The Internal Revenue Service has issued its list of tax scams for 2010.
According to the IRS Commissioner: “Taxpayers should be wary of anyone peddling scams that seem too good to be true.” Tax schemes that are illegal can lead to imprisonment and fines for both scam artists and taxpayers. Taxpayers pulled into these schemes must repay unpaid taxes plus interest and penalties.
Here is a list of common schemes that taxpayers are urged to avoid (not in any particular order):
- Phishing – Phishing is a tactic used by scam artists to trick unsuspecting victims into revealing personal or financial information online. IRS impersonation schemes flourish during the tax return filing season and can take the form of e-mails, tweets or phony Web sites. Scammers may also use phones and faxes to reach their victims.
Scam artists will try to mislead taxpayers by telling them they are entitled to a tax refund from the IRS and that they must reveal personal information to claim it. Criminals use the information they get to steal the victim’s identity, access bank accounts, and run-up credit card charges or apply for loans in the victim’s name. Taxpayers who receive suspicious e-mails claiming to come from the IRS should not open any attachments or click on any of the links in the e-mail. Suspicious e-mails claiming to be from the IRS or Web addresses that do not begin with http://www.irs.gov should be forwarded to the IRS mailbox: firstname.lastname@example.org.
- Abuse of Charitable Organizations and Deductions – The IRS continues to observe the misuse of tax-exempt organizations. Abuse includes arrangements to improperly shield income or assets from taxation and attempts by donors to maintain control over donated assets or income from donated property. Statistics show that charity-based frauds are at their peak in November, December and January.
- Frivolous Arguments – Promoters of frivolous schemes encourage people to make unreasonable and outlandish claims to avoid paying the taxes they owe. Some of these schemes are:
- The filing of a tax return or payment of tax is voluntary
- Wages for personal services are not income
- Taxpayer is not a citizen of the United States, thus not subject to Income Tax laws
- Taxpayers can refuse to pay income taxes on religious grounds by invoking the first amendment
These arguments are false and have been thrown out of court.
- Filing False or Misleading Forms – The IRS is seeing various instances where scam artists file false or misleading returns to claim refunds that they are not entitled to. Under the scheme, taxpayers fabricate an information return (such as Form 1099-OID) and falsely claim the corresponding amount as withholding as a way to seek a tax refund.
- Zero Wages – Filing a phony wage-or-income-related information return to replace legitimate information has been used as an illegal method to lower the amount of taxes owed. Typically, a substitute Form W-2 or a corrected Form 1099 is used as a way to improperly reduce taxable income to zero.
- Nontaxable Social Security Benefits with Exaggerated Withholding Credit – The IRS has identified returns where taxpayers report nontaxable Social Security Benefits with excessive withholding. This tactic results in no income reported to the IRS on the tax return. Often both the withholding amount and the reported income are incorrect. Taxpayers should avoid making these mistakes. Filings of this type of return may result in a $5,000 penalty.
- Fuel Tax Credit Scams – The IRS receives claims for the fuel tax credit that are excessive. Some taxpayers, such as farmers who use fuel for off-highway business purposes, may be eligible for the fuel tax credit. But other individuals are claiming the tax credit for nontaxable uses of fuel when their occupation or income level makes the claim unreasonable. Fraud involving the fuel tax credit is considered a frivolous tax claim and potentially subjects those who improperly claim the credit to a $5,000 penalty.
- Misuse of Trusts – Unscrupulous promoters have urged taxpayers to transfer assets into trusts. While there are many legitimate, valid uses of trusts in tax and estate planning, some promoted transactions promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. Such trusts rarely deliver the tax benefits promised and are used primarily as a means to avoid income tax liability and to hide assets from creditors including the IRS. Taxpayers should seek the advice of a trusted professional before entering into a trust arrangement.
