In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses the annual list of tax scams you should be aware of that was recently released by the IRS.
2022 IRS Dirty Dozen Tax Scams
Hey, everyone, welcome to another episode of Adam Talks. I’m Adam Bergman, tax attorney and founder of IRA Financial. On today’s episode, I’m going to go through some of the recently released dirty tax scams the IRS releases every year. Actually, instead of a dozen, they only came up with eight so far this year. So, that’s good. And none of them really involve US retirement accounts; even better! And some of these are hilarious, honestly, and others are to be expected involving digital currency, stuff like that. But, I wanted to go through these because, just from an issue spot, if anyone ever approaches you with any of these type of transactions, beware, pause; do not say go. Okay? So, I think it’s helpful to spend a few minutes each year kind of going through these potential scams because it’s on the IRS’s radar. That means if you do engage in these, you’re in hot water. Okay? It’s not as bad as maybe being an illicit transaction, but the IRS is saying, hey, you’re on record, we’re on record, you’re being put on notice that these things are scams, and if you engage in them, we’re not going to be so nice. So, I’m just going to kind of go through the eight of them.
As I mentioned, some of them are hilarious; like the first one, actually, let’s start with this, using a Maltese pension arrangement. So, what people are doing is somehow arguing that they are allowed to make contributions to a retirement account in Malta. And what they do is they make these contributions, the investments grow without tax, and they use a tax treaty to pull the money back in the United States without tax, because they argue it’s a pension fund. But the IRS is pretty clear that US persons likely do not have the ability to make contributions to a Maltese retirement arrangement. You could do it, obviously, to a US retirement arrangement, but distributions would be subject to tax. Here what they’re doing is they’re having it; treating these contributions to a Maltese arrangement and then having the treaty bring it back without tax; getting around any distribution tax. These are just stupid. If anyone approaches you with this stuff and you live in the United States, you have no connection to Malta, and they start telling you that you should make contributions to this Maltese retirement arrangement and save taxes; you just know it’s too good to be true. It’s just stupid.
The next one is actually interesting because I’ve seen charitable remainder trusts, crafts used in a way that eliminates taxable gains. So, you basically, what happens is there’s different ways to do it. You can use an annuity, or you can just basically make charitable contributions to a trust and get a deduction for the amount that you contribute to the trust and then use some of that deduction to offset, let’s say, Roth conversions or other income. So, charitable trust exists. There’s nothing wrong with them. The issues is what people are doing is they are for example, transferring appreciated assets to this craft, and then they take a step-up in basis on the fair market value of what they contribute. They have, let’s say, appreciated stock, they transfer it to this craft, they get a tax deduction for what their contribution is, they take a step-up in basis for what they contribute. And then the craft, let’s say, sells the property and there’s no gain, right, because they got a step-up and basis, at least they try to argue a step-up in basis, and then they use the proceeds to buy these annuities. And then the beneficiary is able to get a percentage of the annuity income based off some of these charitable trust rules; which could work. It’s just the issue is the step-up basis removes any of the tax that would be imposed on this trust, and then, not only do you eliminate the tax, but then the beneficiaries get a string of income as part of that annuity without tax. So again, I’ve seen charitable trust work as a way to obviously donate appreciated assets to charity; get a deduction for what you appreciate, and even, if possible, the beneficiary to get some income stream, that would be subject to tax. What this strategy tries to do is eliminate the tax by arguing a step-up basis, which the IRS says there’s no merit to that. So again, charitable trusts are not the issue, but if someone’s trying to push these annuity trust with a step-up in basis, where you can then escape tax, and get income streams of tax, plus get a tax deduction; beware, sounds too good to be true.
The next one involves Puerto Rican foreign captive insurance companies. So, the IRS has been on this foreign captive insurance company stuff for many years. Basically, businesses set up a captive insurance; get a lot of deductions by dumping lots of cash in these captive insurance companies, and basically, never really using the money for any insurance, just getting huge deductions. And basically, they basically, in the last several years have argued that these don’t have any substance and the deduction should not be respected; whether it’s a Puerto Rican or other foreign captive insurance, this is another area, well, this is an area the IRS has been pretty consistent about in terms of really their displeasure and showing their displeasure by having it on this list of tax scams. So in the Build Back Better, they’ve tried to limit IRA’s ability, for example, to invest in captive insurance companies, which never went through. But, here’s another list where the captive insurance companies are on it, and they’re really just saying that the deductions don’t have any substance because there’s not really insurance coverage, right? Insurance coverage in quotations. They argue it’s a scam; it’s just a way to get huge amounts of deductions. So, anyone who’s thinking of using a foreign captive insurance company, beware. Talk to lawyers, get opinion letters, be super careful because the IRS is certainly on that track and they’re watching.
