High-Income Tax Schemes You Should Watch Out For
Taxes are an inherent part of making money in the United States, and most taxpayers are aware of their tax-related responsibilities — whether they work for an employer or themselves. However, not only are we responsible for paying our taxes, but the IRS reminds us that the consequences of tax-related scams or schemes are our responsibility too.
As unfair as it may be, tax schemes and scams do not always result in the schemer or scammer being caught. Instead, when scams are successful, victims are put in a position where they are disadvantaged, placing their tax situation at risk. While it’s very unfortunate, the IRS tries to assist taxpayers by raising awareness of tax-related scams so that we know what to look out for and how to protect ourselves.
Tax scheme #1: Art-related scams
A common tax scam occurs when promoters directly solicit art pieces that are worth either less than the promoters claim or nothing at all. These promoters end up encouraging people to purchase art by claiming that they are selling the artwork at discounted prices.
However, you should be mindful of the fact that not only does the artwork typically carry less value than the promoters claim it does, but the prices are often further inflated due to additional service charges, such as for storing, shipping, appraising and donating the art. These fees amplify the price, which has already been increased under the guise that the art is worth more than the actual purchase price.
Art-related schemes are often crafted in a way that convinces people to donate the art at least one year after purchasing the art. Then the scam artist states that the purchaser can claim a tax deduction for the art at an inflated fair market value, which is always substantially greater than the original price of the artwork.
If you ever find yourself in a position where you want to purchase artwork but you are concerned that you might be the target of an art-related scam, know that the IRS has a team of professionally trained appraisers who can assist you. They provide art appraisal services that can answer your valuation questions.
Just be mindful when you’re facing people who seem aggressive in their marketing and promoting methods. Also, know that while there are legitimate ways to claim an art donation after purchasing a piece of art, there are still a lot of rules that you must understand.
You should also keep an eye out for inflated values or questionable appraisals. After all, in the words of IRS Commissioner Danny Werfel, “Beauty is not always in the eye of the beholder when it comes to tax deductions of art.”
Tax scheme #2: Trust accounts
Next on our list of tax-related scams are those involving trust accounts. Schemers often utilize trusts as a way to eliminate capital gains in a dishonest way. More specifically, the IRS encourages people to be particularly careful about charitable remainder trusts.
These are irrevocable trusts that you can set up if you want to donate your assets to charities. With irrevocable trusts, you can rely on the fact that your trust-related income is properly reported and your assets are distributed to your beneficiaries as indicated by you. These accounts also ensure that you are filing the right tax documents and following the laws or rules that apply to your particular tax situation.
So, how does this type of scam work? Essentially, it starts when you transfer appreciated property to a CRAT. This is done with the goal of giving your assets a step-up in terms of the fair market value because it’s as though said assets have been sold to your trust. From there, the CRAT will sell your assets without accurately acknowledging the monetary gain due to the step-up in basis. Instead, the proceeds are used to purchase a single premium immediate annuity.
After that, the beneficiary will ultimately only report a small portion of the annuity as income rather than the full amount. This ends with the beneficiary misrepresenting funds, yielding inaccuracies that the IRS responds to via negative tax consequences.
Tax scheme #3: Installment scams
Last but not least on our list of tax schemes are those involving installments. With this type of shady deal, the goal is to delay paying taxes on the profit that is made from selling valuable property. This is achieved by using an abusive tax strategy called monetized installment sales.
In this scheme, an intermediary buys the property and gives the seller an installment note. In most cases, this usually requires interest payments, and the main amount is paid at the end of the term. As a result, the seller gets most of the money from the sale right away.
However, the seller also avoids paying taxes on the profit until the final payment on the note, which is often years later. This means the seller doesn’t pay the right amount of taxes in a given tax year, which will lead to questions from the IRS.
What to do if you uncover tax schemes
The IRS asks that you report instances of predatory and abusive tax schemes immediately. Make sure you tell the IRS about tax return preparers who deliberately prepare improper returns as well.
To do so, feel free to use Form 14242, Report Suspected Abusive Tax Promotions or Preparers, which you can find online. You can also complete Form 14242 and send it — along with any supporting material — to the IRS Lead Development Center in the Office of Promoter Investigations in Laguna Niguel, California, via fax number 877-477-9135.
Alternatively, you are more than welcome to send information to the IRS Whistleblower Office. All in all, the IRS has plenty of information about schemes that target taxpayers on its website. To protect yourself, focus on being vigilant all year long, and steer clear of recent tax scams as best you can.
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