- Abusive Retirement Plans – The IRS continues to find abuses in retirement plan arrangements, including Roth IRAs. There are transactions that taxpayers use to avoid the limits on contributions to IRAs, as well as transactions that are not properly reported as early distributions. Taxpayers should be wary of advisors who encourage them to shift appreciated assets at less than fair market value into IRAs or companies owned by their IRAs to circumvent annual contribution limits. Other variations have included the use of limited liability companies to engage in activity that is considered prohibited.
- Disguised Corporate Ownership – Corporation and other entities are formed and operated in certain states for the purpose of disguising the ownership of the business or financial activity by means such as improperly using a third party to request an employer identification number. Such entities can be used to facilitate under-reporting of income, fictitious deductions, non-filing of tax returns, participating in listed transactions, money laundering, financial crimes and even terrorist financing. The IRS is working with state authorities to identify these entities and to bring the owners of these entities into compliance with the law.
- Hiding Income Offshore – The IRS aggressively pursues taxpayers involved in abusive offshore transactions as well as the promoters, professionals and others who facilitate or enable these scams. Taxpayers have tried to avoid or evade U.S. income tax by hiding income in offshore banks or brokerage accounts through the use of nominee entities. Taxpayers also evade taxes by using offshore debit cards, credit cards, wire transfers, foreign trusts, employee-leasing schemes, private annuities or insurance plans.
- Return Preparer Fraud – Dishonest tax return preparers can cause trouble for taxpayers who fall victim to their ploys. Such preparers derive financial gain by skimming a portion of their client’s refunds, charging inflated fees for tax return preparation services and attracting new clients by promising refunds that are too good to be true. Taxpayers should choose carefully when hiring a tax preparer. Federal courts have issued injunctions ordering hundreds of individuals to cease preparing tax returns and promoting fraud, and the Department of Justice has filed complaints against dozens of others, which are pending in court.
IRS AUDIT INFORMATION
There are approximately 130,000,000 individual income tax returns filed each year. As you may know, it has been publicized that individual income tax returns are pulled for an Internal Revenue Service (IRS) audit at about a 1% rate (the IRS audit lottery). This excludes over 200,000 taxpayers pulled for audit each year that did not file a tax return with the IRS when they should have filed (guaranteed IRS audit).
However, upon closer inspection of the “1%” IRS audit lottery statistics, keep in mind that approximately 63% of the individual income tax returns filed did not even itemize deductions. That means their chance for being audited by the IRS is lower than 1% since they might only have a W-2 Form for wages earned or a 1099 Form for Retirement Income received. The IRS receives a copy of the W-2 Forms and the 1099 Forms from the payer of those amounts and automatically matches those Forms to the applicable individual income tax return. Thus audits of those issues are normally not required.
The percentage chance for being audited by the IRS increases as your Adjusted Gross Income increases. Also if you file a tax return including itemized deductions (on Form 1040 Schedule A for such things as mortgage interest, local taxes and donations), your chance of being audited by the IRS is greater than 1% since so many tax returns are filed without itemizing deductions and the IRS knows some taxpayers do not keep adequate support for their itemized deductions. Keep in mind any special tax return forms you need to attach to your tax return such as capital gains or losses, rental property income or loss, partnership income/LLC income/self-employed income, home office deductions, etc. would increase your chance of being audited by the IRS.
Nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer. Please consult with your tax advisor before acting on any of these topics. Your tax advisor can ensure you receive the maximum tax benefits considering your tax filing status, income tax rates, etc. You can also visit the Internal Revenue Service web site www.irs.gov for more information on the issues discussed in this article.
Thomas L. Broderick, C. P. A. is the Treasurer of Pickens-Kane Moving & Storage Co. in Chicago, Illinois. He has served as Chairman of the Board of Trustees of the Illinois Movers’ and Warehousemen’s Risk Management Trust since 1996. He has also served as president of the West Central Association Chamber of Commerce for the years 2007 thru 2009. Many individuals, small businesses and non-profit organizations consult him for various accounting, investment, insurance and tax issues.
Revised: November 10, 2010