The Internal Revenue Service has recently released two publications that reveal how it plans to combat tax evasion. On March 13, 2018, the Large Business and International (“LB&I”) division announced five new compliance areas that it will focus on during audits and on March 21, 2018, the Internal Revenue Service released its annual “Dirty Dozen” list of tax scams.
Large Business Audits
The IRS Large Business and International (LB&I) division, which audits companies with assets of more than $10 million, announced five additional areas that it will focus on during audits. These five campaigns are the third set that have launched since the LB&I division was reorganized in 2015. This new set of campaigns includes three that are focused on partnership issues. One of these campaigns is designed to target partners that are subject to self-employment tax under the Self-Employment Contributions Act on their share of partnership income, but do not pay the tax. Another focuses on partners that do not correctly report the gain or loss on a sale of partnership interest. The third addresses partnerships that stop filing tax returns.
Outside of partnerships, a fourth campaign is concerned with companies that engage in spinoffs, split-offs, or split-ups that are improperly deducting the costs that facilitate these transactions, which should be capitalized. Finally, the fifth campaign deals with recognizing a gain or loss on the disposition of modified accelerated cost recovery system property.
These five campaigns supplement the first set of 13 campaigns that was announced in January 2017 and the second set of campaigns that was added in November of that year.
The Internal Revenue Service also released its annual “Dirty Dozen” list of tax scams as a caution to taxpayers. These scams range from simple to more elaborate, and may put taxpayers at risk for identity theft, penalties, and even criminal liability. This year’s “Dirty Dozen” includes the following:
- Phishing: Taxpayers should be aware of fake e-mails and websites, claiming to be the IRS, asking for personal information. The IRS will never initiate contact through e-mail about a tax liability or a refund.
- Phone Scams: Similar to phishing, scammers are impersonating IRS agents over the phone to threaten taxpayers or steal personal information.
- Identity Theft: Taxpayers should be vigilant about tactics used all year round to steal their identities.
- Return Preparer Fraud: Taxpayers are advised to be aware of dishonest return preparers who may scam clients, perpetuate fraud, or steal client identities.
- Fake Charities: Fake charities with names similar to familiar or nationally recognized charities are soliciting contributions from unsuspecting individuals.
- Inflated Refund Claims: Taxpayers should be wary of preparers promising inflated tax refunds. These preparers often ask taxpayers to sign blank returns and charge fees based on a percentage of the refund.
- Excessive Claims for Business Credits: Taxpayers should be careful not to improperly claim credits, such as the fuel tax credit or research credit, that are generally not available to most taxpayers.
- Falsely Padding Deductions on Returns: Taxpayers should avoid overstating the value of deductions, such as charitable contributions and business expenses, or improperly claiming credits, such as the Earned Income Tax Credit or Child Tax Credit.
- Falsifying Income to Claim Credits: Con artists may convince taxpayers to inflate income to claim credits. This could lead to back taxes, interest, and penalties.
- Frivolous Tax Arguments: Promoters may encourage taxpayers to make unreasonable or outlandish legal arguments against paying taxes; taxpayers are warned that the penalty for filing a frivolous tax return is $5,000.
- Abusive Tax Shelters: These are structures that are used to shelter income to avoid paying taxes. The IRS is targeting the promoters and sellers of these structures in particular, and urges taxpayers to seek an independent opinion if offered one of these complex structures.
- Offshore Tax Avoidance: Taxpayers who are hiding money or income offshore are urged to come forward voluntarily to satisfy their tax-filing obligations.
The last two scams on this list, abusive tax shelters and offshore tax avoidance, are discussed in detail herein.
Micro-Captive Tax Shelters
Regarding abusive tax shelters, the IRS has highlighted micro-captive insurance tax shelters. A captive insurance company, which is permissible under tax law, is one that is owned by the insured or parties related to the insured, resulting in certain tax benefits. Under section 831(b) of the Code, captive insurers that qualify as small insurance companies can elect to exclude limited amounts of premiums from income so that the captive is only taxed on investment income. In micro-captive tax shelters, promoters convince taxpayers, often closely held corporations, to set up micro-captives that lack the attributes of genuine insurance.
In 2016, the IRS issued Notice 2016-66 noting that micro-captive arrangements had potential for tax evasion. The notice established a reporting requirement for those entering into such transactions, or transactions that are substantially similar, on or after November 2, 2006. Congress has also established strict diversification and reporting requirements for new and existing captives in the Protecting Americans from Tax Hikes (“PATH”) Act, effective January 1, 2017. Taxpayers entering into micro-captive arrangements should be aware that the IRS is scrutinizing these schemes for tax evasion.
Offshore Tax Evasion
The IRS has also intensified its efforts in preventing offshore tax evasion, including the launch of the Offshore Voluntary Disclosure Program (“OVDP”) in 2009. Since then, there have been more than 56,400 voluntary disclosures under the program, resulting in more than $11.1 billion in revenue. However, applications have dwindled to just a few hundred per year, and the IRS has announced that the program will end on September 28, 2018. In recent years, the IRS has conducted thousands of offshore civil audits and also pursued criminal charges, leading to billions of dollars of tax revenue, criminal fines, and restitution.
Over the years, the IRS has collected information on individuals identified as engaging in offshore tax evasion. The IRS continues to use information learned through its investigations to target individuals, bankers, and other service providers suspected of helping clients in offshore tax evasion. Taxpayers are warned that, while there are legitimate reasons to maintain foreign financial accounts, there are reporting obligations relating to these accounts, and failure to comply with these requirements can lead to fines or even criminal prosecution.
The Foreign Account Tax Compliance Act (“FATCA”) has helped the IRS curb offshore tax evasion by creating a network of intergovernmental agreements which mandate third-party reporting of foreign financial accounts. FATCA is currently in its third year of operation. With the OVDP ending soon, taxpayers who are not in compliance with reporting have limited time to take advantage of voluntary disclosure. Taxpayers can be sure that the IRS is committed to stopping offshore tax evasion.