Taxes in Your Practice: IRS lists "Dirty Dozen" tax scams
Scott E. Vincent
Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.
Vol. 78, No. 5 / September - October 2022
The IRS recently released a series of notices updating its list of tax scams and illegal tax avoidance schemes, which the agency refers to as its “Dirty Dozen.” The IRS typically updates this list annually as a warning to taxpayers and return preparers. The list is a good reminder of red flags for planning ideas that clients may be investigating. Any strategies that resemble the “Dirty Dozen” categories can expect heightened IRS scrutiny and aggressive IRS enforcement action in the event of an audit. This year, the IRS released the “Dirty Dozen” in a series of notices divided into five groups, which are outlined below, along with quoted IRS language to convey the tone and attitude of the IRS with respect to these issues.
Potentially abusive arrangements
The IRS warns taxpayers who have engaged in or are contemplating engaging in any of the following four “Dirty Dozen” transactions to carefully review the underlying legal requirements and consult independent, competent advisors before claiming any purported tax benefits. The IRS recommends that taxpayers who have already claimed purported tax benefits under these transactions consider taking corrective steps, such as filing an amended return. Where appropriate, the IRS states it will challenge the purported tax benefits from these transactions, and the IRS may assert accuracy-related penalties ranging from 20-40%, or a civil fraud penalty of 75% of any underpayment of tax. The IRS identifies these four transactions as follows:
Charitable Remainder Annuity Trusts (CRAT) to eliminate taxable gain
“In this transaction, appreciated property is transferred to a CRAT. Taxpayers improperly claim the transfer of the appreciated assets to the CRAT in and of itself gives those assets a step-up in basis to the 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 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 seek to achieve this inaccurate result by misapplying the rules under [Code Sections] 72 and 664.”2
Maltese (or other foreign) pension arrangements misusing treaties
“In these transactions, U.S. citizens or U.S. residents attempt to avoid U.S. tax by making contributions to certain foreign individual retirement arrangements in Malta (or possibly other foreign countries). In these transactions, the individual typically 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.”3
Puerto Rican and other foreign captive insurance
“In these transactions, 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.”4
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.”5
Pandemic and benefit scams
The IRS notes the fifth scam of the “Dirty Dozen,” pandemic-related scams, can take a variety of forms including unemployment information and fake job offers to steal personal information. The IRS urges everyone to be leery of suspicious calls, texts, and emails promising benefits, including the following:
Economic Impact Payment and tax refund scams
“Identity thieves who try to use Economic Impact Payments (EIPs), also known as stimulus payments, are a continuing threat to individuals. Similar to tax refund scams, taxpayers should watch out for these tell-tale signs of a scam:
- Any text messages, random incoming phone calls or emails inquiring about bank account information, requesting recipients to click a link or verify data should be considered suspicious and deleted without opening. This includes not just stimulus payments, but tax refunds and other common issues.
- Remember, the IRS won’t 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. Also be alert to mailbox theft. Routinely check your mail and report suspected mail losses to postal inspectors.
- Reminder: The IRS has issued all Economic Impact Payments. Most eligible people already received their stimulus payments. People who are missing a stimulus payment or got less than the full amount may be eligible to claim a Recovery Rebate Credit on their 2020 or 2021 federal tax return. Taxpayers should remember that the IRS website, IRS.gov, is the agency’s official website for information on payments, refunds and other tax information.”6
Unemployment fraud leading to inaccurate taxpayer 1099-Gs
“Because of the pandemic, many taxpayers lost their jobs and received unemployment compensation from their state. However, scammers also 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.
Taxpayers should also be on the lookout for a Form 1099-G reporting unemployment compensation they didn’t receive. For people in this situation, the IRS urges them to contact their appropriate state agency for a corrected form. If a corrected form cannot be obtained so that a taxpayer can file a timely tax return, taxpayers should complete their return claiming only the unemployment compensation and other income they actually received.”7
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.”8
Fake charities that steal your money
“Bogus charities are always a problem. They tend to be a bigger threat when there is a national crisis like the pandemic. 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. To check the status of a charity, use the IRS Tax Exempt Organization Search Tool. Here are some tips to remember about fake charity scams:
- Individuals should never let any caller pressure them. A legitimate charity will be happy to get a donation at any time, so there’s no rush. Donors are encouraged to take time to do the research.
- Potential donors should ask the fundraiser for the charity’s exact name, web address and mailing address, so it can be confirmed later. Some dishonest telemarketers use names that sound like large well-known charities to confuse people.
