How to Avoid IRS Abusive Tax Schemes and Transactions

How to Avoid IRS Abusive Tax Schemes and Transactions

Avoiding IRS Abusive Schemes, Transactions and Arrangements

While the Internal Revenue Service has a reputation for perpetually being the bad guy and going after U.S. taxpayers for every mistake they make on their taxes, there is another aspect of the IRS — which is to protect taxpayers. One of the most common ways that taxpayers find themselves in hot water with the IRS is that they get involved in a tax promotion or tax scheme, which leads to inaccurate tax filing and may further lead to issues involving tax fraud and substantial underpayment payments. Sometimes, taxpayers get caught up in tax promotions involving things like syndicated conservation easements, Malta Pension Plans, and other tax schemes. Let’s look at three increasingly common abusive tax schemes, transactions, and arrangements that impact taxpayers involving international taxes.

First, Tax Fraud vs Tax Avoidance

It is important to note, that taxpayers can ride the line of tax avoidance, as long as they do not cross the line into tax evasion. Oftentimes, there are loopholes and other gray areas of tax that taxpayers can use to reduce their overall tax liability. While the IRS may still challenge the taxpayer and/or seek to reverse any tax benefit that the taxpayer claims — as long as it is not a form of tax fraud or tax evasion and is simply a gray area of tax planning, that in and of itself is not illegal. When the IRS wants taxpayers to avoid abusive schemes, transactions, and arrangements, it is primarily because the IRS takes a position that these are not proper types of tax avoidance.

Malta Pension Plans/Retirement Schemes

One important tax scheme that has been prevalent in the news for the past few years is the Malta pension plan. In general, the problem with the Malta Pension Plan/Retirement Scheme is that taxpayers were using it as if it were a Roth IRA, only with no contribution limits. With a Roth IRA, a taxpayer can contribute post-tax dollars and have their income grow tax-free so when they receive withdrawals they are not paying any taxes on it — but there is a maximum amount of contribution that taxpayer can make each year. With Malta retirement schemes, taxpayers would contribute millions of dollars of post-tax dollars, an asset with realized gain that had not been recognized yet. Then, taxpayers would take distributions that would stagger based on their age and claim that there was no tax liability. To achieve this result, taxpayers relied on a loophole in the Malta U.S. tax treaty.

A few years back, the IRS closed this loophole by way of a Competent Authority Arrangement and then began issuing criminal and civil summons against taxpayers who claim certain benefits that the IRS believe are improper. These taxpayers may become subject to extensive fines and penalties so they should be careful.

As provided by the IRS:

        • The IRS put taxpayers on notice earlier this year that it was reviewing the use of Maltese personal retirement schemes. The IRS is actively examining taxpayers who have set up these arrangements and recognizes that other taxpayers may have filed tax returns claiming Treaty benefits as a result of their participation in these arrangements. These taxpayers should consult an independent tax advisor prior to filing their 2021 tax returns and take appropriate corrective actions on prior filings.
        • The IRS also cautions taxpayers against entering into any substantially similar arrangements that would seek to misconstrue the provisions of a bilateral income tax treaty of the United States to avoid income tax. IRS enforcement, both the civil and criminal divisions, is committed to pursuing abuse and those who market and participate in abusive transactions.

Foreign Trusts

Another way that taxpayers try to circumvent having to pay U.S. taxes, is by moving money into a foreign trust. Tax promoters across the globe create creative types of trusts that straddle the line between what is considered a non-grantor trust. The reason why the non-grantor trust designation is important is that if the taxpayer is not the owner of the non-grantor trust, then they are only taxed on the income that is distributed to them paired with these types of tax promotion-focused trusts, taxpayers are not the owner of the foreign trust but maintain some sense of control and power to achieve withdrawals that are then claimed to be non-taxable. One common example is the Section 643(b) trust which tries to manipulate the definition of the term Distributable Net Income (DNI) to achieve a tax-exempt or tax-free result. The IRS has made it known that these types of trusts are improper and they have begun auditing taxpayers on these types of issues.

