* IRS auditing thousands of U.S. citizens in Israel
* Triggered by suspected false claims for child tax credits
* U.S. regulators separately probing Israeli banks
By Steven Scheer and Tova Cohen
TEL AVIV, July 31 It was called the "Israel
Project", an operation by the U.S. Internal Revenue Service
(IRS) that has uncovered false claims for child tax credits
involving an estimated tens of millions of dollars filed by U.S.
citizens living in Israel.
About 200,000 American citizens live in Israel, one of the
largest U.S. expatriate communities, and in a separate inquiry,
U.S. regulators are investigating whether Israeli banks helped
American clients evade U.S. taxes, mostly at Swiss subsidiaries.
As a result of the child credit scam, many Americans in
Israel who made legitimate claims have faced costly audits by
the IRS. These require claimants to prove they meet conditions
for getting the money, including that they are legitimately
employed and that their children are also U.S. citizens.
Accountants said claims surged when it was realised U.S.
nationals living abroad were eligible for the credit, beginning
in the ultra-Orthodox community and spreading from there.
Ultra-Orthodox families are typically large, but men usually
have no formal employment, devoting their lives to religious
study on small Israeli state stipends. Fathers are therefore
ineligible for the allowance, which is worth $1,000 per child to
middle income wage earners every year. In many cases, mothers
are either not U.S. citizens or earn too little to make a claim.
Accountant Philip Stein said ultra-Orthodox Jews, who are
also known in Hebrew as Haredim, weren't the only people
involved in making false claims. "It started in that sector but
it wasn't just Haredim," he told Reuters.
Ultra-Orthodox leaders declined to comment.
The IRS initially called the examination the "Israel
Project", a phrase one accountant said appeared on letters some
of his clients received from the government agency.
Stein said the IRS "took off its gloves" after pre-audit
letters were ignored and then false income was reported. "I met
an IRS official and she said: 'You are from the land of false
tax returns,'" he said.
The IRS denied there is an "Israel Project" or that it is
singling out U.S. citizens in the country for special scrutiny.
"The IRS bases its exam selection on analysis of the
information reported on individual returns," it said in an
emailed statement to Reuters. "Currently, audits of potential
abuse in the child tax credit and other refundable credits are
underway and ongoing in more than a dozen different countries."
Some expats are being served with IRS penalties amounting to
thousands of dollars, which often results in the case going to
tax courts in the United States.
Under U.S. law, Americans expats must file annual income tax
returns in the United States. But for many who grumble about
this, there's also a perk in the child allowance. Even those who
wind up owing no taxes in the United States after deductions and
foreign income exclusions can claim the money.
"This took off like a torpedo,", said Jeff Melamed, a U.S.
certified public accountant (CPA) practising in Israel.
"Unfortunately, some unscrupulous tax preparers, many of whom
were not CPAs but opened up shop to generate refunds, did a lot
of less-than-kosher things."
Melamed said that even before the IRS had begun to
investigate he had spoken to several rabbis in Orthodox
communities to try to stop the child credit abuse.
The irregularities were of two types. To qualify for the
U.S. credit, one must have "taxable earned income" - but some
people based their claims on religious studies allocations,
child allowances from the Israeli government and even gifts.
Others claimed credits for children who were in the process
of becoming U.S. nationals - but not yet citizens.
"Once the IRS discovered that certain taxpayers may not have
reported their income properly, due possibly to improper advice
they received from some unscrupulous advisers, the IRS
extrapolated and thought most if not all taxpayers from Israel
were filing improperly," said Alan Deutsch, a U.S. CPA in
Israel. "As such, they started auditing thousands of taxpayers
Debbie Eisenberg, a mother of two who runs after-school
programming in Israel, was audited by the IRS over her child
allowance claim - even though her kids were U.S.-born.
"Any time you get a letter from the IRS saying there's a
problem, it's nerve-racking," she said. "So I immediately called
my accountant freaking out and he said: 'Don't worry, it
happened to me too.'"
While no data is available on U.S. audits in Israel, several
accountants interviewed estimate about half their American
clients have been audited in the past few years. In the United
States, less than 1 percent of tax filers were audited in 2013.
Ultimately, Deutsch said, cases in which income was reported
properly have been resolved in the taxpayers' favour in Israel,
but not before they spent thousands of dollars on accountants,
certified translators for documents in Hebrew and tax lawyers.
"The IRS was tough," said Steven Walz, who immigrated from
New York in 2001. "They asked for birth certificates, they asked
for my marriage certificate and a voucher from the kids' doctors
and teachers that they existed and were a part of my family."
Eventually, the IRS ruled all was fine.
Laura Ben David, a mother of six, said her audit has taken
three years and the IRS is demanding $70,000. "They never gave
us a reason why we would owe them any money," said Ben David,
who recently started her own business as a marketing consultant.
"All of a sudden we were a target and it has been extremely
frustrating and scary."
Media have reported scams involving the child allowance in
other countries, and the audits are another step in wider
efforts to boost compliance with U.S. tax law and crack down on
Leumi, Israel's second-largest bank, said last
month it was close to a deal to pay nearly 1 billion shekels
($292 million) to the U.S. Justice Department in relation to an
investigation into possible tax evasion by American clients.
In May, Credit Suisse agreed to pay more than $2.5
billion in penalties for helping Americans dodge taxes.
"We live in an age where you can't be a citizen of the
United States, hold income-producing assets outside of the U.S.
and expect them to be shrouded in secrecy," said Leonard Tuber,
an accountant with Crowe Horwath who heads its U.S. tax services
department in Israel.
According to Israel's Globes financial newspaper, U.S.
customers have withdrawn $4 billion from Israeli banks in the
past few years because of tightened compliance requirements.
($1 = 3.4283 Israeli Shekels)
(editing by David Stamp)