Have you ever had a client bring you a tax strategy that sounded too good to be true? Even if a tax savings idea is setting off alarm bells for you, you may not be sure how to refute it when your client is the one bringing it up with enthusiasm. Of course, in an ideal scenario, you would be ahead of the game and hearing about common tax scams before your clients, so you can preemptively warn them not to heed these get-rich-quick schemes of the tax world. Unfortunately, new scams pop up overnight and spread quickly with the help of the internet—meaning that you need to be prepared to identify fraudulent schemes and explain to your clients why you will not be recommending what may sound like a lucrative strategy.
First, the basics: do your clients know the difference between tax avoidance versus tax evasion? The distinction is essential because the first is the reason they hired you—to find legal strategies for lowering their tax bill. Tax avoidance simply involves structuring transactions so that the taxpayer reaps the largest tax benefits. Tax evasion, on the other hand, relies on concealing information and deceit. This refers to actual criminal activity that can result in major penalties and even jail time.
Scammers are going to attempt to lure your clients in with grand promises of reducing their tax liability, but they will leave the exact details as to “how” very fuzzy. This is where you come in—your expertise is essential to helping taxpayers distinguish a legitimate tax avoidance strategy from a tax evasion scheme that will get them in trouble with the law.
What are some common red flags that may point to the fact that a tax strategy is actually too good to be true? Signs include:
• Secrecy
• Exclusivity
• Overpromising
• Lack of transparency
• Lack of successful history
• Lack of adjudication
Secrecy and exclusivity are similar tactics. Scammers will make a fake tax strategy sound like an insider opportunity that only high-income taxpayers typically know about. This sounds believable because, as we know, there are tax credits like that—legitimate savings opportunities that are underutilized or complex enough that the average taxpayer may not know they are eligible or how to claim it. However, remember that information about tax credits is never a secret. Tax incentives created by the federal government should be backed up by an ample amount of publicly available information. If the person promoting a tax credit claims that they cannot explain exactly how it works because that is “proprietary information,” run the other way.
Overpromising is another common sign of a scam. As tax planners we know that guaranteeing results is illegal. We only provide estimates based on our understanding of tax law and careful calculations. If someone is framing an offer with a level of certainty that makes us uncomfortable, take that as a sign that it’s worth investigating further.
Lack of transparency is key to any scheme. At first glance, the details the promoter provides may sound similar to legitimate tax strategies. The red flag starts to go up if a promoter refuses to share where in the tax code we can find evidence for a strategy or, even worse, they ask you to sign a non-disclosure agreement. No one owns the tax code, so there should be no issue providing proof a strategy is legitimate.
Finally, keep an eye out for a lack of adjudication or examples that a strategy has passed the IRS’ “sniff test” in the past. Keep in mind that scammers will often reference real laws or even real court cases, but a simple read of the actual text will reveal that it doesn’t say what the promoters claim it says!
Key Questions to Ask When Evaluating a Tax Strategy
If one or more of these red flags has been raised, what now? Before making a recommendation to your clients, start researching the evidence behind the claim. Here are a few key questions to start with:
• What is the legal basis for this strategy?
• Who is offering the strategy?
• Has this strategy been tested?
• Does the strategy align with Congress’ priorities?
• What are the risks?
First, determine the legal basis. What section of the Internal Revenue Code speaks to this strategy? Is there other clear documentation of IRS guidance, like regulations or rulings, that supports the claim being made?
Second, who is promoting the strategy, and what are their credentials? Is the person backing this offer a qualified tax professional? Sometimes just looking into the background of a promoter will reveal that the organization they are part of was just formed last year—that could definitely be a red flag! Was this company seemingly established solely to promote this tax credit, or is there other evidence that they are a reputable firm?
Next, has the strategy been tested? This is key in educating your clients—taxpayers may not realize that acceptable strategies should be backed by the tax code, instances where other taxpayers have successfully claimed the credit with no pushback from the IRS, or court cases where a judge definitively says, “Yes, it is okay to apply a tax credit in this way.” Another reliable piece of evidence is if a reputable law firm that is well-insured is willing to stand behind this tax strategy. Again, scammers may claim that their offer is “verified by an attorney” or even put forward fake names—do the research before assuming this is legitimate.
Also, consider whether the strategy aligns with Congress’ priorities? Tax credits are often introduced to incentivize certain behavior or stimulate economic growth within certain sectors or communities. For example, under the Biden administration, the Inflation Reduction Act introduced a number of tax credits to promote the use of clean energy. Other tax credits might be targeted at community development in underserved areas. This is another way of asking “does it make sense that this credit exists?”
Finally, what are the risks? If the IRS disallows the claim, what penalties might be on the line? Taxpayers sometimes naively think that if a strategy doesn’t work, they can just turn around and pay the original tax owed. In reality, between the tax, penalties, and interest, the gamble can end up costing them way more. Even worse, if the IRS determines the taxpayer was intentionally deceiving them, the consequences can be dire for both you and your client. Talking through these risks can often serve as an effective way to persuade a client that it is not worthwhile to take a chance on a tax strategy that doesn’t have enough supporting evidence.
Summary
By educating your clients on the differences between tax avoidance and tax evasion, you can get ahead of alluring tax scams that might pique your clients’ interest. One helpful technique is to prioritize year-round communication with your clients and regularly email them content flagging the latest scams and how to identify them. This education process can also increase your clients’ appreciation for your thorough and proactive approach as a qualified tax professional.
To learn more about how to identify tax scams and how to best educate your clients, sign up to become a Certified Tax Planner today.
