Author Topic: Curious Tax Deduction Strategy  (Read 10943 times)

WalnutJoe

  • 5 O'Clock Shadow
  • *
  • Posts: 1
Curious Tax Deduction Strategy
« on: June 03, 2014, 11:45:38 PM »
So a friend of mine had this idea that I thought I'd run by the community and see your thoughts on its ethics/legality/practicality etc.

The basic idea is this: Person A rents and does not have enough deductions to itemize (over the standard deduction); however, Person A is fairly generous and gives ~$5,000/yr to charity. Person B has a hefty mortgage and regularly itemizes. Person A gifts $5,000 to Person B who in turn donates that to a charity. Person B is able to include this donation in their itemization. Person B saves ~$1,000 in taxes (assuming 20% marginal tax rate) and splits the savings with Person A.

Thoughts?

clifp

  • Pencil Stache
  • ****
  • Posts: 528
Re: Curious Tax Deduction Strategy
« Reply #1 on: June 04, 2014, 12:05:24 AM »
It is unethical IMO, but I have certainly heard of worse tax evasion strategies.

obstinate

  • Pencil Stache
  • ****
  • Posts: 875
Re: Curious Tax Deduction Strategy
« Reply #2 on: June 04, 2014, 12:23:19 AM »
Gifts are taxable, right?

rmendpara

  • Pencil Stache
  • ****
  • Posts: 602
Re: Curious Tax Deduction Strategy
« Reply #3 on: June 04, 2014, 01:01:12 AM »
I think as long as you are within the annual gift exclusion limits.. $14k/yr last I recall... you are fine.

IMO if there's not a rule against it, then I suppose you can go for it. The only thing stopping you is your own feeling about doing that.

However, it doesn't really make sense, since you're giving away $5,000 in order to save $1,000 on taxes.

you're still out $4,000. Am I missing something? Unless these are charities you will be donating to anyway, you're losing $4,000/yr.

penguin456

  • 5 O'Clock Shadow
  • *
  • Posts: 22
  • Age: 49
Re: Curious Tax Deduction Strategy
« Reply #4 on: June 04, 2014, 01:38:32 AM »
Nope, that wont work. The IRS and the courts would say that is a sham transaction and recharacterize it as a direct donation from person A to the charity.  Whether you would get caught is of course much less clear, but it is unethical IMO to enter into a transaction that does not have a strong legal basis in the hopes you wont get caught.


Sent from my iPhone using Tapatalk

Emg03063

  • Bristles
  • ***
  • Posts: 458
Re: Curious Tax Deduction Strategy
« Reply #5 on: June 04, 2014, 05:22:55 AM »
So as a practical matter then, it would work until you got caught? :p

Ethics aside, and I agree it is unethical, the issue as I see it is person A has to trust person B to actually make the donation and not simply pocket $4500.  How trustworthy can a person who is willing to conspire to tax evade really be?

frugalnacho

  • Magnum Stache
  • ******
  • Posts: 3265
  • Age: 36
  • Location: Madison Heights, Michigan
Re: Curious Tax Deduction Strategy
« Reply #6 on: June 04, 2014, 09:56:20 AM »
I think as long as you are within the annual gift exclusion limits.. $14k/yr last I recall... you are fine.

IMO if there's not a rule against it, then I suppose you can go for it. The only thing stopping you is your own feeling about doing that.

However, it doesn't really make sense, since you're giving away $5,000 in order to save $1,000 on taxes.

you're still out $4,000. Am I missing something? Unless these are charities you will be donating to anyway, you're losing $4,000/yr.

I think the intent was to donate $5,000 to charity regardless.   So this way the charity still gets the $5,000, but person B will lower their tax liability more than person A will. 

frugalnacho

  • Magnum Stache
  • ******
  • Posts: 3265
  • Age: 36
  • Location: Madison Heights, Michigan
Re: Curious Tax Deduction Strategy
« Reply #7 on: June 04, 2014, 10:00:05 AM »
Nope, that wont work. The IRS and the courts would say that is a sham transaction and recharacterize it as a direct donation from person A to the charity.  Whether you would get caught is of course much less clear, but it is unethical IMO to enter into a transaction that does not have a strong legal basis in the hopes you wont get caught.


