Tax Scams

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In this 2006 article, tax attorney Robert E. McKenzie discusses tax scams.

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Robert E. McKenzie © 2006

1. Overview - Abusive Tax Schemes 1.1 Since the mid-1990s, the IRS has witnessed a proliferation of abusive tax schemes, particularly those with offshore components. Originally those schemes took the structure of abusive domestic and foreign trust arrangements. However, abusive schemes are evolving into sophisticated arrangements that take advantage of the financial secrecy laws of some foreign jurisdictions and the availability of credit/debit cards issued from offshore financial institutions.

1.2

Anti-Tax Law Evasion Schemes - Facts

Since shortly after the federal income tax was enacted in 1913, some individuals and groups have encouraged others not to comply with the law. There have been unsuccessful challenges about the applicability of tax laws using a variety of arguments. There have been assertions that the sixteenth Amendment was not properly ratified, the tax law was unconstitutional, the tax law did not apply to certain types of income, the tax law only applied to certain individuals, and the tax law violated one or more constitutional rights.

1.3

Courts Have Consistently Rejected

Despite the courts having consistently rejected these arguments, their promoters continue to expound them, even incurring penalties for bringing frivolous cases into court or for filing frivolous tax returns. They often present their arguments in a pseudo-legal format, luring unsuspecting people into participating in their schemes to evade taxes.

1.4

National Program

IRS Criminal Investigation (CI) has developed a nationally coordinated program to combat these abusive tax schemes. CI's primary focus is on the identification and investigation of the tax scheme promoters as well as those who play a substantial or integral role in facilitating, aiding, assisting, or furthering the abusive tax scheme (e.g., accountants, lawyers). Secondarily, but equally important, is the investigation of investors who knowingly participate in abusive tax schemes.

1.5

IRS Steps Against Noncompliance

The Internal Revenue Service has focused its efforts against noncompliance by adopting a multi-functional compliance approach:

· ·

Helping otherwise innocent taxpayers, who have been misled by others, to rejoin the system; and Vigorously pursuing enforcement actions against those who continue to promote schemes or entice others to violate the law.

Regardless of the arguments used, they have two things in common:

· ·

The arguments are consistently rejected by the courts; and The participants may face IRS enforcement.

The IRS has one of the highest conviction rates in federal law enforcement. In addition to serving substantial prison sentences imposed by the courts, those convicted must also pay fines, taxes, civil penalties, and, frequently, court costs.

1.6

What is an Abusive Tax Scheme?

The Abusive Tax Schemes program encompasses violations of the Internal Revenue Code (IRC) and related statutes where multiple flow-through entities are used as an integral part of the taxpayer's scheme to evade taxes. These schemes are characterized by the use of trusts, Limited Liability Companies (LLCs), Limited Liability Partnerships (LLPs), International Business Companies (IBCs), foreign financial accounts, offshore credit/debit cards and other similar instruments. The schemes are usually complex involving multi-layer transactions for the purpose of concealing the true nature and ownership of the taxable income and/or assets.

1.7

Form Over Substance

Form over substance are the most important words to remember before buying into any arrangements that promise to "eliminate" or "substantially reduce" your tax liability. The promoters of abusive tax schemes often

employ financial instruments such as trusts in their schemes. However, the instruments are used for improper purposes including the facilitation of tax evasion.

Abusive Schemes
FY 2005 197 126 70 7 82.9% 38 FY 2004 131 127 82 45 73.3% 36 FY 2003 79 80 73 43 79.1% 47

Investigations Initiated Prosecution Recommendations Indictments/Information Sentenced Incarceration Rate Avg. Months to Serve

Criminal Investigation Statistical Information
FY 2005 4269 2859 2406 2151 2095 83% FY 2004 3917 3037 2489 2008 1777 84% FY 2003 4001 2541 2128 1824 1768 84%

Investigations Initiated Prosecution Recommendations Information/Indictments Total Convictions Total Sentenced* Percent to Prison

Criminal Investigations 10-1-05 to 12-31-05
Totals 926 731 519 486 554 81.0% 52

Investigations Initiated Prosecution Recommendations Information/Indictments Total Convictions Total Sentenced* Percent to Prison Average Months to Serve

2. Overview - Abusive Return Preparer

2.1 The IRS Criminal Investigation Return Preparer Program (RPP) was implemented in 1996, and established procedures to foster compliance by identifying, investigating and prosecuting abusive return preparers. The program was developed to enhance compliance in the return-preparer community by engaging in enforcement actions and/or asserting appropriate civil penalties against unscrupulous or incompetent return preparers. This is a significant problem for both the IRS and taxpayers. Abusive return preparers frequently prepare bad returns for large numbers of taxpayers who, at best, are stuck with paying additional taxes and interest and at worse, depending on culpability, are subject to penalties and maybe even criminal prosecution.

2.2 Return Preparer Fraud Return Preparer Fraud generally involves the preparation and filing of false income tax returns by preparers who claim inflated personal or business expenses, false deductions, unallowable credits or excessive exemptions on returns prepared for their clients. Preparers may also manipulate income figures to obtain fraudulent tax credits, such as the Earned Income Tax Credit.

2.3 Taxpayer Must Pay In some situations, the client (taxpayer) may not have knowledge of the false expenses, deductions, exemptions and/or credits shown on their tax returns. However, when the IRS detects the false return, the taxpayer must pay the additional taxes and interest and may be subject to penalties and criminal prosecution.

2.4 Enhancing Compliance The IRS Return Preparer Program focuses on enhancing compliance in the return-preparer community by investigating and referring criminal activity by return preparers to the Department of Justice for prosecution and/or asserting appropriate civil penalties against unscrupulous return preparers.

Abusive Preparers
FY 2005 248 140 119 FY 2004 206 167 121 FY 2003 229 169 109

Investigations Initiated Prosecution Recommendations Indictments/Information

Sentenced Incarceration Rate* Avg. Months to Serve

118 85.6% 18

90 84.4% 19

49 83.7% 19

3. Some Arguments – Non-filer Enforcement

3.1 Many groups continue to promote myths regarding the duty to file returns. None have ever prevailed in civil litigation but many gullible taxpayers are persuaded to cease filing returns. Complicated arguments against the American tax system are built by stringing together unrelated ideas plucked from widely conflicting court rulings, dictionary definitions, government regulations and other sources. The Truth about Frivolous Tax Arguments addresses false arguments about the legality of not paying taxes or filing returns. Some of the most popular anti-taxation arguments include the following:

Constitutional Argument - Filing an IRS Form 1040 violates the Fifth Amendment right against self-incrimination or the Fourth Amendment right to privacy.

The Truth: The courts have consistently held that disclosure of the type of routine financial information required on a tax return does not incriminate an individual or violate the right to privacy.

Compensation Argument - Wages, tips and other compensation received for personal services are not income because there is allegedly no taxable gain when a person "exchanges" labor for money.

The Truth: The Internal Revenue Code defines gross income as income from whatever source derived and includes compensation for services.

Sixteenth Amendment Argument - The Constitutional Amendment establishing the basis for income tax was never properly ratified.

The Truth: The 16th Amendment was properly ratified in 1913, and it states "The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration."

Religious Arguments - Individuals invoke the Freedom of Religion clause of the First Amendment by taking a vow of poverty or by fraudulently claiming charitable contributions of 50% or more of their adjusted gross income.

The Truth: Taking a purported vow of poverty or claiming fraudulent contributions to filter income through a church is not legal. Many fraudulent religious organizations use funds for personal expenses.

Internal Revenue Code Arguments -There is no Internal Revenue Code that imposes taxes; only "individuals" are required to pay taxes; or IRS can only assess taxes against people who file returns; income taxes are voluntary

The Truth: The tax law is found in Title 26 of the United States Code. The requirement to file an income tax return is not voluntary and it is clearly set forth in the Internal Revenue Code (IRC) Sections 6011(a), 6012(a), et seq., and 6072(a). IRS was established July 1, 1862 by an act of Congress. Our system of taxation allows taxpayers to determine the correct amount of tax and complete the appropriate forms "voluntarily" rather than have the government do it for them.

