Since the mid-1990s, the IRS has witnessed a proliferation of abusive tax schemes, particularly those with offshore components. Originally those schemes took the structure of abusive domestic and foreign trust arrangements. However, abusive schemes are evolving into sophisticated arrangements that take advantage of the financial secrecy laws of some foreign jurisdictions and the availability of credit/debit cards issued from offshore financial institutions.

IRS Criminal Investigation (CI) has developed a nationally coordinated program to combat these abusive tax schemes. CI’s primary focus is on the identification and investigation of the tax scheme promoters as well as those who play a substantial or integral role in facilitating, aiding, assisting, or furthering the abusive tax scheme (e.g., accountants, lawyers). Secondarily, but equally important, is the investigation of investors who knowingly participate in abusive tax schemes.

What is an Abusive Tax Scheme?

The Abusive Tax Schemes program encompasses violations of the Internal Revenue Code (IRC) and related statutes where multiple flow-through entities are used as an integral part of the taxpayer’s scheme to evade taxes. These schemes are characterized by the use of trusts, Limited Liability Companies (LLCs), Limited Liability Partnerships (LLPs), International Business Companies (IBCs), foreign financial accounts, offshore credit/debit cards and other similar instruments. The schemes are usually complex involving multi-layer transactions for the purpose of concealing the true nature and ownership of the taxable income and/or assets.

Form over substance are the most important words to remember before buying into any arrangements that promise to “eliminate” or “substantially reduce” your tax liability. The promoters of abusive tax schemes often employ financial instruments such as trusts in their schemes. However, the instruments are used for improper purposes including the facilitation of tax evasion.

What are some of the Most Common Abusive Tax Schemes?

Tax evasion using foreign jurisdictions is accomplished using many different methods. Some can be as simple as taking unreported cash receipts and personally traveling to a tax haven country and depositing the cash into a bank account. Others are more elaborate involving numerous domestic and foreign trusts, partnerships, nominees, etc. The following schemes are not all- inclusive, but just a sample of abusive tax schemes.

1) Abusive Foreign Trust Schemes

The foreign trust schemes usually start off as a series of domestic trusts layered upon one another. This set up is used to give the appearance that the taxpayer has turned his/her business and assets over to a trust and is no longer in control of the business or its assets. Once transferred to the domestic trust, the income and expenses are passed to one or more foreign trusts, typically in tax haven countries.

As an example, a taxpayer’s business is split into two trusts. One trust would be the business trust that is in charge of the daily operations. The other trust is an equipment trust formed to hold the business’s equipment that is leased back to the business trust at inflated rates to nullify any income reported on the business trust tax return (Form 1041). Next the income from the equipment trust is distributed to foreign trust-one, again, which nullifies any tax due on the equipment trust tax return. Foreign trust-one then distributes all or most of its income to foreign trust-two. Since all of foreign trust-two’s income is foreign based there is no U.S. filing requirement.

Once the assets are in foreign trust-two, a bank account is opened either under the trust name or an International Business Corporation (IBC). The trust documentation and business records of this scheme all make it appear that the taxpayer is no longer in control of his/her business or its assets. The reality is that nothing ever changed. The taxpayer still exercises full control over his/her business and assets. There can be many different variations to the scheme.

2) International Business Corporations (IBC’S)

The taxpayer establishes an IBC with the exact name as that of his/her U.S. business. The IBC also has a bank account in the foreign country. As the taxpayer receives checks from customers, he sends them to the bank in the foreign country. The foreign bank then uses its correspondent account in the United States to process the checks so that it never would appear to the customer, upon reviewing the canceled check that the payment was sent offshore. Once the checks clear, the taxpayer’s IBC account is credited for the check payments. Here the taxpayer has, again, transferred the unreported income offshore to a tax haven jurisdiction.

3) False Billing Schemes

A taxpayer sets up an International Business Corporation (IBC) in a tax haven country with a nominee as the owner (usually the promoter). A bank account is then opened under the IBC. On the bank’s records the taxpayer would be listed as a signatory on the account. The promoter then issues invoices to the taxpayer’s business for goods allegedly purchased by the taxpayer. The taxpayer then sends payment to the IBC that gets deposited into the joint account held by the IBC and taxpayer. The taxpayer takes a business deduction for the payment to the IBC thereby reducing his/her taxable income and has safely placed the unreported income into the foreign bank account.

