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| The Basics | 8 sure ways to tempt fate and the IRS
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Con artists have been ripping off taxpayers -- millions of them -- by touting various trusts, credits and legal strategies. But it's the person who signs the returns who's on the hook.
By MSN Money staff
Let's say you're thinking about your taxes and worried about getting zapped for so much taxable income or so many deductions that you qualify for the alternative minimum tax.
And then the phone rings with an irresistible offer. The caller confides that (for a fee ranging from $5,000 to $70,000) he can help you set up a credit-card account in a tax haven country with money you do not report to the Internal Revenue Service. Then you get a credit or debit card to draw down on the account for personal expenses.
Sound too good to be true? It potentially is. But that hasnt stopped nearly 2 million people from already trying to take advantage of the scam. And there are plenty of other con artists looking to prey on you with other scams.
Dont be tempted by hucksters claiming they can help vastly reduce your tax burden or show you how to pay no taxes at all.
The IRS has cracked down on some of the scams, and, prodded by Congress, it has been getting tougher. Its own "Dirty Dozen" scams list for 2006 adds a few new twists to the classics:
Zero wages, zero return
In this scam, new to the Dirty Dozen, a taxpayer attaches either a Form 4852 (Substitute Form W-2) or a corrected Form 1099 that shows zero or little wages or other income. The taxpayer may include a statement indicating the taxpayer is rebutting information submitted to the IRS by the payer.
An explanation on the Form 4852 may cite "statutory language behind IRC 3401 and 3121" or may include some reference to the paying company refusing to issue a corrected Form W-2 for fear of IRS retaliation.
The Form 4852 or 1099 is usually attached to a Zero Return," where promoters instruct taxpayers to enter all zeros on their federal income tax filings. In a twist on this scheme, filers enter zero income, report their withholding and then write nunc pro tunc Latin for now for then-- on the return. They often also do this with amended returns in the hope the IRS will disregard the original return in which they reported wages and other income.
Shelter income by moving your money offshore
Despite a crackdown by the IRS and state tax agencies, individuals continue to try to avoid U.S. taxes by illegally hiding income in offshore bank and brokerage accounts or using offshore credit cards, wire transfers, foreign trusts, employee leasing schemes, private annuities or life insurance to do so. During fiscal 2005, 68 people were convicted on charges of promotion and use of abusive tax schemes designed to evade taxes.
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The accounts are being set up by banks, brokerages, accounting firms and others for very affluent people -- entertainers, lawyers, doctors and other professionals. Offshore accounts are of little use to people whose wages are reported to the IRS by employers.
The General Accounting Office estimates that 1 million to 2 million Americans have offshore credit-card accounts in tax-haven countries, and fraudulent activities cost the Treasury $20 billion to $40 billion a year. The accounts are legal so long as income generated to the accounts is reported and taxes paid. Failure to disclose the income is a felony punishable by up to five years in prison.
The IRS has convinced VISA, Master Card and American Express to turn over lists of U.S. residents with credit card accounts domiciled outside the United States. The goal: to find out who has an offshore account and, more importantly, who has not reported it and the income illegally disguised.
Cut your taxes with abusive trusts at home
In addition to the offshore accounts, the IRS has also detected a sharp increase in the abuse of domestic trusts set up to conceal taxable income and has 200 investigations ongoing. The average prison sentence for those convicted: 37 months.
The schemes are usually offered in a series of trusts layered upon each other by promoters who target people with incomes in at least six figures. Heres how they work: - A promoter advises a taxpayer to start an asset management company (AMC), with the taxpayer listed as the director of a domestic trust. This gives the illusion that the taxpayer is not managing his business and allows him to start layering the process.
- Then, a business trust is formed with the AMC serving as the trustee. False administrative expenses may be deducted from the trust as a way of cutting taxable income. The scheme gives the appearance that the taxpayer has given up control of their business to a trust; however, in reality the taxpayer is still running the day-to-day activities of their business and is controlling its income stream, said one IRS report on the scam.
- Next comes an equipment or service trust to hold equipment thats rented or leased to the business trust at inflated rates. This lets the business trust reduce its income by claiming deductions for payments to this trust.
- In some promotions, taxpayers are also encouraged to start a charitable trust to pay for personal, education or recreational expenses. These expenses are falsely claimed as charitable deductions on the trusts tax returns. Any remaining balance of income, usually a small amount, is then distributed to the taxpayer.
Try to claim the tax code is unconstitutional
Dont fall for the 16th Amendment scam or other such frivolous arguments. One victim was duped by a promoter claiming that the 16th Amendment authorizing the federal income tax was never ratified, and thus citizens do not have to file a return.
The victim paid the promoter $1,500 for a packet that explained how he could become part of a movement of people who have decided to un-tax themselves. The packet included a series of sample letters to send to the IRS making the case that he did not have to pay taxes.
When the IRS started a collection action against the victim, he made his own situation worse. He gave $100,000 to the promoter to hide in an offshore account, which the promoter ended up taking for his own use.
Your tax preparer promises really big deductions
The IRS advises that you be as careful about choosing a tax preparer as you would in choosing a doctor or a lawyer. The IRS has a special Criminal Investigation Return Prepare Program to root out unscrupulous or incompetent return preparers. In 2005 it prosecuted 110 tax preparers.
The problem for taxpayers is that even if the preparer gets in hot water, you are ultimately responsible for all of the information on your return. At best, you will be stuck with paying additional taxes and interest.
At worst, depending on culpability, you could be subject to penalties and maybe even criminal prosecution. Dont forget that tax evasion is a felony punishable by five years imprisonment and a $10,000 fine.
