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Issue Number:? ??IR-2023-67

Inside This Issue

Dirty Dozen: Beware of abusive tax avoidance schemes

WASHINGTON ? Today the Internal Revenue Service closed out the 2023 Dirty Dozen campaign with a warning for taxpayers to beware of promoters peddling bogus tax schemes aimed at reducing taxes or avoiding them altogether.

These schemes can take many shapes, ranging from abusive deals involving syndicated conservation easements and micro-captive insurance arrangements. They can also involve an international component, such as hiding cash and digital assets offshore or using Maltese foreign individual retirement accounts or foreign captive insurance.

?These tax avoidance strategies often target high-income individuals seeking to reduce or eliminate their tax obligation,? said IRS Commissioner Danny Werfel. ?Sometimes taxpayers are conned into believing they can participate in these schemes. People should always look for advice from an independent, trusted tax professional, not a promoter focused on aggressively marketing and pushing questionable transactions.?

This marks the final day of the IRS annual Dirty Dozen campaign - a list of 12 scams and schemes that put taxpayers and the tax professional community at risk of losing money, personal information, data and more. Some items on the list are new and some make a return visit. While the list is not a legal document or a formal listing of agency enforcement priorities, it is intended to alert taxpayers and the tax professional community about various scams and schemes at large.

Today, the IRS highlights the following Dirty Dozen items:

Bogus tax avoidance strategies

Micro-captive insurance arrangements
Also called a small captive, a micro-captive is an insurance company whose owners elect to be taxed on the captive's investment income only. Abusive micro-captives involve schemes that lack many of the attributes of legitimate insurance. These structures often include implausible risks, failure to match genuine business needs and in many cases, unnecessary duplication of the taxpayer?s commercial coverages. In addition, the ?premiums? paid under these arrangements are often excessive, reflecting non-arm?s length pricing.

Abusive micro-captive transactions continue to be a high-priority enforcement area for the IRS. The IRS has won all micro-captive Tax Court and appellate court cases decided on their merits since 2017.

Syndicated conservation easements
A conservation easement is a restriction on the use of real property. Generally, taxpayers may claim a charitable contribution deduction for the fair market value of a conservation easement transferred to a charity if the transfer meets the requirements of Internal Revenue Code section 170.

Syndicated conservation easements are arrangements that make the Dirty Dozen list again in 2023. In abusive arrangements, promoters are syndicating conservation easement transactions that purport to give an investor the opportunity to claim charitable contribution deductions and corresponding tax savings that significantly exceed the amount the investor invested. These abusive arrangements, which generate high fees for promoters, attempt to game the tax system with grossly inflated tax deductions.

As part of the Consolidated Appropriations Act of 2023, Congress amended section 170 to curb certain abusive conservation easement transactions. The IRS is committed to ensuring compliance with the conservation easement deduction law as amended in the 2023 legislation and will continue to scrutinize transactions that are ?too good to be true.?

Schemes with international elements

Offshore accounts & digital assets
International tax compliance remains a high priority for the IRS. The IRS continues to scrutinize taxpayers attempting to hide assets in offshore accounts and accounts holding digital assets, such as cryptocurrency. The IRS reminds U.S. persons that they are taxable on their worldwide income, unless they can establish there is a statutory or treaty exemption.

The IRS continues to identify individuals who attempt to conceal income in offshore banks, brokerage accounts, digital asset accounts and nominee entities. The IRS scrutinizes structured transactions, private annuities, employee leasing schemes, foreign trusts, the use of nominee ownership and other arrangements used to conceal taxable income, beneficial owners and assets. To complement its enforcement investigations, the IRS requires individuals holding foreign assets and third parties to report to the IRS on foreign assets, foreign accounts, foreign entities and digital assets. Reporting requirements carry penalties for failure to file.

Asset protection professionals and unscrupulous promoters continue to lure U.S. persons into placing their assets in offshore accounts and structures, saying they are out of reach of the IRS. Similarly, unscrupulous promoters recommend digital assets as being untraceable and undiscoverable by the IRS. These assertions are not true. The IRS can identify and track anonymous transactions of foreign financial accounts as well as digital assets.

Many of these schemes are promoted and advertised online, but all these schemes have one thing in common - they promise tax savings that are too good to be true and will likely cause legal harm to taxpayers.

Maltese individual retirement arrangements misusing treaty
These arrangements involve U.S. citizens or residents who attempt to avoid U.S. tax by contributing to foreign individual retirement arrangements in Malta (or potentially other host countries). The participants in these transactions typically lack any local connection to the host country, and unlike U.S. law for individual retirement arrangements, the host country?s laws allow for contributions in a form other than cash and do not limit the amount of contributions by reference to employment or self-employment activities. By improperly asserting the foreign arrangement as a ?pension fund? for U.S. tax treaty purposes, the U.S. taxpayer misconstrues the relevant treaty provisions and improperly claims an exemption from U.S. income tax on gains and earnings in, and distributions from, the foreign individual retirement arrangement.

Puerto Rican and other foreign captive insurance
In these transactions, U.S. business owners of closely held entities participate in a purported insurance arrangement with a Puerto Rican or other foreign corporation in which the U.S. business owner has a financial interest. The U.S. business owner (or a related entity) claims a deduction for amounts paid as premiums for ?insurance coverage? provided by a fronting carrier, which reinsures the ?coverage? with the Puerto Rican or other foreign corporation. Despite being labeled as insurance, these arrangements lack many of the attributes of legitimate insurance. Like the micro-captives described above, the characteristics of the purported insurance arrangements typically will include one or more of the following: implausible risks covered (or duplicative coverage of risks already covered by commercial insurance), excessive premiums indicative of non-arm?s length pricing and a lack of business purpose for entering the arrangement.

Where appropriate, the IRS will challenge the purported tax benefits from these types of transactions and impose penalties. The IRS Criminal Investigation Division is always on the lookout for promoters and participants of these types of schemes. Taxpayers should think twice before including questionable arrangements like this on their tax returns. After all, taxpayers are legally responsible for what's on their return, not a promoter making promises and charging high fees. Taxpayers can help stop these arrangements by relying on reputable tax professionals they know and trust.

The IRS warns anyone thinking about using one of these schemes ? or similar ones ? that the agency continues to improve investigation and enforcement in these areas by utilizing new and evolving data analytic tools and enhanced document matching.

Whether anchored offshore or in the U.S., abusive transactions and schemes remain a high priority for the IRS. The IRS Office of Chief Counsel continues to hire additional attorneys to help the agency combat abusive arrangements, including syndicated conservation easements, micro-captive transactions and others.

The IRS also created the Office of Fraud Enforcement (OFE) and Office of Promoter Investigations (OPI) to coordinate service-wide enforcement activities against taxpayers committing tax fraud and promoters marketing and selling abusive tax avoidance transactions and schemes to effectuate tax evasion.

How to report
As part of the Dirty Dozen awareness effort, the IRS encourages people to report individuals who promote improper and abusive tax schemes as well as tax return preparers who deliberately prepare improper returns.

To report an abusive tax scheme or a tax return preparer, people should mail or fax a completed Form 14242, Report Suspected Abusive Tax Promotions or Preparers and any supporting materials to the IRS Lead Development Center in the Office of Promoter Investigations.

Mail:
Internal Revenue Service Lead Development Center
Stop MS5040
24000 Avila Road
Laguna Niguel, California 92677-3405
Fax: 877-477-9135

Alternatively, taxpayers and tax practitioners may send the information to the IRS Whistleblower Office for possible monetary reward.

For more information, see Abusive Tax Schemes and Abusive Tax Return Preparers.

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