As long as there have been taxes, shady promoters have tried to sell taxpayers on schemes to get out of paying their fair share. Learn about abusive tax shelters, and how to recognize and avoid them.
Tax avoidance? Accelerating tax deductions, deferring income, changing one's tax status through incorporation, and setting up a charitable trust or foundation. All of these are legal tax shelters.
Tax evasion - that's a different story. In tax evasion, you plan to reduce tax payable through illegal means. Abusive tax shelters reduce taxes, promoting the promise of tax benefits with no meaningful change in your income or net worth.
Turns out that in the 1990s, because penalties were too small to have a deterrent effect, tax shelters became quite popular to cushion one-time large capital gains. But these days, the tide has turned against promoting abusive tax shelters. Today, Treasury regulations and IRS rules dealing with tax shelters note that certain types of transactions will no longer pass muster.
The bottom line? Talk to a professional about legitimate ways to reduce your tax burden. Don't go to some shady guy your brother-in-law knows, or follow advice in a book written by someone with no distinguished credentials such as "CFP," "CPA" or "JD" after their names. Various trusts can help with long-term tax planning. And even modest families can legally game the tax system with such vehicles as IRAs, 401(k) plans and 529 plans.
Just in case you're already considering something not too kosher, note that the IRS has its Dirty Dozen list of tax scams - schemes that encourage the use of phony tax shelters designed to avoid paying what is owed. The IRS warns that you could end up paying a lot more in penalties, back taxes and interest than the phony tax shelter saved you in the first place.
One such tax scam on the IRS radar is abusive micro-captive structures: crooked promoters persuade owners of closely held entities to participate in poorly structured or illegal insurance arrangements. For example, coverages may insure implausible risks, fail to match genuine business needs or duplicate the taxpayer’s commercial coverages. Premium amounts may be unsupported by underwriting or actuarial analysis, may be geared to a desired deduction amount or may be significantly higher than premiums for comparable commercial coverage, according to the IRS. It's all in the name of illusory tax savings. So only work with qualified professionals.
There is a fine line between legitimate tax avoidance and illegal tax evasion. The IRS says it won't hesitate to impose penalties on both participants and promoters of abusive tax shelters. Tax fraud convictions can mean fines or even prison. In brief, if something sounds too good to be true, it probably is.