The IRS recently released the start of the 2022 version of its “Dirty Dozen” list. The Dirty Dozen discusses a number of potentially abusive arrangements that taxpayers should avoid.
Keeping an eye on this list is important for any taxpaying individuals or small businesses who want to avoid getting caught up in trouble with the federal government or any of its agencies.
To get critical advice on avoiding these costly issues, reach out to the Dual Licensed Tax Attorneys and CPAs at the Tax Law Offices of David W. Klasing. You can reach us by calling our offices at (800) 681-1295 or by visiting the contact us page of our website to book a reduced rate initial consultation.
What is the IRS’ Dirty Dozen List?
Topics covered in the Dirty Dozen are usually forms of transactions that are wrongfully promoted, induce noncompliance, and will attract additional agency compliance efforts in the immediate future. The first four abusive transactions covered in this release involve charitable remainder annuity trusts, Maltese individual retirement arrangements, foreign captive insurance, and monetized installment sales.
“Taxpayers should stop and think twice before including these questionable arrangements on their tax returns,” said IRS Commissioner Chuck Rettig. “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 they can trust.”
The four potentially abusive transactions on the list are the first four entries in this year’s Dirty Dozen series. In the near future, the IRS will release additional information about their focus on eight additional scams, with some focused on the average taxpayer and others focused on more complex arrangements that promoter’s market to higher-income individuals.
Through publishing the list, the IRS hopes to warn taxpayers to watch out for certain schemes, many of which are currently promoted online, that promise tax savings that are too good to be true and will likely cause taxpayers to fall out of compliance. Taxpayers, tax professionals, and financial institutions must be especially vigilant and watch out for all sorts of scams from simple emails and calls to highly questionable but enticing online advertisements.
First Four Items on the IRS’ 2022 Dirty Dozen List
While this list is not an exclusive list of transactions the IRS is scrutinizing, it represents some of the more common trends and transactions that may peak during filing season as returns are prepared and filed. While the rest of the list’s members will be determined and announced later, the first four on the “Dirty Dozen” list are described below.
Use of Charitable Remainder Annuity Trust to Eliminate Taxable Gain
In this transaction, appreciated property is transferred to a Charitable Remainder Annuity Trust (CRAT). Taxpayers improperly claim the transfer of the appreciated assets to the CRAT in and of itself gives those assets a step-up in basis to fair market value as if they had been sold to the trust. The CRAT then sells the property but does not recognize gain due to the claimed step-up in basis. The CRAT then uses the proceeds to purchase a single premium immediate annuity (SPIA). The beneficiary reports, as income, only a small portion of the annuity received from the SPIA. Through a misapplication of the law relating to CRATs, the beneficiary treats the remaining payment as an excluded portion representing a return of investment for which no tax is due.
Maltese (or Other Foreign) Pension Arrangements Misusing Treaty
In these transactions, U.S. citizens or residents attempt to avoid taxes by making contributions to certain foreign individual retirement arrangements in Malta (or possibly other foreign countries). In these transactions, the individual typically lacks a local connection, and local law allows contributions in a form other than cash or does not limit the amount of contributions by reference to income earned from employment or self-employment activities. By improperly claiming that the foreign arrangement is a “pension fund,” the U.S. taxpayer misconstrues the foreign tax treaty to improperly claim an exemption.
Puerto Rican and Other Foreign Captive Insurance
In these transactions, U.S owners of closely held entities participate in a purported insurance arrangement with a Puerto Rican or other foreign corporation with cell arrangements or segregated asset plans in which the U.S. owner has a financial interest. The U.S. based individual, or entity claims deductions for the cost of “insurance coverage” provided by a fronting carrier, which reinsures the “coverage” with the foreign corporation. The characteristics of the purported insurance arrangements typically will include one or more of the following: implausible risks covered, non-arm’s-length pricing, and lack of business purpose for entering into the arrangement.
Monetized Installment Sales
These transactions involve the inappropriate use of the installment sale rules under section 453 by a seller who, in the year of a sale of property, effectively receives the sales proceeds through purported loans. In a typical transaction, the seller enters into a contract to sell appreciated property to a buyer for cash and then purports to sell the same property to an intermediary in return for an installment note. The intermediary then purports to sell the property to the buyer and receives the cash purchase price. Through a series of related steps, the seller receives an amount equivalent to the sales price, less various transactional fees, in the form of a purported loan that is nonrecourse and unsecured.
How to Avoid Heightened IRS Scrutiny
The IRS has shown a renewed commitment to developing a strong tax enforcement presence that will help boost voluntary compliance in all taxpayers. The federal government’s tax watchdog has a variety of means to find potentially abusive transactions, including examinations, promoter investigations, whistleblower claims, data analytics and reviewing marketing materials.
Taxpayers who have engaged in any of these transactions or who are contemplating engaging in them should carefully review the underlying legal requirements and consult independent, competent advisors before claiming any purported tax benefits. Taxpayers who have already claimed the purported tax benefits of one of these four transactions on a tax return should consider taking corrective steps, such as filing an amended return with the help of a seasoned Tax Lawyer and CPA.
Concerned About IRS Enforcement Action? Call the Tax Law Offices of David W. Klasing
Call the Dual Licensed Tax Attorneys and CPAs at the Tax Law Offices of David W. Klasing today at (800) 681-1295 or click here to schedule your first reduced-rate case evaluation.
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