Sent from my iPhone using Tapatalk

So if my parents decided to gift me $5,000 just because they have excess money,  and I happen to be mustachian and generous so I didn't need the gift, so I donate $5,000 of my income to charity the IRS is going to step in and not allow me to deduct my charitable donation?

I don't really understand what is illegal or unethical about it.  You are using legal means to transfer money around in order to lower tax liability.

curler

  • Stubble
  • **
  • Posts: 111
Re: Curious Tax Deduction Strategy
« Reply #8 on: June 04, 2014, 10:44:17 AM »
Nope, that wont work. The IRS and the courts would say that is a sham transaction and recharacterize it as a direct donation from person A to the charity.  Whether you would get caught is of course much less clear, but it is unethical IMO to enter into a transaction that does not have a strong legal basis in the hopes you wont get caught.


Sent from my iPhone using Tapatalk

So if my parents decided to gift me $5,000 just because they have excess money,  and I happen to be mustachian and generous so I didn't need the gift, so I donate $5,000 of my income to charity the IRS is going to step in and not allow me to deduct my charitable donation?

I don't really understand what is illegal or unethical about it.  You are using legal means to transfer money around in order to lower tax liability.

The difference is that your parents gave you the money - no strings attached.  You then decided what to do with it.  In the original situation, the money exchanged hands with the understanding that it would be donated to charity.  It wasn't a gift to person B at all.

hexdexorex

  • Stubble
  • **
  • Posts: 159
Re: Curious Tax Deduction Strategy
« Reply #9 on: June 04, 2014, 11:25:33 AM »
To latch onto this thread...

Is there any law against income transferring? ( i know the kiddie tax ...but I don't know of a law going the other way )

My plan is this...My dad makes under 20 k a year so he is in the lower 2 income brackets....so capital gains tax for him is 0.

I can transfer 14k in stock to him tax free (14k is the limit you can gift). He can sell the stock....for whatever capital gains his state requires and transfer it back to me....so 0 federal and around 7% state

It might seem like a pain is the ass but I live in CA and even long term capital gains + state is around 25%. I dont see anything immoral about this and I cant find any legal arguments against it...has anyone heard any? Also this will help a ton when I have to support him in the upcoming years.

boarder42

  • Walrus Stache
  • *******
  • Posts: 7849
Re: Curious Tax Deduction Strategy
« Reply #10 on: June 04, 2014, 11:37:47 AM »
Nope, that wont work. The IRS and the courts would say that is a sham transaction and recharacterize it as a direct donation from person A to the charity.  Whether you would get caught is of course much less clear, but it is unethical IMO to enter into a transaction that does not have a strong legal basis in the hopes you wont get caught.


Sent from my iPhone using Tapatalk

So if my parents decided to gift me $5,000 just because they have excess money,  and I happen to be mustachian and generous so I didn't need the gift, so I donate $5,000 of my income to charity the IRS is going to step in and not allow me to deduct my charitable donation?

I don't really understand what is illegal or unethical about it.  You are using legal means to transfer money around in order to lower tax liability.

The difference is that your parents gave you the money - no strings attached.  You then decided what to do with it.  In the original situation, the money exchanged hands with the understanding that it would be donated to charity.  It wasn't a gift to person B at all.

This is very difficult to prove then.  unless there is a blog posting it that you posted in like this one or some type of paper trail logging the information there is no way they can prove that you were in the wrong.

Undecided

  • Handlebar Stache
  • *****
  • Posts: 1075
Re: Curious Tax Deduction Strategy
« Reply #11 on: June 04, 2014, 11:45:03 AM »
To latch onto this thread...

Is there any law against income transferring? ( i know the kiddie tax ...but I don't know of a law going the other way )

My plan is this...My dad makes under 20 k a year so he is in the lower 2 income brackets....so capital gains tax for him is 0.

