Common Types of Fraud

The most common types of fraud will involve underreporting of income and assets and overstating the number of family members in college. Some families may even go so far as to provide a falsified copy of their income tax returns.

Look for the following warning signs:

• Interest and Dividend Income both zero, or very low when compared with the family's wages. Compare these figures with any figures reported for capital gains or losses.
• No alimony income reported or alimony payments reported when the custodial parent is female.
• No business or farm income reported when the parents' occupation suggests that they are self-employed. If the return reports one-half of self-employment tax or self-employed health insurance deduction but no business or farm income, be suspicious.
• Check the return for the telltale signs that it is a photocopy of a photocopy. If it appears to be a photocopy of an original, be suspicious.
• Round numbers like $0, $500 and $1,000 for income.

Also compare the income with the levels required for the Earned Income Credit (EIC). If the family appears to be eligible for the EIC but the return does not reflect this, investigate further. Either you'll turn up evidence of fraud, or make the family realize that they are eligible for the EIC.

A common technique for hiding assets is to buy bonds, especially Zero Coupon Bonds (which pay interest only at maturity). Ownership of these bonds won't show up on the family's income tax returns, since they do not report any interest, dividends, or capital gains until they sell them. Families are more likely to do this than hiding cash in a mattress, since it still provides them with some interest income.

Tips for Combating Fraud

Tips for combating fraud typically fall into three groups. The first involves obtaining independent third-party documentation to confirm the information on the application form. This involves looking for external inconsistencies. The second involves making inferences from the supplied information and comparing ratios to statistical norms. It also involves cross-referencing the available information, looking for internal inconsistencies. The third involves establishing policies to deter fraud.

Documentation and External Inconsistencies

1. Require families to sign a waiver allowing you to obtain the tax returns directly from the IRS. Some families have submitted falsified copies of their tax returns during verification. Obtaining the returns directly from the IRS eliminates this source of fraud. Asking families to provide copies of their W-2 and 1099 forms is another method. Do this especially when the income figures seem suspicious.

2. Ask for copies of the four most recent bank statements and examine them for unreported income and unusual transfers.

3. Do 100% verification.

4. Require proof of registration and a copy of the paid tuition bill for parents who claim to be enrolled in college. Verify the registration with the school. This will help detect parents who fake enrollment in order to obtain a lower EFC. Also be suspicious if a parent with a Masters or PhD is going back to school to get an Associate's Degree.

5. Ask for proof of legal separation or the divorce decree in cases of divorce or separation. Also ask for the street address where each parent lives.

6. Compare two consecutive sets of income tax returns. If the family moved assets in order to hide them, signs of this will show up in differences in interest, dividends, and capital gains reported in the two years.

Inferences and Internal Inconsistencies

1. Impute assets from interest and dividend earnings. For example, if you assume a 5% return on investment, you can multiply the earnings by 20 to get a ballpark estimate of the assets. (A 10% return would mean a factor of 10, a 3% return a factor of 33, and a 1% return a factor of 100.) Compare this figure with the reported assets. If the result is off by more than a factor of 2, something is fishy.

   Choosing an appropriate return on investment figure is difficult. Dividends, for example, vary by the stock. The Dow Jones Industrial Average had an average dividend yield of 2.7% in 2005, while the NASDAQ 100 had an average dividend yield of 1.2%. Bank accounts get different yields depending on whether they are checking, money market, savings or certificates of deposit. Perhaps the best approach is to conservatively multiply by a factor of 20, and if the stated assets is significantly lower than that, it probably indicates underreporting of assets.

2. Compare rent/mortgage payments with monthly income. If these payments represent more than 50% of monthly income, be suspicious.

3. Compare the number of exemptions reported on the income tax forms with the number of members in the household.

Policies

1. Establish policies requiring the expulsion of students who lie on financial aid application forms. If the school disciplines students for cheating on tests and falsifying admissions applications, it should also discipline them for falsifying financial aid applications.

2. Remind families of the penalties for providing false information. Emphasize that failure to report all assets is fraud. Discuss the differences between legitimate ways of maximizing eligibility for financial aid (e.g., paying off consumer debt) and fraud (e.g., hiding assets).

3. Tell families that the US Department of Education will be comparing the income information they report on the FAFSA with the information they submit to the IRS on tax forms. If the numbers are different, they'll get caught.

4. Track suspected cases of fraud from year to year, carefully scrutinizing subsequent applications. If the family got away with fraud one year, they might become bolder the next year.

5. Report cases of fraud to the Inspector General at the US Department of Education by calling 1-800-MIS-USED.

Remember that some cases of apparent fraud are genuine errors. After all, many families find financial aid confusing - it is extremely complicated and has its own language - so some cases of apparent fraud might be nothing more than innocent mistakes. When you uncover fraud, do not get emotional or upset. Instead, handle it in a professional and detached manner. Focus your review on factual information, and try to avoid making statements about the family's intent. If the family committed fraud, they know that they got caught, and don't need you to tell them this. If the family made an honest error, you will have avoided upsetting them by unfairly accusing them. By concerning yourself only with the gathering of facts and the opportunity to educate, you will present yourself as being fair and professional.

The facts will often speak for themselves. For example, if the discrepancies on the financial aid forms are small in nature and do not have much of an impact on financial aid eligibility, it is unlikely to be a case of fraud. But if the family understates their income by several thousand dollars, that fact alone will suggest fraud. If the family is sophisticated enough to commit fraud in a fashion that appears innocent (e.g., a digit transposition in the income figures), the only thing you can do is report the discrepancy.

Even if an apparent error does not rise to the level of conflicting information or the error does not appear to affect aid eligibility, such as an error in assets below the asset protection allowance, it might still worthwhile to send the family a letter that notes "there seem to be errors on your FAFSA, such as asset figures that are inconsistent with the amount of interest and dividend income reported on your income tax return". Chances are if the family failed to report some assets, that isn't the only "error" on their FAFSA. Reminding them of the penalties for fraud might encourage them to correct all the errors, including a few you didn't notice.