Tax-Fraud Case Pinpoints Lax IRS Controls

LITTLE suggested that the undistinguished but workmanlike career of Internal Revenue Service (IRS) agent Robert A. Morales Sr. would turn into what federal officials call the largest single bribery scandal ever to hit the agency.

Earning less in a year than some of his wealthy audit subjects made in a few hours, the 30-year IRS veteran drove a modest car and was known to take calls from his wife seeking approval to buy even a pair of shoes for one of their six children.

His unassuming profile and long tenure helped him to conceal a decade-long scheme in which he took more than $600,000 in bribes to hide $30 million in taxable income for Mario Saikhon, a wealthy California farmer. The case was closed last week as Mr. Saikhon, the last of three people prosecuted in the case, entered federal prison to serve a 6-1/2-year term.

But serious concerns remain about how Mr. Morales was able to control a taxpayer's audits for 10 years, allowing huge deductions in some years and sitting on returns for other years so no one could audit them.

Underscoring that concern is the suspicion - alleged by federal officials in court documents but not prosecuted - that Saikhon was not the only taxpayer bribing Morales. At least six others may have been involved with the corrupt agent.

Morales's attorney denies that his client was involved in any but the Saikhon fraud, to which he pleaded guilty. Morales is serving 12 years for the crime.

This case is an example of a severe breakdown in IRS management controls, say financial-security experts. They say that IRS agents, indoctrinated not to take even a cup of coffee from a taxpayer, rarely accept a bribe. But, they say, the case shows the relative ease with which a single employee can breach the trust of the nation's taxing agency.

"The IRS is an invitation to corruption. It is a continuing problem in every big bureaucracy, particularly the IRS, and it's ignored," says David Burnham, a former New York Times reporter whose late-1980s investigations of the IRS turned up substantial corruption at senior-management levels.

In his 1989 book, "A Law Unto Itself: The IRS and the Abuse of Power," Mr. Burnham argued that corruption is a more continuing problem than the IRS admits. Each case of corruption, he writes, "is also prima facie evidence of pervasive poor management."

Sources familiar with the Morales case paint a picture of him working in a sort of bureaucratic sweat shop - a group of 10 to 28 overworked and underpaid auditors, who had been managed by at least five different supervisors during less than seven years in the 1980s. Group morale apparently reached a low when nearly every auditor filed a grievance against one manager, says one source familiar with the case.

Morales's attorney, Eugene Iredale, claims that his client, as a disgruntled agent in this group, was ripe for corruption.

"This is a man who worked 30 years for the Internal Revenue Service. There was prejudice against him because he is Hispanic. He was passed over for promotion 20 years ago. He filed an EEOC complaint for ethnic slurs.... Doing audits of farmers in the Imperial Valley was like Siberia for him, and he was making $34,000 to $40,000 a year auditing people who make that in three hours," Mr. Iredale says.

The IRS does not publicly admit a failure of management, although it has used the Morales case for internal seminars on potential breakdowns in administrative controls.

The IRS tries to minimize cases of its failings, observes Ed Pankau, a security consultant and former IRS agent, because it must balance the public's traditional distaste for revenuers and its need to maintain the public trust that allows it to collect the money to fuel the federal government.

"The conclusion is that this is just an isolated incident and what are you going to do? We did pretty much everything we could do," says Rick Perez, branch chief of internal security for the IRS western region. He argues that Morales wouldn't be a prime suspect for corruption, because he was a long-time employee who enjoyed a high degree of trust.

"It's not acceptable to say he was a fluke, because of the interlocking nature of the IRS [checks and balances in management procedures]," says Robert D. McCrie, an associate professor of security management at John Jay College of Criminal Justice and publisher of Security Letter, a security-management newsletter.

"There was definitely a supervisory error in that they didn't catch that he was changing the tax base [of returns]," says Mr. McCrie. "Whenever there is a change in a tax computation, usually it's more [money that the taxpayer owes, not less]."

Any time figures are changed in the taxpayer's favor, he suggests, a supervisor should notice and examine the way the auditor arrived at his computations.

Further, says McCrie, a fundamental security procedure is employee rotation - both geographic as well as in type of work. The fact that Morales was handling cases in the same geographic region for more than 30 years violated that principle, he says.

Morales was shifted at one point during his association with Saikhon from the Imperial Valley region to other areas closer to San Diego, says Phillip L. B. Halpern, the assistant US attorney who prosecuted Morales. But Morales circumvented the change by having Saikhon begin filing his tax returns in the auditor's new area.

In the end, it wasn't IRS checks and balances that uncovered Morales, says Mr. Halpern. It was the braggadocio of Morales's son, Robert A. Morales Jr., a private tax preparer who pleaded guilty to assisting his father in the scheme and is serving a 41-month prison term.

When the younger Morales showed his colleagues a suitcase full of cash sometime in 1989, they reported him to federal authorities. Over many months, federal law-enforcement authorities traced the cash to uncover a decade-long escalation of fraud.

The first Saikhon-Morales link was in 1981, when the agent was assigned to audit Saikhon's personal 1978 tax return. Morales computed that the farmer owed $947,000 in taxes because of the disallowance of tax shelters by another IRS agent on the East Coast.

But after a private meeting with Saikhon, Morales allowed him to take $309,000 in deductions for casualty losses on farming ditch-tiling and for "replacement" of a sea wall that had never existed at his La Jolla, Calif., home.

Through the years, according to court documents, Morales was able to channel all of Saikhon's personal and corporate returns to his own desk. By writing on one year's tax return that the taxpayer was under audit for prior years, Morales ensured that the next year's return, if identified for IRS audit, would be assigned to him.

Consequently, he was able to doctor returns, as he did in 1983, for example, when Saikhon reported a tax liability of $818,025 on a gross income of $20 million. After Morales handled his return, Saikhon owed only $205.

It's not clear exactly what bribes Morales received early in the scheme, says Halpern. Among other things, though, Saikhon bought him a new Nissan pickup truck, employed one of his children, and allowed him to use a corporate plane.

They hatched their boldest scheme in 1986. Morales created two sham farm companies to which Saikhon paid more than $2 million. Morales would collect interest on the money, take a small cut, and return the rest to Saikhon directly or in offshore bank accounts. Saikhon was, in effect, writing off the bribes as "farming expenses."

Testimony in the Morales case showed some uncertainty among IRS officials as to how long a revenue agent can handle audits of the same taxpayer. Security experts say three to four years is considered the maximum allowable.

But even if a supervisor was looking for how long the agent had audited a single taxpayer, Morales would circumvent that by waiting until the supervisor was out of the office and go to an acting supervisor to sign off on his audits of Saikhon, says Halpern. In some cases, Morales waited until he was the acting supervisor and approved his own audits.

"There's no question it's a failure of management," says Halpern.