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IR-2004-26, March 1, 2004
WASHINGTON — In an update of an annual consumer alert, the Internal
Revenue Service urged taxpayers to avoid falling victim to one of the “Dirty
Dozen” tax scams and a variety of other schemes. In the new 2004 ranking,
several new scams have reached the top of the consumer watch list, including
abusive trusts and the “claim of right” doctrine.
In addition, the IRS has taken a new step this year and issued 10 new pieces
of legal guidance involving scams in the “Dirty Dozen” and other
tax schemes. The new guidance debunks the schemes and provides new legal details
to help tax practitioners and taxpayers.
"At the IRS, we're augmenting our enforcement resources to attack schemes
and scams. While we're actively targeting promoters, taxpayers themselves should
be wary of anyone who promises to eliminate their taxes," said IRS Commissioner
Mark W. Everson. "Don't be fooled by these outrageous claims. There is
no secret way to escape paying taxes."
The IRS and other federal agencies are aggressively pursuing and successfully
prosecuting promoters of these schemes and many of their clients for fraud
and tax evasion. Participation in these schemes can result in imprisonment,
fines and repayment of taxes owed with interest and penalties. Even innocent
taxpayers involved in these schemes can face a staggering amount of back interest
Taxpayers who suspect tax fraud can report it to the IRS at 1-800-829-0433.
The IRS urges people to avoid these common schemes:
Misuse of Trusts. Promoters of abusive tax transactions are increasingly urging
taxpayers to transfer assets into trusts. The promoters promise a variety of
benefits, such as the reduction of income subject to tax, deductions for personal
expenses paid by the trust and reduction of gift or estate taxes. Taxpayers
should be aware that abusive trust arrangements will not produce the tax benefits
advertised by their promoters and that the IRS is actively examining these
types of trust arrangements. More than a dozen injunctions have been obtained
against promoters, and numerous promoters and their clients have been criminally
prosecuted. Before entering any trust arrangements, taxpayers should seek the
advice of a trusted tax professional.
"Claim of Right" Doctrine. In this emerging scheme, people file
returns and attempt to take a deduction equal to the entire amount of their
wages. The promoters advise them to label the deduction as “a necessary
expense for the production of income” or “compensation for personal
services actually rendered”. The deduction is based on a complete misinterpretation
of the Internal Revenue Code and has no basis in law.
Corporation Sole. The idea is that the arrangement entitles the individual
to exemption from federal income taxes as a nonprofit, religious organization
as described in tax laws. When used as intended, Corporation Sole statutes
enable religious leaders — typically bishops or parsons — to become
incorporated as individuals as a way of separating themselves legally from
the control and ownership of church assets. But the rules have been twisted
at seminars where promoters charge fees of up to $1,000 or more per person.
Would-be participants are mistakenly told that Corporation Sole laws provide
a “legal” way to escape paying federal income taxes, child support
and other personal debts.
Offshore Transactions. Some people use offshore transactions to avoid paying
United States taxes. Use of an offshore bank account, brokerage account, credit
card, wire transfer, trust, offshore employee leasing or other arrangement
to hide or underreport income or to claim false deductions on a federal tax
return is illegal. A taxpayer involved in these schemes could be subject to
payment of taxes, interest, penalties and potential criminal prosecution. This
was the top scam in the 2003 “Dirty Dozen.” A special program last
year has yielded more than $170 million in taxes, interest and penalties, and
the IRS and the states continue to aggressively pursue taxpayers and promoters
in this area.
Employment Tax Evasion. The IRS has seen a number of illegal schemes that
instruct employers not to withhold federal income tax or other employment taxes
from wages paid to their employees. These schemes are based on an incorrect
interpretation of “Section 861” and other parts of the tax law
and have been refuted in court. Recent court cases have resulted in criminal
convictions of promoters. Employer participants could also be held responsible
for back payments of employment taxes, plus penalties and interest. Employees
who have no withholdings are still responsible for payment of their personal
Return Preparer Fraud. Unscrupulous return preparers can cause a lot of problems
for taxpayers who use their services. Abusive return preparers derive financial
gain by diverting a portion of the taxpayer’s refund for their own benefit,
charging inflated fees for the return preparation services, and increasing
their clientele by advertising guaranteed larger refunds. Taxpayers should
choose carefully when hiring a tax preparer — no matter who prepares
the return, the taxpayer is ultimately responsible for all of the information
on that return.
