by George G. Jones and Mark A. Luscombe
Competition for clients in the area of personal tax planning is especially fierce these days. As if it were not sufficiently difficult to run a tax practice based on the complexities of the law itself, however, tax practitioners now must also keep an eye on a new "force-to-be-reckoned with."
An increasing number of tax practitioners are finding themselves competing not only with the firm down the street but also with a more market-savvy group of "tax promoters." Road shows at a local hotel offering free dinner and a tax lecture, Internet offerings and a variety of direct mail campaigns aimed directly at selling your clients certain "tax packages" have exploded over the past several years.
The sophistication of these offerings runs the gamut from the patently absurd to those "deals" that even seem to make some sense on first read to the tax expert. Whatever the level, however, it's reached a point that can't be ignored. Either your clients will ask about them or they will ask themselves why you aren't talking to them about these "opportunities."
Fortunately, the IRS is beginning to take notice of many of these "opportunities." As a result, the practitioner need not only give his or her negative opinion of a particular "deal" when the client comes into the office with literature in hand. Instead, you can use copies of IRS news releases, notices, rulings and other warnings to rebut them. The practitioner can also use this opportunity to suggest alternative tax strategies that will withstand IRS scrutiny.
The IRS has been busy lately issuing guidance that warns against use of certain tax "strategies." Here is a list of what's been released recently:
The "Dirty Dozen" Tax Scams (IR-2002-12): In one of its most comprehensive warnings to date on abusive tax-saving schemes, the IRS listed what it dubbed "the Dirty Dozen tax scams." These schemes, packaged to individual taxpayers under a fee arrangement, promise:
- Special tax refunds available to African-Americans for slavery reparations (legislation has been introduced, but not passed); Although giving some leeway, the IRS also announced in IR-2002-08 that it will treat slavery reparation claims the same as all other categories of frivolous return issues subject to penalties; Starting April 15, 2002, taxpayers could be penalized if they do not amend their return and withdraw the frivolous claim after the initial return has been filed;
- an exemption of wages from federal income or employment tax withholding;
- "secrets" for tax avoidance (for an "upfront" fee, of course);
- qualifying for a purported prize by paying income tax to a certain address;
- proof positive that taxes are voluntary;
- the proper procedure to exercise the right to have all paid-in Social Security taxes refunded;
- help in sharing refunds using phony Forms W-2 or borrowing of social security numbers;
- how to share dependents for the earned income tax credit;
- sham trusts that not only give taxpayers asset-protection from creditors, but protect them from income and estate taxes, as well as IRS collection;
- a way to claim an imaginary home-based business to generate deductions; and
- claiming the disabled access credit for pay phones.
(To round out the "dirty dozen", the IRS also warned of impostors - posing as an IRS collections agent Ð who go door-to-door asking for this year's tax payment.) As ridiculous as these scams sound to the professional, many people want to believe they are true in spite of what common sense tells them.Internet-Marketed Scams (FS-2001-06; IR-2001-18 and Notice 2001-40): The Internet boom has not only brought about e-commerce and an explosion of information, it also has given new life to some old tax frauds. Senate Finance Committee members were told in late 2001 that IRS enforcement efforts were so anemic that hundreds of tax fraud promoters blatantly market scams on the Internet without a response from the IRS.
The IRS position appears to be that before the statute of limitations runs on attacking those schemes now being marketed, aggressive prosecution will have nabbed a large number of these promoters and participants.
The IRS recently identified a number of Internet tax evasion schemes based on patently false interpretations of the U.S. Constitution and the Internal Revenue Code. One very common scam, for example, invites people to become ordained ministers of the gospel Ð for a fee - and then set up a "tax free" church, religious order or religious organization, to which the taxpayer assigns income (which is then used for the taxpayer's private benefit). Another popular fraud claims that the taxpayer will be sent documentation to prove that the Sixteenth Amendment to the U.S. Constitution, authorizing federal income taxes, was never properly ratified because technicalities or rules of parliamentary procedure were not correctly followed.
