Personal Finance

Taxes and penalties may await wealthy parents in college admissions scam

Key Points
  • Fifty people, including two high-profile actresses, were charged in $25 million scheme to help wealthy children get into universities.
  • Certain parents allegedly agreed to disguise their bribes as charitable contributions to a non-profit, meaning they could deduct the payments on their taxes, according to law enforcement officials.
  • The civil tax fraud penalty for that is equal to 75 percent of your underpayment in taxes.
The Internal Revenue Service building in Washington.
Getty Images

Wealthy parents ensnared in a massive college admissions scheme may have another worry on the horizon: the IRS.

Two famous actresses and a group of executives are among the 50 people facing charges in a massive cheating conspiracy to help their children get into elite colleges, according to law enforcement officials.

The scheme allegedly involved parents paying William "Rick" Singer of Newport Beach, California, so that he could facilitate cheating on the SAT and ACT entrance exams, according to the 204-page affidavit.

These payments, which ran from $15,000 to $75,000 per test, were allegedly structured as donations to the Key Worldwide Foundation, a non-profit that Singer established as a charity, according to law enforcement officials.

Parents also allegedly paid Singer a purported $25 million to bribe coaches and college administrators to designate the children as athletic recruits, according to the complaint.

To get a tax deduction for making a gift to charity, you must give it out of 'detached and disinterested generosity.' Paying a bribe is an incredibly interested act.
Joshua Blank
professor of law at the University of California, Irvine School of Law

The parents also made these payments under the guise of charitable donations to the foundation, law enforcement officials allege.

"Many clients then filed personal tax returns that falsely reported the payment to the KWF as charitable donations," federal authorities said.

Under normal circumstances, charitable donations are deductible if you itemize on your income tax return.

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However if those payments were fraudulent, the IRS could claw back those breaks and hit the "donors" with penalties, tax professors said.

"If what they were actually doing was not making charitable contributions but paying bribes, then the IRS should be able to question that and disallow the deductions," said Leandra Lederman, director of the tax program at the Indiana University Maurer School of Law.

Goods and services

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50 people charged in college admission scheme

After parents made payments to Key Worldwide Foundation, employees at the organization mailed letters thanking them for the contribution, federal authorities alleged.

"Your generosity will allow us to move forward with our plans to provide educational and self-enrichment programs to disadvantaged youth," the letter said.

The message also falsely said that "no goods or services were exchanged for the donations," according to the complaint.

If what they were actually doing was not making charitable contributions but paying bribes, then the IRS should be able to question that and disallow the deductions.
Leandra Lederman
director of the tax program at the Indiana University Maurer School of Law

This "quid pro quo" is one way the IRS can question the deductions, said Joshua Blank, professor of law at the University of California, Irvine School of Law.

"If you give a gift, but there's a quid pro quo that the money must be used to get your child into a certain college or pay some other type of bribe, then that's not what the tax law considers a gift," he said.

"To get a tax deduction for making a gift to charity, you must give it out of 'detached and disinterested generosity,'" said Blank. "Paying a bribe is an incredibly interested act."

When are such donations ok?

wakila | E+ | Getty Images

There are situations in which a "quid pro quo contribution" is legitimate. However, even then you can't claim the whole value of the donation.

Here's an example of how that works: You paid $1,000 for a table at a charity ball, but the value of your meal is $750.

In this case, you can only claim $250 as a deduction — the amount you paid less the fair market value of the good or service you received in return, said Charles Douglas, president of HH Legacy Investments in Alpharetta, Georgia.

Sham charities

Douglas P Sacha | Getty Images

Another avenue the IRS may pursue is whether donors knew that their payments were going to a phony non-profit.

The Key Worldwide Foundation is registered as a public charity. Its tax return (Form 990) for 2016 is available for viewing.

"The thing the donors have in their favor is that this is an IRS-approved 501(c)(3)," said Tim Steffen, CPA and director of advanced planning at Robert W. Baird & Co.

However, if the parents were aware that they were paying bribes and not making genuine charitable contributions, they may be on the hook for penalties.

"If the taxpayers knew they were paying bribes to a sham charity, then they may have committed tax fraud," said Blank.

Fraud is forever

SARINYAPINNGAM | iStock | Getty Images

If the IRS can show that the parents intended to defraud the government by claiming these payments as charitable deductions, there could be a civil fraud penalty, Blank said.

Civil tax fraud penalties can add up to 75 percent of the portion of the tax underpayment. The IRS must show that the offending taxpayer willfully defrauded the government in order for this penalty to apply, Blank said.

Under normal circumstances, the IRS has up to three years after you've filed a return to audit it.

However, if you omitted more than 25 percent of your gross income on your return, the taxman has up to six years to question your return and hit you with taxes owed.

Civil tax fraud isn't bound by a statute of limitations. The IRS can dig through years of returns to search for phony deductions and levy penalties.

"With fraud, it's like a basketball game with no shot clock," said Blank. "You can shoot forever."

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