For more than 20 years, the IRS has released its annual list of potentially abusive arrangements and tax scams that taxpayers should avoid, known as the “Dirty Dozen.” Here is what made it into the 2022 Dirty Dozen:
- Use of Charitable Remainder Annuity Trust (CRAT) to Eliminate Taxable Gain. In these transactions, taxpayers transfer appreciated assets to the CRAT and improperly step up their basis to fair market value. The CRAT sells the property without realizing gain due to the stepped-up basis and uses the sale proceeds to purchase a single premium immediate annuity. However, the beneficiary treats only a small portion of the annuity as income and the rest of the payment is improperly treated as a tax-free return of investment.
- Maltese (or Other Foreign) Pension Arrangements Misusing Treaty. In these situations, U.S. citizens or residents try to avoid U.S. tax by claiming an exemption for earnings and distributions from foreign individual retirement arrangements they contributed to in Malta and other foreign countries where they lack a local connection.
- Puerto Rican and Other Foreign Captive Insurance. U.S. owners of closely held entities, or the entities themselves, may claim a deduction for the cost of “insurance coverage” provided by an insurance arrangement involving a Puerto Rican or other foreign corporation that has cell arrangements or segregated assets plans that the U.S. owner also holds a financial interest in. In these cases, a fronting carrier provides the coverage and reinsures the coverage with the foreign corporation. Look for the following characteristics to spot these types of arrangements: implausible risks covered, non-arm’s-length pricing, and lack of business purpose for entering the arrangement. More information on these transactions is available on the IRS website.
- Monetized Installment Sales. These transactions are often structured in a series of related steps using an intermediary to purportedly sell appreciated property for an installment note. As a result, the seller receives an amount equivalent to the sales price, minus various transactional fees, in the form of a purported loan that is nonrecourse and unsecured. Make sure to consult your tax and legal advisors before entering into any such transactions, as the IRS may assert accuracy-related penalties ranging from 20% to 40%, or a civil fraud penalty of 75% of any underpayment of tax.
- COVID-19 Pandemic-Related Scams. The IRS warns taxpayers that scammers continue to attempt to steal money and identities with bogus emails, social media posts, text messages, and unexpected phone calls. For example, these scams may attempt to contact people about stimulus checks asking you to provide bank account information to receive these checks, or by filing fraudulent claims for unemployment with stolen identity information. Also, look out for fake charities that pressure you to donate, especially if it is by gift card or wiring money. For more information on how to spot these scams, visit the IRS site.
- Offer in Compromise (OIC) “Mills.” Taxpayers should be cautious with companies claiming they can settle your tax debt for pennies on the dollar. You’re likely to get the same offer to settle a tax debt if you work directly with the IRS as you would going through one of these “mills,” which often charge excessive fees. You also should watch out for ghost tax preparers who offer to prepare your return but won’t sign it as the paid preparer, as well as preparers who promise a big refund or charge fees based on the size of the refund.
- Suspicious Communications Designed to Either Trick, Surprise, or Scare Someone into Responding Before Thinking. Some common scams the IRS continues to see include text messages with bogus links claiming to be IRS websites or online tools; email phishing scams (the IRS will never initiate contact by email); and phone scams warning that if you don’t call back, a warrant will be issued for your arrest (the IRS does not leave prerecorded, urgent, or threatening messages).
- Spear Phishing Attacks. This one is for tax professionals, who may receive emails attempting to steal their software preparation credentials. The goal is to access client data and the identities of the tax preparers employed by the firm in order to file fraudulent returns and obtain tax refunds. However, these phishing scams also may target other business organizations, so make sure your employees are up to date on how to spot a phishing email!
The final four items on the list include scams targeting high-net-worth individuals who are looking for ways to avoid paying taxes: concealing assets in offshore accounts and improper reporting of digital assets; high-income individuals who don’t file tax returns; abusive syndicated conservation easements; and abusive micro-captive insurance arrangements.
The purpose of the Dirty Dozen list is to put taxpayers on alert against potential scams, as well as bring taxpayer awareness to transactions that the IRS may be paying extra attention to when reviewing tax returns. In general, if it seems too good to be true, it probably is, and you should consult a trusted tax advisor and legal counsel if you think you’re potentially a target of any of these potentially abusive transactions.
If you have any questions, reach out to a professional at FORVIS or submit the Contact Us form below.