IRS Zeros In on Burgeoning Offshore Scams for Tax Dodgers

Tax cheats be warned: The Internal Revenue Service has launched a crackdown on the use of offshore bank accounts to evade income taxes.

The federal government loses an estimated $70 billion annually to illegal offshore tax schemes, IRS Commissioner Charles O. Rossotti told Congress last week.

“Today, in a wide range of guises, there are individuals and organized groups attempting to mislead or entice taxpayers into believing that there is a way out of paying taxes,” Rossotti testified.

“In terms of practical impact, the most important of the various tax schemes are those that actually sell packages to upper-income taxpayers that claim to permit income taxes to be reduced or eliminated.”

Most offshore tax scams involve funneling U.S. income through a series of domestic and offshore trusts and foreign bank accounts. By creating trusts that supposedly receive the taxpayer’s income, and then paying the taxpayer through a second, third or fourth trust located offshore, promoters maintain that the U.S. citizen has no domestic income and is consequently not subject to federal income tax.

Similar scams use domestic trusts and sham corporations, claiming that the taxpayers’ living expenses are legitimate business deductions and that no taxable income is reported.

These abusive programs are pitched on radio, cable television, through newspaper advertisements and over the Internet. Although the bulk of participants are taxpayers with six-figure incomes, the IRS says, even some middle-income taxpayers can be lured by the promise of a dramatically reduced tax bill.

“It’s easy to get caught up in something like this,” said Steven A. Jensen, director of the tax-controversy section at Deloitte & Touche in Costa Mesa. “The promoters tell unsophisticated taxpayers that wealthy people do this and pay no income tax, and these schoolteachers and other middle-income filers get taken in and think that they ought to try it too.”

If you are convicted of criminal tax fraud, you can serve time in prison. Roughly 81% of those convicted of this type of tax fraud served sentences averaging 45 months, according to the IRS.

You also would be required to pay the taxes owed, plus civil fraud penalties as high as 75% of the underpaid tax. For example, someone caught evading $10,000 in income taxes through one of these schemes would be assessed $10,000 in back taxes, plus $7,500, plus interest.

Worse still, taxpayers can’t rely on the statute of limitations to clear them of financial liability. Normally, taxpayers don’t need to worry about an audit of any return that’s more than 3 years old. But different statutes apply when it comes to fraud.

First, there is no time limit on your civil, or monetary, liability when you file a fraudulent tax return, said Mark Matthews, chief of IRS criminal investigations in Washington. Second, the criminal statute of limitations for tax fraud is six years--and there’s no statute of limitations if you flee the country or make efforts to conceal the crime.

Although these types of frauds have been committed for years, the chance of getting caught has never been higher, Matthews said. Indeed, federal tax authorities weren’t aware of the magnitude of the problem until mid-1996, when the owner of a bank in the Grand Cayman Islands began cooperating with U.S. tax officials. The banker provided the IRS with information about hundreds of American citizens who appeared to be participating in tax fraud, Rossotti testified.

The IRS’ subsequent efforts to investigate suspected fraud was often stymied by a variety of foreign laws and regulations that kept U.S. officials from viewing bank records. The agency scored some successes, getting tax treaties and cooperation from a few governments, Matthews said. However, the big break came in October, when a federal judge in Miami ruled that the IRS could examine the bank records of tens of thousands of U.S. citizens with accounts in the Caribbean.

Partly as a result, the IRS’ civil fraud division is auditing 17 tax-shelter promoters and evaluating 161 schemes for possible investigation, Rossotti said.

Also, the agency’s criminal-investigation division has obtained 117 convictions against participants and promoters of illegal trusts and is investigating 135 more. In February, IRS criminal investigators executed three dozen search warrants in a sting aimed at suspected promoters of fraudulent trusts.

The IRS is launching a program to match partnership and trust income with losses reported on other trusts that the IRS believes were created solely for tax evasion. That program is operating on a limited basis, but Rossotti told Congress he expects it to be fully operational next year.

Taxpayers should sidestep anyone who claims they can eliminate income taxes through the use of shelters, Nevada corporations or any other complicated and too-good-to-be-true pitch, Matthews said.

Those who have already participated in one of these schemes may want to confess before they’re discovered, Deloitte’s Jensen said. Although you would be held liable for any underpaid tax, plus interest, the IRS is likely to waive at least some of the fraud penalties if you approach the agency before the agency finds you, he said.

The IRS has a program that’s aimed at offering leniency to people who come forward without any prodding from the agency, Matthews noted. However, not everyone qualifies. He suggested that taxpayers consult an expert--unrelated to the promoter who sold you the tax shelter--to get advice.

“The biggest fear is that people will get years down the road before the fraud is discovered and settled,” Jensen said. “By then, the money has all been spent and they owe twice as much because of the interest and penalties. That can be devastating to the average taxpayer.”

*

Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past Personal Finance columns visit The Times’ Web site at https://www.latimes .com/perfin.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Top Targets

Here are the most frequent reasons for IRS criminal investigations, ranked by investigative time devoted to each area in the fiscal year ended Sept. 30, 2000:

General fraud (underreporting income, etc.): 42.1%

Drug programs (money-laundering and tax fraud): 21.5

Fraudulent tax return preparers: 5.9

Questionable refunds: 5.1

Health care (tax aspects of Medicare fraud): 4.1

Foreign and domestic trusts: 3.6

Financial institutions: 3.2

Public corruption: 2.9

Gaming: 2.2

Telemarketing: 1.6

*

Source: Internal Revenue Service