The last quarter of the year is a time when doctors and business owners decide to swing into action to reduce their personal income tax exposure. It’s also high selling season for a variety of abusive tax plans involving frivolous arguments that the Internal Revenue Service has heard and beat before.
The end of the year presents a variety of good legal opportunities to reduce your income tax in legal and proven ways, with the help of your CPA and in some cases your financial adviser. Over the next few weeks I will examine several of these options and some of the most common scams I see physicians and entrepreneurs get conned with.
In some cases of abuse the tax payer innocently relies on what she is told by those who hold themselves as experts. In other cases they are complicit in plans that rely on promises of secrecy, and which are sold with a “wink.”Either way, the penalties are the same and the taxpayer is ultimately responsible for the accuracy of the return at both a criminal and civil level.
One common category of tax fraud involves what the IRS calls “frivolous arguments.” While this dangerous garbage comes in many flavors, it shares some basic traits:
• They are often promoted by salespeople who lack professional credentials, e.g. a currently licensed attorney or CPA;
• Promoters often request that you sign a nondisclosure agreement to help provide you with “secrecy.” The agreement is actually there for them, not you, and is structured to discourage you from telling others (including advisers) how you’ve been conned;
• They say that only really smart and connected people like the (Insert VIP here — billionaires, politicians, Rothschilds, Illuminati, etc.) know about it, and in fact, they did the same planning for Bill Gates;
• They say the tax system is “voluntary” in some cases;
• They imply that you can be permanently absolved of the burden of filing and paying personal income taxes through certain structures, usually trusts;
• They violate the old “rule of three,” that I was taught many years ago. If you put it in tax free, grow it tax free, and take it out tax free, it’s probably fraud;
• They rely on silly religious objections to being taxed, or bizarrely interpreted constitutional arguments as to why you don’t have to pay taxes.
The following summary comes directly from the IRS itself and should be considered to include a variety of trust scams that combine the comfort of some complex, official sounding trust like a “Pure Trust,” “Admiralty Trust,” “Constitutional Trust,” “Patriot Trust,” “Corporation Sole,” and a variety of other made-up structures that violate the plain language of the U.S. tax code.
Examples of frivolous arguments include contentions that taxpayers can refuse to pay income taxes on religious or moral grounds by invoking the First Amendment; that the only “employees” subject to federal income tax are employees of the federal government and that only foreign-source income is taxable.
Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish claims to avoid paying the taxes they owe. While taxpayers have the right to contest their tax liabilities, no one has the right to disobey the law or disregard their responsibility to pay taxes. The penalty for filing a frivolous tax return is $5,000. The penalty is applied to anyone who submits a tax return or other specified submission, if any portion of the submission is based on a position the IRS identifies as frivolous.
Those who promote or adopt frivolous positions also risk a variety of other penalties. For example, taxpayers could be responsible for an accuracy-related penalty, a civil fraud penalty, an erroneous refund claim penalty, or a failure to file penalty. The Tax Court may also impose a penalty against taxpayers who make frivolous arguments in court.
Taxpayers who rely on frivolous arguments and schemes may also face criminal prosecution for attempting to evade or defeat paying tax. Similarly, taxpayers may be convicted of a felony for willfully making and signing under penalties of perjury any return, statement, or other document that the person does not believe to be true and correct, as to every material matter. Persons who promote frivolous arguments and those who assist taxpayers in claiming tax benefits based on frivolous arguments, may be prosecuted for a criminal felony.