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Protestors, Shelters Draw Increasing Attention

(RIVERWOODS, ILL., January 2005) – While most people and businesses are struggling to figure out how much they owe the Internal Revenue Service or how big a refund they have coming, a small but perhaps growing minority is playing catch-me-if-you-can with the IRS, notes CCH INCORPORATED (CCH), a leading provider of tax and accounting information, software and services (tax.cchgroup.com). Tax protesters, fly-by-night tax preparers promising impossibly large refunds and slick operators offering wealthy individuals and corporations sophisticated tax shelters seem to be on the rise.

But beware if you’re tempted to try some do-it-yourself tax savings tactics: Anti-tax-shelter sentiment has reached fever pitch. Congress, the IRS, Treasury and the courts have had just about enough and are trying to give some would-be tax cheats reason to think twice. Whether their efforts will be enough to stem a rising tide of tax chicanery is another question.

Many people combine a dislike for paying taxes with a devotion to one or more unusual political and legal theories. They may refuse to file, file returns with zeros on almost every line or demand a refund equal to the amounts withheld from their earnings.

The beliefs behind their varied attempts at nonpayment are a crazy quilt of contentions – that Ohio was not a state when it ratified the constitutional amendment that makes the income tax possible, that paying taxes is strictly voluntary, that "sovereign citizens" of states are not subject to federal taxation, that wages represent an equal return for services rendered and hence are not "income," and a variety of other others. The IRS lists a total of 21 "frivolous tax arguments" on its web site (irs.gov), citing cases in which various courts have held such arguments to be invalid.

But that does not keep some tax preparers and promoters from selling various services, books and kits to customers yearning to be free of taxes. And true believers find it difficult to take a firm "no" from the IRS or the courts as final.

The IRS or the Tax Court may warn them not to advance a "frivolous" position, but they persist. They appeal from IRS hearings to the Tax Court or from the Tax Court to District Court, refusing to concede defeat.

When tax protestors or others try to use the courts as a soapbox or simply hope to use legal proceedings to delay the day of reckoning – and paying – their taxes, the law provides that they can be socked with a penalty of up to $25,000.

The courts haven’t been shy about applying this "frivolous proceedings" penalty in recent years, according to CCH Principal Tax Analyst Mark Luscombe, JD, CPA.

"In cases where the court might have warned a taxpayer in the past, they now may impose at least a token penalty. Where the courts think the taxpayer is willfully clinging to a discredited argument after they’ve been warned, it’s getting more common to see multi-thousand dollar penalties handed down," Luscombe observed.

In recent years, a number of taxpayers who have filed "zero" returns have waited until the IRS begins collection proceedings before contesting that they owe any tax at all in "collection due process" hearings with an IRS appeals officer. Only after those appeals have been denied do they go to Tax Court. The Court has been unsympathetic, often adding a significant penalty to the taxes, interest and penalties already determined by the IRS.

The IRS also has been asking the courts for injunctions to stop preparers from practicing and from selling kits that facilitate system abuse. In many cases in which they have prevailed, the courts have ordered promoters to take down sales material from their Internet sites and post a copy of the injunction there instead.

Irwin Schiff, an advocate of the "zero" return, has one of the highest profiles in the anti-tax movement. He has fought – and lost – against the IRS numerous times since he stopped paying income tax in 1973. At one point, the IRS used its levy powers to seize over $100,000 of royalties from his publisher to satisfy his tax debts. Regarding his losing record against the government, Schiff explains on his web site:

"I only lost those trials because of the corruption of the courts and the DOJ [Department of Justice]."

Currently, the IRS is suing Schiff and two business associates, trying to shut down his three Internet sites and book publishing operation. Schiff claims his activities are protected by the First Amendment. Thus far, he has lost in a federal district court in Nevada and before a three-judge appeals court panel. An appeal to the entire appeals court bench is pending.

"Promoters such as Schiff have raised First Amendment issues, but the IRS maintains that there is no right to commercial speech when it amounts to a blueprint for breaking the law," Luscombe said.

The clients of a New Mexico tax preparer were drawn to him not by constitutional arguments but the lure of fat – some would say suspiciously fat – refunds. Typically, they were wage earners or owners of a small business who were referred to the preparer by friends who reported getting nice refunds when they had feared they would owe additional taxes on their returns. This was all due to this preparer’s ability to materialize deductions seemingly out of thin air.

If nothing else, he was easy to work with. He didn’t require his clients to bring in detailed records to substantiate their itemized deductions and seems to have told several of them that such things weren’t necessary: One couple reported that they handed him "everything we had and he handed it back to us," stating that he didn’t need to see it.

The preparer claimed instead that permissible deductions could be determined through use of a formula based on the client’s income. Using this mysterious formula, he prepared returns that made tax liabilities vanish as if by magic.

Things became much less enchanting for the preparer’s clients after the IRS started examining their returns. He advised clients to ignore the IRS’s demands for documentation and the Tax Court’s insistence that they lay out the facts of their cases prior to trial.

They had no basis to contest the IRS’s denial of their deductions, finally admitting that various deductions had little or no basis in fact, but did ask to be spared penalties for negligence. The court can waive the penalty if taxpayers can show that they properly relied on the advice of a professional in preparing their return, even if the advice turned out to be incorrect.

