“…in this world nothing can be said to be certain, except death and taxes.”

-Ben Franklin

Taxes are an unavoidable problem, as observed by Ben Franklin in his November 13, 1789 letter to French physicist Jean Baptiste Le Roy. While many may consider taxes to be of the "high-class problem" variety, they are a challenge frequently faced in my wealth management profession. One typically must have enjoyed earning some income or a gain on an investment in order to be on the hook for taxes. Indeed, most people should prefer to pay higher taxes as higher taxes are often associated with greater wealth.

However, even with the knowledge that paying taxes is a "problem" resulting from good fortune, most investors are open to ideas that lead to reduced tax payments. Retirement account contributions, Roth IRA conversions, tax loss selling, gifting, and asset location are just a few of the tactics we commonly employ to reduce, defer, or even eliminate tax obligations. When done systematically, we can often demonstrate how those savings materially improve our clients' financial outcomes.

There are tried-and-true approaches to tax minimization that follow very clear rules. Say, for example, that you bought a stock for $100, and it dropped in price to $90. If you decide to sell the stock, you can apply the $10 capital loss to your realized gains. As I mentioned before, most of us would prefer to have a profit versus a loss, but by selling the stock at a loss now, the tax laws allow us to offset taxable gains in our portfolio.

The “Dirty Dozen” Tax Scams

Unfortunately, scammers can take advantage of our preferences to avoid taxes. Each year, the IRS publishes a “Dirty Dozen” list of the most prevalent tax scams that can ensnare even the most financially savvy investors.

The list includes several scams that specifically target the wealthy. Among these, charitable remainder trusts and donations are particularly noteworthy. These irrevocable trusts allow individuals to donate assets to charity while drawing annual income for life or for a specified period. However, scammers can manipulate these trusts to eliminate ordinary income or capital gains on property sales, making them an attractive but risky option for tax avoidance.

Another common scam involves inflating the fair market value of art donations in order to claim larger tax deductions. Promoters of this scheme often use direct solicitation to encourage wealthy taxpayers to buy art at a discount and then donate it after a year for a substantially inflated deduction. While this might seem like a smart tax-saving strategy, it can lead to severe consequences if the IRS audits the donation and finds it to be fraudulent.

Abusive capital gains shelters using monetized installment sales also make the list. These schemes entail selling assets and receiving the proceeds in installments, allowing for indefinite tax deferral through manipulation. Similarly, individuals can easily abuse syndicated conservation easements and micro-captive insurance companies to shield income from taxes, resulting in significant penalties. The complete "Dirty Dozen" list from this year is below.

the 2024 IRS Dirty Dozen Tax Scams.

1. Phishing and smishing scams

2. Fake tax help services

3. Abusive tax avoidance schemes

4. Charitable remainder trusts and donations

5. Inflated art donation deductions

6. Abusive capital gains shelters

7. Syndicated conservation easements

8. Micro-captive insurance companies

9. Misuse of Employee Retention Credit

10. Fraudulent online account setup

11. Misleading tax advice on social media

12. Fake charities exploit taxpayers.

Why Investors Fall for These Scams

Despite their financial acumen, wealthy investors can be particularly susceptible to falling for these scams. Here are some reasons why this is the case:

1. Complex Financial Situations: Wealthy investors often have complex financial portfolios involving multiple income streams, investments, and assets. This complexity can make it challenging to stay on top of all financial details and easier to fall prey to scams that promise to simplify tax issues or offer substantial tax savings.

2. High Risk Tolerance: Many wealthy individuals are entrepreneurs or investors who are accustomed to taking significant financial risks. This high risk tolerance can make them more susceptible to tax schemes that promise high rewards but involve substantial risks. The allure of potential tax savings can overshadow the inherent dangers of these scams.

3. Fear of Missing Out (FOMO): Wealthy individuals might fear missing out on lucrative opportunities, including those that promise tax savings. Scammers exploit this fear by presenting their schemes as exclusive opportunities that are only available to a select few. This sense of exclusivity can make these schemes more appealing and harder to resist.

4. Lack of Awareness and Education: Despite their financial success, many wealthy individuals may not have a deep understanding of tax laws and regulations. This lack of knowledge can make them more vulnerable to scams that seem legitimate but are actually illegal. Scammers often take advantage of this gap in knowledge to promote their fraudulent schemes.