The next thing is this transaction involving monetized installment sales, where there’s an inappropriate use of installment sale rules under section 453 by seller who, when they sell property, they receive sale proceeds through loans. So, in a typical transaction, for example, the seller enters into a contract to sell appreciated property to buy for cash and then purports to sell the same property to an intermediary in return for the installment notes. The intermediary then purports to sell the property to the buyer, and receives the cash purchase price. And through all these related convoluted steps, the seller receives the amount equivalent to the sales price, less the fees in purported loan that is nonrecourse, unsecured. So, it’s all these steps with the IRS is arguing it’s a sham and it’s a way to save tax on the sale through this loan function. So again, installment sales work. That’s okay. It’s just when you have these straw buyers out there and notes, be careful. It’s that extra step with the intermediary selling the property to the buyer. Be on the lookout, okay? So, installment sales could work, but just like the charitable trust, once you add the step-up basis and the annuity feature, same here with the installment sales. When you try to monetize it through someone that is an intermediary, you want to be super careful because you don’t want to be in a situation where you run afoul to these rules. Trust me.
Okay, the next one is obvious. Concealing assets in offshore accounts, or improper reporting of digital assets. This is a biggie. The IRS is not messing around here. They’ve gone through the Swiss bank accounts dating back to the early two thousands. They’ve issued John Doe summons to foreign banks. They’re doing that with crypto exchanges now. They are super focused, whether it’s through FBAR reporting, in other areas. If you have foreign bank accounts over $10,000 or interest in foreign investments, you are going to have reporting requirements and you certainly need to comply with them. Penalties are enormous, even including criminal penalties, okay? So remember, US persons are taxed on their worldwide income, not just your US income. And, if you have assets in foreign countries, you need to report them on an FBAR or other relevant returns, that includes digital assets. Yes, some of these foreign organizations will do reporting, but you have responsibilities as well as a taxpayer, a US taxpayer, to report to the US tax authorities your interest in these foreign assets. Okay? So, this is probably the most important of all the dirty tricks because the penalties are the steepest, and failure to comply is the most dangerous from a tax and freedom standpoint, because they will throw you in jail! Okay? If you look at all the Tax Court cases, every day, you can go to the Tax Court and check out all the cases, I say a good chunk of them relate to FBARs – foreign bank account reporting, okay? The IRS is not messing around with this. They are not screwing around when you have foreign assets and you’re not reporting it, they will throw you in jail, okay? So, this is the one tax scam that, even if you have, I grew up in Canada, guess what? I got rid of all my bank accounts over the last 15 years, because I don’t want that to ever go above $10,000. Let’s say, I get interest or some investment pops and I forget to report it. I just said, forget it. I’m just going to take everything, move it out of Canada into the United States. I don’t want to have any FBAR reporting. So, the same if you’re doing cryptos overseas, or have an interest in foreign bank accounts, foreign businesses, be careful, okay? It’s not something the IRS is playing around with.
The next one – high income individuals who don’t file tax returns. I mean, who’s stupid enough not to file tax returns? Well, I got friends. I actually had lunch with someone who’s a lawyer who hasn’t filed a tax return in five years, and he just was like, oh, I’m lazy. I got divorced. I was dealing with all that stuff, and I just haven’t filed the tax return. COVID hit. And I’m just like, dude, you are a moron. Okay? Forget about the taxes, even if you don’t owe taxes, the penalties is enormous, and it’s also potentially criminal. So, don’t mess around. And especially if you have income over $100,000. The IRS is super focused on this. It is super hard to get away with it, especially if you file tax returns in the past and you just stop. The IRS will come after you. If you’ve never filed tax returns, right? You turn 18, and you just never file, maybe you get away with it for a while, but 1099s are going to kick in if you have bank accounts. There’s going to be reporting to the IRS. They’re going to find out who you are and you’re going to go down, okay? So, just don’t be stupid. Pay your taxes, file your tax returns on time. Work with accountants. It’s just part of the game, right? We’re in the best country in the world. Part of the game is you have to pay taxes and file tax returns, okay? It’s just a trade off for being free and living in the greatest country in the world. Yeah. Nothing wrong with working with tax professionals to minimize taxes legally, but to just failure to file is stupid and just makes no sense. So, whether you’re a high earner or a low income earner or a middle income earner, who cares? File your tax returns. You may even get a refund, so don’t be stupid.
