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IRS Issues Warning About Schemes to Avoid Taxes

Be wary of preparers and consultants who try to lure clients by promising to find loopholes, agency says.

March 02, 2004|Kathy M. Kristof | Times Staff Writer

The Internal Revenue Service released Monday its annual list of top tax scams and schemes, warning people to avoid falling prey to the dodges.

"We're augmenting our enforcement resources to attack schemes and scams," IRS Commissioner Mark W. Everson said in a statement. "Don't be fooled by these outrageous claims. There is no secret way to escape paying taxes."

Most schemes are touted by what the IRS calls promoters: tax preparers and consultants who lure clients with promises of finding tax loopholes. People buying into such schemes are at risk because the IRS invariably gets client lists from promoters who are nabbed, tax experts note. Then, each of those clients also faces an audit, potential back taxes and penalties.

"You may think you're safe because you're not a big fish," said Jennifer MacMillan, a tax professional in Santa Barbara. "But if the IRS nets the big fish, it also nets all the little minnows that are swimming along. You are at risk, and it's just not worth it."

Many of this season's top schemes are variations on old scams, MacMillan added.

The IRS list includes:

* Questionable trusts: There is a long list of trusts that promoters say can be used to avoid income taxes. Create a trust, the pitch goes, and personal expenses like your groceries and clothing costs can be cycled through it to become a deduction.

Dozens of promoters and their clients have faced injunctions and criminal prosecution because of the misuse of trusts, the IRS says. Aside from mortgage interest expenses, which are tax deductible, personal expenses cannot be deducted no matter how they are paid, said Martin Nissenbaum, a New York-based tax expert with Ernst & Young.

* The "claim of right" doctrine: Federal tax law allows taxpayers to deduct wages that they've had to repay their employers if they got advance payment for commissions but earned less than the advance. But taxpayers can't invoke this so-called claim of right doctrine to deduct all of their wages as a necessary expense for the production of income.

* Church cheats: Religious overseers of church finances can self-incorporate to separate their personal income and assets from the income and assets of their church. Tax cheats use the idea to contend that they are a church and all of their income is nontaxable. The dodge doesn't work, the IRS said.

* Offshore accounts: Many people put their money in overseas accounts to avoid paying taxes. The IRS says U.S. citizens must report any income that they have received from offshore banks, brokerage accounts and other investments and pay tax on it. The IRS says it is aggressively pursuing offshore tax dodges and recently collected $170 million in back taxes from individuals who tried to hide money in foreign lands.

* Employment taxes: Some bosses assert incorrectly that they are not bound to withhold employment taxes from their workers' wages, the IRS says. Those employers can be held liable for the tax, interest and penalties, according to the IRS -- and the workers are liable for the tax itself.

The IRS also warns taxpayers to steer clear of preparers who say there are deductions for providing services to the disabled and special "reparations" refunds for African Americans. And in general, the agency says, avoid preparers who promise big refunds for a big fee.

People are tempted by scams at this time of year because the promoters are slick and many people simply want to believe, Nissenbaum said.

"But these are not things that you could say had some technical argument that might make sense," he said. "They are off-the-charts, off-the-wall schemes that can get taxpayers into real trouble."

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