I can transfer 14k in stock to him tax free (14k is the limit you can gift). He can sell the stock....for whatever capital gains his state requires and transfer it back to me....so 0 federal and around 7% state

It might seem like a pain is the ass but I live in CA and even long term capital gains + state is around 25%. I dont see anything immoral about this and I cant find any legal arguments against it...has anyone heard any? Also this will help a ton when I have to support him in the upcoming years.

I'm not offering you legal advice, but I don't think you've look very hard if you "can't [sic] find any legal arguments against it."

Consider:

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Frequently-Asked-Questions-on-Gift-Taxes#12

What is considered a gift?
Any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money's worth) is not received in return.


What you describe is not a gift, but rather a sham transaction, specifically one that is subject to the assignment of income doctrine. Although dated, and now likely further codified, consider the following reasonably simple explanation:

http://www.taxprophet.com/archives/faq/faqjul06.html

In addition to the tax you would owe when the service treats the sales as having been made by you directly, I believe you would owe a penalty of 20% of the amount not paid on the basis of the sham transaction.

Undecided

  • Handlebar Stache
  • *****
  • Posts: 1075
Re: Curious Tax Deduction Strategy
« Reply #12 on: June 04, 2014, 11:48:29 AM »
Nope, that wont work. The IRS and the courts would say that is a sham transaction and recharacterize it as a direct donation from person A to the charity.  Whether you would get caught is of course much less clear, but it is unethical IMO to enter into a transaction that does not have a strong legal basis in the hopes you wont get caught.


Sent from my iPhone using Tapatalk

So if my parents decided to gift me $5,000 just because they have excess money,  and I happen to be mustachian and generous so I didn't need the gift, so I donate $5,000 of my income to charity the IRS is going to step in and not allow me to deduct my charitable donation?

I don't really understand what is illegal or unethical about it.  You are using legal means to transfer money around in order to lower tax liability.

The difference is that your parents gave you the money - no strings attached.  You then decided what to do with it.  In the original situation, the money exchanged hands with the understanding that it would be donated to charity.  It wasn't a gift to person B at all.

This is very difficult to prove then.  unless there is a blog posting it that you posted in like this one or some type of paper trail logging the information there is no way they can prove that you were in the wrong.

There's a difference between asking whether something is illegal or unethical and asking whether one's likely to be caught. Although tax law isn't my practice area, I have no doubt that this scenario is a clear sham. If the poster wants to cheat on his taxes, s/he should at least do so on an informed basis, so might want to check on the civil or criminal penalties for that, beyond the financial penalty imposed directly on the transaction.

penguin456

  • 5 O'Clock Shadow
  • *
  • Posts: 22
  • Age: 49
Re: Curious Tax Deduction Strategy
« Reply #13 on: June 04, 2014, 11:50:41 AM »
That strategy wont work either, again because it is part of a prearranged plan to avoid tax. Basically, if the only reason a third party is in the transaction is to avoid tax, the courts/IRs will recharacterize it (asyou selling the stock yourself or in the previous example as person A donating the $ directly). For those who dont see an issue, consider how simple these strategies are. If they were legal dont you think everyone would be doing them?  Most of us have a child/relative in a lower bracket who could help us avoid tax, or one in a higher bracket who could get a better deduction. There are many people who think of ways to avoid of tax all day long. These types of strategies were probably developed and tried 150 years ago which is when the courts started using these doctrines to recharacterize the transactions to show what really happened without the unnecessary straw man. There are also IRS rules and regulations that close these loopholes. In reality, this stuff likely happens all the time because it is difficult to catch, but make no mistake, it is definitely not allowed.

dragoncar

  • Walrus Stache
  • *******
  • Posts: 8333
  • Registered member
Re: Curious Tax Deduction Strategy
« Reply #14 on: June 04, 2014, 11:57:13 AM »
Nobody is pointing out the real downside here?  If you "give" me $5k, I'm gonna keep it.  You can't prove it wasn't a gift without admitting to tax fraud.

