By Paul N. Gada, Business Owner's Toolkit Staff Writer

The IRS has issued an annual consumer alert that cautions taxpayers to avoid falling victim to a variety of tax scams topping its consumer watch list. Additional guidelines debunk the schemes and provide new legal details to aid tax practitioners and taxpayers.

The IRS notice sets out many of the most common frivolous arguments used by tax-avoidance schemes and details potential civil and criminal penalties that may be imposed. Together with other federal agencies, the IRS is aggressively pursuing and prosecuting promoters and clients involved in the scams for fraud and tax evasion.

Taxpayers involved in any tax scam are liable for the actual tax due and statutory interest. Also, together with the promoters, they may be assessed civil penalties or subjected to criminal prosecution.

Without further ado, here are the "Dirty Dozen" tax scams recently highlighted by the IRS:

1. Misuse of Trusts -- Abusive tax scheme promoters often urge taxpayers to transfer their assets into trusts in order to reduce their taxable income, deduct personal expenses paid by the trust, and lower their estate or gift tax liability. The IRS is actively examining such trust arrangements, has obtained injunctions against a number of promoters, and has instituted criminal prosecutions against numerous promoters and their clients. Taxpayers are advised to seek the advice of a trusted tax professional before entering into such sham arrangements.
2. "Claim of Right" Doctrine -- Some taxpayers seek to reduce their tax liability by taking the position that they and their incomes are nontaxable based on a "claim of right." Promoters may be marketing a package, kit, or other materials that purportedly show a taxpayer how to avoid paying taxes based on this meritless argument. However, any allegation that a claim of right argument can be used to reduce tax liability with respect to any item not included in gross income completely misinterprets the tax laws and has no support in law.
3. "Corporation Sole" Laws -- Another scam involves taxpayers who attempt to reduce their tax liability by taking the position that their income belongs to a "corporation sole." They apply for incorporation under the pretext of being a "bishop" or "overseer" of a one-person, phony religious organization or society. However, a corporation sole may be used only by a bona fide religious leader for a specific and limited purpose relating to that party's office.
4. Offshore Transactions -- Parties using offshore transactions to avoid paying U.S. taxes could be subject to the payment of taxes, interest, and penalties, and subjected to potential criminal prosecution. Participants in this scam use offshore bank accounts, brokerage accounts, credit cards, wire transfers, trusts, offshore employee leasing, or other arrangements to conceal or underreport income or to claim false deductions. A special program conducted during 2003 has yielded more than $170 million in taxes, interest, and penalties, and the IRS and the states continue to aggressively pursue those involved in this tax-avoidance scheme.
5. Employment Tax Evasion -- A number of illegal schemes in which employees instruct their employers not to withhold income or employment taxes from their wages are the subject of IRS scrutiny. Taxpayers attempt to reduce their tax liability by taking the spurious position that, pursuant to Internal Revenue Code Section 861, U.S. citizens and residents are not taxable on wages and other income earned or derived in the United States. However, Code Sections 861 through 865 apply only in determining whether income is considered from sources within or without the United States.
6. Return Preparer Fraud -- The IRS has targeted unscrupulous return preparers who derive financial gain by diverting a portion of their clients' refunds for their own benefit, charging inflated fees for their services, and advertising guaranteed larger refunds. Care should be exercised in hiring a tax professional because the taxpayers are ultimately responsible for all of the information reflected on their returns.
7. Disabled Access Credit -- Another scheme involves taxpayers who improperly claim the disabled access credit with respect to the purchase of equipment and services that, according to the promoter, satisfies strict statutory criteria. Under the scam, a minimal payment is made, a nonrecourse note is signed, and the investor provides insignificant services to complete the purchase agreement. The scheme is based on a misinterpretation of the tax law and an overinflated value of the services rendered.
8. Slavery Reparations -- Some taxpayers seek to reduce their income tax liability by taking the position that they are entitled to a reparations tax credit because they are members of a group or class based on race, ancestry, ethnicity, gender, or other classification. Thousands of African-Americans have been misled by promoters offering to file for tax credits or refunds related to slavery reparations; however, no reparations credit entitling individuals to tax refunds or other tax benefits exists. Although reparations claims have fallen considerably over the years, the IRS continues to see activity in this area.
9. Home-Based Businesses -- Schemes in which promoters claim that individuals can deduct most, or all, of their personal expenditures as business expenses by setting up bogus home-based businesses constitute illegal tax avoidance. The purported business in these scams is merely an attempt to create the appearance of running a bona fide, home-based business where none actually exists. Pursuant to the tax code, a clear business purpose and profit motive are prerequisites for generating and claiming business deductions.
10. Frivolous Arguments -- Not that the others aren't equally as bad, certain frivolous tax arguments made by promoters and taxpayers are highlighted in a "kitchen sink" category by the IRS.
    • Some taxpayers attempt to reduce their tax liability by claiming that their wages or other income is excludable from taxable income under Internal Revenue Code Section 911 on the grounds that the U.S. state, commonwealth, or territory in which they reside or perform services is a foreign country. The statute, which permits taxpayers to claim an exclusion for U.S. income tax purposes, applies only when the taxpayer earns income and resides outside the United States under the conditions and limitations set forth in the tax code.
    • Other individuals seek to reduce their tax obligations by claiming that they have been "removed" or "redeemed" from the federal tax system. Some contend that the government acts fraudulently when it attempts to collect tax debts and that the purported fraud entitles them to "chargeback" debts owed to them. However, removal and redemption arguments have been deemed meritless.
    • Additionally, some individuals who realize taxable income try to reduce their tax liability by filing zero-income returns that report no income and no tax liability and seek a refund of withholding taxes. The IRS is committed to identify taxpayers who attempt to avoid or evade their tax obligations in this frivolous manner.
11. Identity Theft -- The IRS has cautioned taxpayers to be wary of parties seeking the disclosure of personal and financial information. Identity thieves use an individual's personal data to steal financial accounts; run up charges on existing credit cards; apply for loans, credit cards, services, or benefits in the victim's name; and file fraudulent returns. Further, abusive return preparers have used their clients' Social Security numbers and other information to file false returns without the taxpayers' knowledge.
12. Earned Income Tax Credit Abuses -- A tax scheme involving the earned income tax credit (EITC) involves unscrupulous return preparers "sharing" one client's qualifying children with another client in order to enable both taxpayers to claim the EITC. Under this scam, the preparer and the client "selling" the dependents split a fee. The IRS pointed out that it prosecutes preparers of such fraudulent claims and may impose civil penalties against participating taxpayers.

Advice to Taxpayers

According to IRS Commissioner Mark W. Everson, "Taxpayers should think carefully before paying for services or signing important documents. Don't be a victim of these scams or others that promise the moon. They carry a high price."

Documents available on the IRS's website are designed to help people filling out their tax forms to avoid becoming involved in abusive schemes and/or making common math errors. Parties who suspect tax fraud are encouraged to report it to the IRS by calling 1-800-829-0433.

On a more practical level, though, don't forget the mighty power of properly applied common sense. If somebody pitches a "no tax" plan that sounds too good to be true, it probably is. Instead of letting greed and the hatred of paying taxes get the better of you, take advantage of the many legitimate ways currently available to lower your tax bill.

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