Costa Rica: The IRS’s Dirty Dozen: A Closer Look at Tax Planning

Last Updated: 28 July 2005
Article by Denis Segura

U.S. tax season has just passed. But while you’re currently thinking about it, now is really not the time to start planning tax strategies for the year gone by. The good news: it’s never too early to plan for the years ahead. Too often people give little thought to tax planning except when it comes time to filling out those annoying governmental forms. You know, those forms that are made all the more annoying when the taxpayer arrives at the bottom line only to discover how much of his hard earned money he has to give away to the government! Feasible and effective tax strategies require both forethought and knowledge, too little of either can be very costly.

I can’t overemphasize how important it is to seek proper counsel when undertaking the task of intelligent and legal tax planning. There’s a huge difference between tax avoidance, which is perfectly legal, and tax evasion. There is always a lot of governmental attention focused in the subject of tax evasion.

You can find thousands of articles just on the internet on the subject of tax planning; or for that matter, on tax evasion. They range from crackpot schemes dreamed up to try to evade paying taxes, to sound intelligent tax strategies for paying less - or no - taxes. But, there is also a lot of misinformation floating around out there. Often it is a fine line that separates proper legal tax avoidance and illegal tax evasion.

When tax planning, strong consideration must be given to properly structure tax shelters, businesses and estates to make sure you are not only overpaying this years annual tax but also the consequences of taxes over the long term. As well, taxpayers must avoid decisional errors that arise from all too common misconceptions regarding taxes.

Some of the most common tax errors we see in our client base, are from tax misconceptions; these arise from clients not being fully informed. While it’s desirable to keep as much of your money as possible to spend as you see fit, it’s dangerous and potentially costly to jump at a scheme that "sounds" good, but may be less than 100% legal. There is great importance in seeking proper council from well-informed, up to date professionals that continually study both international law and USA tax code for correct information.

The Offshore Myth

The general misconception is that anyone who moves money offshore is a criminal, as the headlines about money laundering with offshore havens would lead one to conclude. Since the majority of people receive their news in thirty second blips or from short 300 word news articles like the one on MSNBC’s website(http://msnbc.msn.com/id/7046153), most will probably never take the time to research the truth benefits of offshore assets protection, worldwide business formation and international investing.

It is the position of the IRS in the United States that you may take any and every legal means - and are encouraged to do so - to pay the absolute least tax due. There are many articles on the IRS website at http://www.irs.gov, showing that the same legal structures that are employed for asset protection and estate planning can also be used to avoid overpaying taxes.

The site also shows that there are legal methods to invest capital in foreign jurisdictions which can create less of a tax burden and at the same time create a sound, secure financial portfolio.

When investigating offshore services, it is important to know the intricacies of foreign investment tax law: anyone who would tell you that by secretly moving money offshore you can avoid paying taxes is seriously misleading you. While it may be true that you can invest financially in other jurisdictions and thereby lower your taxes, you are never the less legally liable for paying taxes on all taxable income and correctly reporting your financial activities at tax time. Any offshore specialist or any other "financial authority" who advises you differently is setting you up to take a fall with an inherent risk of getting caught and incurring both tax and penalties.

The article entitled "The Dirty Dozen," appears on the IRS website at the following address:

www.irs.gov/newsroom/article/0,,id=136337,00.html.

In a fast skimming of the article, number one in the dirty dozen is "misuse of trusts", and number four is "Offshore Transactions." If you don’t read exactly what they are talking about you may erroneously conclude that any offshore transaction is illegal and that private trusts are instruments to defraud the government. Nothing could be further from the truth. The President of The United States has offshore trusts set up in the Cayman Islands for his two daughters. This is disclosed in his financial disclosures papers required for his running for the office of president.

While the IRS article contains 12 of the top scams, there are a few good points to consider in the opening paragraphs. I have apart of the beginning few paragraphs and a couple of the points the IRS warns consumers about.

IR-2004-26, March 1, 2004

WASHINGTON — In an update of an annual consumer alert, the Internal Revenue Service urged taxpayers to avoid falling victim to one of the "Dirty Dozen" tax scams and a variety of other schemes. In the new 2004 ranking, several new scams have reached the top of the consumer watch list, including abusive trusts and the "claim of right" doctrine. In addition, the IRS has taken a new step this year and issued 10 new pieces of legal guidance to help tax practitioners and taxpayers. "Taxpayers themselves should be wary of anyone who promises to eliminate their taxes," said IRS Commissioner Mark W. Everson. "Don't be fooled by outrageous claims. There is no secret way to escape paying taxes." The IRS urges people to avoid these common schemes:

1. Misuse of Trusts. Promoters of abusive tax transactions are increasingly urging taxpayers to transfer assets into trusts. The promoters promise a variety of benefits, such as the reduction of income subject to tax, deductions for personal expenses paid by the trust and reduction of gift or estate taxes. Taxpayers should be aware that abusive trust arrangements may not produce the tax benefits advertised by their promoters. Before entering any trust arrangements, taxpayers should seek the advice of a trusted tax professional.

2. "Claim of Right" Doctrine. In this emerging scheme, people file returns and attempt to take a deduction equal to the entire amount of their wages. The promoters advise them to label the deduction as "a necessary expense for the production of income" or "compensation for personal services actually rendered". The deduction is based on a complete misinterpretation of the Internal Revenue Code and has no basis in law.

3. Corporation Sole. When used as intended, Corporation Sole statutes enable religious leaders — typically bishops or parsons — to become incorporated as individuals as a way of separating themselves legally from the control and ownership of church assets. The idea is that the arrangement entitles the non-religious leader individual to exemption from federal income taxes as a nonprofit, religious organization as described in tax laws. The rules have been twisted at seminars where promoters charge fees of up to $1,000 or more per person. Would-be participants are mistakenly told that Corporation Sole laws provide a "legal" way to escape paying federal income taxes, child support and other personal debts.

