According to the IRS, the Dirty Dozen represents the worst of the worst tax scams. The Dirty Dozen is a list that is compiled annually by the IRS in order to alert taxpayers, tax professionals and financial institutions of tax scams that occur at any time during the year. This list has been published by the IRS for over 20 years. The point of the Dirty Dozen is to alert all that Illegal scams will lead to significant penalties, including interest and possible criminal prosecution. IRS Criminal Investigation works closely with the U.S. Department of Justice to prosecute the criminals that continue to originate these scams and shut them down.
The Dirty Dozen for 2022 is broken down into three Categories:
- Abusive arrangements that taxpayers should avoid
- Scams geared towards the average taxpayer
- Complex arrangements that promoters market to higher-income individuals
Dirty Dozen Abusive Arrangements that Taxpayers should avoid
- Use of Charitable Remainder Annuity Trust (CRAT) to Eliminate Taxable Gain. In this transaction, appreciated property is transferred to a CRAT. Taxpayers improperly claim that the transfer of the appreciated assets to the CRAT in and of itself 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. However, it does not recognize a 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 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.
- Maltese (or Other Foreign) Pension Arrangements Misusing Treaty. In these transactions, U.S. Persons (citizens and residents) try to circumvent paying U.S. taxes by making contributions to certain foreign individual retirement arrangements in Malta (or other foreign countries). The individual lacks a local connection, and local law allows contributions in a form other than cash or does not limit the amount of contributions by reference to income earned from employment or self-employment activities. By improperly asserting the foreign arrangement is a “pension fund” for U.S. tax treaty purposes, the U.S. taxpayer misconstrues the relevant treaty to improperly claim an exemption from U.S. income tax on earnings in, and distributions from, the foreign arrangement.
- Puerto Rican and Other Foreign Captive Insurance. In these transactions, the U.S owners of closely held entities participate in a purported insurance arrangement with a Puerto Rican or other foreign corporation with cell arrangements or segregated asset plans in which the U.S. owner has a financial interest. The U.S. based individual, or entity claims deductions for the cost of “insurance coverage” provided by a fronting carrier, which reinsures the “coverage” with the foreign corporation. The characteristics of the purported insurance arrangements typically will include one or more of the following: implausible risks covered, non-arm’s-length pricing, and lack of business purpose for entering into the arrangement.
- Monetized Installment Sales. These transactions involve the inappropriate use of the installment sale rules under section 453 by a seller who, in the year of a sale of property, effectively receives the sales proceeds through purported loans. In a typical transaction, the seller enters into a contract to sell appreciated property to a buyer for cash and then purports to sell the same property to an intermediary in return for an installment note. The intermediary then purports to sell the property to the buyer and receives the cash purchase price. Through a series of related steps, the seller receives an amount equivalent to the sales price, less various transactional fees, in the form of a purported loan that is nonrecourse and unsecured.
Dirty Dozen Scams geared towards the average taxpayer
- Economic Impact Payment and tax refund scams: these are Identity thieves who try to use Economic Impact Payments (stimulus payments) that send text messages, initiate incoming phone calls or emails inquiring about bank account information and then request the recipient to click a link or verify data. The IRS wants all Taxpayers to know that the IRS does not initiate contact by phone, email, text, or social media asking for Social Security numbers or other personal or financial information related to Economic Impact Payments.
Unemployment fraud leading to inaccurate taxpayer 1099-Gs: Scammers took advantage of the pandemic by filing fraudulent claims for unemployment compensation using stolen personal information of individuals who had not filed claims. Payments made on these fraudulent claims went to the identity thieves.
Fake employment offers posted on social media: There have been many reports of fake job postings on social media. The pandemic created many newly unemployed people eager to seek new employment. These fake posts entice their victims to provide their personal financial information. This creates added tax risk for people because this information in turn can be used to file a fraudulent tax return for a fraudulent refund or used in some other criminal endeavor.
Fake charities that steal your money: Taxpayers who give money or goods to a charity may be able to claim a deduction on their federal tax return. Taxpayers must donate to a qualified charity to get a deduction and should check the status of a charity by using the IRS Tax Exempt Organization Search tool.
- Offer in Compromise (OIC) Mills: Taxpayers that have pending tax bills ought to contact the IRS directly and not seek the assistance of tax companies that advertise claims of resolving unpaid taxes for pennies on the dollar while charging excessive fees. An OIC is a legitimate agreement between a taxpayer and the IRS that resolves the taxpayer’s tax debt. The IRS has the authority to settle, or “compromise,” federal tax liabilities by accepting less than full payment under certain circumstances. Nonetheless, there are tax promoters that advise taxpayers to file an OIC application with the IRS, despite the fact that the tax promoters know the person won’t qualify.
In addition, taxpayers should be cautious that there are tax preparers who won’t sign the tax returns they prepare. They are known as ghost preparers. The law stipulates that anyone who is paid to prepare, or assists in preparing federal tax returns, must have a valid Preparer Tax Identification Number (PTIN). Paid preparers must sign and include their PTIN on the return. A paid preparer not signing a return is considered to be a “red flag” as the paid preparer may be looking to make a quick profit by promising a big refund or charging fees based on the size of the refund.