Forming a Trust Argument - Forming a business trust to hold your income and assets will avoid taxes. A family estate trust will allow you to reduce or eliminate your tax liability.

The Truth: Although there are legitimate trusts and legitimate reasons why individuals establish trusts, establishing a trust, foreign or domestic, for the sole purpose of hiding your income and assets from taxation is illegal and will not absolve you of your tax liability. The underlying claims for many "untaxing" trust packages rely on other frivolous arguments--arguments that have subjected promoters, as well as willing participants, to criminal penalties.

Nonfilers
FY 2005 549 413 316 280 78.2% 34 FY 2004 417 317 277 194 92.3% 36 FY 2003 536 302 234 218 81.7% 40

Investigations Initiated Prosecution Recommendations Indictments/Information Sentenced Incarceration Rate Avg. Months to Serve

3.2 Some "Tax Experts" Don't Follow Their Own Advice Some American citizens use these and other arguments advocating non-compliance with the tax laws Inspect promotional material carefully. Aside from being false and misleading, it often contains elaborate disclaimers such as "this report is offered as a vehicle for discussion and debate and for general informational purposes only. It does not constitute legal or professional advice and should not be relied on as a substitute for proper research and inquiries into original sources of authority." Many of these "tax experts" don’t even follow their own advice but choose to file and pay their own taxes.

4. The Dirty Dozen

Each year the IRS announces its Dirty Dozen and urges people to avoid these common schemes: The 2006 list is as follows:

Zero Wages. In this scam, new to the Dirty Dozen, a taxpayer attaches to his or her return either a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 that shows zero or little wages or other income. The taxpayer may include a statement indicating the taxpayer is rebutting information submitted to the IRS by the payer. An explanation on the Form 4852 may cite "statutory language behind IRC 3401 and 3121" or may include some reference to the paying company refusing to issue a corrected Form W-2 for fear of IRS retaliation. The Form 4852 or 1099 is usually attached to a “Zero Return.” (See number four below.) Form 843 Tax Abatement. This scam, also new to the Dirty Dozen, rests on faulty interpretation of the Internal Revenue Code. It involves the filer requesting abatement of previously assessed tax using Form 843. Many using this scam have not previously filed tax returns and the tax they are trying to have abated has been assessed by the IRS through the Substitute for Return Program. The filer uses the Form 843 to list reasons for the request. Often, one of the reasons is: "Failed to properly compute and/or calculate IRC Sec 83––Property Transferred in Connection with Performance of Service." Phishing. Phishing is a technique used by identity thieves to acquire personal financial data in order to gain access to the financial accounts of unsuspecting consumers, run up charges on their credit cards or apply for new loans in their names. These Internet-based criminals pose as representatives of a financial institution and send out fictitious e-mail correspondence in an attempt to trick consumers into disclosing private information. Sometimes scammers pose as the IRS itself. In recent months, some taxpayers have received e-mails that appear to come from the IRS. A typical e-mail notifies a taxpayer of an outstanding refund and urges the taxpayer to click on a hyperlink and visit an official-looking Web site. The Web site then solicits a social security and credit card number. In a variation of this scheme, criminals have used e-mail to announce to unsuspecting taxpayers they are “under audit” and could make things right by divulging selected private financial information. Taxpayers should take note: The IRS does not use e-mail to initiate contact with taxpayers about issues related to their accounts. If a taxpayer has any doubt whether a contact from the IRS is authentic, the taxpayer should call 1-800-829-1040 to confirm it. On March 27, 2006 the Internal Revenue Service announced that it has established an electronic mailbox for taxpayers to send information about suspicious e-mails they receive which claim to come from the IRS. Taxpayers should send the information to: [email protected].

The IRS has seen a recent increase in these scams, many of which originate outside the United States. To date, investigations by the Treasury Inspector General for Tax Administration have identified sites hosting more than two dozen IRS-related phishing scams. These scam Web sites have been located in at least 20 different countries, including Argentina, Aruba, Australia, Austria, Canada, Chile, China, England, Germany, Indonesia, Italy, Japan, Korea, Malaysia, Mexico, Poland, Singapore and Slovakia, as well as the United States. Zero Return. Promoters instruct taxpayers to enter all zeros on their federal income tax filings. In a twist on this scheme, filers enter zero income, report their withholding and then write “nunc pro tunc”–– Latin for “now for then”––on the return. They often also do this with amended returns in the hope the IRS will disregard the original return in which they reported wages and other income. Trust Misuse. For years unscrupulous promoters have urged taxpayers to transfer assets into trusts. They promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. However, some trusts do not deliver the promised tax benefits, and the IRS is actively examining

these arrangements. There are currently more than 200 active investigations underway and three dozen injunctions have been obtained against promoters since 2001. As with other arrangements, taxpayers should seek the advice of a trusted professional before entering into a trust. Frivolous Arguments. Promoters have been known to make the following outlandish claims: the Sixteenth Amendment concerning congressional power to lay and collect income taxes was never ratified; wages are not income; filing a return and paying taxes are merely voluntary; and being required to file Form 1040 violates the Fifth Amendment right against self-incrimination or the Fourth Amendment right to privacy. Don’t believe these or other similar claims. These arguments are false and have been thrown out of court. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law.

Return Preparer Fraud. Dishonest return preparers can cause many headaches for taxpayers who fall victim to their schemes. Such preparers derive financial gain by skimming a portion of their clients’ refunds and charging inflated fees for return preparation services. They attract new clients by promising large refunds. Taxpayers should choose carefully when hiring a tax preparer. As the old saying goes, “If it sounds too good to be true, it probably is.” And remember, no matter who prepares the return, the taxpayer is ultimately responsible for its accuracy. Since 2002, the courts have issued injunctions ordering dozens of individuals to cease preparing returns, and the Department of Justice has filed complaints against dozens of others. During fiscal year 2005, more than 110 tax return preparers were convicted of tax crimes.

Credit Counseling Agencies. Taxpayers should be careful with credit counseling organizations that claim they can fix credit ratings, push debt payment plans or impose high set-up fees or monthly service charges that may add to existing debt. The IRS Tax Exempt and Government Entities Division is in the process of revoking the tax-exempt status of numerous credit counseling organizations that operated under the guise of educating financially distressed consumers with debt problems while charging debtors large fees and providing little or no counseling.

Abuse of Charitable Organizations and Deductions. The IRS has observed increased use of tax-exempt organizations to improperly shield income or assets from taxation. This can occur, for example, when a taxpayer moves assets or income to a tax-exempt supporting organization or donor-advised fund but maintains control over the assets or income, thereby obtaining a tax deduction without transferring a commensurate benefit to charity. A “contribution” of a historic facade easement to a tax-exempt conservation organization is another example. In many cases, local historic preservation laws already prohibit alteration of the home’s facade, making the contributed easement superfluous. Even if the facade could be altered, the deduction claimed for the easement contribution may far exceed the easement’s impact on the value of the property.

Offshore Transactions. Despite a crackdown by the IRS and state tax agencies, individuals continue to try to avoid U.S. taxes by illegally hiding income in offshore bank and brokerage accounts or using offshore credit cards, wire transfers, foreign trusts, employee leasing schemes, private annuities or life insurance to do so. The IRS and the tax agencies of U.S. states and possessions continue to aggressively pursue taxpayers and promoters involved in such abusive transactions. During fiscal 2005, 68 individuals were convicted on charges of promotion and use of abusive tax schemes designed to evade taxes.

Employment Tax Evasion. The IRS has seen a number of illegal schemes that instruct employers not to withhold federal income tax or other employment taxes from wages paid to their employees. Such advice is based on an incorrect interpretation of Section 861 and other parts of the tax law and has been refuted in court. Lately, the IRS has seen an increase in activity in the area of “double-dip” parking and medical reimbursement issues. In recent years, the courts have issued injunctions against more than a dozen persons ordering them to stop promoting the scheme. During fiscal 2005, more than 50 individuals were sentenced to an average of 30 months in prison for employment tax evasion. Employer participants can also be held responsible for back payments of employment taxes, plus penalties and interest. It is worth noting that employees who have nothing withheld from their wages are still responsible for payment of their personal taxes.