- Be careful how a donation is paid. Donors should not work with charities that ask them to pay by giving numbers from a gift card or by wiring money. That’s how scammers ask people to pay. It’s safest to pay by credit card or check — and only after having done some research on the charity.”9
Tax companies and offer in compromise scams
As item six of the “Dirty Dozen,” the IRS cautions taxpayers with pending tax bills to contact the IRS for payment and settlement options and avoid unscrupulous tax companies that use local advertising and false claims that they can resolve unpaid taxes for pennies on the dollar, with these additional cautionary notes and advice:
- “An ‘offer,’ or OIC, is an 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. However, some promoters are inappropriately advising indebted taxpayers to file an OIC application with the IRS, even though the promoters know the person won’t qualify. This costs honest taxpayers money and time.”10
- “Offer in Compromise (OIC) ‘mills’ make outlandish claims usually in local advertising regarding how they can settle a person’s tax debt for pennies on the dollar. The reality usually is that taxpayers pay the OIC mill a fee to get the same deal they could have gotten on their own by working directly with the IRS. OIC mills are a problem all year long but tend to be more visible right after the filing season is over and taxpayers are trying to resolve their tax issues perhaps after receiving a balance due notice in the mail. These ‘mills’ contort the IRS program into something it’s not — misleading people with no chance of meeting the requirements while charging excessive fees, often thousands of dollars."11
- “The IRS reminds taxpayers that under the First Time Penalty Abatement policy, taxpayers can go directly to the IRS for administrative relief from a penalty that would otherwise be added to their tax debt.”12
- “No one can get a better deal for taxpayers, than they can usually get for themselves by working directly with the IRS to resolve their tax issues,” said IRS Commissioner Chuck Rettig. “Taxpayers can check online for their best deal, as well as calling a specialized collection line where they can get fast service by using voice and chat bots or opting to speak with a live phone assistor.”13
- “For those who feel they need help, there are many reputable tax professionals available, and there are important tools that can help people find the right practitioner for their needs. IRS.gov is a good place to start scoping out what to do.”14
- “OIC mills are one example of unscrupulous tax preparers. Taxpayers should be wary of unscrupulous ‘ghost’ preparers and aggressive promises of manufacturing a bigger refund.
Although most tax preparers are ethical and trustworthy, taxpayers should be wary of preparers who won’t sign the tax returns they prepare, often referred to as ghost preparers. For e-filed returns, the ‘ghost’ will prepare the return, but refuse to digitally sign as the paid preparer.
Not signing a return is a red flag that 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.
Unscrupulous tax return preparers may also require payment in cash only and will not provide a receipt; invent income to qualify their clients for tax credits; claim fake deductions to boost the size of the refund; and/or direct refunds into their bank account, not the taxpayer’s account.
Taxpayers are legally responsible for what’s on their tax return even if it is prepared by someone else.”15
For item seven of the “Dirty Dozen,” the IRS warns taxpayers to be on the lookout for bogus calls, texts, emails, and online posts. Criminals use these methods to trick victims into providing sensitive personal financial information, money, or other information that can then be used to file false tax returns, tap into financial accounts, and for other schemes. The IRS expands on these areas of concern as outlined below, and the IRS further requests that taxpayers receiving questionable contacts send evidence by email to the IRS at firstname.lastname@example.org:
Text message scams
“These scams are sent to taxpayers’ smartphones and can reference things like COVID-19 and/or ‘stimulus payments.’ These messages often contain bogus links claiming to be IRS websites or other online tools. Other than IRS Secure Access, the IRS does not use text messages to discuss personal tax issues, such as those involving bills or refunds. The IRS also will not send taxpayers messages via social media platforms ...”16
Email phishing scams
“The IRS does not initiate contact with taxpayers by email to request personal or financial information. The IRS initiates most contacts through regular mail ...”17
“The IRS does not leave pre-recorded, urgent or threatening messages. In many variations of the phone scam, victims are told if they do not call back, a warrant will be issued for their arrest. Other verbal threats include law-enforcement agency intervention, deportation or revocation of licenses. Criminals can fake or ‘spoof’ caller ID numbers to appear to be anywhere in the country, including from an IRS office. This prevents taxpayers from being able to verify the caller’s true number. Fraudsters also have spoofed local sheriff’s offices, state departments of motor vehicles, federal agencies and others, to convince taxpayers the call is legitimate...”18
“Generally, the IRS will first mail a bill to any taxpayer who owes taxes. All tax payments should only be made payable to the U.S. Treasury and checks should never be made payable to third parties. For anyone who doesn’t owe taxes and has no reason to think they do: Do not give out any information. Hang up immediately. For more information, see IRS warning: Scammers work year-round; stay vigilant.”19
Phishing attacks to tax professionals and businesses
The IRS included spear phishing as item eight on the “Dirty Dozen” warning list, noting it is a serious problem because it can be tailored to steal computer system credentials of small businesses with client data bases, including tax professionals’ firms.20 In that context, spear phishing is 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 to file fraudulent tax returns for refunds.
