Tax Shelter. Presented by: Alice Kasubutare Boon Ong. Agenda. Introduction Tax Shelter Abusive tax shelter Tax shelter penalties Tax shelter FAQs Additional readings References Appendix: IRC Code. Introduction.
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There are many methods by which taxpayers shelter their losses, but these three characteristics are usually found in tax shelters, either separately or in combination:
-- The employer withholds these amounts BEFORE calculating income taxes on the employee's pay.
-- The employer forwards the money to a third party administrator, who invests the employees' contributions per specific instructions provided by the employees.
1. Mortgage Interest
Joint tax filers can deduct all the interest on a maximum of $1 million in mortgage debt secured by a first and second home.
2. Equity Loan Interest
deduct some of the interest you pay on a home equity loan or line of credit.
3. Property Taxes
property taxes are fully deductible from your income.
4. Capital Gains Exclusion
Married taxpayers who file jointly now get to keep, tax free, up to $500,000 in profit on the sale of a home used as a principal residence for two of the prior five years. Single folks and married taxpayers who file separately get to keep up to $250,000 apiece tax free (Taxpayer Relief Act of 1997 )
Business must have a “profit motive”
To qualify as business deductions, expenses must be:
Ordinary and necessary,” This is defined as any activity that is associated with that business
Paid or incurred during the taxable year, and connected with the conduct of a trade or business .
you can give up to the annual exclusion amount ($11,000 in 2004) to a person, every year, without facing any gift taxes, and without the recipient owing an income tax on the gifts. And you can give up to $1,000,000 in gifts total, in your lifetime
Tax examiners are taught to investigate the following situations for possible abusive financial maneuvers:
The IRS has also issued the following as a checklist for determining whether a particular offering is an abusive tax shelter. These questions will help to provide a clue as TO THE abusive nature of the plan:
Types of penalties
If you are under 59 and 1/2, the entire amount withdrawn will be taxable and is generally subject to the 10% penalty on early distribution unless you rollover the distribution to another retirement plan or an IRA within 60 days of receiving the distribution.
Yes. It's called a rollover from one qualified plan to another qualified plan. The distribution will not be taxable when the rollover is made within 60 days. In order to avoid the 20% withholding tax, the transfer should be made directly from one trustee to another.
If you are under the age of 59 1/2, you cannot withdraw funds from your 401(k) plan to purchase your first home without being subject to a 10 percent additional tax on early distributions from qualified retirement plans. However, depending on the rules for your 401(k), you may be able to borrow money from your 401(k) to purchase your first home. Your plan administrator should have written information about your particular plan that explains when you can borrow funds from your 401(k) as well as other plan rules
It is not the money you receive for the sale of your home, but the amount of gain on the sale over your cost, or basis, that determines whether you will have to include any proceeds as taxable income on your return. You may be able to exclude any gain from income up to a limit of $250,000 ($500,000 on a joint return in most cases). If you can exclude all of the gain, you do not need to report the sale on your tax return.
With the exception of the 2-year waiting period, there is no limit on the number of times you can exclude the gain on the sale of your principle residence so long as you meet the ownership and use tests.
If you owned and lived in the property as your main home for less than 2 years, you may still be able to claim an exclusion in some cases. The maximum amount you can exclude will be reduced.
You may deduct home equity debt interest, as an itemized deduction, if you are legally liable to pay the interest, pay the interest in the tax year, secure the debt with your home, and do not exceed your home equity debt limit.
A loan taken out for reasons other than to buy, build, or substantially improve your home, such as to pay off personal debts may qualify as home equity debt. The interest would be deducted on line 10, Form 1040 Schedule A Itemized Deductions. You may not deduct interest on any amount of home equity debt that exceeds your home equity debt limit, which generally is $100,000.
Abusive tax schemes multiplied in the 1990's for various reasons:
Taxpayers had large capital gains or other income subject to income tax.
Internal Revenue Service compliance activity decreased.
Promoters increased the marketing of abusive tax schemes as 'legally defensible' ways to minimize tax burdens.
Penalties for participating in abusive tax schemes were too small to have a deterrent effect.
There was no efficient disclosure and reporting system for abusive tax schemes
Tax shelters reduce current tax liability by offsetting income from one source with losses from another source. The IRS allows some tax shelters, but will not allow a shelter which is "abusive." An abusive shelter generally offers inflated tax savings which are disproportionately greater than your actual investment placed at risk. Generally, you invest money to generate income. However, an abusive tax shelter generates little or no income, and exists solely to reduce taxes unreasonably for tax avoidance or evasion. In comparison, a legitimate tax shelter often produces income and involves a risk of loss proportionate to the expected tax benefit. Abusive tax shelters are often marketed in terms of how much you can write off in relation to how much you invest. This "write off" ratio is often much greater than two-to-one as of the close of any of the first five year ending after the date on which the investment is offered for sale. A series of tax laws have been designed to halt abusive tax shelters. An organizer of a potentially abusing tax shelter who doesn't maintain a list of investors is subject to penalty of $50 per failure, per person, unless due to a reasonable cause and not willful neglect.
§ 6111.REGISTRATION OF TAX SHELTERS
(a)(1) IN GENERAL. --Any tax shelter organizer shall register the tax shelter with the Secretary (in such form and in such manner as the Secretary may prescribe) not later than the day on which the first offering for sale of interests in such tax shelter occurs.