“No Gain” Deduction. Filers attempt to eliminate their entire adjusted gross income (AGI) by deducting it on Schedule A. The filer lists his or her AGI under the Schedule A section labeled “Other Miscellaneous Deductions” and attaches a statement to the return that refers to court documents and includes the words “No Gain Realized.”

Two Fall Off The List. Two noteworthy scams have dropped off the “Dirty Dozen” this year: “claim of right” and “corporation sole.” IRS personnel have noticed less activity in these scams over the past year following court cases against a number of promoters.

5. Sham Trusts

5.1 The Internal Revenue Service is cautioning the small business community and public in general about schemes that create “sham” trusts in an attempt to evade federal taxes. In the last few years the IRS has detected a proliferation of abusive trust tax avoidance schemes. Since October of 2001, the courts have issued 19 permanent and 2 preliminary injunctions against promoters of these abusive trusts.

5.2 Responsibility and Control Generally, a trust is a form of ownership that separates responsibility and control of assets from the benefits of ownership. Sham trusts deliberately hide the true ownership and control of the trust assets and income in order to avoid correct federal taxation rules.

5.3 Abusive Trust Schemes In abusive trust schemes, bogus or inflated expenses are often charged against trust income. After the deduction of these expenses, the remaining income is distributed to another trust, and the process is repeated. The result of the distributions and deductions is a decrease in the amount of income ultimately reported to the IRS.

5.4 Components These schemes may be promoted with domestic components, offshore components, or a combination of the two. Often, the trusts involved in the scheme, whether foreign or domestic, are vertically layered with each entity distributing income to another layer. Nondeductible or bogus expenses are often charged against the income throughout the layers. No economic purpose or substantial change in the economic relationship is present, although they give the appearance the taxpayer or small business has given up control of the assets when in reality they have not. The result of these arrangements is intended to substantially reduce the amount of income reported to the IRS.

5.5 Illusive Tax Benefits Abusive trust arrangements will not produce the tax benefits advertised by their promoters and the Internal Revenue Service is actively examining these types of trust arrangements. Furthermore, taxpayers, small businesses and/or the promoters of these trust arrangements may be subject to civil and/or criminal penalties.

6. Types of Trusts: Good & Bad

Common Law Trust Contrary to the claims of promoters, "common law trusts" no longer exist since all states now have statutes relating to the creation and operation of trusts.

Foreign Trust Through 1996, a trust was foreign if the trustee, corpus, and administration were foreign. Since 1996, a trust is foreign unless a U.S. court supervises the trust and a U.S. fiduciary controls all substantial decisions. U.S. taxpayers are subject to filing Form 3520, Creation of or Transfer to Certain

Foreign Trusts, Form 3520-A, Annual Return of Foreign Trust With U.S. Beneficiaries, and Form 926, Return by a Transferor of Property to a Foreign Estate or Trust, when contributing property to a foreign trust. These trusts are usually U.S. tax neutral and are treated as grantor trusts with income taxed to the grantor.

Income Attributable to U. S. Sources Foreign trusts that have income attributable to U.S. sources and are not grantor trusts are required to file Form 1040NR, U.S. Nonresident Alien Income Tax Return. Foreign trusts that have income attributable to U.S. sources and are grantor trusts would have that income directly attributable to the grantor (if U.S. grantor income, it must be included on Form 1040; if nonresident alien grantor income, it must be included on Form 1040NR).

Personal Residence Trust A personal residence trust involves the transfer of a personal residence to a trust with the grantor retaining the right to live in the residence for a fixed term of years. Upon the shorter of the grantor's death or the expiration of the term of years, title to the residence passes to beneficiaries of the trust. This is an irrevocable trust with gift tax implications.

Qualified Personal Residence Trust A qualified personal residence trust (QPRT) involves the transfer of a personal residence to a trust with the grantor retaining a qualified term interest. If the grantor dies before the end of the qualified term interest, the value of the residence is included in the grantor's estate. If the grantor survives to the end of the qualified term interest, the residence passes to beneficiaries of the trust. A QPRT is a grantor trust, with special valuation rules for estate and gift tax purposes, governed under IRC 2702.

Grantor Retained Income Trust In a grantor retained income trust, the grantor creates an irrevocable trust and retains the right to all trust income for: (a) the earlier of a specified term or the death of the grantor; or (b) a specified term. If the grantor survives the specified term, the trust principal passes to others according to the terms and provisions of the trust instrument. For federal tax purposes, this trust is treated as a grantor trust.

Grantor Retained Annuity Trust In a grantor retained annuity trust, the grantor creates an irrevocable trust and retains the right to receive, for a specified term, an annuity based on specified sum or fixed percentage of the value of the assets transferred to the trust. A grantor retained annuity trust is specifically authorized by Internal Revenue Code Section 2702(a)(2)(B) and 2702(b). For federal tax purposes, this trust is treated as a grantor trust.

Grantor Retained Unitrust A grantor retained unitrust is similar to a grantor retained annuity trust. However, in a grantor retained unitrust, the grantor creates an irrevocable trust and retains, for a specified term, an annual right to receive a fixed percentage of the annually determined net fair market value of the trust assets (Treasury Regulation Section 25.2702-(c)(1)). For federal tax purposes, this trust is treated as a grantor trust.

Charitable Lead Trust A charitable lead trust pays an annuity or unitrust interest to a designated charity for a specified term of years (the "charitable term") with the remainder ultimately distributed to non-charitable beneficiaries. There is no specified limit for the charitable term. The donor receives a charitable deduction for the value of the interest received by the charity. The value of the non-charitable beneficiary's remainder interest is a taxable gift by the grantor.

Charitable Lead Annuity Trust A charitable lead annuity trust is a charitable lead trust paying a fixed percentage of the initial value of the trust assets to the charity for the charitable term.

Charitable Lead Unitrust A charitable lead unitrust is a charitable lead trust paying a percentage of the value of its assets, determined annually, to a charity for the charitable term.

Charitable Remainder Trust In a charitable remainder trust, the donor transfers assets to an annuity trust or unitrust. The trust pays the donor or another beneficiary a certain amount each year for a specified period. In an annuity trust, the payment is a specified dollar amount. In a unitrust, the payment is a percentage of the value of the trust, as valued each year. The term of the trust is limited to 20 years or the life of the designated recipients. At the end of the term of the trust, the remaining trust assets must be distributed to a charitable organization. Contributions to the charitable remainder trust can qualify for a charitable deduction. This charitable contribution deduction is limited to the present value of the charitable organization's remainder interest. Revenue Procedures 89-20, 89-21, 90-30, and 90-31 provide sample trust forms that the Service will recognize as meeting charitable remainder trust requirements.

Pooled Income Fund Trust A pooled income fund is an unincorporated fund set up by a public charity to which a person transfers property, reserving an income interest in, and giving the charity the remainder interest in that property. The Code and Regulations under Section 642 establish trust requirements. These funds file Form 1041.

Life Insurance Trust An insurance trust is generally an irrevocable trust that owns insurance on the life of the grantor or grantor and spouse. The trust is designed to avoid federal estate taxation of the insurance proceeds on the deaths of the grantor or spouse. When premium payments or other gifts to the trust are made, the trust instrument grants specified beneficiaries Crummey withdrawal rights over the gifts so that they will qualify for the federal gift tax annual exclusion. These trusts would generally file a Form 1041 as a complex trust, if the $600 income requirement were met.

Qualified Subchapter S Trust (QSST) A QSST is a statutory creature established by IRC Section 1361(d)(3). By meeting the requirements of a QSST, a trust may own S Corporation shares. An election must be made to be treated as a QSST and once made is irrevocable.

Electing Small Business Trust (ESBT) An ESBT is a statutory creature established by IRC Section 641(d). By meeting the requirements of an ESBT, a trust may own S Corporation shares. ESBT's must file

Form 1041 and the S Corporation income is taxed at the trust's highest marginal rate. No income distribution deduction is allowed to beneficiaries. To be treated as an ESBT, an election must be made.