Dishonest tax preparers use several methods to create illegal deductions reducing taxable income including, preparing fraudulent Schedule C, Profit or Loss from Business; and claiming deductions for expenses that have not been paid by the taxpayer for expenses that have not been paid to offset form 1099, Miscellaneous Income.
They also come up with false or inflated itemized deductions on Schedule A for:- Charitable contributions
- Medical and dental expenses
- Claiming false dependents
- Claiming false losses on IRS Schedule E. (This covers supplemental income and losses from rental properties, partnerships, royalties, trusts and the like.)
To protect yourself, avoid tax preparers who claim they can get larger refunds than their competitors. Make sure the preparer signs your tax return and provides you with a copy for your records. And never, ever, sign a blank tax form.
Your company scams its way to avoid payroll taxes
The most prevalent methods of tax evasion by employers include pyramiding, employee leasing, paying employees in cash, filing false payroll tax returns or failing to file payroll tax returns. During fiscal 2005, more than 50 people were sentenced to an average of 30 months in prison for employment tax evasion.
So-called pyramiding of employment taxes is a fraudulent practice where a business withholds taxes from its employees but intentionally fails to remit them to the IRS. Businesses involved in this game often file for bankruptcy to evade the liabilities accrued and then start a new business under a different name and start all over again.
Employee leasing is a legal practice of contracting with outside businesses to handle all administrative, personnel and payroll concerns for employees. But some employee-leasing companies end up not paying any portion of the collected employment taxes to the IRS.
If youre an employee and your employer has failed to pay the income tax, Social Security and Medicare taxes withheld from your paycheck, youre not likely to be held liable. But you have to be able to prove that the money was, in fact, withheld and that you had nothing to do with the fraud. The best proof is a set of valid pay stubs. The employer, meanwhile, is in big trouble because, by withholding the taxes, hes been acting as an agent for the government. Hes personally liable.
ID thieves masquerading as IRS agents
These Internet-based criminals pose as representatives of a financial institution and send out fictitious e-mail correspondence in an attempt to trick consumers into disclosing private information. Sometimes scammers pose as the IRS itself.
In recent months, some taxpayers have received e-mails that appear to come from the IRS. A typical e-mail notifies a taxpayer of an outstanding refund and urges the taxpayer to click on a hyperlink and visit an official-looking Web site. The Web site then solicits a Social Security and credit card number.
In a variation of this scheme, criminals have used e-mail to announce to unsuspecting taxpayers they are under audit and could make things right by divulging selected private financial information. Taxpayers should take note: The IRS does not use e-mail to initiate contact with taxpayers about issues related to their accounts. If a taxpayer has any doubt whether a contact from the IRS is authentic, the taxpayer should call 1-800-829-1040 to confirm it.
Three more to avoid
Form 843 tax abatement. This scam, also new to the Dirty Dozen, rests on faulty interpretation of the Internal Revenue Code. It involves the filer requesting abatement of previously assessed tax using Form 843. Many using this scam have not previously filed tax returns and the tax they are trying to have abated has been assessed by the IRS through the Substitute for Return Program. The filer uses the Form 843 to list reasons for the request. Often, one of the reasons is: "Failed to properly compute and/or calculate IRC Sec 83 -- Property Transferred in Connection with Performance of Service."
No Gain deduction. Filers attempt to eliminate their entire adjusted gross income (AGI) by deducting it on Schedule A. The filer lists his or her AGI under the Schedule A section labeled Other Miscellaneous Deductions and attaches a statement to the return that refers to court documents and includes the words No Gain Realized.
Abuse of charitable organizations and deductions. The IRS has observed increased use of tax-exempt organizations to improperly shield income or assets from taxation. This can occur, for example, when a taxpayer moves assets or income to a tax-exempt supporting organization or donor-advised fund but maintains control over the assets or income, thereby obtaining a tax deduction without transferring a commensurate benefit to charity. A contribution of a historic facade easement to a tax-exempt conservation organization is another example. In many cases, local historic preservation laws already prohibit alteration of the homes facade, making the contributed easement superfluous. Even if the facade could be altered, the deduction claimed for the easement contribution may far exceed the easements impact on the value of the property.
Two more scams driven into hiding
Crackdowns by the Department of Justice and the IRS have knocked two of 2005's Dirty Dozen off the list.
The Department of Justice has obtained injunctions and filed complaints against dozens of promoters of the "Corporation Sole" scheme. Participants apply for incorporation under the pretext of being a bishop or overseer of a one-person, phony religious organization or society with the idea that this entitles the individual to exemption from federal income taxes as a nonprofit, religious organization.
When used as intended, Corporation Sole statutes enable religious leaders to separate themselves legally from the control and ownership of church assets. But the rules were twisted at seminars where taxpayers were charged fees of $1,000 or more and incorrectly told that Corporation Sole laws provide a legal way to escape paying federal income taxes, child support and other personal debts.
Another scheme, known as "Claim of Right," purportedly allowed taxpayer to deduct their entire wages as a necessary expense for the production of income or compensation for personal services actually rendered. The IRS went after promoters there, too.
The two scams join such schemes as slavery reparations and improper home-based businesses on the Dirty Dozen dust heap. But taxpayers should remain wary because the IRS has seen old scams resurface or evolve.
If you have any concerns about your employers activities or if you feel like you are being targeted by a scam artist, the IRS says, seek professional advice from the federal agency or a private tax professional. You can report suspected tax fraud activity to the IRS by calling 1-800-829-0433.
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