All investors seek to take advantage of all legal means to legitimately reduce their overall tax liability, but abusive tax shelters are illegal investments claiming to reduce your income tax liability without changing the value of your income or assets.
Often, tax shelters rely on complex transactions involving trusts, partnerships and other legal entities. The IRS requires investors and their material advisers to file reports outlining certain types of transactions. The agency can issue penalties when abuses are discovered.
IRS Sounds Alarm on Abusive Tax Shelters & Transactions
Your business is required to self-report when it engages in certain types of transactions. The IRS lists five types of transactions that must be reported:
- Listed transactions.
- Confidential transactions.
- Contractual protection.
- Loss transactions.
- Transactions of interest.
If you’ve engaged in any of these transactions, you may be required to file Form 8886, Reportable Transaction Disclosure Statement.
To help taxpayers recognize potential schemes that could be considered abusive tax shelters, the IRS has compiled a list of transactions. If a tax shelter resembles a listed transaction, it’s considered abusive and users may face penalties.
The IRS is focusing particular attention on:
- Basket options contracts that attempt to defer income recognition and convert short-term capital gains and ordinary income to long-term capital gains.
- Micro-captive arrangements in which a taxpayer enters into a purported insurance contract with a captive insurance company or a purported reinsurance contract through an intermediary insurance company, claims deductions for premiums paid, and allows the captive insurance company to exclude portions of premiums from income.
- Syndicated conservation easement transactions that purport to give investors charitable contribution deductions significantly greater than the amount invested.
The IRS Office of Tax Shelter Analysis is responsible for gathering information regarding potential abusive tax shelters. The division seeks to combat abusive tax shelters through “audits, summons enforcements and litigations.”
What will help deter large businesses and individuals from turning to abusive tax shelters and transactions? The IRS notes that it has a comprehensive strategy to:
- Identify and deter participation and promotions of abusive tax transactions.
- Publish taxpayer guidance.
- Promote reportable transaction disclosure filings by those who participate or promote abusive transactions.
The OTSA is looking at transactions that pose a significant compliance risk. There are many ways to let the IRS know that you suspect an individual or company isn’t complying with tax laws or is failing to pay the tax they owe, including whistleblower informant awards.
This is just a summary of a complex topic. The IRS is not trying to cut down on legitimate methods for avoiding or postponing taxes, such as IRAs and 401(k) plans. A certain profit on the sale of a primary residence is also sheltered from taxes. But there are many gray areas where the IRS feels that businesses or individuals are trying to avoid taxes through illegitimate means. If something seems too good to be true, that might be the case. Always consult with a qualified professional before involving yourself or your business in a complex financial situation.
Contact us if you may need any clarification on this topic!