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:
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.
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.