Fraudulent Telephone Tax Refunds, Abusive Roth IRAs Top Off 2007 “Dirty Dozen” Tax Scams

IR-2007-37, Feb. 20, 2007

WASHINGTON –– The Internal Revenue Service today identified 12 of the most blatant scams affecting American taxpayers and warned people not to fall for schemes peddled by scamsters.

This year the “Dirty Dozen” highlights five new scams that IRS auditors and criminal investigators have uncovered. Topping off the list are fraudulent refunds being claimed in connection with the special Telephone Excise Tax Refund available to most taxpayers this filing season. The IRS is actively investigating instances of this scam involving tax preparers who are preparing inflated refund requests.

Also new to the Dirty Dozen this year are abuses pertaining to Roth IRAs, the American Indian Employment Credit, domestic shell corporations and structured entities.

“Taxpayers shouldn’t let their guard down,” IRS Commissioner Mark W. Everson said. “Don’t get taken by scam artists making outrageous promises. If you use a tax professional, pick someone who is reputable. Taxpayers should remember they are ultimately responsible for what is on their tax return even if some unscrupulous preparers have steered them in the wrong direction.”

Involvement in tax schemes leads to problems for scam artists and taxpayers. Tax return preparers and promoters risk significant penalties, interest and possible criminal prosecution.

The IRS urges taxpayers to avoid these common schemes:

1. Telephone Excise Tax Refund Abuses: Early filings show some individual taxpayers have requested large and apparently improper amounts for the special telephone tax refund. In some cases, taxpayers appear to be requesting a refund of the entire amount of their phone bills, rather than just the three-percent tax on long-distance and bundled service to which they are entitled. Some tax preparers are helping their clients file apparently improper requests. The IRS is investigating potential abuses in this area and will take prompt action against taxpayers who claim improper refund amounts and against the return preparers who help them.

2. Abusive Roth IRAs: Taxpayers should be wary of advisers who encourage them to shift under-valued property to Roth Individual Retirement Arrangements (IRAs). In one variation, a promoter has the taxpayer move under-valued common stock into a Roth IRA, circumventing the annual maximum contribution limit and allowing otherwise taxable income to go untaxed.

3. Phishing is a technique used by identity thieves to acquire personal financial data in order to gain access to the financial accounts of unsuspecting consumers, run up charges on their credit cards or apply for loans in their names. These Internet-based criminals pose as representatives of a financial institution –– or sometimes the IRS itself –– and send out fictitious e-mail correspondence in an attempt to trick consumers into disclosing private information. A typical e-mail notifies a taxpayer of an outstanding refund and urges the taxpayer to click on a hyperlink and visit an official-looking Web site. The Web site then solicits a social security and credit card number. It is important to note the IRS does not use e-mail to initiate contact with taxpayers about issues related to their accounts. If a taxpayer has any doubt whether a contact from the IRS is authentic, the taxpayer should call 1-800-829-1040 to confirm it.

4. Disguised Corporate Ownership: Domestic shell corporations and other entities are being formed and operated in certain states for the purpose of disguising the ownership of the business or financial activity. Once formed, these anonymous entities can be, and are being, used to facilitate underreporting of income, non-filing of tax returns, listed transactions, money laundering, financial crimes and possibly terrorist financing. The IRS is working with state authorities to identify these entities and to bring their owners into compliance.

5. Zero Wages: In this scam, which first appeared in the Dirty Dozen in 2006, a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 showing zero or little income is submitted with a federal tax return. The taxpayer may include a statement rebutting wages and taxes reported by the payer to the IRS. An explanation on the Form 4852 may cite statutory language behind Internal Revenue Code sections 3401 and 3121 or may include some reference to the paying company refusing to issue a corrected Form W-2 for fear of IRS retaliation.

