Abusive Tax Shelters: The New IRS "Dirty Dozen" BlackList For 2020
Gary Mauney, one of the foremost litigators of abusive tax shelter lawsuits in the United States, sees more tax shelter litigation on the rise. Here's what to look out for.
Readers of the financial press from 2000-2007 will remember the host of abusive tax shelters that resulted in the criminal prosecution of accountants, bankers, and attorneys at firms like BDO Seidman, KPMG, PwC, and Brown & Wood.
REMEMBER SON of BOSS?
Those shelters bore acronyms like "Son of BOSS," "FLIP," "BLIPS," and "COBRA." These tax shelters operated by creating artificial investment "basis," by "shifting basis," or by using bogus "distressed debt" instruments to generate tax losses or to "eliminate" income or capital gains for tax purposes. Some of these abusive tax shelters became known generically as IRS Notice 2000-44 transactions.
ABUSIVE TAX SHELTERS ARE BEING PROMOTED YET AGAIN!
If you thought the criminal prosecutions and civil lawsuits against the promoters of abusive tax shelters spelled the end of such shenanigans, well, you'd be wrong. There really is nothing new under the sun when it comes to abusive tax shelters. The parade of so-called "Listed Transactions" recognized as abusive by the IRS continues to grow. There are a host of "new" listed transactions that amount to nothing more than re-treads of previously disallowed tax shelters. Distressed asset transactions that claim to "shift a built-in loss . . . to the US taxpayer." A basket option contract transaction that purports to "convert a short-term capital gain to long-term capital gain." A syndicated conservation easement transaction that purports to "give investors the opportunity to to obtain charitable contribution deductions in amounts that significantly exceed the amount invested." And so it goes.
Three variations of these schemes – abusive trusts, abusive micro-captive insurance shelters, and abusive syndicated conservation easements -- are central additions to the latest installment of the IRS's "Dirty Dozen." These three "new" tax avoidance schemes start with a legitimate tax-planning tool that is improperly distorted almost always by a promoter to produce benefits that are too good to be true and ultimately seriously compromise the taxpayer. Taxpayers should be highly skeptical of such claims. Each of them now occupies a special place on the IRS's "blacklist" of listed transactions. Here's a bit more detail if you think an accountant or attorney might have pitched one of these unlawful schemes to you or one of your clients.
ABUSIVE TAX EVASION SCHEMES INVOLVING TRUSTS
Changes in bank secrecy laws of foreign jurisdictions have revealed a plethora of foreign tax evasion schemes involving trusts, and the IRS is actively examining these cases, as well as a variety of tax evasion schemes involving the use of domestic trusts.
Abusive trust arrangements often use multiple layers of trusts as well as offshore shell corporations and entities that are disregarded for U.S. tax purposes to attempt to hide the true ownership of assets and income or to disguise the substance of transactions. Although these schemes give the appearance of separating responsibility and control from the benefits of ownership, such as through the use of purported mortgages or rental agreements, false invoices, fees for services never performed, purchase and sale agreements and distributions, the taxpayer in fact continues to control the structures and directs any benefits received from them. Taxpayers should be aware that abusive tax evasion arrangements involving trusts will not produce the tax benefits advertised by their promoters.
If you invested in an abusive trust transaction, or one like it, based on the advice of an accountant, attorney, or other financial advisor, and find yourself in the cross-hairs of the IRS, you should consider hiring a malpractice law firm like Mauney PLLC.
ABUSIVE MICRO-CAPTIVE INSURANCE TAX SHELTERS
Micro-captives are also on the IRS's Dirty Dozen list, meaning that the IRS will contest and disallow such abusive arrangements through audits, investigations, and litigation. The IRS has more than 500 docketed cases in Tax Court challenging these transactions, and is conducting numerous income tax examinations of the participants in these arrangements, as well as promoter investigations.
Tax law generally allows businesses to create “captive” insurance companies to insure against risks. The insured business claims deductions for premiums paid for insurance policies. Those amounts are paid, either as insurance premiums or reinsurance premiums, to a “captive” insurance company owned by the insured or related parties and are used to fund losses incurred by the insured business. Traditional captive insurance typically allows a taxpayer to reduce the total cost of insurance and loss events.