Undecided

  • Handlebar Stache
  • *****
  • Posts: 1075
Re: Curious Tax Deduction Strategy
« Reply #15 on: June 04, 2014, 12:00:00 PM »
Nobody is pointing out the real downside here?  If you "give" me $5k, I'm gonna keep it.  You can't prove it wasn't a gift without admitting to tax fraud.

Just because the OP's friend and the other poster's dad are tax cheats doesn't mean they're thieves!
:-)

hexdexorex

  • Stubble
  • **
  • Posts: 159
Re: Curious Tax Deduction Strategy
« Reply #16 on: June 04, 2014, 12:06:01 PM »
Well I mean the kiddie tax exist because people did do it a lot. I just don't see any laws going the other way.

I mean of course its like setting up a corporation in another state to avoid tax...but that is legal as well. Is every tax avoidance method illegal? If so it seems like tons of corporations/people wouldn't be doing what they do.

I don't get how a "prearranged plan" as a law is admissible in court. Seems like the gift tax 14k limit is there as a benefit and people that don't take advantage of it are missing out...much like people that dont take advantage of tax loss harvesting.

Undecided

  • Handlebar Stache
  • *****
  • Posts: 1075
Re: Curious Tax Deduction Strategy
« Reply #17 on: June 04, 2014, 12:11:59 PM »
Well I mean the kiddie tax exist because people did do it a lot. I just don't see any laws going the other way.

I mean of course its like setting up a corporation in another state to avoid tax...but that is legal as well. Is every tax avoidance method illegal? If so it seems like tons of corporations/people wouldn't be doing what they do.

I don't get how a "prearranged plan" as a law is admissible in court. Seems like the gift tax 14k limit is there as a benefit and people that don't take advantage of it are missing out...much like people that dont take advantage of tax loss harvesting.

You're kidding yourself or just ignorant. I gave you some starting points; do some reading. Tax avoidance is fine. Tax evasion is illegal. Guess which one you're describing? If you give someone $14k with an agreement to receive something back, you didn't give them a gift and they didn't give you one (or at least not for the full amount).

hexdexorex

  • Stubble
  • **
  • Posts: 159
Re: Curious Tax Deduction Strategy
« Reply #18 on: June 04, 2014, 12:25:45 PM »
Why the personal attack?

Everything I read on evasion is not reporting something you do.

http://apps.irs.gov/app/understandingTaxes/whys/thm01/les03/ac1_thm01_les03.jsp#score

The gift tax seems very murky. If I was to give a relative anything over my lifetime..and they were to give me anything else over their life time of similar value. It seems like someone could say we were avoiding taxes on that transaction.

An example is my mom gave me her old car when I was 18. When I turned 24 I started sending her money tax free under the gift tax. Cant someone say she evaded taxes on selling that car...and the payments I made to her 6 years later were to pay off that car? hrm....

IMO the gift tax shouldn't even exist....or the rules should be made more clearer...but there are plenty of ways the tax system seems to create winners and losers (in CA its prop 13).

Cpa Cat

  • Handlebar Stache
  • *****
  • Posts: 1564
Re: Curious Tax Deduction Strategy
« Reply #19 on: June 04, 2014, 12:31:58 PM »
Is every tax avoidance method illegal?

Actually, tax avoidance is legal. Tax evasion is illegal. The finer points of tax avoidance vs tax evasion keeps tax attorneys in business.

Quote
I don't get how a "prearranged plan" as a law is admissible in court. Seems like the gift tax 14k limit is there as a benefit and people that don't take advantage of it are missing out...much like people that dont take advantage of tax loss harvesting.

Ok, so, prearranged plans are often brought up in gift tax court cases. The $14,000 limit is a generic limit that gives you a good guideline of what the IRS is even willing to look at. But that doesn't mean that the IRS can't come after a consistent pattern of evasion that utilizes that limit. Income transferring has a long and storied precedent of not being a gift - it's just a matter of proving it.

