Step 4

Avoiding Tax Scams, Shams, and Illegal Shelters

Everywhere you look there are advertisements promoting books, seminars, and plans for reducing taxes. Some shout: "Pay no taxes, now and forever." Others claim to show: "How to make a fortune and pay zero tax," or "How you too can live like a millionaire and pay no tax."

The idea of saving money on income taxes appeals to everyone. Even the Supreme Court gave the idea respectability when Justice Learned Hand said: "There is nothing sinister in arranging one's affairs as to keep taxes low as possible."

In 1935, Justice Sutherland wrote:

The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted.

You may wonder, "What does the law permit?" Some people would say that the law permits whatever they say it permits. some people only believe what they want to believe. Yet others are easily convinced that anything is permissible.

The solidity of the Internal Revenue Code isn't even debatable. The massive document is so riddled with loopholes which benefit the special interests, that people readily fall for any scam, sham, shelter, or illegal advice that purports to be legitimate. The average taxpayer is defenseless against the claims of promoters and fancy advertisements promising to bail them out of their ever increasing tax bracket. Even though the IRS has taken positions on a vast number of tax shelters and tax-protester schemes, and has litigated the issues hundreds of times, many illegitimate shelters and schemes are still promoted around the country with alarming success.

So what is a taxpayer supposed to do when he wants to determine if a tax shelter is legitimate? Not only are tax practitioners in disagreement, but IRS employees themselves are little help. The libraries may be full of articles and books on the subject, but the average taxpayer does not have the time and knowledge necessary to conduct the research to make a proper decision. And, in spite of the fact that the IRS has issued rulings and regulations on just about every tax shelter being promoted today, few promoters inform their victims of what IRS's position is, or even if the courts have ruled in favor of the IRS.

Many taxpayers are fooled by financial schemes that allegedly take advantage of loopholes in the law. Taxpayers are unaware of IRS's right to declare these actions a "sham". If the IRS believes that the taxpayer's actions were not legitimately motivated, but were contrived for the sole purpose of tax avoidance, then the transaction could be considered a "sham" and set aside by the IRS.

Be aware that the difference between tax avoidance and tax evasion can be a fine line, distinguished mainly by the motives and the knowledge of the taxpayers. The IRS monitors compliance of taxpayers involved in numerous tax shelters by automatically auditing the returns of those claiming the shelters. To a naive person who unwittingly believes the promises of the shelter promoters and follows their advice, the subsequent IRS audit can be a trying experience.

This chapter will expose the most flagrant and publicly advertised shelters and tax-avoidance devices that IRS feels are tax evasion traps so you won't be taken in. I will discuss each device by explaining what the issues are that the promoters are selling, and what IRS's position is.

1. Tax Scams and Shams
2. Common Tax Protest Schemes & Frivolous Tax Arguments
3. Tax Shelters
4. Identifying an Abusive Tax Shelter
5. IRS's Tax Shelter Program
6. Tax Court Response
7. Should You Invest?
8. Exhibit 4-1: IRS Example of Abusive Tax Shelter Consequences

Next Section: Step 4-6: Tax Court Response

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