Other tax return “red flags” include requiring payment in cash only and not providing a receipt, inventing income to qualify clients for tax credits, claiming fake deductions to boost the size of the refund and directing funds to the tax preparer’s account as opposed to the taxpayer’s account.
- Bogus calls, texts, emails, and posts online to gain trust or steal a Taxpayer’s identity, personal financial information, and money: The IRS continues to see scams that seek to get a taxpayer to provide sensitive personal financial information, money, or other information with the purpose of filing a false tax return or tapping into the taxpayer’s financial accounts. The tactics most often used to steal a Taxpayer’s identity and/or tap into the taxpayer’s account accounts involve: text message scams, Email phishing scams and phone scams.
Taxpayers should NOT click links or open attachments in unsolicited, suspicious, or unexpected text messages or emails whether from the IRS, state tax agencies or others in the tax community. Taxpayers should also be aware that fake actors can “fake” caller ID numbers to appear to be anywhere in the country, including from an IRS office.
- Spear phishing attacks: This activity entails an email scam that attempts to steal a tax professional’s software preparation credentials. The thieves try to steal client data and tax preparers’ identities in an attempt to file fraudulent tax returns for refunds. Spear phishing can affect any type of business or organization. A phishing email can utilize a logo, including the IRS logo and a variety of subject lines such as “Action Required” or “Your account has now been put on hold.” Clicking on one of these logos will prompt a request for tax preparer account credentials.
Dirty Dozen Complex arrangements that promoters market to higher-income individuals
There are four schemes that target high-net-worth individuals who are looking for ways to avoid paying taxes:
- Concealing Assets in Offshore Accounts and Improper Reporting of Digital Assets: The scam list highlights how the IRS is aware of new patterns and trends emerging in complex international tax avoidance schemes and cross-border transactions that have heightened concerns regarding the lack of tax compliance by individuals and entities with an international footprint. The IRS has identified individuals that have attempted to evade U.S. taxes by hiding income in offshore banks, brokerage accounts or nominee entities. These individuals can then access the funds using debit cards, credit cards, wire transfers or other arrangements as well as foreign trusts, employee-leasing schemes, private annuities, and structured transactions. The purpose of the scheme is to “attempt to conceal” the true owner of an account or insurance plan.
IRS acknowledges that the evolution of digital technology across the world has created tax administration challenges regarding digital assets due to an incorrect perception that digital asset accounts are undetectable by tax authorities. Most people still believe this and as a result, unethical promoters continue to perpetuate this myth and make assertions that taxpayers can easily conceal their digital asset holdings.
Taxpayers ought to understand that they will be subject to civil fraud penalties and criminal charges that could result from failure to report transactions involving digital assets.
“The IRS is able to identify and track otherwise anonymous transactions of international accounts as well as digital assets during the enforcement of our nation’s tax laws,” IRS Commissioner Rettig said. “We urge everyone to come into compliance with their filing and reporting responsibilities and avoid compromising themselves in schemes that will ultimately go badly for them.”
- High-income individuals who don’t file tax returns: The IRS continues to focus on people who choose to ignore the law and not file a tax return, especially those individuals earning more than $100,000 a year. Taxpayers that choose not to file a return even when they have a legal filing requirement, particularly those earning more than $100,000 per , continue to be a top priority for the IRS. The IRS has been addressing high income non-filers more aggressively. Non-filer Taxpayers ought to understand that the Failure to File Penalty is initially much higher than the Failure to Pay Penalty. The Failure to File Penalty is generally 5% of the unpaid taxes for each month or part of a month that a tax return is late. The penalty generally will not exceed 25% of unpaid taxes. The Failure to Pay Penalty is generally 0.5% of the unpaid taxes for each month or part of a month the tax remains unpaid. The penalty will not exceed 25% of unpaid taxes. If a taxpayer’s ’s failure to file is deemed fraudulent, the penalty generally increases from 5 percent per month to 15 percent for each month or part of a month the return is late, with the maximum penalty generally increasing from 25 percent to 75 percent.
- Abusive Syndicated Conservation Easements: In this scheme, promoters take a provision of the tax law allowing for conservation easements and twist it by using inflated appraisals of undeveloped land and by using partnership arrangements devoid of a legitimate business purpose. These arrangements generate inflated tax deductions and high fees for promoters. The IRS examines 100 percent of these deals.
“We are devoting a lot of resources to combating abusive conservation easements because it is important for fairness in tax administration,” Commissioner Rettig stated. “It is not fair that wage-earners pay their fair share year after year, but high-net-worth individuals can, under the guise of a real estate investment, avoid millions of dollars in tax through overvalued conservation easement contributions.”
- Abusive Micro-Captive Insurance Arrangements: In these structures, the promoters, accountants, or wealth planners convince owners of closely held entities to participate in schemes that lack many of the attributes of insurance. Examples are coverages that may “insure” implausible risks, fail to match genuine business needs, or duplicate the taxpayer’s commercial coverages. As a result, the premiums paid under these structures are excessive and are used to circumvent the tax law. Of note, the IRS has won all micro-captive Tax Court and appellate court cases, decided on their merits, since 2017. ©