The gift tax seems very murky. If I was to give a relative anything over my lifetime..and they were to give me anything else over their life time of similar value. It seems like someone could say we were avoiding taxes on that transaction.

It is murky. One of the big advantages to filing a gift tax return is that it starts the statute of limitations on the transaction and ensures that, at some point, it will be closed and unable to be revisted.
« Last Edit: June 04, 2014, 12:39:00 PM by Cpa Cat »

lurker

  • 5 O'Clock Shadow
  • *
  • Posts: 13
Re: Curious Tax Deduction Strategy
« Reply #20 on: June 04, 2014, 12:34:44 PM »
Here's a good article about the difference between tax avoidance and tax evasion:

http://www.bizfilings.com/toolkit/sbg/tax-info/fed-taxes/tax-avoidance-and-tax-evasion.aspx

Both of the hypotheticals contemplated in this thread (gift/charitable deduction and gift/capital gains transfer) would likely be viewed in the latter category.

With respect to the example of receiving the gift of a car and several years later sending money to your mom; the fact that these occurred several years apart would be good evidence these were separate transactions.  Also, the IRS doesn't care if 2 people just give money back and forth willy-nilly if it's under the 14k exclusion.  What they care about is someone abusing that exclusion to try to shift recognizable income or create deductions.

hexdexorex

  • Stubble
  • **
  • Posts: 159
Re: Curious Tax Deduction Strategy
« Reply #21 on: June 04, 2014, 12:37:27 PM »
Does anyone know the statue of limitations on it? Is there a set year amount?

Undecided

  • Handlebar Stache
  • *****
  • Posts: 1075
Re: Curious Tax Deduction Strategy
« Reply #22 on: June 04, 2014, 12:39:04 PM »
Why the personal attack?

Everything I read on evasion is not reporting something you do.

http://apps.irs.gov/app/understandingTaxes/whys/thm01/les03/ac1_thm01_les03.jsp#score

The gift tax seems very murky. If I was to give a relative anything over my lifetime..and they were to give me anything else over their life time of similar value. It seems like someone could say we were avoiding taxes on that transaction.

An example is my mom gave me her old car when I was 18. When I turned 24 I started sending her money tax free under the gift tax. Cant someone say she evaded taxes on selling that car...and the payments I made to her 6 years later were to pay off that car? hrm....

IMO the gift tax shouldn't even exist....or the rules should be made more clearer...but there are plenty of ways the tax system seems to create winners and losers (in CA its prop 13).

I didn't mean it as an attack, and apologize if you took it that way, but on the basis of my professional experience I think what you've said here displays either ignorance or willful self-delusion. I can't see any other basis for it and you don't seem interested in actually looking in the direction I've suggested. I do suggest you take whatever steps are available to you to consider the structure you propose and the potential consequences of it being disputed.

HAULIN3

  • 5 O'Clock Shadow
  • *
  • Posts: 75
  • Location: ILLINOIS
  • Plant Strong!
Re: Curious Tax Deduction Strategy
« Reply #23 on: June 04, 2014, 12:41:46 PM »
when you donate to charity do you need to have a receipt for each transaction or is a cancelled check enough?

curler

  • Stubble
  • **
  • Posts: 111
Re: Curious Tax Deduction Strategy
« Reply #24 on: June 04, 2014, 12:44:47 PM »
when you donate to charity do you need to have a receipt for each transaction or is a cancelled check enough?
It depends on the amount.  See #7 and #8  here http://www.irs.gov/uac/Eight-Tips-for-Deducting-Charitable-Contributions

hexdexorex

  • Stubble
  • **
  • Posts: 159
Re: Curious Tax Deduction Strategy
« Reply #25 on: June 04, 2014, 12:45:04 PM »
Cool thanks for your help undecided

lurker

  • 5 O'Clock Shadow
  • *
  • Posts: 13
Re: Curious Tax Deduction Strategy
« Reply #26 on: June 04, 2014, 12:46:17 PM »
Cancelled checks are good enough for contributions < $250.  For contributions over that amount, you must maintain a letter from the charity acknowledging the donation (they are required to provide these on all donations above $75).

