Step 4-2a

Common Tax Protest Schemes

Constitutional Basis Schemes

The constitutional scheme is one of the oldest and most frequently used protest approaches.

Generally, these protesters make the false claim that any payment of tax or providing of tax-return information violates their constitutional rights. In lieu of the information required on Form 1040/1040A, the protester either writes "-0-," "none," or "object"; or cites the Fourth, Fifth, or Sixteenth Amendment to justify his or her refusal. This is commonly referred to as a Porth/Daly return. In some cases, these returns are so incomplete that the IRS treats them as non-filer cases.

For example, protesters may claim they are providing no income information because it would violate their Fifth Amendment right against self-incrimination. The Supreme Court held as early as 1927, however, that a taxpayer could not refuse to file a Federal income tax return on the basis of Fifth amendment protection. Similarly, protesters mistakenly assert that the internal revenue laws constitute an illegal seizure of property in violation of the due process clause of the Fifth Amendment. The courts have also denied this ridiculous claim, stating that, "It is now well settled that the income tax laws are not unconstitutional under the due process clause of the Fifth Amendment."

A Legal Evaluation of the Constitutional Scheme

First Amendment Contention:

The taxpayer refuses to pay income taxes, in whole or in part, on religious or moral grounds, incorrectly contending that to do so would violate First Amendment rights. Federal courts have held in numerous cases that there is no constitutional right to refuse to pay income taxes, in whole or in part on religious or moral grounds, or because the funds are used for government programs opposed by the taxpayer. The fact that some persons may object, on religious grounds, to some of the things that the government does is not a basis upon which to claim a constitutional right to avoid taxation.

Fifth Amendment:

The taxpayer claims that the filing of an income tax return violates the Fifth Amendment right against self-incrimination, and that he is entitled to secure a ruling on the incriminating possibility of each item on the return. There is no constitutional right to refuse to file an income tax return because of the Fifth Amendment (United States v. Sullivan, 274 U.S. 259 (1927)). In Sullivan, the court upheld a conviction for failure to make a return. It held the Fifth Amendment generally does not authorize one to refuse to state their amount of income. (However, some recent cases indicate that taxpayers earning illegal income may be entitled to claim the Fifth Amendment privilege as to the amount of income. See United States v. Barnes, 604 F.2d 121, 147 (2d Cir. 1979), cert. denied, 446 U.S. 807 (1980); United States v. Carlson 617 F. 2d 518 (9th Cir. 1980)).

Fifth Amendment - Due Process:

Protesters falsely assert that various provisions of the Internal Revenue laws violate the due process clause of the Fifth Amendment. Generally they claim that the graduated income tax scale and the fact that certain deductions or benefits allowed by the Internal Revenue Code are not available to some people denies them their Constitutional rights. The protesters also assert that some of the statutory collection procedures violate the due process clause. Brushaber v. Union Pac. RR Co., 240 U.S. 1 (1916) held that due process was not denied by discriminating between classes or by having a progressively graduated income tax scale. United States v. Keig, 334 F. 2d 823 (7th Cir. 1964) held that progressive rates are constitutional. Further, in Swallow v. United States, 325 F. 2d 97 (10th Cir. 1963), cert. denied, 377 U.S. 951 (1964), the court held, "It is now well settled that the income tax laws are not unconstitutional under the due process clause of the Fifth Amendment."

Unconstitutionality of the Federal Reserve System:

Protesters contend that the Federal Reserve System is unconstitutional; therefore, the Code is unconstitutional to the extent it taxes income represented by notes or checks which do not contain or are not redeemable in gold or silver. This argument has been consistently rejected by the courts as frivolous. In Hatfield v. Commissioner, 68 T.C. 895 (1977), the Court uniformly held that Federal Reserve Notes constitute legal tender, "Money," which must be reported on a taxpayer's accounting.

Thirteenth Amendment:

Protesters make the ridiculous assertion that the bookkeeping, records maintenance, and employer withholding requirements are in reality "involuntary servitude" and, therefore, unconstitutional. This ludicrous argument was rejected in Porth v. Brodrick, 214 F. 2d 925 (10th Cir. 1954), and is completely without merit.

Tax Court is Unconstitutional:

Protesters contend that the Tax Court illegally constituted, and there is a denial of a jury in tax litigation. Obviously, the Tax Court is a court of record under Article 1, Section 8 of the Constitution. The protester intentionally disregards our right to litigate a tax refund suit before a jury. Numerous decisions have sustained the constitutionality of the Tax Court of the United States in the exercise of the jurisdiction conferred upon it by Congress.