As provided by the IRS:

      • Abusive foreign trusts are often formed in foreign countries that impose little or no tax on trusts and also provide financial secrecy. These are usually “tax haven” countries, supposedly outside the jurisdiction of the U.S. Typically, abusive foreign trust arrangements enable taxable funds to flow through several trusts or entities until the funds ultimately are distributed or made available to the original owner, purportedly tax-free. In actuality, the income from these arrangements is fully taxable.
      • Foreign packages often begin with an Asset Management Company, a business trust, and then distribution of income to several trust layers. These schemes also involve offshore bank accounts and International Business Corporations (IBCs). 

Syndicated Consideration  Eastment/Art Contributions

With these types of tax promotions, the idea is that the taxpayer can acquire certain artworks or interest in a conservation easement at a reduced value, but when the easement or the art is appraised — it appraises for significantly more than the buy-in amount. Then, when the taxpayer donates their interest in, they can claim a significantly higher tax benefit based on the appraised value than the amount they acquire the asset for. As a result, the taxpayer receives a significantly higher benefit. What are the key issues with this type of tax scheme is that the appraisals are artificial and are valued much higher than their actual value which would be significantly lower. These types of transactions are a red flag for the Internal Revenue Service and can lead to significant fines and penalties for the taxpayer.

As provided by the IRS:

Syndicated Conservation Easements

      • The Department of the Treasury and the Internal Revenue Service today issued proposed regulations that provide guidance under a new section of the law that disallows deductions for certain charitable conservation contributions by partnerships and other pass-through entities. Syndicated conservation easements have been included in the IRS’ annual list of Dirty Dozen tax schemes for many years.
      • The SECURE 2.0 Act of 2022 added new subsections to the part of the tax law that provides rules for deductions for charitable contributions under Internal Revenue Code section 170.
      • “The IRS is focusing its new compliance efforts on those who evade taxes through complex partnership structures and overvalued conservation easement contributions. The regulations issued today will stem the tide of certain syndicated conservation easements that are nothing more than retail tax shelters, while protecting the integrity of legitimate conservation easements and helping law-abiding taxpayers more easily meet their obligations,” said IRS Commissioner Danny Werfel.
      • Generally, these regulations affect partnerships and S corporations that make conservation contributions and upper-tier partnerships, upper-tier S corporations, partners and S corporation shareholders that are allocated a portion of these contributions. The regulations provide definitions, explanations, computational guidance and examples of the new law, which disallows deductions if the amount of the contribution is more than two and a half times the sum of each partner’s or shareholder’s relevant basis in the partnership or S corporation.

Improper art donation deductions

      • There are ways for taxpayers to properly claim donations of art. But some unscrupulous promoters use direct solicitation to promise values of art that are too good to be true.
      • These promoters encourage taxpayers to buy various types of art, often at a “discounted” price. This price may also include additional services from the promoter, such as storage, shipping and arranging the appraisal and donation of the art. The promotor promises the art is worth significantly more than the purchase price.
      • These schemes are designed to encourage purchasers to donate the art after waiting at least one year and to claim a tax deduction for an inflated fair market value, which is substantially more than they paid for the artwork. Promoters may suggest taxpayers donate art annually and allow them to buy a quantity of art that guarantees a specific deductible amount. Promoters may even arrange for certain charities to take the donations.
      • The IRS has a team of professionally trained Appraisers in art appraisal services who provide assistance and advice to the IRS and taxpayers on valuation questions in connection with personal property and works of art.
      • “Creativity in art is a beautiful thing, but aggressive creativity in art donation deductions can paint a bad picture for people pulled into these schemes,” Werfel said. “This is another example where people should be careful when it comes to aggressive marketing and promotions. There are legitimate ways to claim an art donation, but taxpayers should be careful to understand the rules and watch out for inflated values or questionable appraisals. Beauty is not always in the eye of the beholder when it comes to tax deductions of art.”

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure

Contact our firm today for assistance.