According to the IRS, a recent phishing email uses the IRS logo and a variety of subject lines such as “Action Required: Your account has now been put on hold.” The IRS has observed similar phishing emails that claim to be from a “tax application provider” and may offer an “unusual activity report” with a solution link for the recipient to restore their account. The IRS confirms these emails are scams which send users to a website with logos of popular tax preparation software providers, and then prompts a request for tax preparer account credentials. Similar phishing emails may include malicious links or attachments designed to steal information or download malware.21 Unsolicited and suspicious phishing emails should be sent to email@example.com.
Bogus tax avoidance strategies
For its last four items on the “Dirty Dozen” list, the IRS warns taxpayers to avoid being misled into using bogus tax avoidance strategies by promotors peddling these schemes, which typically target high-net-worth individuals seeking to avoid paying taxes. “These tax avoidance strategies are promoted to unsuspecting folks with too-good-to-be-true promises of reducing taxes or avoiding taxes altogether,” Rettig said, adding that “[t]axpayers should not kid themselves into believing they can hide income from the IRS. The agency continues to focus on these deals, and people who engage in them face steep civil penalties or criminal charges.”22 The IRS specifically identifies these four transactions:
Concealing assets in offshore accounts and improper reporting of digital assets
“The IRS remains focused on stopping tax avoidance by those who hide assets in offshore accounts and in accounts holding cryptocurrency or other digital assets. International tax compliance is a top priority of the IRS... Over the years, numerous individuals have been identified as evading U.S. taxes by attempting to hide income in offshore banks, brokerage accounts or nominee entities. They then access the funds using debit cards, credit cards, wire transfers or other arrangements. Some individuals have used foreign trusts, employee-leasing schemes, private annuities and structured transactions attempting to conceal the true owner of accounts or insurance plans.
U.S. persons are taxed on worldwide income. The mere fact that money is placed in an offshore account does not put it out of reach of the U.S. tax system. U.S. persons are required, under penalty of perjury, to report income from offshore funds and other foreign holdings. The IRS uses a variety of sources to identify promoters who encourage others to hide their assets overseas …”23
Rettig notes: “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. 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.”24
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 who exercise their best efforts to file their tax returns and pay their taxes, or enter into agreements to pay their taxes, deserve to know that the IRS is pursuing others who have failed to satisfy their filing and payment obligations. The good news is most people file on time and pay their fair share of tax …
Here’s a key reminder for taxpayers who may be wrongly persuaded that not filing their return is a smart move. The Failure to File Penalty is initially much higher than the Failure to Pay Penalty. It is more advantageous to file an accurate return on time and set up a payment plan if needed than to not file. 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 person’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.”25
Abusive syndicated conservation easements
“In syndicated conservation easements, promoters take a provision of the tax law allowing for conservation easements and twist it by using inflated appraisals of undeveloped land (or, for a few specialized ones, the facades of historic buildings), and by using partnership arrangements devoid of a legitimate business purpose. These abusive arrangements do nothing more than game the tax system with grossly inflated tax deductions and generate high fees for promoters …
In the last five years, the IRS has examined many hundreds of syndicated conservation easement deals where tens of billions of dollars of deductions were improperly claimed. It is an agency-wide effort using a significant number of resources and thousands of staff hours. The IRS examines 100 percent of these deals and plans to continue doing so for the foreseeable future.”26
Rettig writes: “We are devoting a lot of resources to combating abusive conservation easements because it is important for fairness in tax administration. 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.”27
Abusive micro-captive insurance arrangements
“In abusive ‘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. For example, coverages may ‘insure’ implausible risks, fail to match genuine business needs or duplicate the taxpayer’s commercial coverages. The ‘premiums’ paid under these arrangements are often excessive and are used to skirt the tax law.
Recently, the IRS has stepped up enforcement against a variation using potentially abusive offshore captive insurance companies. Abusive micro-captive transactions continue to be a high-priority area of focus.
The IRS has conducted thousands of participant examination and promoter investigations, assessed hundreds of millions of dollars in additional taxes and penalties owed, and launched a successful settlement initiative … The IRS’s activities have been sustained by the Independent Office of Appeals, and the IRS has won all micro-captive Tax Court and appellate court cases, decided on their merits, since 2017.”28
The “Dirty Dozen” are certainly focus areas for the IRS, and any matters relating to these areas should be scrutinized. Practitioners must also remember that, depending on the nature of our involvement in planning and executing transactions, we can have exposure as return preparers or even promoters in these areas.
1 Scott E. Vincent is the founding member of Vincent Law, LLC in Kansas City.
2 I.R.S. News Release IR-2022-113 (June 1, 2022).
6 I.R.S. News Release IR-2022-117 (June 6, 2022).
10 I.R.S. News Release IR-2022-119 (June 7, 2022).
16 I.R.S. News Release IR-2022-121 (June 8, 2022).
20 I.R.S. News Release IR-2022-122 (June 9, 2022).
22 I.R.S. News Release IR-2022-125 (June 10, 2022).