6. Return Preparer Fraud: Dishonest return preparers can cause many headaches for taxpayers who fall victim to their schemes. Such preparers make their money by skimming a portion of their clients’ refunds and charging inflated fees for return preparation services. They attract new clients by promising large refunds. Some preparers promote filing fraudulent claims for refunds on items such as fuel tax credits to recover taxes paid in prior years. Taxpayers should choose carefully when hiring a tax preparer. As the old saying goes, “If it sounds too good to be true, it probably is.” Remember that no matter who prepares the return, the taxpayer is ultimately responsible for its accuracy. Since 2002, the courts have issued injunctions ordering dozens of individuals to cease preparing returns, and the Department of Justice has filed complaints against dozens of others. During fiscal year 2006, 109 tax return preparers were convicted of tax crimes and sentenced to an average of 18 months in prison.

7. American Indian Employment Credit: Taxpayers submit returns and claims reducing taxable income by substantial amounts citing an American Indian employment or treaty credit. Although there is an Indian Employment Credit available for businesses that employ Native Americans or their spouses, there is no provision for its use by employees. In a somewhat similar scam, unscrupulous promoters have informed Native Americans that they are not subject to federal income taxation. The promoters solicit individual Indians to file Form W-8 BEN seeking relief from all withholding of federal taxation. A recent “phishing” variation has promoters using false IRS letterheads to solicit personal financial information that they claim the IRS needs in order to process their "non-tax" status.

8. Trust Misuse: For years unscrupulous promoters have urged taxpayers to transfer assets into trusts. They promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. However, some trusts do not deliver the promised tax benefits. There are currently more than 150 active abusive trust investigations underway and 49 injunctions have been obtained against promoters since 2001. As with other arrangements, taxpayers should seek the advice of a trusted professional before entering into a trust.

9. Structured Entity Credits: Promoters of this newly identified scheme are setting up partnerships to own and sell state conservation easement credits, federal rehabilitation credits and other credits. The purported credits are the only assets owned by the partnership and once the credits are fully used, an investor receives a K-1 indicating the initial investment is a total loss, which is then deducted on the investor’s individual tax return. Forming such an entity is not a viable business purpose. In other words, the investments are not valid, and the losses are not deductible.

10. Abuse of Charitable Organizations and Deductions: The IRS continues to observe the use of tax-exempt organizations to improperly shield income or assets from taxation. This can occur when a taxpayer moves assets or income to a tax-exempt supporting organization or donor-advised fund but maintains control over the assets or income. Contributions of non-cash assets continue to be an area of abuse, especially with regard to overvaluation of contributed property. In addition, the IRS is noticing the return of private tuition payments being disguised as charitable contributions to religious organizations.

11. Form 843 Tax Abatement: This scam rests on faulty interpretation of the Internal Revenue Code. It involves the filer requesting abatement of previously assessed tax using Form 843. Many using this scam have not previously filed tax returns and the tax they are trying to have abated has been assessed by the IRS through the Substitute for Return Program. The filer uses the Form 843 to list reasons for the request. Often, one of the reasons is: "Failed to properly compute and/or calculate IRC Sec 83-Property Transferred in Connection with Performance of Service."

12. Frivolous Arguments: Promoters have been known to make the following outlandish claims: the Sixteenth Amendment concerning congressional power to lay and collect income taxes was never ratified; wages are not income; filing a return and paying taxes are merely voluntary; and being required to file Form 1040 violates the Fifth Amendment right against self-incrimination or the Fourth Amendment right to privacy. Don’t believe these or other similar claims. These arguments are false and have been thrown out of court. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law.

IRS Still Watches Scams That Fall Off the List

Five of last year’s Dirty Dozen tax scams rotated off the list for 2007. While the IRS has seen a decline in the occurrence of some of these scams –– abusive credit counseling agencies, for example –– other problems, such as offshore abusive transactions continue to be an area of particular concern for the agency. The absence of a particular scheme from the Dirty Dozen should not be taken as an indication that the IRS is unaware of it or not taking steps to counter it.