5. Trust in Professional Advisors: Wealthy individuals frequently rely on financial and tax planning advisors. However, not all advisors operate with integrity. Unscrupulous advisors can easily mislead their clients into participating in fraudulent schemes, especially if they present themselves as knowledgeable and trustworthy professionals.

6. Sophistication of scams: Scams targeting the wealthy are often highly sophisticated, involving complex financial maneuvers that can be difficult to detect. Designed to appear legitimate, these scams can involve intricate schemes such as abusive tax shelters, fraudulent charitable contributions, and monetized installment sales. The complexity and apparent legitimacy of these scams make them particularly dangerous.

Investors who understand these factors can be more vigilant and take steps to protect themselves from falling victim to the "dirty dozen." Working with reputable and knowledgeable tax advisors, staying informed about common scams, and exercising caution with any tax-saving strategies are essential practices for avoiding these pitfalls.

Preventing Involvement in Tax Scams

To avoid falling victim to these schemes, investors must exercise caution and due diligence in their tax planning efforts. This means working with reputable tax advisors who have a proven track record of ethical and effective tax strategies. It's also crucial to stay informed about the latest scams and to exercise skepticism towards any tax-saving opportunity that appears excessively promising.

Spotting tax scams can be challenging, especially given the sophistication of schemes targeting wealthy individuals. However, there are several red flags and best practices that can help identify potential scams:

1. Promises of Unusually Large Refunds: Be wary of anyone promising a significantly larger refund than expected. Scammers frequently entice victims by offering substantial tax savings or refunds that appear improbable.

2. Requests for Upfront Fees: Scammers frequently request upfront fees before providing their "services." Usually, legitimate tax professionals charge after rendering services, not before.

3. Pressure to Act Quickly: High-pressure tactics urging immediate action are a common sign of a scam. Scammers create a sense of urgency to prevent victims from thinking too carefully or seeking a second opinion.

4. Lack of Proper Credentials: Verify the credentials of anyone offering tax advice or services. Legitimate tax preparers have Preparer Tax Identification Numbers (PTINs) and are often certified public accountants (CPAs), enrolled agents (EAs), or tax attorneys. Planning professionals may not prepare taxes but should have a designation such as Certified Financial Planner (CFP®).

5. Secretive or Exclusive Strategies: Exercise caution when presenting strategies as "secret" or limited to a select few. Reputable tax professionals openly discuss legitimate tax-saving strategies, which are based on well-known provisions of the tax code.

6. Requests for Personal Information via Email or Text: The IRS does not initiate contact with taxpayers via email, text messages, or social media to request personal or financial information. We should treat any such requests with suspicion.

7. Inconsistent or Poorly Explained Advice: A tax preparer's advice could indicate a scam if it doesn't align with other professional opinions or doesn't provide a clear explanation. Reputable professionals can clearly explain their strategies and relevant tax laws.

8. Unregistered or Fake Charities: Scams involving charitable donations often involve fake or unregistered charities. Before donating, verify the charity's status with the IRS using the Tax Exempt Organization Search tool.

9. Too Good to Be True Tax Shelters: Abusive tax shelters that promise to eliminate or significantly reduce taxes are often scams. Examples include syndicated conservation easements, micro-captive insurance arrangements, and offshore schemes.

Best Practices for Avoiding Tax Scams:

Work with Reputable Professionals: Ensure that your tax preparer has a valid PTIN and is credentialed. Seek referrals from trusted sources, and check for any disciplinary actions against them.

Stay Informed: To stay updated on common scams, regularly review the IRS’s Dirty Dozen list and other official IRS communications.

Verify Communications: You should verify any unsolicited communication claiming to be from the IRS by contacting them directly using their official contact information.

Seek Second Opinions: When in doubt, seek a second opinion from another qualified tax professional.

Investors who are vigilant and informed can better protect themselves from falling victim to tax scams. While there are undoubtedly dishonest individuals who exploit our desire to pay less tax, there are numerous legitimate strategies you can use to legally reduce your tax liability. If you don’t have a plan for that, get in touch.