More nefarious and sophisticated tax-cheating involves use of phony trusts and entities to hide income, which can be used in conjunction with off-shore banks and credit cards to further eliminate a paper trail.

IRS has begun a crackdown on trusts and off-shore banking, but the results thus far have not been impressive. In contrast, the illegal trust-scam industry seems to be thriving. IRS apparently believes that criminal prosecution will deter promoters of these schemes, but despite an impressive conviction rate, millions, if not billions, of tax dollars are escaping the system. It takes years to successfully prosecute and convict a tax scam promoter and by that time, many taxpayers will have used their phony trusts and other arrangements to escape taxation.

In addition, there is a sophisticated tax-cheating industry flourishing on the Web, including phony identification numbers and shopping baskets full of off-shore companies, credit cards and banks ready to assist the tax cheat. One can even own an off-shore bank with which to launder your income, for the right price. Thus far, IRS has refused to crack down on Internet-based tax cheating services, citing First Amendment (freedom of speech) concerns, although the Food and Drug Administration has had no such First Amendment qualms shutting down websites that promote illegal or harmful products.

In his testimony before Congress, IRS Commissioner Charles Rosatti has made it clear that he intends to rely on criminal prosecution of trust scam promoters (he calls them "abusive trust" promoters) as the main deterrent, rather than taking swift action against website that advertise and sell tax-cheating packages. Notably, however, IRS recently has begun filing civil lawsuits aimed at shutting down some of the more notorious scams.

Of course, a prerequisite to tax cheating is generating income that is not reported on a W-2 or Form 1099. This usually means business income generated by self-employed workers or small companies, illegal income (which probably would not be reported in the first place) or income from rents, royalties or investments (held outside the U.S.).

Billions in Tax Cheating Goes Undetected  

Michael Brostek, director of tax issues for the General Accounting Office, says that according to government estimates, between $20 and $40 billion was lost to offshore schemes alone in 2000, with as many as 505,000 taxpayers taking part. IRS believes there could be 1 million to 2 million U.S. citizens holding credit or debit cards issued by offshore banks. The agency located 235,000 such accounts issued through 28 banks located in three countries. It is estimated that these accounts cheat the government, and the American people, of at least $70 billion annually.

At least another $2.9 billion was lost to abusive trusts used for the express purpose of sheltering income from taxes; and frivolous claims for refunds resulted in another $4.9 billion loss. As Senator Max Baucus of Montana has said, ". . . it is clear that tax cheats punish not only honest taxpayers by forcing them to shoulder the burden, but cost our government literally tens of billions of dollars each year."

If the taxes on K-1 income alone were collected, it is estimated that it would be enough to exempt from income tax the 62.5 million taxpayers who made less than $508 a week, with $29 billion left over.

IRS Amnesty Program Nets $16 Billion in Phony Losses  

To smoke suspected tax violators out of the woodwork, IRS recently initiated a four-month amnesty program, encouraging taxpayers to voluntarily disclose tax shelters in exchange for immunity from IRS tax penalties that would otherwise be due on monies owed. Officials expect that the actual cost is likely much higher than $16 billion because many taxpayers failed to list the amounts of their deductions.

Sophisticated tax shelters typically generate big artificial investment losses which become tax deductions. Deductions by participants ranged from $10 million to $300 million according to IRS officials, and the tax avoided averages one-third the amount of the deduction -- a $300 million tax deduction reduces taxes by roughly $100 million.

IRS was surprised at the number of individuals involved. In the past, IRS focused their attention and resources on deals promoted to major corporations. Of the 577 taxpayers tallied thus far in this program, about 400 are individuals.

Even with administration backing, congressional advocates admit they face an uphill battle in promoting tax-shelter legislation to go after tax-scam promoters. Major accounting firms and investment banks, assisted by major law firms lend confidence to taxpayers seeking shelter from tax bills.

Generally, taxpayers face little financial risk in attempting to thwart IRS. Even without the amnesty program, taxpayers are shielded from basic IRS penalties by lawyers' opinion letters approving the deals. Also, IRS can't exact separate penalties for failure to comply with disclosure agreements. All the waiters need is really big tips so that they can afford the accounting firms and lawyers.

IRS Audit vs. Death by Accident - Here are the Odds  

Continuing the theme, people with small businesses with revenue of less than $25,000 are more than twice as likely to be audited as those with revenue of $100,000 or more.

But for those who earn greater than $100,000, the odds are far greater, more than 4 to 1, that they could die from an accident than of ever being audited by IRS.

Better yet, if you own an S-Corporation, like many professionals such as doctors and lawyers, you stand a chance of audit of only 1 in 233. Chances of being killed by a firearm are close, 1 in 299; but you have a greater chance of being killed (homicide odds are greater at 1 in 197) than receiving an audit notice for an S corporation!

Partnerships and Limited Liability Companies fare best of all in avoiding IRS audits with only a 1 in 400 chance. The chance of dying by poison is greater, 1 in 344!

Tax Planning Tip: Sole proprietorships and freelancers earning more than $100,000 a year have a 1:83 chance of audit. Switch your business operations to an S corporation (1:233 chance of audit) and you reduce the chances of audit three times. Better yet, become an LLC (1:400 chance of audit) and reduce your audit risk by a factor of five! Note: the LLC will need at least two or more members to file as a partnership and obtain the 400:1 odds against audit.

A small "C" corporation (separate taxpaying entity) has a 1:49 chance of audit. By converting to an "S" corporation, the odds of audit are reduced almost six-fold to 1:233.

The current manner of policing wage earners more assiduously than higher income investors and business owners undermines our tax system and is grossly unfair - returns are not being equally verified for all Americans.

Where's Congress?  

In an effort that sounds like a rebuttal to the New York Times expose on its tax-auditing practices, IRS told congress that it expects a new focus on auditing higher-income taxpayers beginning in 2003. A survey done in 2001 indicated that as many as 24% of taxpayers are comfortable with "some level of cheating;" although serious noncompliance was only sanctioned by 3% to 5% of participants.

IRS Oversight Board Chairman Larry Levitan has stated that he believes voluntary compliance by the general public is beginning to erode at the very time that "the broad decline in enforcement activity increases reliance on voluntary compliance." IRS acknowledged that in 2001, about $3 billion in enforcement revenue was lost due to a drop in compliance activities.

Conclusion:  

Where is Robin Hood when we need him?