How to Report Suspected Tax Fraud Activity

Suspected tax fraud can be reported to the IRS using IRS Form 3949-A, Information Referral. Form 3949-A is available for download from the IRS Web site at IRS.gov, or by mail by calling 1-800-829-3676. The completed form or a letter detailing the alleged fraudulent activity should be addressed to the Internal Revenue Service, Fresno, CA 93888. The mailing should include specific information about who is being reported, the activity being reported, how the activity became known, when the alleged violation took place, the amount of money involved and any other information that might be helpful in an investigation. The person filing the report is not required to self-identify, although it is helpful to do so. The identity of the person filing the report can be kept confidential. The person may also be entitled to a reward.

My question is: US-specific

QUESTION: We have property in Birch Bay Village ( a building lot) We are
thinking of selling. Is this the right time or should we wait another
year.Birch Bay Village is a gated community.

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david ingram replies:

The first time I was asked about selling Birch Bay Village lots was back in
1969.

Then a Friend Ed Keate wrote a wonderful witty book called "Land, Land,
Loverly Land" which was a blatant push for Canadians to buy land in Whatcom
county. I have likely prepared 300 or more tax returns for Canadians who
have bought and sold down there and done okay. Another 100 have lost their
shirts, usually when they bought in Sudden Valley which just sat there and
sat there and sort of compares to Canada's Hemlock Valley.

Should you hold or sell now? I haven't got a clue. The prices there are
always an anomaly to me.

I was down at one of the other developments three weeks ago and amazed at
the recent price spike.

If you have a better use for the money, sell and use it. If you do not have
a specific or better use of the money hold on.

QUESTION:

Is there any estate tax implication for an inheritence for a Mexican citizen
who has permanent resident status in Canada?

--------------------------
david ingram replies:

There is no Canadian Tax on the inheritance received.

If the inheritance arose in Canada, any capital gains tax or tax on RRSP or
pension amounts are paid by the estate of the deceased person.

Canada does not have an inheritance or estate tax although we do have an
estate tax return.

QUESTION:

Hello,

We currently have our primary residence in Ontario, have a rental property
in California and likely to move to Australia within 6 months. We moved back
to Canada not too long ago after many years away.

What would you advice we do to minimise taxes all round ? E.g. (1) Would it
be a good idea to rent our house in Canada instead of selling it ? We have
not decided where or when we'll be retiring.(2) Keep or sell the rental
property in California ?

Would appreciate any advice you may have for us. Thanks in anticipation.

=========================---------
david ingram replies:

I just hung up from talking to a lady client who had moved back into their
Vancouver Condo after stints in two other cities. When she left she really
wanted to sell the condo and I talked her out of it.

She was quite happy to move back in with its value doubled. If she had sold
Vancouver and bought in the other places, she could not have afforded the
buy back in Vancouver.

Tax should be the least of your worries. You should be keeping both of your
houses unless you absolutely need the money for your Australian venture. If
the intent is to stay in Australia, then you should be buying there sooner
rather than later.

I would suggest that over time, the Ontario property will not do as well as
the California property but it really depends upon "where" in Ontario and
"where" in California.

As an example A Harbour Castle Condo On the water at the foot of Yonge
Street) in Toronto will almost certainly do better than a Riverside condo in
California.

If you can keep them both, keep them both. In the long run they will
appreciate and if you do decide to return to either place, there is a home
waiting for you at today's cost.

You will keep on filing 1040NR and 540NR returns for California and a
Section 216(4) rental return for Canada.

Minimizing taxes is not the aim - preservation of capital and future worth
is / should be the goal.

QUESTION: Hi David,

As per your November 2001 CENTA newsletter my husband and I are going to
deduct interest on accumulated rental expenses on our two rental properties,
one of which I own and the other that he owned prior to our marriage. As
well we wish to borrow money to invest in real estate and well as other
ventures together. I share a line of credit with my husband that we will use
solely for investment purposes. My question is how should we allocate the
tax deductible interest expenses between the both of us when we do our
seperate tax returns since there is only one line of credit. Are we better
off splitting up the line of credit into two accounts or can we allocate the
deductions between the both of us in some kind of manner?

