Suspicious Minds: Developments and Trends in Tax Enforcement

The powerful United States House of Representatives Committee on Ways and Means held a hearing on May 19, 2010, to discuss tax proposals related to legislation that would create a federally authorized Internet gaming, or i-gaming, regime in the United States. The Ways and Means Committee hearings primarily focused on the tax aspects of the recent legislative proposals designed to establish an i-gaming regulatory framework in the United States. While the subject of the hearing was i-gaming legislation, the hearing also provided important insight for land-based casino operators with respect to recent developments in the areas of tax enforcement and Financial Crimes Enforcement Network (FinCEN) reporting.

My article last month, “The Dice Are Out on Identity Theft,” provided an overview of the Federal Trade Commission’s Red Flags Rule, which is intended to reduce incidences of identity theft. The corollary to identity theft for casino operators is the reporting of suspicious activities and money laundering, which is governed by a host of federal tax and financial laws. Reviewing and understanding recent enforcement initiatives is relevant to land-based casino operators. Understanding the tax enforcement activities and FinCEN reporting developments can reveal common illicit behavior. In turn, knowledge of this illicit behavior can be useful in order to implement proper procedures to protect against fraudulent activities, including anti-money laundering initiatives.

Background
While i-gaming remains a hot topic within the gaming industry, and likely will garner significant attention from land-based casino operators for the foreseeable future, land-based casino operators and proponents of i-gaming have similar concerns with respect to gambling-related tax and financial crimes. Congressman Jim McDermott (D–Wash.), the lead sponsor of the i-gaming tax legislation, enumerated financial-related threats to the gaming industry during the hearing. McDermott noted that specifically within the unregulated i-gaming market there are often inadequate safeguards against fraud, identity theft and player protections. Land-based casino operators share concerns with regard to developing and implementing safeguards against fraudulent activities directed at casinos. A lack of safeguards not only exposes casinos to becoming victims of fraudulent activities, but also exposes casinos to substantial penalties for failing to comply with FinCEN obligations. The Internal Revenue Service and FinCEN testimony on recent trends and developments concerning tax law and financial issues related to gambling activity offers land-based casinos meaningful insight.

Land-based casino operators, by virtue of both federal tax and financial laws, coupled with state (or, in the case of Indian gaming, federal) gaming laws, are already obligated to report suspicious activities and financial transactions meeting certain threshold standards. As result, land-based casinos have implemented comprehensive internal control procedures to assist in identifying and reporting suspicious transactions, which may involve fraud or money laundering.

Themes and Trends
Charles M. Steele, the deputy director of FinCEN, testified with respect to money laundering vulnerabilities in the traditional land-based casino industry. Steele’s testimony is useful for land-based operators because he addressed recent trends in money laundering. His comments were based on a FinCEN analysis of over 15 years of suspicious activity reports. The results of FinCEN’s study can be helpful to develop or enhance existing internal control procedures.

As many industry executives are already well aware, the Bank Secrecy Act (BSA) and USA PATRIOT Act impose certain reporting and record keeping obligations on casinos. The BSA, and its underlying regulations, require “financial institutions” to report and track certain types of transactions. A casino is considered to be a “financial institution” for purposes of the BSA if the casino (1) has gross annual gambling revenue exceeding $1 million, and (2) is licensed as a casino under state or federal gaming laws. There are two types of reports that casinos may file with FinCEN pursuant to the BSA: (1) a Currency Transaction Report Casino for currency transactions that exceed $10,000; and (2) a Suspicious Activity Report by Casinos (SAR-C). In contrast to Currency Transaction Reports, the standard to file a SAR-C is not necessarily a bright line. Rather, the SAR-C filing obligation arises when a casino knows, suspects or has reason to believe that a transaction, or pattern of transactions, involves funds (at least $5,000) derived from illegal activities.

Under the BSA, casinos are mandated to implement anti-money laundering programs that set forth written procedures for detecting and reporting suspicious activities. Casinos are primarily cash businesses, which can expose them to becoming unwilling participants in money laundering activities and targets for fraud. While casinos may be the target of unsavory activities, they have several means by which to acquire information that may operate as red flags for the purpose of identifying fraud and money laundering activities. These means include check cashing, providing credit and player reward programs. These activities allow a casino to collect certain personal identification information, and the personal information, in turn, can serve as a resource to prevent money laundering and other fraudulent activities.

