On 4/10/24, as part of its Dirty Dozen Campaign for 2024, the IRS issued a warning to High Net Worth Individuals regarding three tax traps designed for them by dishonest promoters and shady tax practitioners. High Net Worth individuals continue to be targets of tax schemes and aggressive tax strategies designed to reduce taxes. Examples highlighted in the IRS warning include inflated art donation deductions to aggressive charitable remainder annuity trusts and detailed shelters that maneuver to delay paying gains on property. “High-income taxpayers can be vulnerable to being pulled into these aggressive schemes and scams,” said IRS Commissioner Danny Werfel. “Taxpayers should be extra careful on tax maneuvers that seem too good to be true. Beware of advertisements for seemingly ideal tax structures that distort tax laws and leave victims with civil or criminal tax penalties.” “There’s growing risk for taxpayers pulled into aggressive schemes as the IRS continues to accelerate and expand our compliance work involving high-income individuals,” Werfel added. “The IRS reminds taxpayers that relying on an independent tax or legal professional can help avoid problems with aggressive promoters.”
Common tax scams and schemes targeted towards High Net Worth Individuals include:
- Improper art donation deductions: although there are legitimate methods to properly claim donations of art, unscrupulous promoters use direct solicitation to promise or guarantee values of art that are too good to be true. shipping, appraisal by encouraging the high net worth individual to purchase art at a discounted price; often including fees such as storage, shipping, appraisal and donation of the art. The promoter that the art is worth significantly more than the purchase price and then encourages a one year holding period for the taxpayer to then claim a tax deduction for an inflated fair market value. The claim for the tax deduction would be for substantially more than what was paid for the artwork. In addition, promoters will also encourage taxpayers to donate art annually and allow them to buy a quantity of art that guarantees a specific deductible amount and arrange for certain charities to take the donations.
- Charitable Remainder Annuity Trust (CRAT): these are irrevocable trusts whereby the taxpayer donates assets to charity and is able to draw income. This type of trust can be “misused” to eliminate capital gains. The scheme calls for the appreciated property to be transferred to a CRAT. The IRS states that taxpayers wrongly claim the transfer of the appreciated assets to the CRAT, which gives those assets a step-up in basis to fair market value as if they had been sold to the trust. “The CRAT then sells the property but does not recognize gain due to the claimed step-up in basis. The CRAT then uses the proceeds to purchase a single premium immediate annuity (SPIA). The beneficiary then reports, as income, only a small portion of the annuity received from the SPIA. Through a misapplication of the law relating to CRATs, the beneficiary treats the remaining payment as an excluded portion representing a return of investment for which no tax is due. Taxpayers who seek to achieve this inaccurate result do so by misapplying the rules.”
- Monetized installment sales: in this scheme, promoters are looking for taxpayers that are seeking to defer the recognition of gain upon the sale of appreciated property and then organize an abusive shelter through selling them monetized installment sales. “These transactions occur when an intermediary purchases appreciated property from a seller in exchange for an installment note, which typically provides for payments of interest only, with principal being paid at the end of the term. In these arrangements, the seller gets the lion’s share of the proceeds but improperly delays the gain recognition on the appreciated property until the final payment on the installment note, often slated for many years later.”
High Net worth Individuals are “Schematized” By Fraudsters
Taxpayers be wary of promoters who advertise abusive tax arrangements. Since all taxpayers are ultimately legally responsible for all the information on their tax return, it is best to obtain tax advice from a reputable and trusted tax expert.
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