Sixteenth Amendment:

Protesters claim that the tax laws are unconstitutional because the Sixteenth Amendment was not properly ratified. They claim that since the State of Ohio was not properly a state at the time of the ratification of the Sixteenth Amendment, the Amendment is not valid and, therefore, the income tax law is unconstitutional. This allegation is overcome by looking at the history of the Sixteenth Amendment. It was ratified by forty states, including Ohio, and a proclamation issued in 1913. Shortly thereafter, two other states also ratified it. Under Article V of the Constitution, only three-fourths of the states were needed to ratify this Amendment so there were enough states (without Ohio) to complete the number needed for ratification. Every case in which this issue has been presented has been decided against the taxpayer.

Warning:

The IRS and the courts are losing patience with taxpayers who persist in these spurious assertions. The IRS is stepping up assessments of penalties and so are the courts.

Case Citations- Constitutional Schemes

First Amendment:
     1. Autenrieth v. Cullen, 69-2 USTC, 9724

Fifth Amendment:
   * Incrimination:
     1. United States v. Sullivan, 1 USTC, 236
     2. United States v. Daly, 68-2 USTC, 9617
     3. Neff, 80-1 USTC, 9397
     4. Carlson, 80-1 USTC, 9299
     5. Moore, 79-2 USTC, 9676
     6. Garner v. U.S., 76-1 USTC, 9301

   * Due Process:
     1. Brushaber v. Union Pac RR Co., USTC, 4
     2. United States v. Keig, 64-2 USTC, 9563
     3. Swallow v. United States, 64-1 USTC, 9117

Thirteenth Amendment:
     1. Porth v. Brodrick, 54-2 USTC, 9552
     2. American Friends Service Com., Sup. Ct., 74-2 USTC, 9774

Sixteenth Amendment:
     1. See Brushaber above.
     2. Baker, Richard M.T.C., Memo 1978-60

Federal Reserve System:
     1. Edward A. Cupp, 65 TC, 68
     2. U.S. v. Wangrud, 76-1 USTC, 9358
     3. Hatfield v. Comm., 68 TC, 895 (1977)

Tax Court:
     1. Nash Miami Motors, Inc. v. Comm., 66-1 USTC, 9354
     2. Hartman v. Switzer, 74-1 USTC, 9478

Valid Return:
   * "Jurat" Omitted:
     1. Dixon v. Comm., 28 TC 338
     2. Ellison v. Comm., 35 TC 1261
     3. Vaira v. Comm., 52 TCM 986
     4. Lucas v. Pilliod Lumber, 2 USTC 521
     5. Moore, 80-2 USTC, 9627
     6. Cupp.  See "Federal Reserve System" above.

   * Zeros:
     1. Morris R. Smith, 80-2 USTC, 9476
     2. Robert M. Long, 80-2 USTC, 9627

   * Sufficiency of Information:
     1. Porth, 70-1 USTC, 9329
     2. Hatfield. See "Federal Reserve System" above.
     3. Daly, 73-2 USTC, 9574
     4. Cupp.  See "Federal Reserve System."

Church Related Schemes

A number of dishonest opportunists are involved in the sale of minister's credentials and church charters through mail order. These schemes, which claim to reduce an individual's income taxes, are perhaps the fastest growing area of protest schemes.

The alleged church scheme has two variations. Under the first, an individual purchases fake ministerial credentials and perhaps a church charter. The tax evader then forms a front organization, or becomes a branch of another organization, claiming to establish a tax-exempt church. In most cases, the person's residence houses the "church," and his or her family is the "congregation." The tax protester then contributes up to 50 percent of his or her income- the maximum allowable- to the alleged church and claims it as a Form 1040 deduction, substantially reducing taxes. Of course, the church's revenue is actually used to pay the person's living expenses.

Under the second variation, the tax protester allegedly takes a vow of poverty, pledging to obey the orders of the church. The alleged "orders" actually do no more than "require" a person to retain his or her current job and continue his or her present life-style. While the protester may file a Form 1040 claiming income, he or she then takes an adjustment against gross income for an equal amount. This unreasonable adjustment eliminates any tax liability. Some protesters show no financial data, claiming that they are not required to pay taxes as ministers under a vow of poverty.

