8 sure ways to tempt fate and the IRS
By Ed Henry
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 with the feds.
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 hasn’t 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.
Don’t 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. Here are eight of the biggest scams to watch for:
Scam 1: Shelter income by moving your money offshore
According to a Senate Finance Committee report, there’s been a strong increase in the “use of credit or debit cards by people to access offshore accounts established in tax-haven countries to conceal taxable income.” 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.
A former physician for the U.S. cycling team told Congress how easy it is to be suckered into illegal tax shelters by con artists. Much of the information comes from the Internet, he testified, and makes claims that courts have repeatedly refused to ratify. Daniel Bullock served 18 months in federal prison for tax evasion. He was convinced by a Utah promoter to set up a series of domestic and offshore trusts that would filter the money out so that it was impossible to track back to the doctor. Under the scheme, he could get the money in a second trust and use the cash tax-free for personal expenses.
The IRS launched a major crackdown on credit cards issued by banks such as Swiss American Bank Ltd., Royal Bank of Canada, and HSBC Bank International with operations in places such as the Bahamas and the Cayman Islands. The General Accounting Office estimates that 1million 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.
Only an estimated 170,000 of these people state on their federal income tax returns that they have such off-shore accounts. 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.
But the General Accounting Office, the investigative arm of Congress, says the IRS has not gone far enough to protect consumers. Bullock’s lawyer, Jennifer Prager Sodaro, and Michael Brostek, director of tax issues for the General Accounting Office agreed the IRS should get more help from the courts and more staff to enforce tax laws.
Scam 2: 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. 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. Here’s how they work:
But be forewarned: Uncle Sam is catching up to the crooks. The IRS has opened a number of criminal investigations and won 114 convictions in the last three years. The average prison time meted out to those individuals has been 37 months.
- 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 that’s 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 trust’s tax returns. Any remaining balance of income, usually a small amount, is then distributed to the taxpayer.
Scam 3: Try to claim the tax code is unconstitutional
Don’t fall for the 16th Amendment scam. 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. For more on this question, see “5 reasons you really do have to pay the IRS."
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.
Then he really hit rock bottom: The victim’s original attorney believed in the protest movement and sucked another $70,000 out of him, before the victim finally wised up and found a new attorney.
Scam 4: Claim all personal expenses as business expenses
A small businesswoman from Montana was convinced by a con artist that she would be able to legally deduct all of her personal expenses as business expenses.
The scheme involved setting up two trusts: one for the business and one for the woman’s personal expenses. She paid a total of $10,000 to the con artist to set up these trusts and prepare her return.
The promoter advised claiming just about everything for a business expense deduction and even supplied false invoices to help. The promoter also changed the numbers on the tax form submitted by the victim in order to eliminate any tax liability at all.
The woman involved has six children and no medical or life insurance. She went ahead with the scheme because she thought it was the only way to provide safety and security for her family.
But it all backfired. In addition to the $10,000 she shelled out to the scam artist, the IRS has slapped a $32,000 lien on her home until the proper tax payment is worked out. As a result of the lien, the woman has not been able to get any loans for her business.
Scam 5: Claim the so-called African-American reparations credit
Some 90,000 taxpayers have filed specious claims in recent years with the IRS for a “reparations credit” payable to descendants of slaves. There is no such credit. For more on this, see “IRS cracks down on slavery claims.”
The problem has been made worse by the fact that the IRS has not been effective in stopping the bogus claim. In 2001, many taxpayers claiming the reparations credit did receive refunds, some of them the tune of $80,000 for married taxpayers. And that forced the IRS to move to take the money back.
The Treasury Department’s inspector general for tax administration has now developed software to help the IRS detect and stop claims for reparations. In an embarrassing twist for the IRS, the inspector general's office discovered one current and eight former IRS employees who claimed the credit.
Scam 6: You can get a refund on your Social Security taxes
Almost annually, the IRS sends out a warning about a scam in which taxpayers are offered refunds of the Social Security taxes they have paid during their lifetimes. The scam artist merely collects a “paperwork” fee of $100, plus a percentage of any refund received, as long as the taxpayer files a refund claim with the IRS.
This is a hoax designed to fleece the victims for the upfront fee, IRS officials say. Federal law does not allow such a refund of Social Security taxes paid.
If you try to claim the refund, the IRS will “contact” you -- a nice way of saying that you are likely to trigger an audit with such a frivolous claim. In 2002, the IRS blocked more than 1,100 refund claims totaling some $95 million. Be skeptical of any “tax professional” who demands a fee tied to a percentage of the refund. It's likely to be a scam.
Scam 7: 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.
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. Don’t 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:
Here are some hints to help protect yourself:
- 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.)
- 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.
- Never sign a blank tax form.
Scam 8: 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.
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 you’re an employee and your employer has failed to pay the income tax, Social Security and Medicare taxes withheld from your paycheck, you’re 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, he’s been acting as an agent for the government. He’s personally liable.
If you have any concerns about your employer’s 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.