How Does the Taxpayer Access the Funds in Offshore Accounts

Although the unreported funds sitting in the offshore bank account are earning interest or being used for investment purposes, most of the time the taxpayer wants to have access to the money. There are several methods used to get the funds back to the taxpayer, but the following are the most common.

1) Fraudulent Loans

The taxpayer’s International Business Corporation (IBC) will make a loan to the taxpayer. The funds are wire transferred back to the taxpayer’s U.S. bank account. Since these wired funds are allegedly loans they are not taxable. Many times ownership of the IBC is through bearer shares so it is very difficult to prove that the loan is a complete sham. Further adding to the difficulty is the fact that the promoters provide their clients with loan documents to make the transaction appear legitimate.

2) Credit/Debit Card

One of the most popular methods in recent years has been use of the bankcard to access offshore funds. Once the foreign bank account is established, the taxpayer is issued a bank card. The taxpayer can use the bankcard in the to withdraw cash and to pay for everyday expenses.

IRS’s Criminal and Civil Enforcement & the Department of Justice

The IRS criminal and civil enforcement divisions work with the Department of Justice, Tax Division to shut down these abusive schemes as quickly as possible in an effort to protect taxpayers from potential additional financial harm. Parallel civil and criminal investigations are an effective and aggressive IRS approach that halts these schemes quickly and permanently. A civil injunction against the promoter stops the scheme and prevents additional ‘clients’ from investing. In addition, CI shares abusive tax scheme investor lists with the civil operating divisions to ensure investor tax returns are considered for examination (audit).

The IRS civil enforcement divisions have issued several consumer alerts.

Civil and Criminal Penalties

Investors of abusive tax schemes that improperly evade tax are still liable for taxes, interest, and civil penalties. Violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty or criminal prosecution. Civil fraud can include a penalty of up to 75% of the underpayment of tax attributable to fraud, in addition to the taxes owed. Criminal convictions of promoters and investors may result in fines up to $250,000 and up to five years in prison.

Enforcement of criminal violations has increased over the past few years. Also increased is the number of investigations initiated, prosecutions recommended, indictments, convictions and months to serve in prison.

Significant Case Summaries

The following case summaries are excerpts from public record documents on file in the courts in the judicial district in which the cases were prosecuted.

Promoter of Abusive Trusts Scheme Pleads Guilty

On December 12, 2003, in Phoenix, Arizona, John F. Poseley pleaded guilty to his role in a conspiracy to defraud the U.S. Government by marketing bogus trusts through an organization known as Innovative Financial Consultants. According to court documents, the conspiracy charge alleged that from 1995 through 2003, Innovative Financial Consultants, based in Tempe, Arizona, created and sold over 3,000 bogus “onshore” and “offshore” trust packages for financial gain by falsely claiming that taxpayers could avoid paying income taxes by placing their income and assets into such a trust. Poseley admitted that he had falsely represented to taxpayers that they could avoid paying income taxes by placing assets into the trusts while retaining use, control, and dominion of those assets.

Man Sentenced for Evading Over $235,000 in Taxes

On December 3, 2003, in Kansas City, Missouri, Mark A. Fronce was sentenced to 15 months in prison, ordered to pay a $2,000 fine, and ordered to pay $434,522 in back taxes with interest and penalties. Fronce pleaded guilty on June 26, 2003, to one count of tax evasion. By pleading guilty, Fronce admitted that he had taxable income of approximately $565,806 in 1997 and should have paid $235,486 in taxes. Instead, Fronce did not file a tax return and attempted to conceal his true income by diverting his income to “trust” bank accounts.

Former CPA Sentenced to 39 Months in Prison for Tax Fraud Using Abusive Trust Arrangements

On November 24, 2003, in Prescott, Arizona, Ralph N. Whistler, a certified public accountant, was sentenced to 39 months in prison for aiding and assisting in the preparation and filing of false 1995 income tax returns. Whistler was convicted on July 30, 2003, after a jury trial in Prescott, Arizona. According to evidence at trial, Whistler purchased a so-called “trust package” that purported to legally reduce his federal income tax liabilities. Whistler then modified this package which he promoted and sold to approximately 20 clients for between $5,000 and $10,000 per client. Clients testified that Whistler directed them to transfer business income to and through a series of bank accounts titled in the names of trusts. Whistler claimed the amounts placed in these bank accounts as deductions on the client’s federal income tax returns.

Three Sacramentans Sentenced To Lengthy Prison Sentences In Tax Fraud, Investment Fraud and Money Laundering Scheme

On November 4, 2003, in Sacramento, CA, Herbert Arthur Bates, Christopher R. Bates and David Larry Smith were sentenced to lengthy prison terms after being convicted of conspiracy to defraud the United States by impairing and impeding the IRS in the assessment and collection of income taxes, conspiracy to engage in mail and wire fraud, and conspiracy to engage in money laundering. Herbert Bates, Christopher Bates, and David Larry Smith were sentenced to 136 months, 63 months and 151 months in prison, respectively. All three were also ordered to pay restitution in the amount of $1,738,520, a criminal forfeiture of $1,000,000, and serve 36 months of supervised release. Evidence presented at trial proved that the defendants sold a form of trust, which they called an Unincorporated Business Organization (UBO), to approximately 249 investors. The defendants charged between $3,000 and $7,500 for the creation of these UBO’s. Herbert Bates and Smith advised clients that they could transfer all of their income and assets to the UBO, and after transferring their income and assets, the clients no longer had to file individual income tax returns nor pay federal income taxes.

Executive Sentenced To 20 Years, Ordered To Pay $92 M In Restitution In Investment Fraud And Money Laundering Case

On October 31, 2003, in Cleveland, OH, J. Richard Jamieson was sentenced to 20 years imprisonment, ordered to serve a three-year term of supervised release, pay $92,125,491 in restitution, and pay a Special Assessment of $15,700. Jamieson was found guilty of federal money laundering charges and conspiracy to commit mail fraud. On January 23, 2002, J. Richard Jamieson was indicted along with 16 other individuals in connection with a scheme to defraud life insurance companies and investors throughout the United States. The indictment charged that the defendants, including Jamieson, conspired to defraud approximately 2,850 investors in viatical settlements of approximately $105,000,000. Jamieson was also charged with laundering his profits from the fraud scheme using domestic and foreign trust entities. As a result of this trial and subsequent conviction, there is a special personal judgment against Jamieson in the amount of $28,243,980 that was rendered by the jury in his trial and relates to the funds involved in the money-laundering scheme. Jamieson must also forfeit all the assets in over 50 domestic and foreign companies, corporations, partnerships, and trusts, which Jamieson owned and controlled. Additionally, Jamieson was ordered to forfeit his personal assets, including his million-dollar residence, his million-dollar vacation home, the contents of his investment accounts and other personal property. On October 28, 2003, Judge Katz amended his original order of forfeiture to include $5,675,075 in other assets.

Institute of Global Prosperity Affiliate Sentenced to 21 Months

On October 10, 2003, in Seattle, WA, Laura Jean Marie Struckman, an affiliate of the Institute of Global Prosperity, was sentenced to 21 months in prison to be followed by three years supervised release. Struckman was convicted by jury on May 28, 2003, of conspiracy to structure a financial transaction. Trial evidence showed that Struckman and an unindicted co-conspirator engaged in a 14-month conspiracy from June 1997 through August 1998 to evade currency reporting requirements by making cash withdrawals of over $960,000 in 122 separate transactions, none of which exceeded $10,000. The evidence further established that Struckman was the co-signer on three nominee bank accounts into which she and another individual deposited over $3.7 million, earned from IGP, during the time period of the conspiracy. Struckman faces a maximum statutory penalty of five years imprisonment and a $250,000 fine. The Institute of Global Prosperity was an organization that encouraged its members to sell various products for profit – such as “foreign trusts,” “pure trusts,” as well as other reliance packages – that although touted as legal means to avoid taxes, were nothing more than tax evasion devices. The organization discontinued its operations in May 2002.