Under the law, a "vow of poverty" is characterized in Order of St. Benedict of New Jersey v. Steinhauser, 214 U.S. 640 (1914), as a legally enforceable agreement between a religious order and a member of the order to the effect that the gains and acquisitions of the member become the common property of the order. In turn, the order, at least implicitly, agrees to supply the individual with the necessities of life. Most taxpayers who file vow of poverty returns are sincere in their religious convictions, and are not motivated by tax avoidance.

A Legal Evaluation of Alleged Church Schemes

Assignment of Income: It is basic principle of Federal income tax law that an assignment or similar transfer of compensation for personal services to another individual or entity is ineffectual to relieve the taxpayer of Federal Income tax liability on such compensation, regardless of the motivation behind the transfer. (See Lucas v. Earl, Helvering v. Horst, and Helvering v. Eubank.)

Any taxpayer, even a member of the clergy, who performs services in an individual capacity is taxed on the income from those services. Therefore, the assignment of income issue in any vow of poverty case depends upon whether the taxpayer is performing services as an agent of the church or as a principal. If the taxpayer receives income as an agent of the church, that income is deemed to belong to the church and the taxpayer is not taxed on it. If the taxpayer is not an agent, the income is taxed to him or her.

For a minister to be performing services as an agent, the minister is required by the church to perform those services for, or on behalf of, the church. Most importantly, it means that the services are the type that are ordinarily the duties of church members. (See Revenue Rulings 76-323, 77-290, and 78-229.)

Requirements for Deductibility of Contributions:

IRC 170(c) defines a charitable contribution, and establishes three important requirements for deductibility: * The contribution must be a true "gift"; * The gift must be made to an organization that is organized and operated exclusively for religious or charitable purposes; and, * No part of the net earnings of the organization can inure (accrue) to the benefit of any private shareholder or individual.

Gift (Quid Pro Quo):
A gift for the purpose of IRC 170 is a voluntary transfer of money or property that is made with no expectation of receiving a commensurate financial benefit in return.

Revenue Ruling 78-232 states that if the donor can reasonably expect by making the transfer to obtain sufficiently substantial benefits to provide a quid pro quo for it, then no deduction under IRC 170 is allowable. Quid pro quo, therefore, is the test applied when determining if a gift has been made. It means something given or received in exchange for something else.

If the taxpayer-minister controls the church bank account(s), and causes personal expenses to be paid directly or indirectly to himself or herself, it can be said that he or she received or expected to receive financial benefits in return and that a quid pro quo exists. Protesters using the church scheme will generally attempt to have the alleged church pay for lodging, food, automobile, medical, education, or other personal expenses. (See Rev. Rul. 78-232.)

Organized and Operated Exclusively for Religious Purposes:

A church need not formally request and receive exempt status from the IRS to be considered exempt. However, for a contribution to be deductible, the burden of proof is on the taxpayer to show that the church is organized and operated for religious purposes. In this regard, Regs. 1.170A-1(a)(2)(iii) states that, "Any deduction for a charitable contribution must be substantiated, when required by the District Director, by a statement from the [church] indicating whether the [church] is a domestic organization, the name and address of the contributor, the amount of the contribution, the date of actual receipt of the contribution, and such other information as the District Director may deem necessary.

Inurement:

The term "inurement" relates to the requirement in IRC 170(c)(2) that no part of the church's net earnings may inure to the benefit of any private shareholder or individual. Developing the inurement issue is almost identical to the quid pro quo issue, in that if the church has paid personal expenses of the taxpayer, then inurement exists. The difference is that inurement applies in determining if a contribution has been made to a qualified organization under IRC 170(c). That is, if the organization uses the contribution to pay a "dividend" to its members, the organization is not a qualified donee and no deduction is allowed under IRC 170(a)(1). (See Rev. Rul. 78-232.)

