The IRS recently released its 2023 “Dirty Dozen” tax avoidance and fraud list consisting of nine consumer-targeted fraud schemes and three categories carried over from 2022.
Employee Retention Credit. The ERC is a refundable tax credit designed for businesses that closed during COVID-19 but still paid their employees or that had a significant decline in gross receipts during the eligibility periods. It’s not available to individuals, and employers cannot claim it on wages reported as payroll costs in obtaining Paycheck Protection Program loan forgiveness.
The IRS warns that ERC promoters are not describing eligibility limits and are often collecting personal information.
Smishing and Phishing. Taxpayers receive unsolicited communications through text message (smishing) or email (phishing) that appear to be from legitimate organizations, including the IRS. The IRS never initiates contact by email, text, or social media.
IRS Account Assistance. Scammers offer to assist a taxpayer in creating an IRS account and instead use the information to file fraudulent tax returns, steal refunds, obtain loans, and open credit accounts.
Fuel Tax Credits. This credit is only available for off-highway businesses and farms. However, the IRS has seen an increase in claims on Form 4136, “Credit for Federal Tax Paid on Fuels.” Preparers and promoters earn inflated preparation fees by convincing ineligible taxpayers to claim the credit.
Fake Charities. Illegitimate charities often take advantage of the public’s generosity in the wake of emergencies and natural disasters by seeking money and personal information.
Tax Return Preparation. Taxpayers should watch their return preparer for warning signs, including:
• charging a fee based on refund size;
• requesting cash payment with no receipt;
• inventing false income to claim tax credits;
• claiming false deductions to increase refunds;
• directing refunds into their own bank accounts; and
• refusing to include their signature or preparer tax identification number on the return.
Taxpayers should never sign a blank or incomplete return and can report misconduct on Form 14157, “Complaint: Tax Return Preparer.” Taxpayers who suspect that a preparer filed or changed their return without their consent can file Form 14157-A, “Tax Return Preparer Fraud or Misconduct Affidavit.”
Fraudulent Forms and Advice. Social media circulates hashtags and tax topics that frequently involve using a legitimate tax form for the wrong purpose, such as encouraging people to use tax software to create false forms W-2 or 8944.
Spearphishing is a tailored phishing email to tax professionals and businesses. It tries to steal client data, tax software preparation credentials, and tax preparer identities to obtain fraudulent refunds. The email may use the IRS logo, claim that an account has been put on hold, and urgently ask the recipient to click links or input or verify information. The messages may impersonate a potential client, include a malicious attachment or URL, or target employees in payroll or accounting departments.
Offer in Compromise Mills. These mills place local ads making misleading claims that they can settle a tax debt for pennies on the dollar.
Fraud Aimed at High-Income Filers
Charitable Remainder Annuity Trust (CRAT). Taxpayers transfer appreciated property to a CRAT and claim a step-up in basis to fair market value as if the assets had been sold to the CRAT. The CRAT sells the assets but does not recognize gain because it relies on the step-up. The CRAT then uses the proceeds to purchase a single premium immediate annuity.
The beneficiary includes in income only a small portion of the annuity proceeds and treats the remainder as a tax-free return on investment.
Monetized Installment Sales. These involve the use of the section 453 installment sale rules by a property seller who effectively receives the sale proceeds through loans in the year of the sale.
The seller enters into a contract to sell appreciated property to a buyer for cash and then sells the same property to an intermediary in return for an installment note. The intermediary then sells 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 transactional fees in the form of a nonrecourse unsecured loan and reports the transaction as an installment sale.
Abusive Tax Avoidance
Microcaptive Insurance Arrangements. A microcaptive is an insurance company whose owners elect to be taxed on the captive’s investment income only. Abusive microcaptives involve schemes that lack many of the attributes of legitimate insurance. These structures often include implausible risks, failure to match genuine business needs, and, in many cases, unnecessary duplication of the taxpayer’s commercial coverages.
Syndicated Conservation Easements. Promoters sell ownership interests in land to investors through partnerships and then grant conservation easements on the land to qualified charitable or government organizations. By using inflated appraisals of real estate assets, like undeveloped land or historic building facades, the arrangements inflate tax deductions and generate fees for promoters.
Offshore Accounts and Digital Assets. Individuals evade U.S. tax by hiding income in offshore banks, brokerage accounts, or nominee entities. The funds are accessed using debit and credit cards, wire transfers, or other arrangements.
Treaty Pension Benefits. U.S. citizens and residents make contributions to foreign individual retirement arrangements in Malta (or other foreign countries). The individual typically lacks a local connection, local law allows contributions of assets other than cash, or local law does not limit the amount of contributions by reference to income earned from employment or self-employment activities.
By treating the foreign retirement arrangement as a pension fund under a tax treaty, the U.S. taxpayer claims an exemption from U.S. tax on the arrangement’s earnings and distributions.
Foreign Captive Insurance. U.S. owners of closely held entities participate in a purported insurance arrangement with a Puerto Rican or other foreign corporation that has cell arrangements or segregated asset plans in which the U.S. owner has a financial interest.
The U.S. individual or entity claims deductions for the cost of insurance coverage provided by a fronting carrier, which reinsures the coverage with the foreign corporation.