Insurers that qualify as small insurance companies can elect to be treated as exempt organizations or to exclude limited amounts of annual net premiums from income so that the captive insurer pays tax only on its investment income. In certain “micro-captive” structures, promoters, accountants or wealth planners persuade owners of closely-held entities to participate in schemes that lack many of the attributes of insurance.
Be advised, the IRS has been successful in litigating against these transactions. In 2017, the U.S. Tax Court disallowed the “wholly unreasonable” premium deductions the taxpayer claimed under a section 831(b) micro-captive arrangement, concluding that the arrangement was not “insurance” under long established law. (Avrahami v. Commissioner, 149 T.C. No. 7 (2017).) In 2018, the Tax Court again concluded that the transactions in a second micro-captive arrangement were not “insurance”. (Reserve Mechanical Corp. v. Commissioner, T.C. Memo. 2018-86.)
The IRS in 2016 issued guidance, through IRS Notice 2016-66, advising that micro-captive insurance transactions have the potential for tax avoidance or evasion. The Notice designated transactions that are the same as or substantially similar to transactions described in the Notice as “Transactions of Interest." If you invested in a Notice 2016-66 transaction, or one like it, based on the advice of an accountant, attorney, or other financial advisor, and find yourself in the cross-hairs of the IRS, you should consider hiring a malpractice law firm like Mauney PLLC.
SYNDICATED CONSERVATION EASEMENTS
Generally, a charitable contribution deduction is not allowed for a charitable gift of property consisting of less than the donor’s entire interest in that property. However, the law provides an exception for a “qualified conservation contribution” that meets certain criteria, including exclusive use for conservation purposes. If taxpayers meet the criteria in the tax code and regulations, they may claim charitable contribution deductions for the fair market value of conservation easements they donate to certain organizations.
Some tax shelter promoters are syndicating conservation easement transactions that purport to give investors the opportunity to obtain charitable contribution deductions and corresponding tax savings that significantly exceed the amount an investor invested.
Typically, promoters of these schemes identify a pass-through entity that owns real property or form a pass-through entity to acquire real property. The promoters syndicate ownership interests in the pass-through entity or tiered entities that own the real property, suggesting to prospective investors that they may be entitled to a share of a charitable contribution deduction that greatly exceeds the amount of an investor’s investment. The promoters obtain an inflated appraisal of the conservation easement based on unreasonable factual assumptions and conclusions about the development potential of the real property.
In Notice 2017-10, the IRS alerted tax professionals that transactions the same or substantially similar to those described are tax avoidance transactions and the IRS likewise identified them as “Listed Transactions.” The notice applies to transactions in which the promotional materials suggest to prospective investors that they may be entitled to a share of a charitable contribution deduction that equals or exceeds two and a half times the amount invested. In December 2018, the United States Department of Justice sued to shut down promoters of a conservation easement syndicate scheme. A copy of the DOJ Complaint against Ecovest Capital, Inc., and others, can be found here.
If you invested in a Notice 2017-10 transaction, or one like it, based on the advice of an accountant, attorney, or other financial advisor, and find yourself in the cross-hairs of the IRS, you should consider hiring a malpractice law firm like Mauney PLLC.
EXPERIENCED ABUSIVE TAX SHELTER REPRESENTATION
Gary Mauney of Mauney PLLC has almost two decades of experience representing tax shelter investors across the United States in civil malpractice and fraud litigation against tax shelter promoters, such as accountants, attorneys, and other financial advisors. Gary's knowledge about tax shelter litigation has been featured in prominent books on the subject, and in newspapers like The New York Times and the Wall Street Journal. Gary has written and taught extensively on the subject of tax shelter lawsuits and litigation, including the Journal of Taxation and Regulation of Financial Institutions and the American Trial Lawyer's Association.
If you invested in what might be an unlawful or abusive tax shelter, do not sit back and wait for the IRS to come calling and hope for the best. Time is not on your side. The amount you paid the promoters, the amount of your investment, and IRS penalties and interest, are losses to which you are exposed. Statutes of limitation running in favor of the tax shelter promoters apply in virtually every state and may quickly cut off your right to sue. Crucial evidence concerning your transaction may be "lost" or may "disappear" as document retention "policies" are applied by the promoters. If you think you might have invested in an abusive tax shelter, contact Gary Mauney at Mauney PLLC for a confidential and privileged consultation regarding your options. Please send a confidential email to Mauney PLLC at firstname.lastname@example.org. Or call attorney Gary Mauney directly at 704/945-7185.