There is no crime in arranging financial affairs to keep taxes as low as possible. So, when does a tax shelter cross the line between tax avoidance and tax evasion?
Tax preparers, Certified Public Accountants (CPAs), investment advisors, and attorneys must know the difference between legitimate and abusive tax shelters or risk penalties for “promoting” abusive transactions. The IRS has put practitioners on notice that tax strategies that have no economic purpose are typically illegal and may be punished with fines, penalties, and even imprisonment. In fact, two new IRS offices are actively investigating tax shelter transactions: the Office of Promoter Investigations and The Office of Fraud Enforcement.
What To Do if You Get an IRS Notice or Letter as a Tax Preparer
If you get an IRS notice or letter, review it with a tax controversy attorney. If the information the IRS provided is incorrect, you can dispute the penalty or request a refund. Sometimes, you can easily correct the problem with the IRS in writing about and avoid a penalty.
Your tax litigation attorney can advise you on the best course of action.
What Is an Abusive Tax Shelter?
Abusive tax shelters are a form of tax evasion. They have no economic purpose other than to reduce taxes. Unlike legitimate tax shelters, like deferring income, saving for retirement, or changing your tax status, abusive tax shelters do not change the value of income or assets.
The IRS does not have a clear definition of what constitutes an abusive tax shelter. Rather, the agency asks questions to determine a transaction’s economic purpose.
A transaction may be an abusive tax shelter if:
- The tax benefits far outweigh the economic benefits
- The transaction involves an exchange of assets, goods, or services that are below fair market value
- The interest rate paid to another party is unusually low or high
- You would not seriously consider the transaction if you hoped to make a profit
- The shelter assets are not insured
- Profits and losses cannot be justified
Common abusive tax shelters include debt straddles, foreign trusts, sale-leaseback transactions, and basket option contracts.
What Are the Penalties for Promoting Abusive Tax Shelters?
The IRS calculates tax preparer penalties based on the regulations allegedly violated, the number of alleged violations, and the rates of inflation for the tax years involved.
For people who organize or sell abusive tax shelters, the penalties depend on their conduct:
- If you make false statements about a transaction’s tax benefits, you will owe 50% of the gross income you made for the activity.
- If you provide a gross valuation overstatement, you will owe 100% of the gross income you made from the arrangement or $1,000 – whichever is less.
- Each abusive tax shelter you promote is considered a different transaction or financial activity.
Promoting an abusive tax shelter can also result in an investigation and discipline from the IRS Office of Professional Responsibility (OPR).
How To Dispute a Tax Preparer IRS Penalty
If the information you receive in your IRS notice or letter is not correct, or you don’t agree, you can request a refund or dispute the penalty. From there, the IRS will consider your request and approve or reject it.
If the IRS rejects your request to remove a penalty, you can request an appeals conference or hearing. Keep in mind that you only have 30 days from the date of the rejection letter to file an appeal.
Throughout the dispute process – and especially during your appeals conference or hearing – you should have a tax attorney represent you.
Think Twice Before Signing
Both taxpayers and tax preparers accept responsibility by signing a tax return. If you are unsure of a transaction, always have it reviewed by a tax attorney or another trusted tax professional before signing.
Hendershot Cowart P.C. represents tax practitioners as well as taxpayers in civil tax controversies. If you find yourself on the receiving end of a letter from the IRS, contact our tax litigation law firm today. We can review the letter in a consultation and advise you on the best strategy to dispute or defend the allegations.
We have more than 100 years of collective experience helping business owners and executives in all industries navigate their legal concerns, including tax issues. Our firm values lifelong relationships, and we want to be your law firm for life.
For an IRS defense strategy designed to protect your best interests, please call us at (713) 909-7323 or contact us online today.