Abusive Tax Shelters

Tax shelters can be a great way to lower your tax liability and get a break on your taxes. But if they’re done illegitimately, they’re an easy way to get in big trouble with the IRS. Illegitimate tax shelters, known as abusive tax shelters, come with serious consequences.  Read on to learn all about abusive tax shelters to ensure you’re staying in good standing with the IRS. 

What is a Tax Shelter?

In order to understand tax shelters, it’s important to first understand a central feature of taxes, known as tax liability. Tax liability is the amount of tax payment you are responsible to pay the IRS. Your tax liability is based on a percentage of your taxable income, or the portion of money that you make that you are obligated to pay taxes on.    A great way to lower your tax liability and therefore pay less in taxes is to reduce the portion of your income that is taxable. In order to do so, many taxpayers put their income directly into places where they cannot be taxed. These places are known as tax shelters.    Tax shelters can come in many forms. Those include: 
  • Tax deductions: The IRS has designated a number of expenses that are considered to be for the betterment of a community. Those are things like charitable donations, student loan payments, and more. In order to incentivize taxpayers to take on these expenses, they have designated them as tax shelters. That means that taxpayers can deduct the cost of these expenses from their taxable income, therefore lowering their overall tax liability. 
  • Retirement accounts: Contributions to 401(k) accounts are also considered tax shelters. Tax payers who contribute to retirement accounts can deduct the amount they’ve contributed from their taxable income for the year. Additionally, the interest and earnings of the money in your retirement account are not taxable. 
  • Home equity: The sale of your home is another type of tax shelter. When you sell your home ,the first $250,000 to $500,000 is exempt from taxes. 

How are Tax Shelters Abused?

While there are plenty of completely legitimate and credible forms of tax shelters, many individuals and tax scammers use tax shelters to illegally lower their tax liability. Any tax shelter that is used solely for the purpose of lowering tax liability is considered abusive.    Let’s say you’re an independent contractor and you make $500,000 a year in taxable income. In order to avoid paying taxes on the full $500,000 a month, you set up a fake corporation and “hire” 5 of your friends and family as employees of that corporation. You split $250,000 of your taxable income into 5 smaller payouts for each of your friends and family, lowering your taxable income to $250,000. They, in turn, hand the money right back to you. You maintain your $500,000, but through a tax shelter only pay income tax on half of it. Your fraudulent company would be known as an abusive tax shelter. 

Abusive Tax Shelter Examples

The tricky thing about tax shelters is that the line between a legitimate tax shelter and an abusive tax shelter can be very thin. In order to help taxpayers stay in the clear, the IRS has published a list of “Listed Transactions”, i.e. IRS recognized abusive tax shelters, on IRS.gov. Those include things like: 
  • Guam trusts 
  • Debt Straddles 
  • Stock Compensation Transactions 
  • Inflated Partnership Basis Transactions 
  • Basis-Shifting Transactions

Tax Shelter Abuse Consequences

The IRS treats illegal tax shelters as fraudulent activity and can charge you a penalty of 75% of the tax you underpaid, on top of requiring you to pay the unpaid taxes in full, as a result of your illegal tax scheme. If you or your business has been using abusive tax shelters or tax avoidance transactions for multiple years and the IRS can prove it, you can expect to pay that 75% penalty for each year you falsely filed your taxes. If the offense(s) are bad enough, the IRS may also choose to pursue criminal charges and potential jail time for those involved.

How to Avoid Tax Shelter Abuse

When it comes to the IRS, honesty is the best policy. If you’re legitimately using a tax shelter as it was intended to be used, chances are that you’re not committing tax shelter abuse.    When you complete your taxes, be sure to be transparent with your tax shelter usage. As long as you provide the IRS with things like donation receipts, proof of student loan payments, and other necessary information, you shouldn’t have much to worry about. The IRS provides abusive tax shelter regulations that anyone can read over if they wish to avoid being caught in a sticky situation.   The IRS takes tax avoidance and tax evasion very seriously. If you knowingly or unknowingly participated in any form of tax shelter abuse or tax avoidance transactions, contact a tax representative immediately—there are preemptive measures you can take to avoid criminal charges and penalties. A tax attorney may be able to negotiate and reduce your penalties during the audit process or a trial.

Tax Shelter Assistance 

If you or your business are looking at potential penalties and fines from the IRS, don’t hesitate to contact Community Tax today. Our exceptional team of tax attorneys, CPAs, and tax professionals are standing by to assist you with any and all of your tax related needs. We even offer tax assurance and tax preparation services, so that you can take the stress out of doing your taxes. Don’t let tax penalties cripple you and your small businesses finances, call Community Tax today.