The IRS is in the process of doubling their work force. DOUBLE. That means more agents and examiners and that of course, means more audits. We expect to see a notable increase in the number of audits in 2021 and 2022, as the IRS gets up and running with their new hires.
Here are the red flags that we know they are already concentrating on.
Red Flag Warning for Captive Insurance Companies
First, the warning. Don’t do this.
But, let’s take a minute and discuss what a captive insurance company actually is. The particular type under fire right now is called a micro-captive. A micro-captive is a captive insurance company operating with an annual gross premium up to $2.2 million. Premiums paid by the operating company are deductible. But the income received by the micro-captive are largely not taxable. While the premiums are deductible, only the investment income needs to be taxable. And that is either taxed as qualified dividends or capital gains income.
On the surface, it operates like a regular insurance company, but the fact that this is closely held by the business owner made it subject to abuse.
And the IRS started watch. In 2019, the IRS issued a settlement offer that required substantial concessions of the income tax benefits claimed by the taxpayer together with appropriate penalties. A lot of taxpayers took advantage of that, but some double-downed and refused to amend their returns.
There is now an Office of Promoter Investigations that is looking specifically at promoters of schemes like this and syndicated conservation easements. That’s next up on the IRS hit list.
Syndicated Conservation Easements Red Flag Warning in 2021
A syndicated conservation easement involves a promoter who assembles unrelated investors to invest in a partnership (or LLC-P) that has an undeveloped piece of real estate. The idea is that the partnership will elect to have a conservation easement with a greatly inflated value. This means that the investors receive an inflated charitable tax deduction.
Promoters have already been criminally charged with this scheme. There is no business purpose for the deduction and they lack economic substance. The fact that the value is so greatly inflated in such a short period of time, with no substance, is at the heart of the problem.
Conservation easements are still done and are legitimate. The syndicated conservation easements are wrought with fraud. And the IRS has put these under the purview of the new Office of Promoter Investigations.
Puerto Rico Acts 20, 22 and Incentives Code 60
In the right circumstances, taxpayers are able to greatly reduce, maybe even completely eliminate, their income tax by moving to Puerto Rico. But they have to follow the rules and the IRS maintains a lot of claimants aren’t.
Look for a lot more regarding this.
For more information regarding the Puerto Rico crackdown, please go to:
FBAR Penalties and Reckless Disregard
Every year, under the law known as the Bank Secrecy Act, you must report foreign bank accounts, brokerage accounts and mutual funds, to the Treasury Department and keep records of those accounts. You report the accounts by filing a Report of Foreign Bank and Financial Accounts (FBAR) on FinCEN Form 114.
If you don’t, the minimum penalty is $10,000. The IRS is watching for non-filers.
Cryptocurrency Income Audit Target
The IRS has complicated tax rules regarding cryptocurrency and, at the same time, some taxpayers believe that crypto is invisible. They don’t know what to report and/or don’t think they need to report
The IRS has been increasing the number of crypto investor audits. They believe that a lot of crypto investors are not filing when they should. There have even been criminal charges brought against some that were hiding their crypto ownership. Look for a lot more IRS activity here.
Offshore Cryptocurrency Reporting
Part of the big problem with crypto reporting is that the IRS hasn’t given us good, or consistent, advice on how to file. On one hand, the US government has told us that crypto is property. It’s not currency, and so pretty much every transaction is taxable.
And yet, on the other hand, the IRS wants US taxpayer who have foreign accounts with crypto to report them via FBAR rules. The penalties for failure to file START at $10,000. So this is a significant issue.
Look for more guidance on this in the future. There are legal and safe ways to greatly reduce the amount of tax you pay. These are the kinds of topics we discuss as part of Wednesday Coaching. Sign up now!