Funeral Trust This is an arrangement between the grantor and funeral home/cemetery to allow for the prepayment of funeral expenses. The funeral trust is a "pooled income fund" set up by a funeral home/cemetery to which a person transfers property to cover future funeral and burial costs. These are grantor trusts with the grantor responsible for reporting income. The trustee may make an election on qualified pre-need funeral trusts to not be treated as a grantor trust, with the tax being paid by the trustee.

Rabbi Trust An irrevocable trust that functions as a type of retirement plan or deferred compensation arrangement that offers a limited amount of security to the deferring employee.

Business Trust The term "business trust" is not used in the Internal Revenue Code. The regulations require that trusts operating a trade or business be treated as a corporation, partnership, or sole proprietorship, if the grantor, beneficiary or fiduciary materially participates in the operations or daily management of the business. If the grantor maintains control of the trust, then grantor trust rules will apply. Otherwise, the trust would be treated as a simple or complex trust, depending on the trust instrument.

Pure Trust The term "pure trust" is not used in the Internal Revenue Code. Whatever the name of the arrangement, however, the taxation of the entity must comply with the requirements of the Internal Revenue Code. The requirements are based on the economic reality of the arrangement, not its nomenclature. If the pure trust meets the definition of a trust, then it would be taxed under simple, complex, or grantor trust rules, depending on the trust instrument.

Illinois Land Trust In Illinois, and in five other states, legislation has been enacted that creates a special type of trust, commonly referred to as an "Illinois Land Trust". These trusts are designed to house real estate within a grantor trust and provide limited access to grantor or beneficiary information contained in the trust instrument or known to the trustee. Once a land trust is established, the ability to trace property transactions becomes limited as state law establishes the right of the trustee not to disclose the true owner of the property or those with a beneficial interest. The "land trust" has no special distinction in the Internal Revenue Code and would be a simple, complex, or grantor trust depending on the terms of the trust instrument. Filing requirements would depend on the type of trust.

Delaware Business Trust or Alaska Business Trust A trust established to hold and invest assets with greater flexibility than allowed by most trusts. Permits limited liability, creditor protection, and valuation discounts. These trusts are a creation of the Delaware and Alaska legislatures and have no impact on taxation of trusts for federal purposes. These "business trusts" have no special distinction in the Internal Revenue Code and would be a simple, complex, or grantor trust depending on the terms of trust instrument. The regulations require that trusts operating a trade or business be treated as a corporation, partnership, or sole proprietorship, if the grantor, beneficiary or fiduciary materially participates in the operations or daily management of the business. Filing requirements would depend on this classification.

Unincorporated Business Organization (UBO) A term used by trust promoters to identify trusts they sell and to disguise the fact that it is a trust. This term and the term "Massachusetts Business Trust" are often used interchangeably. These are not terms used by the Internal Revenue Code.

7. Money Laundering

7.1 The term “money laundering” refers to the activities and financial transactions that are undertaken specifically to hide the true source of the income. In most cases, the money involved is earned from an illegal enterprise and the goal is to give that money the appearance of coming from a legitimate source. 7.2 Why is IRS Involved in Money Laundering Investigations? One look at the daily news is proof that the crimes dealing with or motivated by money make up the majority of criminal activity in the nation. Tax evasion, public corruption, health care fraud, money laundering and drug trafficking are all examples of the types of crimes that revolve around money. In these cases, a financial investigation often becomes the key to a conviction. For this reason, IRS is one of the key agencies involved in money laundering investigations. 7.3 Complex Crime Money laundering is a very complex crime involving intricate details, often involving numerous financial transactions and financial outlets throughout the world. Criminal Investigation has the financial investigators and expertise that is critical to “follow the money trail.” 7.4. Income Tax Laws Criminal investigation focuses on money laundering where the underlying conduct is a violation of the income tax laws. According to the IRS, money laundering is the means by which criminals evade paying taxes on illegal income by concealing the source and the amount of profit. Money laundering is in effect tax evasion in progress.

7.5 Illegal Income When a criminal has a large amount of illegal income, they have to do something with it in order to hide it from the IRS. They attempt to launder it to make it appear as if it was from a legitimate source, allowing them to spend it or invest it in assets without having to worry about the IRS and tax consequences.

7.6 Send Dollars Abroad One of the ways to launder illegal proceeds is to move the money out of the United States and then bring it back in a clean form, often disguised as loan proceeds. Another method is to channel or co-mingle the money through various business activities to give the appearance that the money was derived from a legal source. Money laundering creates an underground, untaxed economy that harms our country’s overall economic strength. It is a global threat that erodes our financial systems.

How to Interpret Criminal Investigation Data
Since actions on a specific investigation may cross fiscal years, the data shown in cases initiated may not always represent the same universe of cases shown in other actions within the same fiscal year. FY 2005 FY 2004 FY 2003

Investigations Initiated 1639 1789 Pros. Recommendations 1338 1515 Indictments/Information 1147 1304 Sentenced* 782 687 Incarceration Rate 88.4% 89.1% Average months to Serve 62 63 *Includes confinement to federal prison, halfway house, home detention or a combination thereof.

1590 1141 1041 667 89.2% 66

Bank Secrecy Act (BSA) Investigations Investigations Initiated Prosecution Recommendations Indictments/Information Sentenced Incarceration Rate* Average Months to Serve

FY 2005 546 379 359 310 83.2% 42

Currency Reporting - Money Laundering

The Currency Transaction Report (CTR) came into existence with the passage of the Currency and Foreign Transactions Reporting Act, better known as the Bank Secrecy Act (BSA), in 1970. When the first version of the CTR was introduced the only way a suspicious transaction of less than $10,000 was reported to the government was if a bank teller called an agent and provided the information. This was due, primarily, to the concern by financial institutions about the Right to Financial Privacy. On October 26, 1986, with the passage of the Money Laundering Control Act, the Right to Financial Privacy was no longer an issue. As part of the Act, Congress had stated that a financial institution could not be held liable for releasing suspicious transaction information to law enforcement. As a result, the next version of the CTR had a suspicious transaction check box at the top. This was in effect until April 1996 when the Suspicious Activity Report (SAR) was introduced. Currency reporting has changed since its introduction in 1970. There are now several different requirements for several different types of financial institutions as well as non-financial institutions. The various currency forms, their reporting requirements, and the number filed in calendar year 2004 are shown in this chart:

Report
Currency Transaction Report (CTR) Currency Transaction Report Casino (CTRC) (Includes both

Requirements
Filed by financial institutions that engage in a currency transaction in excess of $10,000 Filed by a casino to report currency transactions in excess of $10,000.

Filed in CY 2004
13,588,109

524,537

Form 8362 & Form 8852) Report of Foreign Bank and Financial Filed by individuals to report a financial interest in or signatory Accounts (FBAR) authority over one or more accounts in foreign countries, if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year. IRS Form 8300, Report of Cash Filed by persons engaged in a trade or business who, in the course of Payments Over $10,000 Received in a that trade or business, receives more than $10,000 in cash in one Trade or Business transaction or two or more related transactions within a twelve month period. Suspicious Activity Report (SAR) Filed on transactions or attempted transactions involving at least $5,000 that the financial institution knows, suspects, or has reason to suspect the money was derived from illegal activities. Also filed when transactions are part of a plan to violate federal laws and financial reporting requirements (structuring)

