Legal And Financial Questions: What Is An Abusive Tax Shelter?

The difference between tax evasion and avoidance and the implications this has for abusive tax shelters.

Tax avoidance can be differentiated from tax evasion easily. Tax avoidance is basically arranging one's finances so that only the minimum amount of tax is required by law. Notice the words required by law. This activity is a perfectly legal way to reduce the amount of taxes one owes. Tax avoidance is using tax loopholes in the IRS code to minimize the amount of tax you owe to the IRS. Tax evasion, however, is not legal. Tax evasion is not paying taxes that are legitimately owed to the IRS. Whether one just doesn't pay taxes outright, or one tries to find illegal means to avoid paying taxes (deductions that aren't legitimate, abusive tax shelters, etc.), tax evasion is the illegal dodging of paying taxes.

Abusive tax shelters are those tax shelters set up by unscrupulous people attempting to cheat the IRS out of money (and often the taxpayer loses out as well). They involve fictitious transactions and the over inflation of immediate losses compared to actual, investment. Essentially, it's a marketing ploy using phony transactions to lower the tax investors owe. There are a lot of scams out there claiming to be legitimate tax shelters, but often, they are nothing more than fraudulent arrangements that try to hide taxable income or make deductible items that normally would not be. An abusive tax shelter exists just to lower taxes. A legitimate tax shelter exists to provide economic benefit, and thus there is risk involved.

The IRS lists some of the top abusive tax shelters that are commonly found, and successfully prosecuted, today. At the top of the list is misuse of trusts. The people who promote abusive trusts as a way for the taxpayer to get out of paying taxes are breaking the law, and the taxpayer is complicit in that illegal activity and can be held fully responsible for any penalties incurred. The promoters claim that they can move assets from individual ownership into the trust that normally aren't tax deductible, like living expenses, and make them deductible expenses. This is false. Just because the trust owns the assets, the person who benefits from those assets is responsible for the taxes. The IRS is actively examining and pursuing the promoters and beneficiaries of these kinds of abusive tax shelters.

Another abusive tax shelter is the corporation sole. This set up is meant to allow religious leaders to become incorporated to legally separate them from the assets of the church. Some promoters are telling taxpayers that they can use this to legally avoid taxes, as well as other financial obligations such as child support. This isn't a legal tax avoidance maneuver. It is fraudulent and can be prosecuted.

Offshore transactions that are intended to hide assets and/or income are also illegal. This includes an offshore bank account or brokerage account. Any activity of this nature intended to misrepresent the amount of income received and tax owed could be punished by being charged penalties and interest, as well as criminal prosecution.

It is also against the law to set up a fake home business in order to use your primary residence and personal expenses as tax deductions. Any business, home based or otherwise, must meet certain standards for clear business practices with an eye toward profit in order to qualify for any tax breaks. Just saying you have a home business, without meeting these standards is not a legal tactic.

There are other illegitimate tax shelters. All are set up with the express purpose of circumventing the payment of taxes that are rightfully owed to the IRS. There are ways to exploit the ADA and take advantage of the Disabled Access Credit. Another way is to set up a trust to look like a charity (a charitable trust), then have the trust pay expenses for the taxpayer and deduct the bogus payments as charitable contributions. Since a charity has to be certified to get any tax break, these kinds of contributions can not be deducted legally.

The IRS is cracking down on abusive tax shelters. Any promoter of a trust is required to register with the IRS and must keep a list of all investors for seven years. The promoter must give that list of investors to the IRS if they ask. The penalties for engaging in abusive tax shelters are high, from having to pay the taxes owed plus interest, to a possible 75% underpayment penalty, to jail time. Taxpayers need to be very careful when becoming involved in any plan to reduce the amount of tax paid. Carefully check out the system being invested in, research the legality of the system, and know who is running the system before investing and claiming tax write-offs.

© High Speed Ventures 2011