Issue 5 - April 2004

Finance & Taxes
Want to lower taxes? Beware of schemes!
By Mark E. Battersby

How far would you go to minimize your tax bill or the tax bill of your chiropractic practice? Would you send your profits to one of the shrinking number of offshore tax havens? Would you transfer your practice and your personal assets to a trust — even a trust that you control — based in a country that promises low taxes and banking secrecy laws?

Not too surprisingly, increasing numbers of small-business owners and professionals have turned to this type of offshore trust as well as a variety of other strategies and schemes in an effort to avoid paying taxes. Unfortunately, not only are many of those tax-savings schemes risky, many also border on the illegal.

In recent months the Internal Revenue Service has been ratcheting up — and making plenty of noise about — its efforts to curb the use of abusive tax shelters and schemes. Lawmakers too, have been quite vocal about individuals and businesses who use tax shelters or schemes to help them shirk their share of the nation’s tax burden.

Obviously, it is perfectly legal to plan for ways to keep your annual tax bill — as well as that of your chiropractic practice — as low as possible. However, when plans to avoid high taxes cross the line and become “avoidance,” the IRS inevitably cracks down.

Here are a few tax schemes you’ll want to avoid:

Bogus tax credits
and trusts

For years, a few tax professionals touted a “slavery reparation tax credit.” Although no such credit has ever been approved by Congress, thousands of taxpayers claimed it on their tax returns and received large — and erroneous — refunds. Today, the IRS has created a special task force to combat this nonexistent tax credit and those who attempt to promote it.

And who has not heard rumors of business owners with low or nonexistent tax bills — the result of transferring ownership of their business and personal assets into an offshore trust? The former business owner, now employed by the trust and/or the business owned by the trust is provided a residence (his or her former home) owned by the trust plus personal living expenses — all tax-free — in exchange for managing the trust’s business.

Despite thousands of dollars paid to promoters of these trusts and despite reams of legal opinions written and participation by impressive-sounding offshore banks, everyone but the ever-vigilant IRS seems to have ignored the tax rule requiring a trust to be a separate entity. The individual who transfers assets into that trust must relinquish control or the transfer will not be recognized by the IRS.

Usually, these trusts are located in a country with low taxes, effectively placing it outside the control of the IRS — or so the promoters claim. Unfortunately for the unwary participants in many of these schemes, U.S. tax law requires U.S. citizens to state, under penalties of perjury, whether they have any foreign holdings. Plus, even foreign or foreign-based entities are required to report — and pay taxes on — U.S. profits.

What’s more, the IRS has discovered a way around the bank secrecy laws in many of those tax havens. It has successfully sued, in U.S. courts, for the names, addresses and tax identification numbers of those holding or using credit cards issued by banks and other financial institutions in those tax havens. American Express, Visa and MasterCard are, after all, U.S.-based operations.

In the spring of 2003, the IRS announced a program that promised amnesty for users of these offshore trusts and shelters. The results, according to the IRS, were staggering. Those seeking amnesty were required to not only pay the taxes due and interest and penalties, but they were also required to disclose the promoter behind the scheme.

As a result, the IRS was able to go after those who promoted illegal offshore trusts as well as their clients using similar schemes.

Unconstitutional tax system

Be careful of this dodge: You might be so eager to slash your tax bill or so overburdened by taxes that you may be tempted to buy into the unproven theory that claims taxes to be unconstitutional.

Take the case of Richard Simkanin, a Bedford, Texas, businessperson. Simkanin and others reportedly believe that the majority of U.S. citizens working for U.S. companies are not required to pay federal income taxes under the Constitution or any other law.

In March 2001, the group took out a full-page ad in USA Today, accusing the government, particularly the IRS, of taking trillions of hard-earned dollars from average citizens. The IRS and the U.S. Justice Department maintain that these arguments are merely ploys in a string of illegal tax evasion scams promoted by a few self-styled tax experts.

Simkanin was taken to court and pleaded guilty to failing to collect and pay tax on his employee’s wages.

Do-it-yourself

The IRS recently revealed an abusive tax scheme involving indirect contributions to Roth IRAs, those tax-preferred retirement accounts employed by so many professionals and small business owners.

According to the IRS, some business owners sell their receivables for less than fair value to a shell company owned by their individual Roth IRAs.

This scheme, according to the IRS, artificially shifts the taxable income away from the individual’s business into the shelter of the Roth IRA structure. The problem with this, according to the IRS, is that the transaction is a disguised contribution to a Roth IRA and is prohibited.

Use the smell test

What is an abusive tax shelter or scheme? Or, how can you differentiate between an appropriate and an abusive tax scheme or shelter?

Use the “smell” test advocated by the IRS which say that if you’re looking at a transaction in which the business purpose is suspect and it appears you are outside the intended realm of the law, then you are looking at a transaction that might be suspect.

An overaggressive approach to tax savings, the use of questionable tax shelters and schemes, can lead you into the IRS’s sights. Back taxes, interest and penalties and civil and/or criminal prosecution are only the tip of the iceberg. You could also lose your investment as many others have.

Mark E. Battersby is a tax and financial advisor, freelance writer, lecturer and author with offices in suburban Philadelphia. He can be contacted at 610-789-2480.

Disclaimer: The author is not engaged in rendering tax, legal or accounting advice. Please consult you professional adviser for any issue related to your practice.