Thanks,
ccccccccc

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david ingram replies:

You should likely get a Manulife Line of Credit which can be divided into 5
separate expense portions. That solves the question in two ways because you
can apportion your share and his share and keep them properly segregated.
If you do not do this, I suggest two lines of credit. One for yourself and
one for your husband. If the bank is unhappy for some reason, you can
cop-sign each other's loan. For MANULIFE information, call Stuart Rodger at
(604) 351-6133. You can also hear Stuart as a guest on Fred Snyder's Sunday
morning radio program "ITS YOUR MONEY" from 9 to 10:30 AM.

I will be a guest myself this next Sunday as I appear on the last Sunday of
every month.

Dear Experts:

In 2006 I am a returning to Canada citizen to settle, I started in Ottawa, ON. registered a Masters Business License as sole Proprietor in carpentry, but I worked as a carpenter exclusively for another local Construction Co. (Renovations) who when they paid, paid me with out any deductions. After three months I relocated to Nova Scotia & began work exclusively for a Security Co. with deductions until today. I have done nothing else with the my registered (Sole Proprietor) in Ottawa, in conclusion, half my income for 2006, (renovations) not Taxed & the other (Security Co,) Taxed. I received a T4 from (Security), nothing from (Renovations) My question is; do I receive something from (Renovations)and how & what forms do I use to file taxes?

Thanks
__________________________________________________________________________
david ingram replies:

Welcome home.

The renovation company should have issued a T4A slip showing the gross income they paid you but if they did not, you are still responsible to report the income. Usually, you would use form 2024 or 2032 and report the self employed income on line 135 on form 2024 if you consider it to be a business or line 137 on form 2032 if you consider it to have been a profession (master finishing carpenter for instance).

The proprietorship registration is the name you should use as the business name.

The employment income would go on line 101 on page 2 of the T1 Canadian retrurn.

My question is: Canadian-specific

QUESTION: Hi,
If we buy a fixer-upper to renovate and flip without renting it out what are the allowable expenses for deductions?
Thanks

____________________________________________________________________
david ingram replies:

In general anything you spend to do the fixing is a deduction from the final sale profit. This would include but is not limited to:

materials, subcontractors, legal, accounting, real estate commissions, surveyors, appraisals, interest on the mortgage, interest on a building loan, interest on material loans (maybe because you used a credit card to buy), truck expenses to get supplies and transport tools, afvertising, utilities, photography, landscaping, trash removal, dumping fees, building permits, architects fees, engineering fees, home inspection fees, insurance, helpers, etc.

Remember that any profit is taxable at straight income rates on line 135. Flipping or renovating does NOT create capital gains tax. The following older Questions will explain that a bit.

______________________________________________________________________
DAVID

A "friend" who is a BC realtor and has the flipping question presented to her
from time to time recently attended a seminar that was related to this
subject. As a result she was able to provide me with some interesting
thoughts to ponder concerning "intent" and "professional background" when it comes to "flipping houses"
and tax in Canada. You may possibly be looked at as a Developer all the
subsequent implications.

Read the full article at <http://tax.centa.com/comment.php?mode=view&cid=8>;

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david ingram replies:

In Canada, the purchase and sale of any piece of real estate with or without
renovations is considered a sale and subject to straight income tax unless:

1. It was bought for and clearly used as your personal residence and was
intended to be used for an indefinite period of time which is usually in the
five to ten year range.

2. It was bought as and used as a recreational property

3. It was bought for the purposes of earning long term rental income.

In the case number 1, there is no tax.

In the case of numbers 2 and 3, the sale is treated as a capital gain and
only fifty per cent of the profit is taxed at your regular tax rates.

Lots of / many (anyone caught) are taxed full tax rates when they buy a
house, move in, fix it up and sell it a year or two later and then do
another one.

Of course, most are NOT caught in these circumstances.

However, "any" flip is going to be straight income unless the person can
prove that they bought it to live in and then:

* married a person with three children and it is not big enough (had to sell
and bought bigger)

* were transferred to another city (had to sell to buy in new city)

* lost their job, were injured, etc. and can no longer afford to move in. In
this case, they would have to show that they had the finances to have paid
for it when they bought it. (Not only can they not afford it but they have
moved into their parents' basement (boomeranged).

