IRS Cautions Taxpayers about Common Tax Scams
February 28, 2005
IR-2005-19 (02/28/05)

In an update of an annual consumer alert, the IRS is urging taxpayers to avoid falling victim to one of the “Dirty Dozen” tax scams. IR-2005-19 (02/28/05).
Yesterday, the IRS released its annual listing of notorious tax scams, the “Dirty Dozen,” urging taxpayers to be wary of schemes that promise to eliminate taxes or otherwise sound too good to be true. In the new 2005 ranking, several new scams have reached the top of the consumer watch list, including the manipulation of the laws governing charitable groups, abuse credit counseling services, or relying on refuted arguments to claim tax exemptions. The IRS also warns that it was seeing the continuing spread of identity theft schemes preying on people through e-mail, phone, or the Internet, sometimes with con artists posing as IRS representatives.

The IRS notes that it is pursuing and shutting down promoters of these scams. It cautions taxpayers that anyone pulled into those schemes can face repayment of taxes plus interest and penalties.

OBSERVATION: People who suspect tax fraud can call the IRS at 1-800-929-0433.

The IRS urges people to avoid these common schemes:

• Trust misuse: Promising the reduction of income subject to tax, deductions for personal expenses, and reduced estate or gift taxes, unscrupulous promoters have urged taxpayers to transfer assets into trusts. The IRS warns that some trusts will not deliver the promised tax benefits and that it is examining these arrangements. More than two dozen injunctions have been obtained against promoters since 2001, and numerous promoters and their clients have been prosecuted, the IRS says.

• Frivolous arguments: Promoters have been known to make the following claims: that the Sixteenth Amendment, concerning the congressional power to lay and collect income taxes was never ratified; that wages are not income; that filing and paying taxes is voluntary; and that being required to file a Form 1040 violates the Fifth Amendment right against self-incrimination or the Fourth Amendment right to privacy. Such claims have been repeatedly tossed out of the courts, the IRS cautions.

• Return Preparer Fraud: Dishonest return preparers can cause many headaches. Such examples include preparers skimming a portion of the client’s tax refund, charging inflated fees for return preparation services, or promising large refunds. Taxpayers should choose their return preparer carefully, the IRS says. If it sounds too good to be true, it probably is.

• Credit Counseling Agencies: The IRS warns taxpayers about credit counseling organizations that claim that they can fix credit ratings, push debt payment agreements, or charge high fees, monthly service charges, or mandatory “contributions” that may add to debt. The IRS says that it has made auditing such organizations a priority because these organizations often charge debtors large fees while providing little or no counseling.

• Claim of Right Doctrine: In this scheme, a taxpayer files a return and attempts to take a deduction equal to the entire amount of his or her wages. The promoter advises the taxpayer to label the deduction as necessary expenses for the production of income or compensation for personal services actually rendered. The IRS warns that this so-called deduction is based on a misinterpretation of the Internal Revenue Code and has no basis in law.

• ‘No Gain’ Deduction: Similar to the claim of right doctrine, files attempt to eliminate their entire adjusted gross income (AGI) by deducting it on Schedule A. The filer lists his or her AGI under the Schedule A labeled “Other Miscellaneous Deductions,” and attaches a statement to the return, referring to court documents and including the words, “No Gain Realized.”

• Corporation Sole: In this scheme, participants apply for incorporation under the pretext of being a “bishop” or an “overseer” of a one-person religious organization or society with the idea that this entitles the individual to exemption from federal income taxes as a non-profit, religious organization. While the corporation sole is a legal way for religious leaders to separate themselves from the control and ownership of church assets, promoters have misrepresented to taxpayers that they can use this to avoid paying federal income taxes, child support, and other personal debts, the IRS explains. Since 2001, the IRS cautions that the government has obtained six injunctions against promoters of this scheme and filed complaints against eleven others.

• Identity Theft: The IRS states that taxpayers should be choosy about disclosing personal information. The IRS warns that it has become aware of several identity theft scams involving taxes where perpetrators send taxpayers fictitious correspondence and IRS forms to deceive the taxpayers into disclosing their personal financial data as well as their Social Security number. Last year, the IRS notes, it shut down a scam where taxpayers received e-mails stating that they were under audit from the IRS and that the taxpayers could correct the situation by divulging sensitive financial information on an official-looking Web site. The IRS does not use e-mail to contact taxpayers, the IRS explains. If there are questions about whether an IRS contact is authentic, they may call 1-800-829-1040 to confirm it.

• Abuse of Charitable Organizations and Deductions: There has been an increase in the use of tax-exempt organizations to improperly shield income or assets from taxation, such as moving assets or income to a tax-exempt supporting organization, thereby obtaining a tax deduction without transferring a commensurate benefit to charity. Another example, the IRS states, was a contribution of a historic facade easement to a tax-exempt conservation organization. In many cases, the IRS explains, local historic preservation laws already prohibit the alteration of the home’s facade thereby making the contributed easement useless.

• Offshore Transactions: The IRS is continuing to crack down on individuals illegally hiding income in offshore bank and brokerage services or using offshore credit cards, wire transfers, foreign trusts, employee leasing schemes, private annuities, or life insurance.

• Zero Return: In this scheme, promoters instruct taxpayers to enter all zeros on their federal income tax return, report their withholding, and then write “nunc pro tunc” – Latin for “now and then” – on the return.

• Employment Tax Evasion: The IRS warns taxpayers of illegal schemes that instruct taxpayers not to withhold federal income tax or other employment taxes from wages paid to their employees, based on a variety of arguments, such as an incorrect interpretation of Code Section 861. Employers participating in these transactions will be held responsible for back payments of employment taxes, including penalties and interest, the IRS states.

Other schemes are still extant, the IRS advises. These include slavery reparations, improper home-based deductions, the Americans with Disabilities Act and earned income tax credit dependent sharing.

Home