The next one, I’ve actually heard about this stuff, and I can’t believe people do it, but it’s basically syndicated conservative easements or conservation easements, where you get these deductions for conservation easements, and you use it where you get inflated appraisals of these undervalued land, and you get the deductions for these easements. So, basically, these arrangements do nothing more than just game the tax system for grossly inflated tax deductions, and the promoters get a lot of money. So, you basically take a piece of land that’s underdeveloped, and you argue it’s inflated, and you have these conservation easements that generate these huge tax deductions and they’re scams. So, anytime someone’s approaching you with conservation easements that’s going to generate high tax deductions for you, be cautious, beware, it’s probably a scam.
Next one, again is these micro captive insurance arrangements. And again, it’s the same theme, right? We talked about foreign insurance captive arrangements. Here is micro captive insurance, and this happens all the time; this is pretty common actually, where there’s insurance for implausible risks, and it fails to match business needs, or duplicates taxpayer’s commercial coverages. The idea is you get huge tax deductions for dumping these funds into these micro captive insurance arrangements. And oftentimes, there’s really no insurable risk here. So, the IRS is clear, they’ve stepped up enforcement on these arrangements. Captive insurance is a big theme here, so be careful. If you’re thinking about doing US-based captive insurance, foreign-based captive insurance, the IRS is on the lookout and they’ve stepped up enforcement in these areas.
Okay, so this is the Dirty Dozen list, even though there’s only eight Dirty Dozen transactions this year, and potentially more can come. But, the IRS sort of said this is it on the June 10 release. But, I wanted to kind of share this with everyone because it’s important to kind of just spot these issues, know what’s out there, know what the IRS is looking at. And again, if it’s too good to be true, it is. Anything that’s generating high deductions, it seems kind of fishy, whether it’s like intermediaries or just random stuff. Obviously if you’re contributing to a Malta pension plan, that’s just stupid. If you’re not filing tax returns, that’s just stupid. If you’re getting huge tax deductions for conservation easements on land that’s worthless; kind of stupid. If you’re not reporting foreign assets, digital assets, that’s stupid. And the captive insurance company; the average American me, you, we’re not going to be involved with captive insurance company, but companies with a lot of cash do because they generate deductions, and generally you can get that money back because it’s invested. And they’re pretty well promoted by super smart companies, even accounting firms, law firms that will promote these foreign captive, micro captive insurance company arrangements.
So again, the whole purpose of this podcast is kind of just to be like, hey, I just want to let you know these things are out there. The IRS is scrutinizing these; be on the lookout. If you get approached by these things, by anyone that’s pushing these type of arrangements, probably turn away, walk away, not worth your time or effort.
So, that’s it. You’re on notice now! Can’t blame me; tell me I didn’t tell you. These are the Dirty Dozen. So, happy no US retirement arrangements; I don’t include Malta as like, a real IRA/retirement arrangement, because anyone that contributes to a foreign pension company and tries to argue that they’re entitled to US tax treatment from a US retirement account is just foolish. It’s just abusive.
So, there you go. I hope you guys enjoyed it. You’re probably like, thank God, there’s nothing I’ve done on this list, because most of us are not doing stupid stuff like this. If you’ve not filed tax returns, file them! If you have foreign assets in foreign bank accounts, talk to someone about an FBAR. If you don’t need that bank account, let’s say you’re born in Germany or Greece, and you just had that account, get rid of it. Move it to the US. Do not play around with this stuff, okay? The penalties are huge, and there’s criminal enforcement. You have criminal risk. So that’s it. Just do not mess around.
So other than that, have a great rest of your day. I appreciate you guys spending some time with me today. It’s a weekly podcast; doing this many years, we’re almost getting to 400 episodes. So, I love this podcast. I have so much fun with it. I kind of get to dabble in different areas, not just self-direct retirement accounts. Like today I’m doing the Dirty Dozen. So, generally, anything involving tax, retirement investments, alternative take on it, I get to put on my lawyer cap and have some fun. So, take care. Thanks for spending some time with me and talk to everyone again next week. Take care.