IRS’ Top 12 Tax Scams: 2014’s Dirty Dozen

6. Hiding Income Offshore

U.S. taxpayers who maintain financial accounts abroad must fulfill reporting requirements. Over the years, however, the IRS has identified numerous individuals as evading U.S. taxes by hiding income in offshore banks, brokerage accounts or nominee entities and then using debit cards, credit cards or wire transfers to access the funds. Others have employed foreign trusts, employee-leasing schemes, private annuities or insurance plans for the same purpose.

The IRS pursues taxpayers with undeclared accounts, as well as the banks and bankers it suspects of helping clients hide their assets overseas. And the agency works with the Department of Justice to prosecute tax evasion cases. New foreign account reporting requirements being phased in over the next few years will make hiding income offshore increasingly difficult.

At the beginning of 2012, the IRS reopened for an indefinite period its Offshore Voluntary Disclosure Program following continued strong interest from taxpayers and tax practitioners after the closure of the 2011 and 2009 programs. The agency has collected billions of dollars in back taxes, interest and penalties so far from people who participated in the voluntary programs since 2009.

7. Impersonation of Charitable Organizations

Big natural disasters elicit powerful responses from charities and donors. Scam artists usually show up too, commonly impersonating charities to get money or private information from well-intentioned taxpayers. Some operators of bogus charities contact people by telephone or email to solicit money or financial information, or set up websites to solicit funds for disaster victims.

Sometimes, scammers directly contact disaster victims and claim to be working for or on behalf of the IRS to help the victims file casualty loss claims and get tax refunds. They may try to obtain personal financial information or Social Security numbers that can be used to steal the victims' identities or financial resources.

The IRS cautions both victims of natural disasters and people wishing to make charitable donations to avoid scam artists by following these tips:

• To help disaster victims, donate to recognized charities.
• Be wary of charities with names that are similar to familiar or nationally known ones, but are phony organizations. IRS.gov's Exempt Organizations Select Check allows donors find legitimate, qualified charities to which contributions may be tax-deductible.
• Don't give out personal financial information to anyone who solicits a contribution as this information could be used to steal your identity and money.
• Don't give or send cash. For security and tax record purposes, contribute by check or credit card or another way that provides documentation of the gift.

8. False Income, Expenses or Exemptions

Inflating or including either wages or self-employment income on a tax return that was never earned in order to maximize refundable credits could result in repaying the erroneous refunds, including interest and penalties, and in some cases, even prosecution, the IRS said.

Farmers and other taxpayers who use fuel for off-highway business purposes may be eligible for the fuel tax credit. But ineligible individuals have also claimed this tax credit. The IRS said fraud involving the fuel tax credit is considered a frivolous tax claim, and can result in a penalty of $5,000.

9. Frivolous Arguments

Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish claims to avoid paying the taxes they owe. Such arguments are wrong and have been thrown out of court, according to the IRS. Those who promote or adopt frivolous positions 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 tax. 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.

10. Falsely Claiming Zero Wages

The IRS warned taxpayers not to fall prey to people who encourage them to claim deductions or credits to which they are not entitled, or willingly allow others to use their information to file false returns. Parties to such schemes could be liable for financial penalties or even face criminal prosecution.

One scheme involves filing a phony information return in order to lower the amount of taxes an individual owes. A Form 4852 (Substitute Form W-2) is used as a way to improperly reduce taxable income to zero. The taxpayer may also submit a statement rebutting wages and taxes reported by a payer to the IRS. Filing this type of return may result in a $5,000 penalty.

Another fraudulent scheme involves use of false Form 1099 refund claims. For instance, individuals may claim a refund based on the bogus theory that the federal government maintains secret accounts for U.S. citizens and that taxpayers can gain access to the accounts by issuing 1099 Original Issue Discount forms to the IRS. The perpetrator files a fake Form 1099-OID to justify a false refund claim on a corresponding tax return.

11. Abusive Tax Structures

Abusive tax schemes have evolved into sophisticated strategies that take advantage of the financial secrecy laws of some foreign jurisdictions and the availability of credit/debit cards issued from offshore financial institutions. The IRS said it was on the case. Its Criminal Investigation program identifies and investigates promoters of abusive tax structures and those who aid and abet them. Equally important, it investigates investors who knowingly participate in such schemes.

Abusive schemes encompass violations of the Internal Revenue Code and related statutes where multiple flow-through entities are used as an integral part of the taxpayer's effort to evade taxes. The IRS said these schemes were usually complex, involving multi-layer transactions for the purpose of concealing the true nature and ownership of the taxable income and/or assets.

The agency cautioned that form over substance are the most important words to remember before buying into any arrangements that promise to "eliminate" or "substantially reduce" a tax liability. It said promoters of abusive tax schemes often use financial instruments in their schemes.  However, the instruments are used for improper purposes including the facilitation of tax evasion.

12. Misuse of Trusts

Trusts are essential estate planning tools, but the IRS often sees highly questionable transactions. It said unscrupulous promoters urged taxpayers to transfer large amounts of assets into trusts, including not only cash and investments, but also successful on-going businesses. These transactions promise reduced taxable income, inflated deductions for personal expenses, the reduction or elimination of self-employment taxes and reduced estate or gift transfer taxes. Such transactions commonly arise when taxpayers are transferring wealth from one generation to another.

The agency said questionable trusts rarely delivered the tax benefits promised, and were used primarily as a means of avoiding income tax liability and hiding assets from creditors, including the IRS.

– Check out these related stories on ThinkAdvisor:

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For more tax planning advice, check out ThinkAdvisor's 21 Days of Tax Planning Advice for 2014 home page.