* Inherited a house from their parents and do not need it any more. (are
living in the new house)

You can read more by going to www.centa.com - click on tax guide in the top
left hand corner and then click on the "capital gain" section.

david

This older q & A also gives an idea

My daughter is closing on a presale Yaletown condominium this summer. She
is working until Christmas in Alberta. She returns to Vancouver from Jan to
May and if the job becomes a full time position, then she may return to
Alberta to live. At the time of presale, February 2004, we thought that the
suite would be assigned to her and that she would live in the suite.

I was hoping that she could declare the suite as her permanent residence
since she is only renting in Alberta and the work is not permanent. In
May 2007, she could decide to keep or sell the suite.

What does she need to do in order to qualify the suite as her permanent
residence?

-----------------------------------------

david ingram replies:

There is no absolute answer because you can call a toad a frog all day long
but it is still a toad.

To be a principal residence and tax free for income tax purposes, the
property must have been bought by her to live in and she HAS TO move into
it. - No exceptions that I know of.

You can expect that the CRA will be looking at "every" quick resale in EVERY
downtown building.

In deciding if it is a capital gain or a flip, the CRA will be looking at
the suitability of the unit as a residence, the ability to pay for the unit
and past and even future performance.

In other words if she claimed this one as a principal residence and then did
it again a year later, the CRA would have every right to go back and
reclassify the first one.

QUESTION: If I borrow money from my professional corporation, do I have to report this amount as part of my income and pay personal income tax on that amount, or do I only pay corporate tax after I return the amount to the corporation. Thank you.

___________________________________
david ingram replies:

If you borrow money from your corporation it is not taxable if you pay it back within 6 months of your year end. If you do not pay it back, it becomes taxable income to you and changes on the corporation's books from a loan receivable to an expense.

In the meantime, since a loan is not an expense, the corporation owes tax on that amount if it is in a profitable position.

And, in my opinion, less than 5% of people who have professional corporations should have them.

QUESTION:

My wife and I are planning to sell our home in Nova
Scotia, which we have owned for six years. We are both
residents of New York State and are American citizens (my
wife, however, was born in Canada and still has a
Canadian passport, and her mother still lives in Nova
Scotia). Question: do we have to pay capital gains or any
other taxes on the disposition from the sale? I understand
there are exemptions from taxes if the home is a primary
residence (which, as far as Canada goes, it certainly is) or
under tax treaty with the U.S. Would we qualify on either
of these counts or would we have to pay the punitive 25 %
tax? thank-you
____________________________________________________________________________
david ingram replies:

The home is taxable in Canada because you are not residents of Canada.

When you have a sale arranged, file forms T2062 and T2062A to get the tax reduced from 25% of the gross sale price to 25% of the actual capital gains realized on the sale.

When filing the T2062 and T2062A you can not deduct any legal or real estate costs so more tax is usually dedcuted than will be calculated on the actual tax return.

Then in March or April of Next year you will both file a T1 return to report the sale and you can then claim any sales costs and will get a refund at that time.

You will report the sale again on your US 1040 schedule D and your New York IT-201. You claim the tax paid to Canada as a tax credit on US form 1040.

Depending upon the profit, You will have paid Canada 23 to 44% on 1/2 of the profit. If the profit is less than $100,000 your actual tax will be about 12%. At the same time, the US tax will be 15%.
Form 1116 will/should give you full credit for the tax paid to Canada on your US federal return unless the rest of your US income is very very low.

Filling in these forms is what we do and we are happy to look after the Canadian New York and 1040 at the time if your accountant does not understand them which is quite likely. You can send them by fax, email, snail mail or courier. If you did not want to deal with us, Steve Peters in Halifax with KPMG is also more than capable of helping you but more expensive. Gary Gauvin in Dallas Texas can also do them. I do not know of anyone in New York who deals with cross border issues.