217,699

152,982

380,162

Filed on transactions or attempted transactions if it is conducted or attempted by, at, or through a casino, and involves or aggregates at least $5,000 in funds or other assets, and the casino/card club knows, suspects, or has reason to suspect that the transactions or pattern of transactions involves funds derived from illegal activities. Also filed when transactions are part of a plan to violate federal laws and transaction reporting requirements (structuring). Registration of Money Services Each Money Services Business (MSB), except one that is a money Business (RMSB) services business solely because it serves as an agent of another MSB, must register. Suspicious Activity Report by Money Filed on transactions or attempted transactions if it is conducted or Services Businesses attempted by, at, or through a MSB, involving or aggregating funds or other assets of at least $2,000 in funds or other assets, and the MSB knows, suspects, or has reason to suspect that the transactions (MSB) (SARM) or pattern of transactions involves funds derived from illegal activities. Also filed when transactions are part of a plan to violate federal laws and transaction reporting requirements (structuring) or when the transaction has no business or apparent lawful purpose and the MSB know of no reasonable explanation for the transaction after examining the available facts. When transactions are identified from a review of records of money orders or travelers checks that have been sold or processed, an issuer of money orders of traveler's checks shall be required to report a transaction or a pattern of transactions that involves or aggregates funds or other assets of at least $5000. Suspicious Activity Report by the Filed on transactions, or attempted transactions, if it is conducted by, Securities & Futures Industries at, or through a broker-dealer, it involves aggregates funds or other assets of at least $5,000, and the broker-dealer knows, suspects, or has reason to suspect that the transaction involves funds derived from illegal activities or is intended or conducted in order to hide or disguise funds or assets derived from illegal activity. Also filed when transactions are designed, whether through structuring or other means, to evade filing requirements. Also filed when transaction has no business or apparent lawful purpose or is not the sort in which the particular customer would normally be expected to engage, and the broker-dealer knows of no reasonable explanation for the transaction after examining the available facts. Also filed when the transaction involves the use of the broker-dealer to facilitate criminal activity Designation of Exempt Person Used by bank or other depository institution to designate an eligible customer as an exempt person from currency transaction reporting rules.

Suspicious Activity Report Casino (SARC)

5,821

12,411

304,242

5,656

78,539

EXAMPLES

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Defendant Used Internet Auction Web Sites to Carry Out Scam On December 19, 2005, in Seattle, WA, Evangelos Dimitrios Soukas was sentenced to 92 months in prison to be followed by three years supervised release. Soukas was sentenced for submitting fraudulent claims to the IRS, identity fraud and conspiracy to commit wire and mail fraud. According to court documents, Soukas admitted to using a variety of schemes from 1999 to 2004, in his attempts to defraud his victims of more than $1.1 million dollars. Soukas posted false and fraudulent advertisements for merchandise on various internet auction web sites, knowing he did not have the merchandise and having no intention of delivering it. Soukas advertised expensive electronic equipment such as laptop computers, camcorders and cell phones. But, after purchasers mailed Soukas checks or paid into a Paypal account, they never received the merchandise. Soukas also used at least 15 victims' names, Social Security Numbers and dates of birth to open bank accounts, to apply for lines of credit and loans on the internet, and to purchase merchandise. Using the false identities, Soukas also filed false income tax returns in his victims' names in an attempt to obtain tax refunds to which he was not entitled.

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International Business Consultant Goes To Jail On December 16, 2005, in Oakland, CA, Yogesh Gandhi was sentenced to serve two years in prison for structuring monetary transactions on four different occasions between October 25, 2001 and February 20, 2002, totaling $156,000. In addition to jail time, Gandhi was sentenced to three years supervised release and fined $4,000. Gandhi pleaded guilty to the charges in June 2005 to the structuring to avoid having the financial institutions file Currency Transaction Reports. He admitted that he had his nephews make certain cash deposits at several different Citibank Federal Savings Bank branches throughout Contra Costa County to avoid suspicion.

8. Financial Crimes Enforcement Network

As reflected in its name, the Financial Crimes Enforcement Network (FinCEN) is a network, a means of bringing people and information together to fight the complex problem of money laundering. Since its creation in 1990, FinCEN has worked to maximize information sharing among law enforcement agencies and its other partners in the regulatory and financial communities. Working together is critical in succeeding against today's criminals. No organization, no agency, no financial institution can do it alone. Through cooperation and partnerships, FinCEN's network approach encourages cost-effective and efficient measures to combat money laundering domestically and internationally.

9. Patriot Act

USA PATRIOT Act Section 314(b) permits financial institutions, upon providing notice to the United States Department of the Treasury, to share information with one another in order to identify and report to the federal government activities that may involve money laundering or terrorist activity.

10. Employment Tax Evasion Schemes

Employment tax evasion schemes can take a variety of forms. Some of the more prevalent methods of evasion include pyramiding, employee leasing, paying employees in cash, filing false payroll tax returns or failing to file payroll tax returns.

Pyramiding "Pyramiding" of employment taxes is a fraudulent practice where a business withholds taxes from its employees but intentionally fails to remit them to the IRS. Businesses involved in pyramiding frequently file for bankruptcy to discharge the liabilities accrued and then start a new business under a different name and begin a new scheme.

Employment Leasing Employee leasing is another legal business practice, which is sometimes subject to abuse. Employee leasing is the practice of contracting with outside businesses to handle all administrative,

personnel, and payroll concerns for employees. In some instances, employee-leasing companies fail to pay over to the IRS any portion of the collected employment taxes. These taxes are often spent by the owners on business or personal expenses. Often the company dissolves, leaving millions in employment taxes unpaid.

Paying Employees in Cash Paying employees in whole or partially in cash is a common method of evading income and employment taxes resulting in lost tax revenue to the government and the loss or reduction of future social security or Medicare benefits for the employee.

Filing False Payroll Tax Returns or Failing to File Payroll Tax Returns Preparing false payroll tax returns understating the amount of wages on which taxes are owed, or failing to file employment tax returns are methods commonly used to evade employment taxes.

Employment Tax Evasion
Investigations Initiated Prosecution Recommendations Indictments/Information Sentenced Incarceration Rate Avg. Months to Serve FY 2005 108 101 82 52 90.4% 30 FY 2004 113 97 71 51 86.3% 18 FY 2003 104 66 44 45 75.6% 20

11. Abusive Home-Based Business Tax Schemes

The IRS is providing information about abusive Home-Based Business schemes to help taxpayers avoid the pitfalls of these schemes:

These schemes are abusive because they manipulate and misinterpret tax laws.

Don't be fooled by home-based business schemes that claim taxpayers can deduct most, or all, of their personal expenses as business expenses.

Be wary of promoters who claim otherwise.

The IRS and other federal agencies are aggressively pursuing and successfully prosecuting promoters of schemes and scams, including abusive home-based business schemes.

Participating in these schemes can result in repayment of taxes owed with interest and penalties, and possibly imprisonment and fines.

Even innocent taxpayers involved in these schemes can face a staggering amount of back interest and penalties.

Taxpayers involved in one of these schemes should correct any improper tax return filings.

Preparers face penalties and sanctions

12. Misuse of the Law

The IRS has uncovered a number of schemes that claim to allow deductions for personal living expenses. Taxpayers should consider these points before investing in a possible abusive scheme:

Any investment scheme or promotion that claims to allow a federal income tax deduction for normal personal expenses should be considered highly suspect.

A business must truly exist prior to claiming expenses.

In order to be deductible, the expenses must be ordinary and necessary expenses paid or incurred in carrying on a trade or business.

Personal, family and living expenses are not deductible business expenses.

12.1 Pass-through Entity Forming an S corporation, partnership, or any other pass-through entity does not cause personal, living and family expenses to become deductible; nor do incorporation, the existence of board minutes, and partnership agreements authorizing personal, living or family expenses cause these expenses to become deductible

12.2

Examples of misuse of the law:

·

TRAVEL – Deducting travel, meals, and entertainment under the guise that everyone is a potential client.

·

AUTO – Excessive car and truck expenses when the asset has been used for both business and personal use.

·

PAYMENTS TO FAMILY MEMBERS – Deducting payments to family members for routine household tasks that are not ordinary and necessary to the operation of the business, such as taking out the trash, mowing the lawn, washing the car, answering the telephone, etc. Also payments to family members that are excessive in relation to the services performed.

·

BUSINESS USE OF HOME - Abusive promoters often advise taxpayers to deduct excessive costs associated with the operation of the home. The promoters claim that the “exclusive use” restriction can be avoided by placing business-related items in each room of the house. A deduction for the business use of a home is limited to that area of the home that is used regularly and exclusively for business purposes (Internal Revenue Code Section 280A). For example, merely placing a calendar or file cabinet in a room does not satisfy the “regular and exclusive business use” requirement.