The testimony presented by FinCEN at the May 19 House Committee on Ways and Means hearing summarized a recent study that identified common behaviors and activities that have prompted casinos to file a SAR-C. Categories of behavior that were frequently identified included:

• Structuring transactions. Sixty percent of the SAR-C reports identified this as a suspicious activity. Examples of structuring transactions included cash-outs followed by cash buy-ins and payments on markers; reducing the number of chips/tokens to be cashed out at the cage to slightly below $10,000 when identification was requested; reducing cash buy-ins at pits to avoid providing identification; using agents to cash out chips; engaging in a pattern of cashing out chips multiple times per day or at different cages; requesting pay-outs over $10,000 to be paid in multiple checks; and splitting the purchase of chips at the cage and pit.
• Minimal or no casino play. Thirty percent of the SAR-C reports identified minimal or no casino play as a suspicious activity. Specific examples identified in the SAR-C included cashing out chips in instances when the casino did not have a record of the patron buying or playing the chips; buying chips with cash, casino credit, credit card advances or wired funds followed by no or little play and leaving the casino without redeeming the chips; requesting funds received by wire transfer to be wired by the casino to a second bank account without casino play; frequent deposits of money orders or casino checks into accounts followed by minimal play and cashing out via a casino check; and converting cash into TITO vouchers and then cashing out the TITO vouchers.
• Use of false, expired, altered or stolen identifications, typically in the form of Social Security numbers and drivers’ licenses.
• Fraudulent conduct perpetuated against casinos. Fraudulent activity included using counterfeit money and misusing player’s club points.

The FinCEN testimony at the hearing offers guidance for land-based casinos with respect to common categories of activities that have prompted filing a SAR-C. An important point that can be derived from the behaviors identified in the FinCEN study is that a singular event may not appear suspicious in isolation; however, when viewed collectively or over a period of time with other events, the events may arise to reportable suspicious activities. By understanding frequent patterns of suspicious activities, casinos can develop effective policies and procedures, along with properly training front-line staff, to combat money laundering and other criminal activities.

Tax Law Developments
The IRS also testified at the House Committee on Ways and Means hearing with respect to the tax law relating to gambling income and recent criminal tax investigations connected to gaming activities. A common theme of the enforcement activities centered on internal threats to casinos associated with money laundering and payments made to evade federal taxation.

Casinos are subject to a variety of reporting obligations relating to payments of gambling winnings. Casinos may also be required to withhold income tax on gambling winnings. Casinos must withhold income tax at a 25 percent tax rate when the winnings, minus the wager, exceed $5,000. Backup withholding at a 28 percent rate is required when gaming winnings exceed certain thresholds and the winner does not furnish a correct taxpayer identification number.

A hallmark of the United States system of taxation is the voluntary reporting of income and payment of taxes. Thus, absent disincentives to discourage tax evasion, there can be obstacles to ensuring tax compliance. Congress has enacted several statutory provisions within the federal tax law that provide the IRS with mechanisms to prompt tax compliance. The enforcement tools include the ability to conduct criminal investigations, which can culminate in criminal prosecutions.

As outlined at the May 19 hearing, the IRS “Criminal Investigation [division] focuses attention on the gaming industry through the enforcement tax, money laundering, and other related financial criminal statutes … .” The summary of recent enforcement activities presented at the hearing highlighted trends in enforcement activity relating to the gaming industry. Investigations included:

• Tran Organization Card Cheating Operation—Members of the Tran Organization operated a card cheating operation that illegally obtained approximately $2.5 million from casinos by using electronic devices and computer software to track and predict cards during blackjack card games.
• Oklahoma Video Gaming Scheme—Ivy Ong supplied video gaming equipment to tribal casinos. The investigation revealed that Ong used a series of accounts to make illegal payments to tribal officials, ostensibly to protect his gaming business. Ong pleaded guilty to tax evasion and conspiring to pay illegal kickbacks.
• Kickapoo Traditional Tribe of Texas—Isidro Graza Jr. manipulated operating accounts of a tribal casino for his personal benefit, including to pay campaign expenses for an unsuccessful congressional bid.
• South Carolina Casino Boat—Samuel and Marilyn Gray, operators of casino boats, were convicted for failing to pay employment and excise taxes in connection with the operation of casino boats.

The recent investigations conducted by the IRS Criminal Investigation division reveal that internal fraud threats exist with respect to casino operations. As an example, a pattern within the investigations demonstrated instances of internal casino personnel fraudulently obtaining funds from casino operations for personal benefit. The investigations further revealed that fraudulent activities are often characterized by a series of payments and the use of multiple accounts to funnel funds. Thus, implementing proper accounting procedures to track payments and accounts, coupled with vigilantly scrutinizing the flow of funds within a casino operation, is an important mechanism to combat against internal fraud threats.

Final Thoughts
The May 19, 2010, House Committee on Ways and Means hearing primarily focused on federal tax law related to i-gaming legislative proposals. Although the hearing subject was i-gaming, much of the content presented at the hearing offers useful guidance for land-based casino operators. Particularly, the testimony presented by FinCEN and the IRS highlighted recent trends in suspicious activity reporting and fraudulent activities directed at casinos. This content is important to the gaming industry because of not only the significant penalties that can be imposed for failing to adopt written anti-money laundering procedure and reporting suspicious activities, but also because of the costs to casinos as victims of fraudulent activity. The summary of recent investigations reveals recent trends, which in turn can be used to develop and enhance internal control standards.

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