(a)(2) INFORMATION INCLUDED IN REGISTRATION. --Any registration under paragraph (1) shall include --
(a)(2)(A) information identifying and describing the tax shelter,
(a)(2)(B) information describing the tax benefits of the tax shelter represented (or to be represented) to investors, and
(a)(2)(C) such other information as the Secretary may prescribe
(b) FURNISHING OF TAX SHELTER IDENTIFICATION NUMBER; INCLUSION ON RETURN.
(b)(1) SELLERS, ETC. --Any person who sells (or otherwise transfers) an interest in a tax shelter shall (at such times and in such manner as the Secretary shall prescribe) furnish to each investor who purchases (or otherwise acquires) an interest in such tax shelter from such person the identification number assigned by the Secretary to such tax shelter.
(b)(2) INCLUSION OF NUMBER ON RETURN. --Any person claiming any deduction, credit, or other tax benefit by reason of a tax shelter shall include (in such manner as the Secretary may prescribe) on the return of tax on which such deduction, credit, or other benefit is claimed the identification number assigned by the Secretary to such tax shelter.
(C) Tax shelter
(c)(1) IN GENERAL. --The term "tax shelter" means any investment --
(c) (A) with respect to which any person could reasonably infer from the representations made, or to be made, in connection with the offering for sale of interests in the investment that the tax shelter ratio for any investor as of the close of any of the first 5 years ending after the date on which such investment is offered for sale may be greater than 2 to 1, and
(c) (A)(B) which is --
(c) (A) (B) (i) required to be registered under a Federal or State law regulating securities,
(c) (A) (B) (ii) sold pursuant to an exemption from registration requiring the filing of a notice with a Federal or State agency regulating the offering or sale of securities, or
(c) (A) (B) (iii) a substantial investment.
(d) CERTAIN CONFIDENTIAL ARRANGEMENTS TREATED AS TAX SHELTERS. –
(d)(1) IN GENERAL. --For purposes of this section, the term "tax shelter" includes any entity, plan, arrangement, or transaction --
(d)(1)(A) a significant purpose of the structure of which is the avoidance or evasion of Federal income tax for a direct or indirect participant which is a corporation,
(d)(1)(B) which is offered to any potential participant under conditions of confidentiality, and
(d)(1)(C) for which the tax shelter promoters may receive fees in excess of $100,000 in the aggregate.
§ 6112. ORGANIZERS AND SELLERS OF POTENTIALLY ABUSIVE TAX SHELTERS MUST KEEP LISTS OF INVESTORS
(a) IN GENERAL. --Any person who --
(a)(1) organizes any potentially abusive tax shelter, or
(a)(2) sells any interest in such a shelter,
shall maintain (in such manner as the Secretary may by regulations prescribe) a list identifying each person who was sold an interest in such shelter and containing such other information as the Secretary may by regulations require.
(b) POTENTIALLY ABUSIVE TAX SHELTER. --For purposes of this section, the term "potentially abusive tax shelter" means --
(b)(1) any tax shelter (as defined in section 6111) with respect to which registration is required under section 6111, and
(b)(2) any entity, investment plan or arrangement, or other plan or arrangement which is of a type which the Secretary determines by regulations as having a potential for tax avoidance or evasion.
§ 6707.FAILURE TO FURNISH INFORMATION REGARDING TAX SHELTERS.
(a) FAILURE TO REGISTER TAX SHELTER. --
(a)(1) IMPOSITION OF PENALTY. --If a person who is required to register a tax shelter under section 6111(a) --
(a)(1)(A) fails to register such tax shelter on or before the date described in section 6111(a)(1), or
(a)(1)(B) files false or incomplete information with the Secretary with respect to such registration,
such person shall pay a penalty with respect to such registration in the amount determined under paragraph (2) or (3), as the case may be. No penalty shall be imposed under the preceding sentence with respect to any failure which is due to reasonable cause.
(a)(2) AMOUNT OF PENALTY. --Except as provided in paragraph (3), the penalty imposed under paragraph (1) with respect to any tax shelter shall be an amount equal to the greater of --
(a)(2)(A) 1 percent of the aggregate amount invested in such tax shelter, or
(a)(3) CONFIDENTIAL ARRANGEMENTS. --
(a)(3)(A) IN GENERAL. --In the case of a tax shelter (as defined in section 6111(d)), the penalty imposed under paragraph (1) shall be an amount equal to the greater of --
(a)(3)(A)(i) 50 percent of the fees paid to all promoters of the tax shelter with respect to offerings made before the date such shelter is registered under section 6111, or
Clause (i) shall be applied by substituting "75 percent" for "50 percent" in the case of an intentional failure or act described in paragraph (1).
(a)(3)(B) SPECIAL RULE FOR PARTICIPANTS REQUIRED TO REGISTER SHELTER. --In the case of a person required to register such a tax shelter by reason of section 6111(d)(3) --
(a)(3)(B)(i) such person shall be required to pay the penalty under paragraph (1) only if such person actually participated in such shelter,
(a)(3)(B)(ii) the amount of such penalty shall be determined by taking into account under subparagraph (A) (i) only the fees paid by such person, and
(a)(3)(B)(iii) such penalty shall be in addition to the penalty imposed on any other person for failing to register such shelter.
(b) FAILURE TO FURNISH TAX SHELTER IDENTIFICATION NUMBER. --
(b)(1) SELLERS, ETC. --Any person who fails to furnish the identification number of a tax shelter which such person is required to furnish under section 6111(b)(1) shall pay a penalty of $100 for each such failure.
(b)(2) FAILURE TO INCLUDE NUMBER ON RETURN. --Any person who fails to include an identification number on a return on which such number is required to be included under section 6111(b)(2) shall pay a penalty of $250 for each such failure, unless such failure is due to reasonable cause.