·

EDUCATION EXPENSES - Some schemes advise taxpayers that they may claim up to $5,250 per year in educational expenses for each family member. There are specific requirements that preclude virtually all investors in this scheme from qualifying for this deduction (Internal Revenue Code Section 127).

·

MEDICAL REIMBURSEMENT PLANS - Abusive promoters assert that taxpayers can make their family’s medical expenses 100 percent deductible merely by employing their family member(s). In order for the medical expenses to be deductible under a self-insured medical reimbursement plan, a bona fide employer-employee relationship must exist. In addition, the plan has to meet other requirements (Treasury Regulation Section 1.105-11).

·

RECORD KEEPING - Taxpayers in these schemes are advised to maintain detailed records of all expenses incurred. The existence of such records does not negate the requirement that expenses be “ordinary and necessary” in relation to a legitimate business activity. The expenses must also satisfy any other deductibility requirements (Internal Revenue Code Section 274).

13. EP Abusive Tax Transactions

The IRS is engaged in extensive efforts to curb abusive tax shelter schemes and transactions. The Tax Exempt and Governmental Entities Division of the IRS, including the office of Employee Plans, participates in this IRS-wide effort by devoting substantial resources to the identification, analysis, and examination of abusive tax shelter schemes and promotions.

14. Listed Transactions

The IRS periodically lists transactions which it believes to abusive. The promoter of such tax shelters is required to maintain investor lists and is subject to promoter penalties. The taxpayer is required to fully disclose such transactions on her tax return. You can find a listing of abusive transactions at: http://www.irs.gov/businesses/corporations/article/0,,id=120633,00.html.

15. Slavery Reparation Scam

The Internal Revenue Service issued a nationwide warning for taxpayers not to be misled into filing slavery reparation claims. There is no provision in the tax law that allows African-Americans to get tax credits or refunds related to slavery reparations.

16. Arguments Related to the Internal Revenue Code

These false arguments claim that:

There is no Internal Revenue Code that imposes taxes;

Only "individuals" are required to pay taxes;

Code Section 861 limits taxable income to certain sources which do not apply to most U.S. citizens; or

The government can assess taxes only against people who file returns.

The tax law is found in Title 26 of the United States Code.

Section 6012 of the Code makes clear that only people whose income falls below a certain minimum level do not have to file returns.

Sections 861 through 865 determine whether income is from a U.S. or foreign source - they do not in any way exclude income from taxation for a U.S. citizen or resident.

Section 6201 of the Code states that the Secretary of the Treasury is required to make assessments "of all taxes imposed by this title".

17. Constitution-Related Arguments

17.1 First Amendment These arguments focus on using the Freedom of Religion clause of the First Amendment to reduce income tax liability. A common scheme calls for individual taxpayers to obtain minister's credentials and a church or religious order charter by mail for a fee. The individuals set up a new organization that purports to be a church, religious order, or other religious organization. They then take a "vow of poverty" and assign their assets and income to the new organization. However, filtering money through a purported church to fraudulently claim charitable contribution deductions is illegal. The tax law affords benefits to churches and other religious organizations and to those who make gifts or contributions to these organizations. The law requires, however, that such organizations actually be operated for religious purposes and not for the private benefit of individuals.

17.2 Fourth and Fifth Amendments These arguments claim that filing an income tax return violates the Fourth Amendment right to privacy or the Fifth Amendment right against self-incrimination. However, the courts have consistently held that disclosure of routine financial information required on a tax return does not incriminate an individual or violate the right to privacy.

17.3 Sixteenth Amendment These arguments claim that the constitutional amendment establishing the basis for income tax was never properly ratified. However, the courts have held that none of the points presented undermine the fact that the Sixteenth Amendment was indeed ratified in 1913.

18. The Voluntary Nature of the Federal Income Tax System

Contention: The filing of a tax return is voluntary Some assert that they are not required to file federal tax

returns because the filing of a tax return is voluntary. Proponents point to the fact that the IRS itself tells taxpayers in the Form 1040 instruction book that the tax system is voluntary. Additionally, the Supreme Court's opinion in Flora v. United States, 362 U.S. 145, 176 (1960), is often quoted for the proposition that "our system of taxation is based upon voluntary assessment and payment, not upon distraint."

The Law: The word "voluntary," as used in Flora and in IRS publications, refers to our system of allowing taxpayers to determine the correct amount of tax and complete the appropriate returns, rather than have the government determine tax for them. The requirement to file an income tax return is not voluntary and is clearly set forth in Internal Revenue Code §§ 6011(a) , 6012(a) , et seq., and 6072(a). See also Treas. Reg. § 1.6011-1(a). Any taxpayer who has received more than a statutorily determined amount of gross income is obligated to file a return. Failure to file a tax return could subject the noncomplying individual to criminal penalties, including fines and imprisonment, as well as civil penalties. In United States v. Tedder, 787 F.2d 540, 542 (10 th Cir. 1986), the court clearly states, "although Treasury regulations establish voluntary compliance as the general method of income tax collection, Congress gave the Secretary of the Treasury the power to enforce the income tax laws through involuntary collection . . . . The IRS' efforts to obtain compliance with the tax laws are entirely proper."

19. The Meaning of Income: Taxable Income and Gross Income

19.1 Contention: Wages, tips, and other compensation received for personal services are not income This argument asserts that wages, tips, and other compensation received for personal services are not income, because there is allegedly no taxable gain when a person "exchanges" labor for money. Under this theory, wages are not taxable income because people have basis in their labor equal to the fair market value of the wages they receive; thus, there is no gain to be taxed. Some take a different approach and argue that the Sixteenth Amendment to the United States Constitution did not authorize a tax on wages and salaries, but only on gain or profit.

The Law: For federal income tax purposes, "gross income" means all income from whatever source derived and includes compensation for services. I.R.C. § 61. Any income, from whatever source, is presumed to be income under section 61, unless the taxpayer can establish that it is specifically exempted or excluded. In Reese v. United States, 24 F.3d 228, 231 (Fed. Cir. 1994), the court stated, "an abiding principle of federal tax law is that, absent an enumerated exception, gross income means all income from whatever source derived."

19.2 All compensation for personal services, no matter what the form of payment, must be included in gross income. This includes salary or wages paid in cash, as well as the value of property and other economic benefits received because of services performed, or to be performed in the future. Furthermore, criminal and civil penalties have been imposed against individuals relying upon this frivolous argument.

19.3 Contention: Only foreign-source income is taxable Some maintain that there is no federal statute imposing a tax on income derived from sources within the United States by citizens or residents of the United States. They argue instead that federal income taxes are excise taxes imposed only on nonresident aliens and foreign corporations for the privilege of receiving income from sources within the United States. The premise for this argument is a misreading of sections 861, et seq., and 911, et seq., as well as the regulations under those sections.

The Law: As stated above, for federal income tax purposes, "gross income" means all income from whatever source derived and includes compensation for services. I.R.C. § 61. Further, Treasury Regulation § 1.1-1(b) provides, "[i]n general, all citizens of the United States, wherever resident, and all resident alien individuals are liable to the income taxes imposed by the Code whether the income is received from sources within or without the United States." I.R.C. sections 861 and 911 define the sources of income (U.S. versus non-U.S. source income) for such purposes as the prevention of double taxation of income that is subject to tax by more than one country. These sections neither specify whether income is taxable, nor do they determine or define gross income. Further, these frivolous assertions are clearly contrary to well-established legal precedent. "Recently the IRS explained its position on the I.R.C. 861 argument in Rev. Rul. 2004-30 and on the I.R.C. 911 argument in Rev. Rul. 2004-28."

19.4 Contention: Federal Reserve Notes are not income Some assert that Federal Reserve Notes currently used in the United States are not valid currency and cannot be taxed, because Federal Reserve Notes are not gold or silver and may not be exchanged for gold or silver. This argument misinterprets Article I, Section 10 of the United States Constitution.

