As the saying goes, if it sounds too good to be true, it usually is. And that's the case with scams that seem to show up around tax-filing season. Here are some of the biggies to look out for this year.

African-American reparation tax refund
Thousands of African-Americans have been scammed by tax preparers offering to file for tax credits or refunds related to reparations for slavery. Quite simply, there is no such provision in the tax law. The scam basically works when these promoters encourage clients to pay them in order to file such a claim for refund. By the time the victim realizes that no refund is forthcoming, the scam artist is long gone. To add insult to injury, filing a false claim can cause the victim to be assessed a $500 civil penalty.

Home-based business deductions
This scheme offers tax "relief," but is really nothing more than illegal tax evasion. The promoters claim that an individual can deduct virtually all of their personal expenses as business expenses by setting up a bogus home-based business. However, such a practice is illegal. The tax code clearly states that a business must be genuine, with a clear purpose and profit motive, before any business expenses are deductible. 

Even if you do have a legitimate business, personal expenses, such as the household expenses, are not deductible. In fact, this scam has become so popular that the IRS has created an information pamphlet warning taxpayers.

Pay the tax, get the prize
This is generally a telephone scam as opposed to a classic tax scam, but the result is the same: You get fleeced. The voice on the other end of the phone tells you that you've won a prize (such as $10,000 in cash or a new car). All you have to do is pay the tax on the prize in order to receive it. Of course, the caller says you must make the tax payment to him.

Don't be fooled: There are no requirements to prepay taxes for any prize won. If you were lucky enough to win something of value, you might have to adjust any estimated tax payments in order to avoid some IRS penalties. But any taxes paid goes directly to the IRS, not to a third-party prize giver.

Taxes are voluntary -- and I volunteer not to pay
This scam has many faces, from promoters showing you (for a fee, of course) that you don't have to have any taxes withheld from your wages, to a promoter charging a fee to share this little known "secret," to purchasing an "untax package" that shows you how you can avoid paying any taxes. Many of these scams are showing up with more and more regularity on the Internet.

Don't be taken in! The courts have continuously rejected these and various other similar schemes. The advice contained in these packages can result in civil and/or criminal penalties.

No taxes in a trust
The perpetrators of these abusive trust schemes charge a substantial fee (many thousands of dollars) for trust packages that look all nice and pretty, not to mention official and legal. Part of the fee charged is to allow the taxpayer to use various foreign trustees, bank accounts, and corporations within the trust documents. The taxpayer is then advised to transfer his assets to these trusts and corporations, with the advice that he will never again be subject to taxes.

Many folks have been advised to use ATM or credit cards issued by foreign banks, with the understanding that anything paid with these cards can be called a business deductions, regardless if the purchase is for a legitimate business purpose or (most likely) non-deductible personal reasons. This scam is particularly dangerous since it's being promoted by professionals that provide official-looking documents.

These promoters go on to explain that because of the separation of responsibility and control between the taxpayer and these trusts and corporations, no income ever accrues to the taxpayer. Since there is no control, there are no income taxes.

Sadly, once the IRS uncovers all of the facts and circumstances surrounding the trust documents, it becomes clear that the taxpayer controls all of these trusts and corporations, either directly or indirectly. Therefore, the claim that the taxpayer can avoid income taxes just doesn't hold up. The IRS is investigating many of these abusive trusts, trying to nail not only the promoters but also the taxpayers involved. Don't be one of them. Read more about abusive trusts in Publication 2193 at the IRS web site (.pdf reader required).

IRS "agent" visiting to collect
You may find somebody knocking at your door who claims to be an IRS agent collecting back taxes. He'll try to scare into writing a check on the spot. Don't do it.

In fact, don't let anybody into your home that purports to be an IRS agent without seeing proper documentation. IRS field auditors, collection officers, and special agents all carry picture IDs. Additionally, the IRS official who might have legitimate business with you will normally call you before they pay a visit. If you think that the person on your doorstep is an impostor, lock your door and immediately call your local police. Then make your next call to the Treasury Inspector General's Hotline at 1-800-366-4484.  

To find out more about many other popular scams, visit the Quatloos website. For additional information, read the testimony given by Jay D. Adkisson before the Senate Finance Committee regarding tax and financial frauds. You can also read more about tax schemes on the IRS Criminal Investigation Division fraud page. 

If you are given a "too good to be true" offer that doesn't quite pass the smell test, or seems otherwise tainted, grab your wallet and run as far and as fast as you can. When you finally get to a telephone, notify the IRS by calling 1-800-829-0433.

Related Links:
Home-Based Business Tax-Avoidance Schemes
Too Good to Be True Trusts
Quatloos: Scams and Frauds Exposed

If you like the way Roy Lewis simplifies confusing tax issues, check out his just-published book, The Motley Fool's Investment Tax Guide 2002: Smart Tax Strategies for Investors. This handy 360+ page guide covers just about every tax aspect of a typical Fool's life: investing, marriage, children, education, homes, home offices, retirement accounts, medical expenses, and much more.)

January 3, 2003

Reprinted by permission. Disclaimer
© Copyright 2000-2003, The Motley Fool.
All rights reserved.