Many scams twist the language of the Internal Revenue Code. They take the literal meaning of words and claim that only "individuals" are required to pay taxes. Or they claim that federal taxes attach only to foreign-source income, or vice-versa, and will show a taxpayer how to classify his or her income as one or the other.
The Internet also has been a gold mine for promoters of abusive trusts. Trusts have been misrepresented from being able to do everything from diverting income and creating deductions for distributions, to shifting income earned by one family member to another.
Not just corporate tax shelters anymore (TD 8896; Notice 2000-44; TDNR LS-831): The IRS and the Treasury Department unleashed another strategic offensive in the continuing war against abusive tax shelters when they expanded enforcement efforts to include packages marketed to, and invested in, by individuals (rather than just focusing their attack on abusive corporate tax shelters). The Office of Tax Shelter Analysis followed up by announcing that it was ready to respond to questions and accept tips "relating to potentially improper tax shelter activity by corporate and non-corporate taxpayers."
Circular 230.One weapon new to the front lines is a proposal to revise Circular 230, which contains the rules governing practice before the IRS. Criticism has been leveled especially against the broad definition of tax shelter found in the proposal. Of course, every transaction has tax consequences and tax minimization is a legitimate business objective. Yet the IRS's grand design, by default, must capture "routine" transactions if it is to be all-inclusive. This appears simultaneously to be the strength and weakness of the IRS's approach to combat abusive tax shelters.
Temporary penalty waiver (Announcement 2002-2). In exchange for voluntary disclosure, taxpayers questioning their participation in suspect tax shelters are temporarily being given a waiver against application of the accuracy-related penalty. The new temporary penalty-waiver initiative is targeted to taxpayers investing in "listed" transactions or transactions that meet the IRS's definition of abusive. The goal of this initiative is to weed out abusive tax shelters, and provide information to pursue promoters and other investors, who may not have voluntarily revealed this information to the IRS. So far, the number of voluntary disclosures is low and many practitioners are confused about how much information must be disclosed. The IRS also hasn't been clear on how disclosure will impact client confidentiality.
The accuracy-related penalty will be waived if the taxpayer makes full disclosure either before April 23, 2002 or before the transaction is raised in examination, whichever is earlier. Disclosures should be submitted to the Office of Tax Shelter Analysis. If the taxpayer is under examination, disclosure should be made directly to the assigned team manager.
Help from the public. The IRS has also been relying on disclosure by the public as a tool to smoke out scams and shelters. Individuals who have information that would expose abusive tax shelter activities can call the Tax Shelter Hotline at (202) 283-8740 or the Tax Fraud Hotline at (800) 829-0433. They can write to Internal Revenue Service, LM:PFTG:OTSA, Office of Tax Shelter Analysis in Washington, DC; send an e-mail to email@example.com; or send a Fax to (202) 283-8354. In addition, the IRS maintains a tax shelter Web site designed to alert taxpayers and tax practitioners to tax scams and fraud schemes (at www.treas.gov/irs/ci or by going to www.irs.gov and clicking, "Tax Scams and Tax Fraud Alerts; IRS Criminal Investigation."
Instead of simply telling clients what they can't do, offer concrete, alternative tax strategies. In place of maintaining that taxes are voluntary, suggest that the client voluntarily postpones tax on compensation through deferred compensation, timing year-end bonuses, incentive stock options and qualified retirement plan contributions. Instead of starting a bogus family "business" for which deductions are claimed, investigate whether your client's part-time business activities can be channeled into producing a bona fide home office deduction. Ideas about abusive "family trusts" can be replaced with plans to form a Crummy trust - a family limited partnership, or a uniformed gifts to minor accounts. An inclination toward an abusive tax shelter can be deflected with an investment plan offering legitimate deductions or a tax-exempt income stream. In the end, the best defense is a good offense.
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