The Law: Congress is empowered "[t]o coin Money, regulate the value thereof, and of foreign coin, and fix the Standard of weights and measures." U.S. Const. Art. I, § 8, cl. 5. Article I, Section 10 of the Constitution prohibits the states from declaring as legal tender anything other than gold or silver, but does not limit Congress' power to declare the form of legal tender. See 31 U.S.C. § 5103; 12 U.S.C. § 411. In United States v. Rifen, 577 F.2d 1111 (8 th Cir. 1978), the court affirmed a conviction for willfully failing to file a return, rejecting the argument that Federal Reserve Notes are not subject to taxation. "Congress has declared Federal Reserve notes legal tender . . . and federal reserve notes are taxable dollars." Id. at 1112. The courts have rejected this argument on numerous occasions.

20. The Meaning of Certain Terms Used in the Internal Revenue Code

20.1 Contention: Taxpayer is not a "citizen" of the United States, thus not subject to the federal income tax laws Some individuals argue that they have rejected citizenship in the United States in favor of state citizenship; therefore, they are relieved of their federal income tax obligations. A variation of this argument is that a person is a freeborn citizen of a particular state and thus was never a citizen of the United States. The underlying theme of these arguments is the same: the person is not a United States citizen and is not subject to federal tax laws because only United States citizens are subject to these laws.

The Law: The Fourteenth Amendment to the United States Constitution defines the basis for United States citizenship, stating, "[a]ll persons born or naturalized in the United States, and subject to the jurisdiction thereof, are citizens of the United States and of the State wherein they reside." The Fourteenth Amendment therefore establishes simultaneous state and federal citizenship. Claims that individuals are not citizens of the United States but are solely citizens of a sovereign state and not subject to federal taxation have been uniformly rejected by the courts.

20.2 Contention: The "United States" consists only of the District of Columbia, federal territories, and federal enclaves Some argue that the United States consists only of the District of Columbia, federal territories (e.g., Puerto Rico, Guam, etc.), and federal enclaves (e.g., American Indian reservations, military bases, etc.) and does not include the "sovereign" states. According to this argument, if a taxpayer does not live within the "United States," as so defined, he is not subject to the federal tax laws.

The Law: The Internal Revenue Code imposes a federal income tax upon all United States citizens and residents, not just those who reside in the District of Columbia, federal territories, and federal enclaves. In United States v. Collins, 920 F.2d 619, 629 (10 th Cir. 1990), cert. denied, 500 U.S. 920 (1991), the court cited Brushaber v. Union Pac. R.R., 240 U.S. 1, 12-19 (1916), and noted the United States Supreme Court has recognized that the "Sixteenth Amendment authorizes a direct nonapportioned tax upon United States citizens throughout the nation, not just in federal enclaves. " The courts have uniformly rejected this frivolous contention.

20.3 Contention: Taxpayer is not a "person" as defined by the Internal Revenue Code, and thus is not subject to the federal income tax laws Some maintain that they are not a "person" as defined by the Internal Revenue Code, and thus not subject to the federal income tax laws. This argument is based on a tortured misreading of the Code.

The Law: The Internal Revenue Code clearly defines "person" and sets forth which persons are subject to federal taxes. Section 7701(a)(14) defines "taxpayer" as any person subject to any internal revenue tax and section 7701(a)(1) defines "person" to include an individual, trust, estate, partnership, or corporation. Arguments that an individual is not a "person" within the meaning of the Internal Revenue Code have been uniformly rejected. A similar argument with respect to the term "individual" has also been rejected.

20.4 Contention: The only "employees" subject to federal income tax are employees of the federal government Some argue that the federal government can tax only employees of the federal government; therefore, employees in the private sector are immune from federal income tax liability. This argument is based on an apparent misinterpretation of section 3401, which imposes responsibilities to withhold tax from "wages." That section establishes the general rule that "wages" include all remuneration for services performed by an employee for his employer. Section 3401(c) goes on to state that the term "employee" includes "an officer, employee, or elected official of the United States, a State, or any political subdivision thereof".

The Law: Section 3401(c) defines "employee" and states that the term "includes an officer,

employee or elected official of the United States . ." This language does not address how other employees' wages are subject to withholding or taxation. Section 7701(c) states that the use of the word "includes" "shall not be deemed to exclude other things otherwise within the meaning of the term defined." Thus, the word "includes" as used in the definition of "employee" is a term of enlargement, not of limitation. It clearly makes federal employees and officials a part of the definition of "employee", which generally includes private citizens.

21. Constitutional Amendment Claims

21.1 Contention: Federal income taxes constitute a "taking" of property without due process of law, violating the Fifth Amendment. Some assert that the collection of federal income taxes constitutes a "taking" of property without due process of law, in violation of the Fifth Amendment. Thus, any attempt by the Internal Revenue Service to collect federal income taxes owed by a taxpayer is unconstitutional.

The Law: The Fifth Amendment to the United States Constitution provides that a person shall not be "deprived of life, liberty, or property, without due process of law . . . ." The U.S. Supreme Court stated in Brushaber v. Union Pacific R.R., 240 U.S. 1, 24 (1916), that "it is . . . well settled that [the Fifth Amendment] is not a limitation upon the taxing power conferred upon Congress by the Constitution; in other words, that the Constitution does not conflict with itself by conferring upon the one hand a taxing power, and taking the same power away on the other by limitations of the due process clause." Further, the Supreme Court has upheld the constitutionality of the summary administrative procedures contained in the Internal Revenue Code against due process challenges, on the basis that a post-collection remedy (e.g., a tax refund suit) exists and is sufficient to satisfy the requirements of constitutional due process. Phillips v. Commissioner, 283 U.S. 589, 595-97 (1931).

21.2 The Internal Revenue Code provides methods to ensure due process to taxpayers:

The "refund method," set forth in section 7422(e) and 28 U.S.C. §§ 1341 and 1346(a), where a taxpayer must pay the full amount of the tax and then sue in a federal district court or in the United States Court of Federal Claims for a refund; and

The "deficiency method," set forth in section 6213(a), where a taxpayer may, without paying the contested tax, petition the United States Tax Court to redetermine a tax deficiency asserted by the IRS. Courts have found that both methods provide constitutional due process.

Generally, the IRS must provide taxpayers notice and an opportunity for an administrative appeals hearing upon the filing of a notice of federal tax lien (section 6320) and prior to levy (section 6330).

Taxpayers also have the right to seek judicial review of the IRS's determination in these due process proceedings. I.R.C. § 6330(d). These reviews can extend to the merits of the underlying tax liability, if the taxpayer has not previously received the opportunity for review of the merits, e.g., did not receive a notice of deficiency. I.R.C. § 6330(c)(2)(B). However, the Tax Court has indicated that it will impose sanctions pursuant to section 6673 against taxpayers who seek judicial relief based upon frivolous or groundless positions.

21.3 Contention: Taxpayers do not have to file returns or provide financial information because of the protection against self-incrimination found in the Fifth Amendment. Some argue that taxpayers may refuse to file federal income tax returns, or may submit tax returns on which they refuse to provide any financial information, because they believe that their Fifth Amendment privilege against self-incrimination will be violated.

The Law: There is no constitutional right to refuse to file an income tax return on the ground that it violates the Fifth Amendment privilege against self-incrimination. In United States v. Sullivan, 274 U.S. 259, 264 (1927), the U.S. Supreme Court stated that the taxpayer "could not draw a conjurer's circle around the whole matter by his own declaration that to write any word upon the government blank would bring him into danger of the law." The failure to comply with the filing and reporting requirements of the federal tax laws will not be excused based upon blanket assertions of the constitutional privilege against compelled self-incrimination under the Fifth Amendment.

21.4 Contention: Compelled compliance with the federal income tax laws is a form of servitude in violation of the Thirteenth Amendment. This argument asserts that the compelled compliance with federal tax laws is a form of servitude in violation of the Thirteenth Amendment.

The Law: The Thirteenth Amendment to the United States Constitution prohibits slavery within the United States, as well as the imposition of involuntary servitude, except as punishment for a crime of which a person shall have been duly convicted. In Porth v. Brodrick, 214 F.2d 925, 926 (10 th Cir. 1954), the Court of Appeals stated that "if the requirements of the tax laws were to be classed as servitude, they would not be the kind of involuntary servitude referred to in the Thirteenth Amendment." Courts have consistently found arguments that taxation constitutes a form of involuntary servitude to be frivolous.

