Tax-avoidance schemes round out ‘Dirty Dozen’

By Paul Bonner

The IRS wrapped up its annual "Dirty Dozen" list of tax-related scams and dodges Friday with four "bogus tax-avoidance strategies" the Service advised taxpayers and their advisers to steer clear of.

As with other items during the 2022 listing, the scams in this final batch (News Release IR-2022-125) are likely familiar to tax professionals, since they have been highlighted in previous Dirty Dozens and at other times, not only through news releases but in formal guidance and other administrative documents and actions. They also echoed in some respects transactions and arrangements that were the subject of the first of this year's Dirty Dozen releases on June 1.

They are: concealing assets in offshore accounts and improper reporting of digital assets, nonfiling of income tax returns by high-income individuals, abusive syndicated conservation easements, and abusive microcaptive insurance arrangements. Some of these ploys, like those described in the initial release, are commonly pushed by promoters, and the four identified Friday may turn up in solicitations to high-income individuals, the IRS said.

Hidden offshore accounts and digital assets

The IRS reminded taxpayers that they are taxed on their worldwide income. Despite having new laws and better tools in recent decades for detecting unreported foreign income, the IRS recognizes that many individuals employ new and sophisticated tactics for concealing it, such as foreign trusts, employee-leasing arrangements, private annuities, and transactions and nominee entities structured to conceal accounts' or insurance plans' true owners. Consequently, international tax compliance remains a top enforcement priority for the IRS.

Cryptoassets have proliferated throughout the world's economies and, because their true ownership is often opaque, likewise pose a challenge to tax enforcement, the IRS said. Nonetheless, the IRS has means to identify owners of digital assets and track their transactions, contrary to a common but incorrect perception that such transactions are undetectable by tax authorities, the IRS said.

High-income nonfilers

The IRS said it focuses as a "top priority" on "people who choose to the ignore the law and not file a tax return, especially those individuals earning more than $100,000 a year." It also reminded taxpayers of failure-to-pay and failure-to-file penalties and that the latter can be enhanced if the failure is deemed fraudulent.

Abusive syndicated conservation easements

While qualified conservation contributions as defined under Sec. 170(h) can yield legitimate charitable deductions, including properly established easements and other qualified real property interests, the IRS maintains an ongoing campaign to identify and deny improper tax benefits claimed from arrangements that fail the tests of law and regulation. Generally, these abusive arrangements are syndicated, using partnership arrangements lacking a legitimate business purpose. Often, their values are artificially inflated.

The IRS said in the last five years it has examined "many hundreds" of syndicated conservation easement arrangements involving tens of billions of dollars in improper deductions claimed and has litigated hundreds of them.

Abusive microcaptive insurance arrangements

In the first Dirty Dozen release for 2022, the IRS highlighted foreign captive insurance abusive arrangements, which it said sometimes involve a Puerto Rico-based closely held corporation. This time, the Service discussed abusive microcaptive insurance structures more generally, which are also often promoted schemes.

These arrangements generally fail the tests of insurance in its commonly accepted sense and may feature bloated premiums and cover risks that are implausible or lack a business purpose. "Microcaptive" refers to the purported insurer's claim to be a small insurance company under Sec. 831(b), which allows it to pay tax only on investment taxable income.

Like syndicated conservation easements, microcaptive arrangements have been frequently litigated, the IRS said, and the Service's microcaptive legal settlement initiative, in operation since 2020, has brought about numerous out-of-court settlements as well.

On Tuesday, the IRS touted its recent win in the Tenth Circuit, which affirmed a Tax Court decision that a taxpayer's microcaptive insurance transactions were abusive (News Release IR-2022-118, describing Reserve Mechanical Corp., No. 18-9011 (10th Cir. 5/13/22), aff'g T.C. Memo. 2018-86). The opinion was the first appellate court decision recognizing the IRS's position that these transactions are shams, the IRS said then.

— To comment on this article or to suggest an idea for another article, contact Paul Bonner at Paul.Bonner@aicpa-cima.com.

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