The Internal Revenue Service has announced the dozen worst tax scams as a warning to taxpayers who might find these deals tempting but will wind up paying dearly for being so foolish.
"Don't fall prey to these tax scams,” IRS Commissioner Douglas Schulman said. “They may look tempting, but these fraudulent deals end up hurting people who participate in them."
The fraudsters may get socked civilly or criminally by the government, but the taxpayer will also wind up paying the taxes, interest and penalties. A bad deal all around.
At the top of the IRS list is hiding income offshore. The IRS and Congress are hot on eliminating abusive offshore transactions and secret accounts. While dealing internationally is perfectly legal, the IRS is focusing on the abuse of accounts through nominee entities, unreported foreign trusts, employee-leasing schemes, private annuities and insurance.
This is not to say that these are illegal, but that they can be used in structures which result in tax evasion, which is illegal. In particular, the government wants to find out who are the promoters, professionals, and other facilitators of the abusive form of offshore transactions.
Identity theft and “phishing” is the next big concern. Of particular concern is where a criminal steals the identity of a taxpayer, files a tax return, and gets a refund. Phishing is one tactic that these criminals use to get the taxpayer's personal information. During tax season, scammers pose as some phony website or email and sometimes even pretend to be the IRS. Even spyware loaded on an unsuspecting taxpayer's computer can allow identity thieves to get the information to pull off the scheme. The IRS has a specialized unit for identity theft which can be reached at 1-800-908-4490.
Preparers are now under close scrutiny due to the proliferation of preparers who engage in fraud. The government recognizes that most preparers are professionals who provide an "honest and excellent" service. Then, there are some who engage in fraud and other illegal ploys. The IRS is implementing a number of requirements for paid tax preparers, which includes registration with the IRS and obtaining a preparer tax identification number. These professionals will be required to have competency tests as well as ongoing professional education.
Filing false or misleading tax forms is also on the IRS hit list. Basically, these involve various types of phony refund of tax schemes. The announcement by the IRS uses as an example a fraudulent 1099 scheme which involves original discount to get false withholding credits and thereby a fraudulent refund of tax. The IRS is being aggressive in pursuing this and claims it stops the vast majority of incorrect refunds.
But it should be realized that as the tax code is vastly complex with lots of forms and filings, it is a difficult problem to maintain the administrative integrity of the system.
Taxpayers have been victimized by promoters of frivolous legal positions and the IRS doesn't like it. These promoters sell some sort of outlandish claim which is clearly unreasonable to anyone who has even a little knowledge of the tax code. The difficulty is that few taxpayers are very knowledgeable when it comes to taxes and some either are all too gullible or eager to jump on something that just sounds almost too good to be true in order to save some tax. The IRS has a list of frivolous legal tax positions that should be avoided but the list keeps growing along with the size of the tax code.
A form of false filing is the scheme to report nontaxable Social Security benefits with excessive withholding of tax. The result often is that the withholding amount and the reported income are incorrect. This sort of abuse can quickly result in a $5,000 penalty.
Charity represents a huge area for abuse and the IRS is concerned over abusive arrangements. These can take the form of arrangements to improperly shield income or assets as well as the donor's attempt to keep control over the donated assets or income from the donated property. There are a whole host of schemes that involve charitable contributions involving non-cash asset situations. The IRS announcement points out that The Pension Protection Act of 2006 imposed increased penalties for inaccurate appraisals. Donations will require qualified appraisals from qualified appraisers.
Retirement plans represent an area of abuse that the IRS is looking into closely. They warn taxpayers to be wary of advisers who encourage contributions of appreciated assets at less than fair market value and other methods to avoid the contribution limitations. Interestingly, the IRS warns about the use of limited liability companies to engage in prohibited activities in this area.
Disguised corporate ownership can be used for underreporting of income, fictitious deductions, non-filing of tax returns, participating in abusive transactions which the IRS has listed, money laundering, financial crimes, and even terrorist financing. In other words, some really bad stuff. The IRS warns that it is working with state authorities to identify these entities and bring them into compliance. It should be expected that this will be a difficult area to police as many states make forming corporate-type entities easy. Structures using multiple entities and layers is fairly common in everyday planning of investments and company structuring.
Since there are so many informational returns that can and should be filed, it is no wonder that filing a phony return is used by some scammers to lower the amount of taxes owed. An example given by the IRS is a Substitute Form W-2 (Form 4852), which is then used to reduce taxable income to zero. Again, this can result in a quick $5,000 penalty among other penalties that could be applied if the IRS or Justice Department chooses.
Abusive trust arrangements have been on the radar scope of the IRS for a long time. The government does not question the legitimate uses of trusts for tax and estate planning. But the IRS does not appreciate where they are used primarily as "a means to avoid income tax liability."
Of particular concern are private annuity trusts and foreign trusts to shift income and deduct personal expenses. The IRS states that, “as with other arrangements, taxpayers should seek the advice of a trusted professional before entering a trust arrangement."
I can see this being something in the future on the websites for lawyers and accountants as well as others associated with providing trusts to clients as their professional service.
Lastly, the IRS tells us that they are concerned about fuel tax credit scams. I had not realized it was such a major problem. But clearly where there is an opportunity to get a tax credit, it represents an opportunity for somebody to make a frivolous claim.
With federal income taxes being so all pervasive and basically a year-round exercise, it presents a fertile field for promoters of abusive and illegal tax schemes. The announcement by the IRS was just the top dozen that they wanted to warn taxpayers about. Basically, it just highlights how difficult the current income tax system is on both taxpayers and the government. It is a system where both compliance and administration are getting nearly impossible to get right.
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