Don't get caught in an illegal tax shelter

The economic slowdown hasn't affected one group of people – promoters selling tax shelters.  Some shelters are perfectly legal, but many are termed abusive by the IRS.

Because illegal shelters cost the Treasury billions of dollars in lost taxes, the IRS is stepping up enforcement efforts against promoters and buyers of these shelters.

How can you avoid illegal tax shelters?  It's not always easy for the average taxpayer to know when a tax shelter is illegal.  The tax code is long and complex, and there's sometimes a fine line between legal and abusive.  But the IRS has the ability to disallow any transaction if it believes it is a sham.  The final decision may then be up to the Tax Court.

The IRS is likely to challenge any arrangement that has no "economic substance" – in other words a transaction that lacks an obvious business or economic purpose or that shelters other income not related to the transaction.

Beware of shelters involving complicated financial transactions, especially if they involve setting up new domestic or offshore companies or partnerships.  Use your common sense to decide if the proposal is related to your normal business or investment activities.  And as always, be suspicious of any scheme that seems too good to be true.  Don't fall for a "hard sell" approach or limited time offers.

The best protection is to review any proposal with your own tax advisor.  If a scheme is legal, the promoters shouldn't fear a second opinion.