4. Offshore Transactions. Some people illegally use offshore transactions to avoid paying United States taxes. Use of an offshore bank account, brokerage account, credit card, wire transfer, trust, offshore employee leasing or other arrangement to hide or underreport income or to claim false deductions on a federal tax return is illegal. This was one of the top 2003 "Dirty Dozen."

While the ease of simply using foreign jurisdictions through a variety of means may be attractive, tax evasion is always illegal. Simply by taking unreported cash receipts, traveling to a foreign jurisdiction and depositing the cash into a bank there one can avoid paying taxes on that sum may sound easy enough, but it is each citizen’s duty to report all income to the IRS.

There are other much more complex schemes using multilevel structures of different legal entities. In the end, it is the responsibility of each individual taxpayer to know and properly report their financial activities. Following are several tax evasion techniques from the article entitled "What are some of the Most Common Abusive Tax Schemes?" posted on the IRS website in which the author details some common tax evasion schemes.

It is interesting to note, however these same "tax schemes" - depending on the set-up and the reporting aspects - may be the same tools that abuse tax laws or the tools may be legally used by as perfectly legal asset protection tools to lower tax liability. Like smashing the atom - which is used for the good of mankind by providing an inexpensive fuel source, or for the destruction of man when constructed into bomb - these legal tools may be used for ligitament or illegal activity. When put to proper use some of the tools used to evade taxes may also be used for reducing taxes and in this sense may be used to enhance ones financial position in a wholly legitimate and legal manner.

Abusive Foreign Trusts:

The foreign trust schemes usually start off as a series of domestic trusts layered upon one another. This set up is used to give the appearance that the taxpayer has turned his/her business and assets over to a trust and is no longer in control of the business or its assets.

Once transferred to the domestic trust, the income and expenses are passed to one or more foreign trusts, typically in tax haven countries. As an example, a taxpayer's business is split into two trusts. One trust would be the business trust that is in charge of the daily operations. The other trust is an equipment trust formed to hold the business's equipment that is leased back to the business trust at inflated rates to nullify any income reported on the business trust tax return (Form 1041). Next the income from the equipment trust is distributed to foreign trust-one, again, which nullifies any tax due on the equipment trust tax return. Foreign trust-one then distributes all or most of its income to foreign trust-two. Since all of foreign trust-two's income is foreign based there is no filing requirement.

Once the assets are in foreign trust-two, a bank account is opened either under the trust name or an International Business Corporation (IBC). The trust documentation and business records of this scheme all make it appear that the taxpayer is no longer in control of his/her business or its assets. The reality is that nothing ever changed. The taxpayer still exercises full control over his/her business and assets.

There can be many different variations to the scheme.

International Business Corporations (IBC):
The taxpayer establishes an IBC with the exact name as that of his/her business. The IBC also has a bank account in the foreign country. As the taxpayer receives checks from customers, he sends them to the bank in the foreign country. The foreign bank then uses its correspondent account to process the checks so that it never would appear to the customer, upon reviewing the canceled check that the payment was sent offshore. Once the checks clear, the taxpayer's IBC account is credited for the check payments. Here the taxpayer has, again, transferred the unreported income offshore to a foreign jurisdiction.

False Billing Schemes:
A taxpayer sets up an International Business Corporation (IBC) in a tax haven country with a nominee as the owner (usually the promoter). A bank account is then opened under the IBC. On the bank's records the taxpayer would be listed as a signatory on the account. The promoter then issues invoices to the taxpayer's business for goods allegedly purchased by the taxpayer. The taxpayer then sends payment to the IBC that gets deposited into the joint account held by the IBC and taxpayer. The taxpayer takes a business deduction for the payment to the IBC thereby reducing his/her taxable income and has safely placed the unreported income into the foreign bank account I include these above mentioned tactics so that you know to stay away from anyone proposing such tactics as legitimate strategies for lowering taxes. Anyone purporting to be an international asset protection specialist (offshore specialist) who would give such advice can be dismissed as a fraudulent right away. These examples should help you understand the difference between legitimate asset protection and tax planning strategies and flat-out tax evasion.

CONCLUDING THOUGHTS

All people have the same instruments available to them; it is how people choose to use the various instruments at their disposal that reflects the legality or illegality of their decisions. It is their intensions that dictate the true nature of their actions. Just as the splitting of the atom can be used to bring power to households, factories and hospitals, or it can utilized in the destruction of civilization as we know it. While one can hardly compare the consequences of utilizing atomic technology for malaise with consequences of misrepresenting financial status, it does serve to illustrate the point.

Remember it is your job as a citizen of the country whose passport you carry to abide by the laws of that country. When it comes to protecting your money and your assets you should choose a long term plan that you are comfortable with - what you do today will affect you for the rest of your life. Know your sources, check references and use trusted resources such as your family attorney to recommend someone in the field of tax planning and asset protection, one that he or she feels comfortable with, and ultimately you will feel comfortable with also. There are just too many intricacies in law to stay abreast of all areas of specialty, learn to rely on expert sources you can trust.

Denis Segura, CPA is an offshore financial expert dedicated to helping individuals and businesses fulfill their objectives of worldwide banking; e-commerce and internet banking; international company, trust and foundation formation; and offshore asset protection. Mr. Segura is an active member of ITPA (International Tax Planners Association), API (Asia Pacific Institute), The San Jose Chamber of Commerce and the Association of practicing charted accountants in Costa Rica.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions