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  Copyright© 2005 Colin M. Cody, CPA and, LLC, All Rights Reserved.
Headline: IRS and FinCEN Announce Latest Efforts to Crack Down on Tax Avoidance Through Offshore Accounts

Recently the IRS has been throwing around the term "tax avoidance" as though it is a criminal act.

It used to be that "tax evasion" was the criminal act whereas arranging one's affairs to result in "tax avoidance" was just fine and dandy.  Offering "Tax Avoidance" is one way that the US Congress changes public behavior.  For example, to encourage drilling for Crude Oil and Natural Gas, the US Congress passed various laws giving Tax Avoidance benefits to anyone entering that business.  Offering immediate tax refunds for "Intangible Drilling Costs" up front and then offering additional tax refunds later on during the production cycle from a "paper-only deduction" called "Percentage Depletion" - just to name two.

It is not illegal to avoid paying taxes by legitimately drilling domestically for Crude Oil and Natural Gas, as a matter of fact it is encouraged, and even patriotic!

But eventually the phrase "Tax Evasion" wasn't good enough for the IRS, so they supplemented this with the phrase "Abusive Tax Avoidance Schemes."  This was subsequently shortened to "Abusive Tax Avoidance" or  "Tax Avoidance Schemes"  and finally that morphed into simply the phrase "Tax Avoidance" being used by the IRS as a bad thing, to be subject to severe penalties if not criminal prosecution.

Rather than use the term "Tax Evasion Transactions" occasionally the IRS will use the term "Tax Avoidance Transactions" to mean a transaction with no economic substance, one who's sole purpose (or principal purpose) is tax motivated.  "Listed Transactions" similarly are specific transactions that the IRS considers suspect.

Much of this came about because of new crackdowns on "Tax Shelters"
IRS Code §6662(d)(2)(C)(ii) Tax Shelter-
For purposes of clause (i), the term `tax shelter' means--
(I) a partnership or other entity,
(II) any investment plan or arrangement, or
(III) any other plan or arrangement,
if a significant purpose of such partnership, entity, plan, or arrangement is the avoidance or evasion of Federal income tax.

Google search showing confusion over Tax Avoidance & Evasion

IRS - Lesson 3: The Taxpayer's Responsibilities discussion over Tax Avoidance & Evasion

Deductible Expenses and Deductible Trading Losses are not "tax shelters" in the sense used here.  A Trader's business activity is 100% hands-on (not merely a passive investment) his tax deductions result only from real, true economic disbursements of real cash money.

"Tax Shelters" on the other hand create losses for taxpayers without a full outlay of actual cash by using "non-recourse debt" for example.  Often then expenses are paid to a related party and the purported business ventures themselves never have a snow-ball's chance of being viable or returning a profit on the invested cash.

It is therefore important to be on the alert, to document with good books and records, your properly structured business operations.  If entities or other related parties are involved, treat them fairly at arm's length.

That way your perfectly legitimate, legal "Tax Avoidance" plans can clearly be distinguishable from what the IRS is looking for: tax shelter schemes and tax evasion that are sometimes inappropriately called "tax avoidance transactions" rather than "tax evasion schemes".

United States Supreme Court Justice George Sutherland in Gregory v. Helvering (1934-5) 293 U.S. 465,460 said:  "The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted."

Judge Learned Hand  (1872-1961), Judge, U. S. Court of Appeals
Source: in the case of Helvering v. Gregory, 69F.2d 809

"Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one's taxes.  Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands."

Tax evasion is the general term for efforts by individuals, firms, trusts and other entities to evade the payment of taxes by breaking the law. Tax evasion usually entails taxpayers deliberately misrepresenting or concealing the true state of their affairs to the tax authorities to reduce their tax liability, and includes, in particular, dishonest tax reporting (such as underdeclaring income, profits or gains; or overstating deductions).

By contrast tax avoidance is the legal exploitation of the tax regime to one's own advantage, to attempt to reduce the amount of tax that is payable by means that are within the law whilst making a full disclosure of the material information to the tax authorities.

Tax avoidance may be considered as either the amoral dodging of one's duties to society or the right of every citizen to find all the legal ways to avoid paying too much tax. Tax evasion, on the other hand, is a crime in almost all countries and subjects the guilty party to fines or even imprisonment. Switzerland is one notable exception: Tax fraud (forging documents, for example) is considered a crime, tax evasion (like underdeclaring assets) is not.

Some tax evaders see their efforts to evade taxation as based upon some novel legal theory: these individuals and groups are sometimes called tax protesters. U.S. tax protesters are an example of this kind of approach to tax evasion that has generally ended in failure for those making such claims. True tax protesters strongly deny tax evasion: they are openly refusing to pay the tax rather than attempting to deceive the tax authorities. Some donate their unpaid taxes to charity, while others (at least in the US) take creative "deductions" such as not paying a percentage of tax equal to the defense budget.

IRS Tax Seizure Auction website:

2005 Revisions to Circular 230 Regs Clarify Covered Opinion Guidelines (IR-2005-59; T.D. 9201)

Principal Purpose

Finally, the rules modify the definition of "principal purpose." A transaction will have the principal purpose of avoidance or evasion of tax if the avoidance or evasion of tax exceeds any other purpose.  A transaction structured to claim tax benefits in a manner intended by the code and Congress will not be deemed to have the principal purpose of avoiding or evading tax. This definition of principal purpose is similar to the Reg. §1.6662-4(g)(2) definition. The rules also clarify that a transaction may have a significant purpose of avoiding or evading tax, even though that is not the principal purpose.




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