Since it’s tax time, it’s time to revisit the Internal Revenue Service’s periodic notice reminding taxpayers to stay away from “abusive tax-avoidance schemes” that will only get you into trouble. As the IRS says: “If an idea to save on taxes seems too good to be true, it probably is.”
The IRS notice lists what they call “some of the most common frivolous arguments used by… abusive tax-avoidance schemes.” Many of them really need no explanation. Here is a sampling of the claims you should not make:
- The only persons subject to federal income and employment taxation are federal employees and persons residing in Washington, D.C., or federal territories.
- A taxpayer can avoid tax by filing a return that reports zero income and zero tax liability.
- A taxpayer can avoid income tax by referring to a separate ‘straw man’ entity created by the use of the taxpayer’s name in all capital letters, or other variations of a taxpayer’s name, in government documents.
- Wages are not taxable income, pursuant to section 1001, because taxpayers have basis in their labor equal to the fair market value of the wages they receive; thus, there is no gain to be taxed.
- The 16th Amendment is invalid because it contradicts the original Constitution, was not properly ratified, and lacks an enabling clause.
- A taxpayer can make a ‘claim of right’ to exclude the cost of his labor from income
- Only income from a foreign source is taxable under section 861.
- I am not a ‘citizen’ or a ‘person’ within the meaning of the Internal Revenue Code.
- Residents of states, such as New York or California, are residents of a foreign country and therefore not subject to U.S. income tax.
- A taxpayer can escape income tax by putting assets in an offshore bank account.
- A taxpayer can eliminate tax by attributing his income to a trust and filing a Form 1041, U.S. Income Tax Return for Estates and Trusts, instead of a Form 1040, U.S. Individual Income Tax Return.
- A taxpayer can deduct amounts paid to maintain his household and for other personal expenses by establishing a home business.
- Nothing in the Internal Revenue Code imposes a requirement to file a return.
- A taxpayer can refuse to pay taxes if the taxpayer disagrees with the government’s use of the taxes it collects.
- A taxpayer can escape income taxes or the tax system by submitting a set of documents in lieu of a tax return.
There are a few equally wrong, but slightly more plausible, tax dodges listed in the IRS notice that merit a little explanation because the faulty logic supporting them is not obvious without a little background. Here are some examples:
- A taxpayer can place all of his assets in a trust to escape income tax while still retaining control over those assets. A taxpayer who places assets in a trust but retains certain powers over or interests in the assets, including the power to control the beneficial enjoyment of the assets, is treated as the owner of the assets for federal tax purposes and is subject to tax on the income from those assets.
- Filing a tax return is ‘voluntary.’ Some people mistake the word “voluntary” for ”optional” but filing a tax return is not optional for those who meet the law’s minimum gross income requirements. The word “voluntary,” as used in IRS publications, court decisions and elsewhere, refers to the fact that the U.S. tax system is a voluntary compliance system. This means only that taxpayers themselves determine the correct amount of tax pursuant to law and complete the appropriate returns, rather than have the government do this for them as is done in some other countries. This system of self-reporting does not make the filing of tax returns or the payment of tax optional. For those who do not comply with this system and fail to self-report their tax liability, the tax law authorizes various enforced compliance measures.
The IRS notice goes on to highlight some of the penalties that can be imposed if you use one of the schemes discussed above:
Civil and criminal penalties may apply to taxpayers who make frivolous arguments. Potentially applicable civil penalties include: (1) the section 6651 additions to tax for failure to file a return, failure to pay the tax owed, and fraudulent failure to file a return; (2) the section 6662 accuracy-related penalties, which are generally equal to 20 percent of the amount of taxes the taxpayer should have paid; (3) the section 6663 penalty for civil fraud, which is equal to 75 percent of the amount of taxes the taxpayer should have paid; (4) a $500 penalty under section 6702 for filing a frivolous income tax return; and (5) a penalty of up to $25,000 under section 6673 if the taxpayer makes frivolous arguments in the United States Tax Court.
Taxpayers who take frivolous positions also may face criminal prosecution under: (1) section 7201 for attempting to evade or defeat tax, the penalty for which is a significant fine and imprisonment for up to 5 years; (2) section 7203 for willful failure to file a return, the penalty for which is a fine of up to $25,000 and imprisonment for up to one year; and (3) section 7206 for making false statements on a return, statement, or other document, the penalty for which is a significant fine and imprisonment for up to 3 years.
Have you filed your tax return yet?
Nathan B. Hannah is a Shareholder in the Tucson office, and practices in the areas of estate planning and administration, real estate, and commercial transactions. He is also a noted blogger, and you can find more of his articles on his private blog.
Contact Attorney Hannah: firstname.lastname@example.org or 520/ 322-5000