a second, the new law may have some unexpected interaction with the old law. With each new law, the number of potential interactions grows quickly until it passes the ability of any layman to grasp (and eventually even the professionals, which is why they’re increasingly specialized). We are long past that point with the tax code.

The obvious answer is “tax simplification.” Other countries do not have quite this tangled mess, after all. But the dirty secret of tax simplification is that the stuff that complicates matters is the stuff people like. “Tax complexity” sounds terrible, but what about IRAs? Deductions for dependent children, excess health expenses or interest on home mortgages? Educational tax credits?

If we try to get rid of stuff that people love, taxpayers will scream. A big reason the tax code is so complicated is that we give deductions where other countries use subsidies. A simple, comprehensible tax code cannot offer the wide array of deductions and credits. And so we have this paradox: Everyone wants taxes to be simpler, but no one wants to get rid of the things that make them complex. This leaves us vulnerable, not just to scams but to a pervasive sense that the government may descend at any moment to punish us.

But apparently, we’d rather have that than lose our mortgage interest deduction — or admit what our tax policy is doing, and offer straightforward subsidies for the things we want to encourage.

Megan McArdle is a Bloomberg View columnist.