The court wasn’t buying that argument in any of the 10 small-claims cases reported thus far. The taxpayers had not checked the preparer’s credentials and had no reason to rely on him, especially since they knew that the deductions that the preparer had entered on their returns had no basis in fact.

What’s more, in most of the cases, the judge imposed an additional $500 penalty for even bringing the matter to court. The taxpayers’ cases were so hopeless that the only possible purpose they could serve would be to delay the eventual day of reckoning with the IRS, he reasoned.

One recent focus of the IRS and congressional investigators has been the tax shelters marketed to corporations and wealthy individuals to help them greatly reduce or eliminate taxes.

In tax talk, a "shelter" can mean a legitimate tax-saving feature of the law, such as the various benefits associated with home ownership, or it can be a scheme for making taxable income appear untaxable, with nothing of any real economic substance taking place. Certain kinds of schemes require registration with the IRS, which may decide to label them as "potentially abusive," warning taxpayers that they may be subject to audit and assessment of back taxes, interest and penalties for using them.

In recent years, the IRS has turned its attention toward tax shelter promoters and has begun issuing summonses against accounting firms, investment bankers and law firms.

Underpinning the government’s pursuit of professionals promoting tax shelters is the belief that practitioners must be held accountable and set a positive example, instead of exploiting the complexity of the tax code to generate unintended tax consequences. This has led to issues with respect to the scope of the attorney/client privilege and tax practitioner privilege.

The IRS also has announced that it will take a closer look at "opinion letters" by lawyers that are used to avoid penalties in tax shelter cases. The letters would no longer provide a near-automatic defense in cases where the shelter is found to be abusive, especially in cases where the attorney is involved in promoting the shelter.

"A bigger question is whether the complexity of the tax laws doesn’t invite ingenious people to come up with ingenious ways to pay less tax," Luscombe noted. "It can be difficult to draw a sharp line between legitimate and illegitimate practices, and if the legality of a shelter isn’t immediately obvious to IRS lawyers, how can anyone else tell a valid tax-saving mechanism from outright tax cheating?"

Congress had its own say on shelters in 2004 with the American Jobs Creation Act. The new law has a number of provisions that increase information requirements and penalties for tax shelter promoters and users and gives the IRS more authority to regulate tax shelter opinions.

The Act also limits the economic benefits of a common tax shelter known as a sale-in-lease-out transaction, or SILO. In a typical SILO, a tax-exempt body such as a city transit agency would sell some of its assets to a for-profit company, then lease them back. The company could claim depreciation on the assets (something which a tax-exempt body cannot do), lowering its tax bill, while the deal was usually structured so that the company made money on the transaction and bore little risk. In effect, the Act takes away the economic incentives for these transactions when they simply serve to reduce corporate taxes.

"It’s interesting to note that many municipalities found this shelter to be a boon to their own finances and opposed this ‘reform,’" Luscombe noted.

Most worrisome for many observers are not the protestors who flaunt their noncompliance or the well-heeled investors in sophisticated shelters, but average taxpayers who increasingly may ask: "If other people get away with it, why not me?"

The IRS Oversight Board – a group set up to provide long-term guidance and direction to the IRS – has commissioned a series of surveys showing an increasing willingness of the general public to consider cheating – at least somewhat – on their taxes. In the most recent survey, about 17 percent of respondents said that it was all right to cheat – at least a little bit – on their returns. Even more alarming, about 30 percent of young adults 18-24 years of age thought that any amount of cheating is acceptable.

The Board has also warned repeatedly that the IRS faces a growing compliance gap, fueled by a workload that has grown while its workforce shrank between 1995 and 1998. Since then, while the total level of staffing has remained more or less constant, employees assigned to field compliance have continued to decline as more people are assigned to customer service tasks.

The IRS has announced that beginning this year, however, it will hire private collection firms to pursue some of the outstanding tax debts.

"This may have a positive impact on compliance, but it has raised some privacy concerns. When private collection agencies were used in the past, public pressure forced the IRS to cancel the program," Luscombe said. "The program also does not address non-filers and other types of non-compliance that require access to confidential taxpayer information. Only IRS employees can go after that type of abuse."

In March 2004, the Oversight Board recommended increases in IRS enforcement programs that would boost the agency’s overall fiscal 2005 budget to $11.2 million. The Bush administration’s budget proposal for the IRS was $10.6 million, and the final appropriation was only $10.3 million.

"The IRS is beginning to apply budgeting and management techniques to many categories of abuse, and it may well improve with practice," Luscombe said. "But if it doesn’t have the wherewithal to go after people who already owe it money, there is a question of how effective its overall compliance effort will be.

CCH INCORPORATED (tax.cchgroup.com), based in Riverwoods, Ill., is a leading provider of tax and accounting information, software and services. CCH has served tax, accounting and business professionals and their clients since 1913, providing them with the most authoritative, timely and comprehensive tax resources. CCH is a Wolters Kluwer company (www.wolterskluwer.com).

Wolters Kluwer is a leading multinational publisher and information services company. The company’s core markets are spread across the health, tax, accounting, corporate, financial services, legal and regulatory, and education sectors. Wolters Kluwer has annual revenues (2003) of €3.4 billion, employs approximately 18,750 people worldwide and maintains operations across Europe, North America and Asia Pacific. Wolters Kluwer is headquartered in Amsterdam, the Netherlands. Its depositary receipts of shares are quoted on the Euronext Amsterdam (WKL) and are included in the AEX and Euronext 100 indices.

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