When Is a Tax Shelter Considered “Abusive?” An Experienced Texas IRS Lawyer Explains
The Internal Revenue Service (IRS) targets high-income and high-net-worth taxpayers who use “abusive” tax shelters to evade federal income tax liability. However, there often is a fine line between using an abusive tax shelter and engaging in strategic tax planning. As a result, many audits and investigations targeting allegedly abusive tax shelters are misguided, and avoiding unwarranted liability in these cases is a matter of working with an experienced Texas tax attorney to demonstrate compliance with the Internal Revenue Code.
Of course, this is often easier said than done. High-income and high-net-worth tax planning strategies can be extremely complex, and when in doubt, revenue agents will typically err on the side of non-compliance. With this in mind, it is important for taxpayers who use these strategies to be aware of the risks involved and to rely on their counsel to proactively generate the documentation they need to withstand scrutiny from the IRS if necessary.
Examples of Tax Shelters Commonly Targeted By the IRS
When can high-income and high-net-worth taxpayers face scrutiny related to their alleged use of abusive tax shelters? Here are some examples of tax shelters commonly targeted by the IRS:
Intercompany Financing and Transactions
The IRS closely scrutinizes intercompany financing arrangements and other transactions between related business entities. While these are not inherently unlawful—and these types of arrangements and transactions can serve a variety of legitimate tax-related and non-tax-related purposes—the IRS views them as presenting a high risk of fraud. As with other types of tax planning strategies, when used for tax planning purposes, thorough documentation is essential for avoiding (or withstanding, if necessary) scrutiny from the IRS in relation to all types of intercompany transactions.
Loss Importation Transactions
The IRS also pays close attention to transactions that it classifies as “loss importation transactions.” These are transactions “in which a U.S. taxpayer uses offsetting positions with respect to foreign currency or other property for the purpose of importing a loss, but not the corresponding gain, in determining U.S. taxable income.” As discussed below, this is just one example of many types of cross-border transactions that can raise fraud concerns at the IRS.
Offshore Accounts and Other Foreign Holdings
Along with loss importation transactions, the IRS classifies many other transactions and structures involving foreign holdings as abusive tax shelters as well. These include undisclosed offshore accounts, undisclosed interests in foreign businesses and foreign tax credit transactions, among many others. Offshore disclosure compliance is an enforcement priority for the IRS generally, and, when combined with concerns about potential tax fraud, taxpayers’ offshore holdings can trigger invasive IRS audits.
Syndicated Conservation Easements
Syndicated conservation easements have garnered attention from the IRS in recent years due to the aggressive promotion of syndicated conservation easements that violate the Internal Revenue Code. However, syndicated conservation easements are not inherently unlawful—and many high-income and high-net-worth taxpayers use them as tools for tax mitigation. Once again, thorough documentation is critical, and for taxpayers who have been approached by promoters, it is important to consult with a Texas IRS lawyer who can ensure that your tax mitigation strategy is fully compliant.
Trust Arrangements
The IRS classifies various types of trust arrangements as potential abusive tax shelters—though, here too, these arrangements are frequently used for lawful tax planning purposes. Some examples of trust arrangements that are likely to trigger scrutiny from the IRS include:
- Cash-Value Life Insurance Trusts
- Charitable Remainder Trusts
- Contested Liability Trusts
- Distressed Asset Trusts
- Guam Trusts
Again, these are just examples. When using trusts for tax planning purposes, high-income and high-net-worth taxpayers should consult with their counsel to ensure that they are not setting themselves up for exposure to liability for back taxes, interest and penalties. At Brown, P.C., we both work with taxpayers to help them affirmatively establish compliance and defend their tax planning strategies to the IRS when necessary. As a result, if you have questions about using trusts for tax planning purposes or if you are facing an IRS audit related to your strategic use of tax planning trusts, we encourage you to contact us promptly for more information.
Potential Red Flags for Abusive Tax Shelters (According to the IRS)
While the IRS is prioritizing enforcement in cases involving high-income and high-net-worth taxpayers’ use of abusive tax shelters, it simply doesn’t have the resources to identify and audit all concerning entity structures, trusts, offshore holdings and transactions. As a result, to determine how best to deploy its resources, the IRS focuses on a variety of “red flags” for abuse. These include (but are not limited to):
- Using Tax Shelters that Are Commonly the Subject of Fraudulent Promotion Schemes
- Using Complex Transactions, Trust Arrangements and Corporate Structures to Shift Basis in Appreciated or Depreciated Assets
- Shifting Gains or Losses Between Related Entities
- Claiming Substantial Losses or Tax Benefits Not Claimed in Prior Tax Years
- Lack of Substantiation Made Available to the IRS
Here, too, these are just examples. Additionally, while the IRS generally views these as red flags for abusive tax shelters, none of these are inherently indicative of fraud. As a result, regardless of the circumstances or allegations at hand, high-income and high-net-worth taxpayers accused of leveraging abusive tax shelters can—and should—engage an experienced Texas tax attorney to interface with the IRS on their behalf. At Brown, P.C., we regularly represent clients in these types of matters, and we can use our experience to help ensure that you are not unfairly penalized for engaging in strategic tax planning.
Request an Appointment with a Texas Tax Attorney at Brown, P.C.
Do you need to know more about the IRS’ ongoing efforts to target high-income and high-net-worth taxpayers’ use of tax shelters? If so, we can help, and we invite you to get in touch. To request an appointment with an experienced Texas tax attorney at Brown, P.C., please call 888-870-0025 or contact us confidentially online today.