NewStachian

  • Stubble
  • **
  • Posts: 218
  • Age: 35
  • Location: DC
    • VarsityFinances
Re: Curious Tax Deduction Strategy
« Reply #27 on: June 04, 2014, 12:54:51 PM »
Disclaimer: I am not a tax attorney.

But, I don't think you can characterize something as a gift if there's a kickback involved. As benevolent as donating to charity is, there is definitely an exchange of goods or services which is a transaction, not a gift. It's like arguing that I am going to sell you something and characterize it as gift when I'm actually conducting a transaction (obviously not the exact same, but not too far off either).

I heard someone else mention it, but I have heard a lawyer friend tell me that doing things like this for the sole purpose of evading tax can be classified as tax fraud. The bigger question I have to ask is why bother getting yourself into this mess for such a small reward?

jasonw223

  • 5 O'Clock Shadow
  • *
  • Posts: 17
Re: Curious Tax Deduction Strategy
« Reply #28 on: June 04, 2014, 01:18:34 PM »
If anyone wants to give me $4500, I'll donate $5000 to a charity of your choosing!  No kickback involved when wording it that way...

boarder42

  • Walrus Stache
  • *******
  • Posts: 7849
Re: Curious Tax Deduction Strategy
« Reply #29 on: June 04, 2014, 01:24:47 PM »
If anyone wants to give me $4500, I'll donate $5000 to a charity of your choosing!  No kickback involved when wording it that way...

thats exactly what i was thinking.  and i'm sure you'll donate it too... haha

penguin456

  • 5 O'Clock Shadow
  • *
  • Posts: 22
  • Age: 49
Re: Curious Tax Deduction Strategy
« Reply #30 on: June 04, 2014, 01:36:06 PM »
For those interested in exactly how the courts strike these down, google step transaction doctrine, conduit theory, and sham transaction doctrine in federal tax law. There are tax avoidance schemes that pass muster under these doctrines, but the ones discussed in this thread are clear losers.

dragoncar

  • Walrus Stache
  • *******
  • Posts: 8333
  • Registered member
Re: Curious Tax Deduction Strategy
« Reply #31 on: June 04, 2014, 04:33:43 PM »
If anyone wants to give me $4500, I'll donate $5000 to a charity of your choosing!  No kickback involved when wording it that way...

thats exactly what i was thinking.  and i'm sure you'll donate it too... haha

I already donated $5000, feel free to send me $4500.

jpdcpajd

  • 5 O'Clock Shadow
  • *
  • Posts: 97
  • Age: 43
  • Location: St. Louis
Re: Curious Tax Deduction Strategy
« Reply #32 on: June 04, 2014, 08:51:49 PM »
So a friend of mine had this idea that I thought I'd run by the community and see your thoughts on its ethics/legality/practicality etc.

The basic idea is this: Person A rents and does not have enough deductions to itemize (over the standard deduction); however, Person A is fairly generous and gives ~$5,000/yr to charity. Person B has a hefty mortgage and regularly itemizes. Person A gifts $5,000 to Person B who in turn donates that to a charity. Person B is able to include this donation in their itemization. Person B saves ~$1,000 in taxes (assuming 20% marginal tax rate) and splits the savings with Person A.

Thoughts?

You are not my client
but
One strategy would be to load up in one year using a Donor Advised Fund, Itemize that year and make the gifts to charity out of that fund over two or more years. Fidelity has these with $5,000 minimum and they charge around 1% and fees if you leave in cash. More fees if you invest in funds.
 
So year one person A puts in $10,000 gets deduction for that amount plus any state taxes, etc.

can have fund distribute to charity $5,000 in yr 1 and another $5,000 in yr 2. and donation can say "The Person A Foundation" or some other name. 

If you made estimated state taxes you could pay 4th qtr in both January of yr 1 for yr 0 and dec of yr 1 for yr 2.  doubt this applies if not enough state taxes to itemize though.