The IRS has released its “Dirty Dozen” tax avoidance and fraud list for 2022, consisting of heavily promoted transactions likely to attract IRS scrutiny, consumer-focused fraud, and activities targeting high-net-worth individuals.
“Dirty Dozen” activity tends to be most prevalent during the filing season.
The IRS has compiled the annual list for more than 20 years to alert taxpayers and practitioners of its concerns. The list is not a legal document or a catalog of enforcement priorities; rather, it’s intended to raise awareness among audiences that might not be aware of developments in tax administration.
The IRS identifies problematic transactions through taxpayer examinations, promoter investigations, whistleblower claims, data analytics, document matching, and marketing material review.
Heavily Promoted and Potentially Abusive
On June 1 the IRS released items 1-4 of its 2022 list (IR-2022-113) with a focus on transactions involving charitable remainder annuity trusts (CRATs), foreign individual retirement arrangements, foreign captive insurance, and monetized installment sales.
CRATs. Taxpayers transfer appreciated property to a CRAT 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 IRC sections 72 and 664).
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, 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.
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.
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.
Consumer-Focused Fraud
Between June 6 and 9, the IRS released “Dirty Dozen” items 5-8 involving common tax-related frauds that target average taxpayers. These consumer-focused activities prey on individuals or organizations to steal financial information and cash. They include COVID-related fraud (IR-2022-117), offer in compromise mills (IR-2022-119), anonymous solicitations (IR-2022-121), and spear phishing (IR-2022-122).
COVID-Related Fraud. These activities involve stolen economic impact payments, fraudulent unemployment benefits, and 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.
The 2020 Stimulus check. With the word “stimulus” stamped in red ink. Sent to US citizens during the … [+]
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. Also, unemployed people receive fake job postings that entice them to provide personal information that can be used to file fraudulent tax returns for fraudulent refunds.
Fake charities are bigger threats during a national crisis.
Offer in Compromise Mills. These mills claim in local advertising that they can settle a tax debt for pennies on the dollar. Taxpayers pay a fee to the mill and receive the same compromise they could have gotten by working directly with the IRS. The mills charge excessive fees and mislead people who have no chance of meeting the compromise requirements.
Anonymous Communications. Suspicious texts, emails, or phone calls are designed to trick, surprise, or scare individuals into responding. Victims provide personal information and money.
Spear Phishing. Phishing emails use the IRS logo and subject lines like “Action Required: Your account has now been put on hold.” Similar bogus emails claim to be from a tax return preparation application. One variation offers an unusual activity report and a solution link for recipients to restore their accounts.
High-Net-Worth Activities
On June 10 the IRS released list items 9-12 (IR-2022-125), highlighting activities that target high-net-worth individuals for solicitation. Those items include digital asset transactions, failure to file, syndicated conservation easements, and microcaptive insurance transactions.
Offshore Accounts and Digital Assets. Individuals evade U.S. tax by hiding income in offshore banks, brokerage accounts, or nominee entities. The funds are accessed using debit and credit cards; wire transfers; or other arrangements, including foreign trusts, employee leasing schemes, private annuities, and structured transactions that conceal the owner of accounts or insurance policies.
High-Earner Failure to File. The IRS continues to focus on individuals who fail to file tax returns, prioritizing those earning more than $100,000 a year. The agency has pointed out that it’s “more advantageous to file an accurate return on time and set up a payment plan” than not file because the penalty for failure to file is initially higher than the penalty for failure to pay (see code section 6651).
Syndicated Conservation Easements. Promoters sell ownership interests in land to investors through partnerships and then grant conservation easements on the land to qualified charitable or government organizations (see code section 170). By using inflated appraisals of real estate assets like undeveloped land or historic building facades, the arrangements inflate tax deductions and generate fees for promoters.
Microcaptive Insurance Arrangements. Similar to foreign captive insurance, microcaptive insurance structures involve owners of closely held entities conducting activities that lack sufficient insurance attributes. For example, coverage may insure implausible risks, fail to match genuine business needs, or duplicate the taxpayer’s commercial coverage. The premiums are often excessive.