21.5 Contention: The Sixteenth Amendment to the United States Constitution was not properly ratified, thus the federal income tax laws are unconstitutional. This argument is based on the premise that all federal income tax laws are unconstitutional because the Sixteenth Amendment was not officially ratified, or because the State of Ohio was not properly a state at the time of ratification. This argument has survived over time because proponents mistakenly believe that the courts have refused to address this issue.

The Law: The Sixteenth Amendment provides that Congress shall have the power to lay and collect taxes on income, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration. U.S. Const. Amend. XVI. The Sixteenth Amendment was ratified by forty states, including Ohio, and issued by proclamation in 1913. Shortly thereafter, two other states also ratified the Amendment. Under Article V of the Constitution, only three-fourths of the states are needed to ratify an Amendment. There were enough states ratifying the Sixteenth Amendment even without Ohio to complete the number needed for ratification. Furthermore, the U.S. Supreme Court upheld the constitutionality of the income tax laws enacted subsequent to ratification of the Sixteenth Amendment in Brushaber v. Union Pacific R.R., 240 U.S. 1 (1916). Since that time, the courts have consistently upheld the constitutionality of the federal income tax.

21.6 Contention: The Sixteenth Amendment does not authorize a direct non-apportioned federal income tax on United States citizens. Some assert that the Sixteenth Amendment does not authorize a direct non-apportioned income tax and thus, U.S. citizens and residents are not subject to federal income tax laws.

The Law: The courts have both implicitly and explicitly recognized that the Sixteenth Amendment authorizes a non-apportioned direct income tax on United States citizens and that the federal tax laws as applied are valid. In United States v. Collins, 920 F.2d 619, 629 (10 th Cir. 1990), cert. denied, 500 U.S. 920 (1991), the court cited Brushaber v. Union Pac. R.R., 240 U.S. 1, 12-19 (1916), and noted that the U.S. Supreme Court has recognized that the "Sixteenth Amendment authorizes a direct nonapportioned tax upon United States citizens throughout the nation."

22. Fictional Legal Bases

22.1 Contention: The Internal Revenue Service is not an agency of the United States. Some argue that the Internal Revenue Service is not an agency of the United States but rather a private corporation, because it was not created by positive law (i.e., an act of Congress) and that, therefore, the IRS does not have the authority to enforce the Internal Revenue Code.

The Law: There is a host of constitutional and statutory authority establishing that the Internal Revenue Service is an agency of the United States. The U.S. Supreme Court stated in Donaldson v. United States, 400 U.S. 517, 534 (1971), "[w]e bear in mind that the Internal Revenue Service is organized to carry out the broad responsibilities of the Secretary of the Treasury under § 7801(a) of the 1954 Code for the administration and enforcement of the internal revenue laws."

Pursuant to section 7801, the Secretary of Treasury has full authority to administer and enforce the internal revenue laws and has the power to create an agency to enforce such laws. Based upon this, the Internal Revenue Service was created. Thus, the Internal Revenue Service is a body established by "positive law" because it was created through a congressionally mandated power. Moreover, section 7803(a) explicitly provides that there shall be a Commissioner of Internal

Revenue who shall administer and supervise the execution and application of the internal revenue laws.

22.2 Contention: Taxpayers are not required to file a federal income tax return, because the instructions and regulations associated with the Form 1040 do not display an OMB control number as required by the Paperwork Reduction Act. Some argue that taxpayers are not required to file tax returns because of the Paperwork Reduction Act of 1980, 44 U.S.C. § 3501, et seq. ("PRA"). The PRA was enacted to limit federal agencies' information requests that burden the public. The "public protection" provision of the PRA provides that no person shall be subject to any penalty for failing to maintain or provide information to any agency if the information collection request involved does not display a current control number assigned by the Office of Management and Budget [OMB] Director. 44 U.S.C. § 3512. Advocates of this contention claim that they cannot be penalized for failing to file Form 1040, because the instructions and regulations associated with the Form 1040 do not display any OMB control number.

The Law: The courts have uniformly rejected this argument on different grounds. Some courts have simply noted that the PRA applies to the forms themselves, not to the instruction booklets, and because the Form 1040 does have a control number, there is no PRA violation. Other courts have held that Congress created the duty to file returns in section 6012(a) and "Congress did not enact the PRA's public protection provision to allow OMB to abrogate any duty imposed by Congress." United States v. Neff, 954 F.2d 698, 699 (11 th Cir. 1992).

23. Talking Points

23.1 All citizens must comply with the requirements of the tax law to file returns and pay taxes. Fortunately, the vast majority of Americans recognizes their civic duty and voluntarily complies with their tax-filing obligation. Taxpayers who fail to file income tax returns and pay taxes pose a serious threat to tax administration and the American economy. Their actions undermine public confidence in the Service's ability to administer the tax laws fairly and effectively.

23.2 Whether because of an inability to pay or severe procrastination, some citizens drop out of the tax system. The IRS has made attempts to make it easier for persons to voluntarily comply with the tax laws and to bring themselves current on any outstanding filings or tax due. Assistance is provided to those persons to resolve issues that caused them to drop out of the tax system and bring them back into compliance.

23.3 When the Sixteenth Amendment to the Constitution was ratified (February 3, 1913) giving Congress the power "to lay and collect taxes on incomes", citizens began arguing that it was not properly ratified and income taxes are illegal. Unfortunately, some citizens continue to raise such arguments in spite of the fact that they have no basis in law and the courts have repeatedly rejected their arguments as frivolous.

23.4 Unscrupulous promoters and their followers have long employed frivolous arguments concerning the legality of the income tax as pretexts to enrich themselves or evade their taxes. Their motivation is usually monetary, not some legitimate purpose or belief. Anti-taxation groups have been around for a long time. They are small but vocal. Though the leadership of these movements used different arguments to gain followers, they all share one thing in common; they received substantial sentences in a federal prison for their activities. Their followers paid a steep price for following bad advice. Some were prosecuted, many more were involved in years of litigation and ultimately had to pay all taxes owed along with penalties and interest.

10 Year Statistics

FY 1996 Investigations Initiated Tax Investigations Other Financial Crimes Total Prosecution Recommendations Tax Investigations Other Financial Crimes Total Indictments/ Information Tax Investigations Other Financial Crimes Total Sentenced Tax Investigations Other Financial Crimes Total Special Agents

FY 1997

FY 1998

FY 1999

FY 2000

FY 2001

FY 2002

FY 2003

FY 2004

FY 2005

3278 2056 5334

3049 2286 5335

2461 2194 4655

1916 2036 3952

1785 1587 3372

1851 1433 3284

2466 1440 3906

2446 1555 4001

2163 1754 3917

2631 1638 4269

1944 1661 3605

1813 2004 3817

1726 1801 3527

1358 1762 3120

1043 1391 2434

1002 1333 2335

1025 1108 2133

1353 1188 2541

1461 1576 3037

1454 1405 2859

N/A N/A 3274

1673 1858 3531

1445 1735 3180

1260 1692 2952

1122 1347 2469

998 1294 2292

954 970 1924

1036 1092 2128

1114 1375 2489

1195 1211 2406

1488 1289 2777 3335

1484 1525 3009 3158

1482 1492 2974 3004

1167 1452 2619 2850

1134 1341 2475 2740

906 1332 2238 2800

1023 1178 2201 2903

835 933 1768 2805

855 922 1777 2796

1015 1080 2095 2843

Corporate Fraud
Investigations Initiated Prosecution Recommendations Indictments/Information Sentenced Incarceration Rate* Average Months to Serve FY 2005 102 115 69 51 80.4% 23 FY 2004 107 78 57 18 61.1% 34

"REPRESENTING THE AUDITED TAXPAYER BEFORE THE IRS"

AND

REPRESENTATION BEFORE THE COLLECTION DIVISION OF THE IRS

07/16/2009

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