Americans with Disabilities Act. Another scheme seen for several years involves
the purchase of equipment and services that the promoter alleges meets the
strict criteria of the Disabled Access Credit, which was created with the passage
of the “Americans with Disabilities Act”. A minimal payment is
made and a non-recourse note signed. The investor then provides insignificant
services to complete the purchase agreement. This scheme is based on an incorrect
interpretation of law and an over-inflated value of the services rendered.
African-Americans Get a Special Tax Refund. Thousands of African-Americans
have been misled by people offering to file for tax credits or refunds related
to reparations for slavery. There is no such provision in the tax law. Some
unscrupulous promoters have encouraged clients to pay them to prepare a claim
for this refund. But the claims are a waste of money. Promoters of reparations
tax schemes have been convicted and imprisoned. And taxpayers could face a
$500 penalty for filing such claims if they do not withdraw the claim. Related
scams include claiming an illegal tax credit by misusing Form 2439, “Notice
to Shareholder of Undistributed Long-Term Capital Gains.” The slavery
reparations scam was at the top of the 2002 “Dirty Dozen,” and,
although claims have fallen considerably, the IRS continues to see activity
in this area.
Improper Home-Based Business. This scheme purports to offer tax “relief” but
in reality is illegal tax avoidance. The promoters of this scheme claim that
individual taxpayers can deduct most, or all, of their personal expenses as
business expenses by setting up a bogus home-based business. But the tax code
firmly establishes that a clear business purpose and profit motive must exist
in order to generate and claim allowable business expenses. This scam has been
around for years, but the IRS continues to see activity in this area.
Frivolous Arguments. Frivolous arguments are false arguments that are unsupported
by law. When a scheme promoter says “I don’t pay taxes – why
should you” or urges you to “untax yourself for $49.95,” beware.
The ads may claim that the promoter knows the “secret” for never
paying taxes again, but that’s just plain wrong. The U.S. courts have
continuously rejected this and other frivolous arguments. Unfortunately, people
across the country have paid for the “secret” of not paying taxes
or have bought “untax packages.” Then they find out that following
the advice contained in them can result in civil and/or criminal penalties.
Numerous sellers of the bogus schemes have been convicted on criminal tax charges.
More than a dozen injunctions have been issued.
Identity Theft. Identity thieves use someone’s personal data to steal
his or her financial accounts, run up charges on the victim’s existing
credit cards, apply for new loans, credit cards, services or benefits in the
victim’s name and even file fraudulent tax returns. The IRS is aware
of several identity theft scams involving taxes or the IRS. In one example,
fraudsters sent bank customers fictitious bank correspondence and IRS forms
in an attempt to trick them into disclosing their personal and banking data.
In another, abusive tax preparers have used clients’ Social Security
numbers and other information to file false tax returns without the clients’ knowledge.
For taxpayers, it pays to be choosy about disclosing personal and financial
information. And the IRS encourages taxpayers to carefully select a reputable
Share/Borrow EITC Dependents. Unscrupulous tax preparers "share" one
client's qualifying children with another client in order to allow both clients
to claim the Earned Income Tax Credit. For example, one client may have four
children but only needs to list two to get the maximum EITC. The preparer will
list two children on the first client’s return and the other two on another
client’s tax return. The preparer and the client "selling" the
dependents split a fee. The IRS prosecutes the preparers of such fraudulent
claims, and participating taxpayers could be subject to civil penalties.
Beyond the “Dirty Dozen,” the IRS sees many more tax schemes.
In one, a telephone caller says you’ve won a prize, and all you have
to do to get it is to pay the income tax due — to the caller. Other scams
can play off recent news events, such as one last year targeting members of
“Taxpayers should think carefully before paying for services or signing
important documents,” Everson said. “Don’t be a victim of
these scams or others that promise the moon. They carry a high price.”