Case Citations - Church Schemes

Charitable Contribution Deduction - In General:
IRC 170(a)
IRC 170(c)

Substantiation Requirements:
Regulation 1.170(A)(2)

Vows of Poverty- Assignment of Income:
Rev. Rul. 80-332, 1980-2 C.B. 34 (C.B. = Cumulative Bulletin)
Rev. Rul. 79-132, 1979 C.B.
Rev. Rul. 78-229, 1978-1 C.B. 305
Rev. Rul. 77-436, 1977-2 C.B. 25
Rev. Rul. 77-290, 1977-33 C.B. 11
Rev. Rul. 76-341, 1976-2 C.B. 307
Rev. Rul. 76-323, 1976-2 C.B. 18
Rev. Rul. 68-123, 1968-1 C.B. 1

Lucas v. Earl, 281 U.S. 111 (1930)
Helvering v. Horst 311 U.S. 112 (1940), 1940-2, C.B. 206
Helvering v. Eubank, 311 U.S. 112 (1940), 1940-2, C.B. 209
Kelly v. Comm., 62 T.C. 131 (1974)
National Carbine Corp. v. Comm., 336 U.S. 422 (1949)

Organized and Operated Exclusively for Religious Purposes:
Brown v. Comm., T.C.M. 1980-55
Abney v. Comm., T.C.M. 1980-27 (1980)
Dusch v. Comm., T.C.M. 1980-4
Walker v. Comm., T.C.M. 1978-493
Heller v. Comm., T.C.M. 1978-149
Western Catholic Church v. Comm., 73 T.C. No. 19 (October 31, 1979)
Oaknoll v. Comm., 69 T.C. 770 (1978)
Clippenger v. Comm., T.C.M. 1978-107
General Conference of the Free Church of America v. Comm., 71 T.C.
920 (1979)
Rev. Rul. 81-94, 1981 C.B. 15

Inurement:
IRC 170(c)(2)(c)
Rev. Rul. 78-232, 1978-1 C.B. 69
Rev. Rul. 69-266, 1969-1 C.B. 151
Abney v. Comm., T.C.M. 1980-27 (1980)
Beth El Ministries v. U.S., 44 AFTR 2nd 5190
Martinsville Ministries v. U.S., 45 AFTR 2nd 80-578 (D.D.C. 1979)
Clippenger v. Comm., T.C.M. 1978-107
Walker v. Comm., T.C.M. 1978-493
Heller v. Comm., T.C.M. 1978-149

Family Estate Trust Schemes

A family estate trust is another questionable vehicle used by tax protesters to avoid or substantially reduce personal income taxes. The Service has published several rulings adverse to these schemes and the courts have repeatedly upheld the Service's position.

Under this scheme, an individual assigns all real and personal property, and income from current employment to the trust. In exchange, the creator of the trust receives "compensation" as an officer, trustee, or director, as well as certain "fringe benefits," such as "pension rights," "tax-free use of a residence," and "educational endowments" for children.

Once the taxpayer's income is transferred to the trust, the trust is allegedly taxed only on undistributed net income. Promoters claim that substantially all living expenses of the taxpayer and his or her family may be deducted on the trust's fiduciary income tax return as business expenses, and that the balance might then be distributed to the taxpayer's family or to a separate "non-profit" educational trust, leaving little or no taxable income.

How the Scheme Operates

Typically, the taxpayer attends a family estate trust scheme promotional meeting in which a salesperson explains the purported tax advantages of creating a family estate trust. The sales promotion emphasizes the savings of income taxes, probate fees, and estate and gift taxes. The promoter is paid a fee which may include an amount based on a percentage of the individual's annual gross income and net worth. In return, the taxpayer receives an "educational package" consisting of a pro forma trust and indenture containing a copyright seal (often entitled "Declaration of Trust of this Pure Trust"). Included are instructions on how to create and manage the trust, and how to file individual and fiduciary income tax returns for the desired tax result. The package also contains extensive legal opinions on the validity of the family estate trust, and, sometimes, contains guarantees for free legal representation before the IRS.

The specific language and general design of the trust instrument rarely differs from one family estate trust to another. (For an outline of the relevant terms of the "family estate" trust, see Horvat v. Commissioner, TCM 1977-104.) The trust instrument generally contains the following characteristics:

• The alleged purpose of the trust is stated in moral terms, such as patriotic, or promotion, of the general welfare. The trust purpose may contain the grantor's constitutional rights or religious beliefs.
• The term of the trust is generally 20 or 25 years. However, the instrument may call for termination at an earlier date by unanimous vote of the trustees who will then distribute the remaining assets to the beneficiaries in proportion to their shares of beneficial interest (see below).
• The trustees generally have sole discretion to distribute income and corpus, but the grantor retains substantial control.
• The trust usually bears the name of its creator and is generally fashioned "John Doe Family Estate (A Trust)."
• The complete trust instrument is signed in the presence of a notary public and may be recorded in a local court of records. Neither procedure is required to establish a legal validity. However, the procedure is stressed by promoters as being vital to proper establishment of the trust, apparently to create an atmosphere of legality.

