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Tax Scams

The IRS has targeted two scams that are sure to result in an audit or immediate change to your return. One is the recurring slave reparations scheme and the other involves the use of Guamanian trusts.

The slave reparations scheme has two variants. In one the person claims a credit for black investment taxes or reparations for African-Americans. In the other the person attaches a form listing thousands of dollars in tax withholding that never occurred. These were popular in 1994 and 1996. The IRS has consistently disallowed this credit. There is currently no basis in law to allow this credit. Put it on your return and you are guaranteed to receive a letter or visit from the IRS. Unfortunately, there are tax preparers who solicit business claiming the credit is valid. They then pocket your money and disappear before the IRS catches up with them.

The second credit is considerably more sophisticated. Promoters of the trust argue that Code Section 935 allows an individual who is subject to Guam tax to pay tax only to Guam, not to the US Treasury. In fact, Code Section 935 does in fact relieve certain residents of Guam (but not Guam citizens) from paying tax to the US. However, the promoters have argued that the law applies to trusts as well. Their pitch is that income from your Guamanian trust is not subject to US tax (nor do they pay any tax to Guam). The IRS has stated unequivocally that Code Section 935 applies only to certain individuals and not to trusts.

The IRS has begun alerting practitioners as well as the general public that attempting to avoid US income tax by participation in these types of trusts will be vigorously prosecuted. In addition to the normal penalties for under payment of income tax, the IRS might well invoke accuracy related penalties, failure to file penalties, and aiding and abetting in tax avoidance. Like with most things, if it sounds too good to be true, it probably is.

The IRS has listed a number of red flags for trusts on their web site. Trusts serve a legitimate and useful purpose. But you should exercise caution if a trust promoter assures you that you can pay many personal expenses through a trust without paying any income tax. And if your tax preparer has not heard of this type of trust, you should exercise even more caution.

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