As CPA’s, we are constantly bombarded by on-line or in-person solicitations for the next great Tax Avoidance Strategy.  Just as frequently, we have clients that have pursued these strategies after attending a free-lunch seminar or heard it from a well-meaning neighbor.  We will then spend an hour or more researching the strategy only to find that particular scheme has long ago been disallowed by the IRS.

If a planning strategy has one or more of the following characteristics, it may be too good to be true.

  • A promoter is involved. Promoters often receive commissions, which may incentivize them to operate in their own interest, not the client’s or CPA’s.
  • A signed confidentiality agreement is required to learn about the strategy. Confidentiality agreements create an aura of exclusivity, but they may also be an attempt to prevent the IRS from getting wind of a potential strategy.
  • The strategy appears to run afoul of one or more judicial doctrines. Federal court decisions have established various judicial tax doctrines. If a transaction does not withstand scrutiny under one or more of these doctrines, it is less likely to be upheld upon examination.
    • The substance-over-form doctrine allows the IRS to ignore the legal form of a transaction and examine whether its substance results in tax avoidance.
    • The step-transaction doctrine treats a series of separate steps as a single transaction to determine the underlying intent.
    • The business-purpose doctrine invalidates a transaction if it appears that it has no substantial business purpose other than to obtain tax benefits.
    • The sham-transaction doctrine identifies transactions where the economic activities purported to give rise to the tax benefits do not occur.
    • The economic substance doctrine invalidates a transaction if the transaction lacks economic substance independent of the tax considerations.
  • Professionals associated with the strategy are paid a higher-than-customary fee. While the professionals may have invested considerable time and resources in developing the tax planning strategy, fees should be similar to those for other strategies.
  • The strategy is overly complex. Is the “loophole” the strategy is trying to fit through so narrow that a complex structure must be created to meet the exception? If many attorneys, CPAs, and other advisers are involved, maybe.
  • Contracts with the promoter attempt to limit damages. Beware of provisions purporting to limit recoverable damages if the transaction fails under scrutiny and have all such contracts reviewed by legal counsel prior to execution. Check for disciplinary actions or complaints against the promoter.

The Experts at CS CPA Group are always happy to speak with you to determine if the particular strategy you are considering might be too risky or already have been disallowed by the IRS.