The spouses and a third party are generally named as co-trustees in the original trust instrument. Within a few days of the trust's creation, the third party resigns as co-trustee, leaving the husband and wife as co-trustees. The third party is usually a close relative, such as a sister, brother, or a close personal friend. The third party may also have created a family estate trust scheme.

The taxpayer is named "executive manager," the spouse "executive secretary," and the third-party "treasurer." These terms are generally foreign to the operations inter vivos trusts. After the third party resigns, the spouse may become "secretary/treasurer."

The taxpayer will then transfer personal assets, and possibly business assets, to the trusts. Personal assets may consist of the personal residence, automobiles, household furnishings, bank accounts, and securities. Business assets may include lifetime services, inventory, and/or depreciable property. The transfer of real property is generally recorded in the local court of records. Income subsequently earned on the transferred assets is sometimes paid directly to the trust rather than to the individual.

Although personal or business liabilities are allegedly transferred to the trust, there is normally no evidence that they are so transferred. Nonetheless, substantially all personal and business expenses of the grantor and the grantor's family are paid out of "trust funds" and deducted on he fiduciary income tax return.

An essential element of the scheme is the anticipatory assignment of wages, salaries, bonuses, commissions, and income from personal service contracts purported to exist between the trust and the individual's employer. When the individual is the sole stockholder, or a substantial stockholder in a corporation, such a contract may exist. At the direction of the taxpayer/stockholder, earned income will be paid directly to the trust without withholding of Federal, state, and local income taxes, and FICA. In most cases, however, the employee does not have control over the employing company. The employer usually will not be notified of the existence of the trust and will continue to make payments directly to the employee.

In exchange for transferring assets, liabilities, and the "lifetime services," to the trust, the grantor receives units of beneficial interest, represented by printed forms similar to stock certificates. The grantor may then distribute the shares among the grantor's spouse, children, third-party co-trustee, and/or to himself or herself. For example, if there are three children, 100 units of beneficial interest may be distributed in the following manner, 25 units each to the grantor and the grantor's spouse, 20 units to the third party, and 10 to each of the children. Normally, all units of beneficial interest are held by the grantor and/or his family.

A Legal Evaluation of Family Estate Trust Schemes

Assignment of Income:

• Lifetime Services- All income, from whatever source derived, is taxed to the person who earns it unless specifically excluded by law. Gross income includes income realized in any form, whether in money, property, or services. (See Commissioner v. Culbertson, 337 U.S. 733, 739-740 (1949), 1949-2 C.B.5; Rev. Rul. 75-257, 1975-2 C.B. 251.)
• Withholding and FICA- The grantor, and not the trust, is the employee subject to withholding under IRC 3402(a) and to FICA under IRC 3121(a), regardless of any payments made directly or indirectly to a trust under a "lifetime services" contract. (See Rev. Rul. 80-321, IRB 1980-48, 6.)

Grantor Type Trust:

For Federal income tax purposes, the grantor is considered the owner of all "family estate" trust income and corpus under IRC 674, 676, or 677, or a combination of these sections as the case may be.

Sham Transaction:

As an alternative to attacking a "family estate" trust with the "assignment of income" and "grantor trust" arguments, the sham-transaction theory may be used. The sham theory is most appropriate where the trust funds are being used to pay the grantor's personal living expenses, the grantor exercises dominion and control over the trust assets as if they ere the grantor's own assets, the grantor borrows from the trust without adequate security, and the trust does not maintain a checking account of its own. Under these circumstances, trust income is property attributable to the grantor. (See, generally, Paster v. Commissioner, T.C.M. 1961-240; Jones v. Page, 102 F. 2d 144, cert. denied, 308 U.S. 562 (1939).)

Corporation Trusts:

• In the case of a transfer of business property to a trust, the IRS will consider Revenue Ruling 75-258. This ruling concluded that the family estate trust, based on the provisions contained in the trust instrument, possessed more corporate than noncorporate characteristics.
• When raising this issue, the IRS may also include the alternative position shifting the income to the grantor's return(s) under the assignment of income principle discussed earlier.
• Warning: The Internal Revenue Manual advises all examiners to, "Consider the negligence penalty on all family estate trust cases." This will mean an additional 5 percent penalty plus an additional 50 percent of the interest tacked onto your bill.

