Should you consider forming an Entity? |
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Are you hearing people talk about tax schemes involving multiple layered entities? Ways to avoid taxes? Have you come across an online website that is promoting a "secret" way to structure an entity, that they can only tell you about after you've paid them hefty consulting fees?
Before you jump into something, consider this...
IRS Web Site Warns of Abusive Tax Shelters
http://www.irs.gov/individuals/content/0,,id=97749,00.html
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If the promotion you are considering sounds too good to be true, it may be an abusive tax shelter. The following are red flags to look out for:
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"Never pay taxes again"
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"Deduct the cost of your personal living expenses"
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"Deduct the cost of your child's education"
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"The IRS doesn't want you to know about this"
This statement is often used by those selling abusive tax shelters to convince you that what they are selling is legitimate in spite of what you may hear from the IRS. If you don't trust the IRS, ask a tax professional that you do trust who is not involved in the marketing of tax shelter schemes.
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"This is so new, your CPA doesn't know about it yet"
This is something said by promoters to discourage you from seeking advice from someone else about a proposed investment. While new laws are passed often, if there is a new one that could save you taxes, the promoter of the investment should encourage you to get a second opinion and provide a reference just in case your CPA really doesn't know about it yet. If the investment can't stand being looked at by an unbiased third party, it is probably one you want to avoid.
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Multiple trusts, partnerships or other entities are involved
The existence of multiple levels of entities does not necessarily mean there is anything wrong with the investment if there is a business purpose for each of the entities. Be wary of schemes that use multiple levels of entities with no apparent business purpose other than reducing taxes and making the money hard (but not impossible) to trace.
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Some of the entities involved are foreign
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How aggressive should you be with your tax strategy? In the end, that is up to you.
Excerpts from IRS.gov:
"Abusive tax shelters are marketing schemes that involve artificial transactions with little or no economic reality. They often make use of unrealistic allocations, inflated appraisals, losses in connection with nonrecourse loans, mismatching of income and deductions, financing techniques that do not conform to standard commercial business practices, or the mischaracterization of the substance of the transaction."
"Penalties: Investing in an abusive tax shelter may be an expensive proposition when you consider all of the consequences. First, the promoter generally charges a substantial fee. If your return is examined by the IRS and a tax deficiency is determined, you will be faced with payment of more tax, interest on the underpayment, possibly a 20% accuracy-related penalty, or a 75% civil fraud penalty. You may also be subject to the penalty for failure to pay tax."
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