Help Clients Avoid the IRS 'Dirty Dozen'

What You Need to Know

One of these may involve a single-premium immediate annuity.
Another relates to Malta.
Two refer to captive insurance arrangements.

Every year the IRS releases its “Dirty Dozen” tax avoidance and fraud list, which consists of heavily promoted transactions that are likely to attract IRS scrutiny.

The list includes items like consumer-focused fraud. Activities targeting high-net-worth individuals tend to be the most prevalent during the tax filing season.

As highly trained licensed professionals, we hear from our prospects and clients things like:

“I want to make sure I’m on track to reach my retirement goals.”
“I’m nearing retirement and want help navigating the financial transition.”
“I’m already retired and am thinking about protecting my future and family.”

When we ask our prospects and client what their main goal is as they plan for retirement we hear:

“I’m focused on growing my wealth.”
“I’m focused on protecting the wealth I’ve built.”

Whether you sell life insurance, annuities or other products, or you focus on advising and planning, rather than selling products, you have the opportunity to help your prospects and clients stay out of trouble.

You can help people avoid, or correct, deviations from the correct path.

Here are 12 dangerous turns to discuss. The IRS announced them in June, but this is as good a time as any to warn clients about paths to ruin.

1. CRATs

Taxpayers transfer appreciated property to a charitable remainder annuity trust 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 doesn’t recognize gain because it relies on the step-up — then uses the sales 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. (See Internal Revenue Code sections 72 and 664.)

2. Treaty Benefits for Pensions

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 to the foreign jurisdiction, and local law either allows contributions of assets other than cash or doesn’t 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.

3. Foreign Captive Insurance

U.S. owners of closely held entities participate in a purported insurance arrangement with a Puerto Rican or 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 corporation.

The arrangements typically include implausible risks covered, non-arm’s-length pricing, or lack of business purpose.

4. Monetized Installment Sales

These transactions involve use of the section 453 installment sale rules by a property seller, who effectively receives the sales 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.

5. COVID-Related Fraud

This is one of four items on the latest IRS Dirty Dozen list that involves common tax-related frauds aimed at average taxpayers.

Fraudulent activities related to COVID-19 may involve stolen economic impact payments, fraudulent unemployment benefits, or fake employment offers and charities.

As with tax refund fraud, identity thieves try to steal stimulus payments.

They use text messages, random phone calls, and emails to inquire about bank account information or advise recipients to click a link or verify data.

Systemic job losses during the pandemic led to fraudulent claims for unemployment compensation using stolen information of individuals who hadn’t filed claims.

Unemployment benefits were paid to the identity thieves and generated false Forms 1099-G.