Foreign Trust Organization Schemes

Some tax advisors have been promoting abusive foreign trust, or double trust, organization schemes. These schemes are attempts by promoters to reap substantial profits from uninformed taxpayers or from illegal tax protesters willing to gamble that these schemes will not be challenged by the IRS. Generally, the schemes involve at least two foreign trusts and sometimes one or more domestic trusts which enter into sham transactions designed solely as tax-avoidance arrangements. Some taxpayers who use the foreign trust schemes have been coached by promoters to use tax-protester tactics to frustrate, intimidate, or confuse examiners in conducting their examinations.

How the Scheme Works

The scheme is established when an agent, who is named as the creator/ grantor, creates a trust in a foreign country, naming the taxpayer as trustee. The trust is usually established in a country that has no tax treaty agreement with the U.S. government for the exchange of information.

The taxpayer then transfers his assets and income-producing property to the trust. The agent then creates a second trust in the same foreign country, naming the first trust as the trustee of the second trust. The taxpayer and both trusts then enter into sham transactions with each other, conceived only for tax purposes.

These schemes sometimes use overseas bank accounts, and may include both domestic and foreign counterfeit trusts.

Example:

A doctor establishes a domestic trust to which is transferred the assets of the protester's medical practice. The promoter had created three foreign trusts for the protester: FTO #1, FTO #2, and FTO #3. FTO #1 serves as sole trustee for FTO #2 and FTO #3.

The protester conducts his or her medical practice during the year using the bank accounts of the domestic trust to receive income and to pay expenses. At the end of the year, the trust has a $125,000 profit. The protester directs the trust to pay FTO#2 $125,000 as a management fee. The domestic trust files Form 1041, U.S. Fiduciary Income Tax Return, showing no profit or loss. FTO#1, as trustee for FTO#2, directs FTO#2 to pay a $125,000 management fee to FTO #3. FTO #2 files a Form 1040NR, showing the $125,000 in income and $125,000 in expenses. FTO #3 now has $125,000 in cash. FTO #3 is not required to file a Federal income tax return since it does not conduct business in the United States. FTO #1, as sole trustee of FTO #3, directs FTO #3 to pay the protester the $125,000 as a gift or a loan. The protester claims that since this is a gift or a loan, it is not required to be reported as income.

A Legal Evaluation of Foreign Trust Schemes

The tax advisors who promote these schemes have gone to great lengths to give them the appearance of legitimacy. The protesters may feel they have found a means of legally avoiding their tax liability. Listed below is a brief explanation of three primary approaches that will be used by IRS examiners to defeat these schemes.

* Substance v. Form

1. The courts have long recognized and applied the general principle that the substance, not the form, of the transaction controls the tax consequences. See Gregory v. Helvering, 293 U.S. 465 (1935).
2. When a series of transactions, taken as a whole, show that the transactions themselves are shams, or that the transactions have no substance, utility, or purpose apart from tax considerations, the courts will refuse to allow the sought-after tax benefits of these transactions. See Goldstein v. Commissioner, 364 F. 2d 734 (2nd Cir. 1966); Goldstein v. Commissioner, 267 F. 2d 127 (1st Cir. 1959).

• Sham Theory- Rev. Rul. 80-74, 1980-1 C.B. 137, "Foreign Tax Haven Double Trust," sets forth an example of a foreign tax haven double trust in which two foreign trusts were created to accomplish the "tax benefits" similar to those described earlier. It holds that the creation of both trusts will be considered a sham, and that the substance of the transaction will control. See Knetsch v. United States, 364 U.S. 361 (1960); Higgin v. Smith, 308 U.S. 473 (1940); National Lead Co., 336 F. 2d 134 (2nd Cir. 1964); Lynch 273 F 2d 867 (2nd Cir. 1959).
• Assignment of Income- Income will be taxed to the one who earns it or otherwise creates the right to receive it and to enjoy the benefit of it when paid. See Lucas v. Earl, 281 U.S. 111 (1930); and Rev. Rul. 750257, 1975-2 C.B. 251.

  Warning: The IRS states that because of the great latitude and flexibility in the way a trust may be operated, alternative approaches may have to be used. There are at least six other approaches listed in the Internal Revenue Manual. The IRS has many weapons to fight these schemes, and it is not likely that you could persevere in the event of an IRS challenge.

Miscellaneous Wild Schemes

False W-4 Schemes

Since 1974, the filing of a false Form W-4, Employee's Withholding Allowance Certificate, has become more common and is often used by illegal protesters in conjunction with another scheme.

Under the false W-4 scheme, an employee claims excessive withholding allowances or complete exemption from withholding so that little or no Federal income taxes are withheld by the employer. Later, the employee may either underreport income, refuse to pay the difference between taxes withheld and due, or not file a return at all, thus creating a collection problem for IRS.

This scheme usually starts with a few employees and expands as others learn that their counterparts take home more money for the same work. For example, in 1981 about 3,500 General Motors auto workers in Flint, Michigan, primarily at the urging of two leaders, filed questionable form W-4s. The scheme has even been used by Federal employees and municipal employees, such as policeman and sanitation workers.

Under IRS procedures now in effect, employers are required to send to IRS every W-4 that claims in excess of 10 allowances. The IRS corresponds with taxpayers to determine if they are, in fact, entitled to claim that many allowances.

In 1986 the IRS adjusted 212,000 forms W-4 of employees who underestimated their withholding by claiming too many allowances. The $500 civil penalty for filing false wage withholding information was levied on over 45,000 taxpayers (over 100,000 taxpayers were fined in 1984).

Fair Market Value Scheme

The fair market value scheme, which is seldom used, involves taking a deduction for the declining value of the dollar, thus substantially reducing taxes. Gross income is listed on the face of the return and there is a large adjustment to income which makes the adjusted gross income small enough for the zero bracket amount to eliminate taxable income. The adjustment to gross income is on Schedule D, Schedule of Capital Gains and Losses, or Form 2106, Statement of Employee Business Expenses, for Form 1040. The tax court has upheld IRS's position that such a deduction is neither provided for nor authorized by the Internal Revenue Code or regulations.

Gold/Silver Standard Scheme

Under the gold/silver standard scheme, which is also seldom used, protesters argue that Federal Reserve Notes do not constitute income because they are not redeemable in gold and silver. They further argue that Federal Reserve Notes are not legal tender. In most cases, the protester will file a blank return with supporting arguments attached. These arguments have been consistently rejected by the courts as being frivolous and without merit.

Protest Adjustment and Nonpayment Protest Schemes

The protest adjustment scheme involves the use of an unallowable deduction, adjustment, or credit based on philosophical objections to the use of tax money for certain Government programs, such as defense or foreign aid.

The nonpayment protest scheme involves correctly computing the tax, but refusing to pay the balance due on the basis of philosophical objections.

Federal courts have held in numerous cases involving these schemes that there is no constitutional right to refuse paying income taxes because the funds might be used for Government programs that the taxpayer opposes.

Forms 843 and Amended Returns -

Some individuals are filing Form 843 Claims and/or Amended Form 1040 (1040X) returns to obtain a total refund on all taxes paid in prior years, even though returns have not yet been filed for the prior years.

Blank Form 1040/1040A -

These generally fall into two categories. In one category the individual files a return with only a name and address, and possibly signature, and Form(s) W-2 is attached. This scheme is usually verified upon correspondence with the taxpayer. In the second category, the individual files a return similar to the Porth-type return. In both instances the return may or may not list marital status and/or exemptions.

Other Tax Protester Schemes -

Many variations of the above schemes exist. They generally involve frivolous constitutional arguments or sham transactions in continually changing forms. Some examples of these schemes are:

• "Wages are Not Income" or Nontaxable Receipts- These schemes involve various deductions, usually equivalent to the amount of W-4 or 1099 income, based on arguments that wages are not profits or not income and, therefore, not taxable. These deductions have appeared on Schedule C as the total of business expenses, cost of goods sold, or as wage expense. The Eisner v. Macomber return is a "Wages are Not Income"-scheme variation.
• Eisner v. Macomber - A document which looks almost identical to page 1 of Form 1040, but line items are altered to reflect Eisner v. Macomber and/or other similar court citations to deduct large amounts from income.
• Factor Discount - Involves claiming a loss on Form 1040 created by discounting a wage earner's paycheck with a foreign trust financial organization pursuant to a life-services contract. The amount of loss claimed is for the net amount from the face value of the paycheck less a nominal fee. Simultaneously with the discounting, the life-services contract is purchased by a second foreign trust financial organization. These sham transactions disguise what is nothing more than an assignment of income. This scheme is distinguishable from the Multiple Foreign Trust Organization scheme in that the wage earner does not create any foreign trusts.

Next Section: Frivolous Tax Arguments

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© 1986, 1998 to 2002, Jack Warren Wade, Jr.