The IRS has issued a warning to taxpayers about fraudulent tax schemes involving donations of ownership interests in closely held businesses, often disguised as “Charitable LLCs.” These schemes, targeting high-income individuals, are deemed abusive by the IRS. Taxpayers should be aware that they are ultimately liable for the accuracy of their tax returns. Engaging in such schemes to reduce tax burdens can lead to significant consequences, including additional taxes, penalties, interest, potential fines, and even imprisonment. Charities must also exercise caution to avoid unintentionally facilitating these schemes.

While legitimate deductions exist for donations of closely held business interests, unscrupulous promoters exploit this opportunity to lure taxpayers into fraudulent schemes. These schemes typically involve creating LLCs, investing assets into them, and donating non-voting, non-managing membership units to a charity while the taxpayer retains control over the voting units. The taxpayer then directly or indirectly reclaims the assets for personal use. The promoter often has influence over the receiving charity, further enabling the scheme.

This blog will delve into the details of these fraudulent schemes, the risks involved, and how taxpayers can safeguard themselves.

Understanding the Scam

The “Charitable LLC” Scheme

Promoters of this scheme often convince taxpayers to:

  • Create a Limited Liability Company (LLC).
  • Transfer cash or other assets into the LLC.
  • Donate a majority percentage of nonvoting, nonmanaging membership units to a charity.

However, the taxpayer retains control over the voting units and often reclaims the cash or assets for personal use. In some cases, promoters control the charity receiving the donation, making it easier to manipulate the transaction.

Red Flags to Watch For

Taxpayers should be cautious if a transaction involves:

  • Promises of personal benefits beyond the tax deduction.
  • Claims of creating wealth in a “tax-free environment.”
  • Entities that don’t engage in legitimate business activities.
  • Retention of control or access to the donated assets.
  • Use of specific appraisers and charities provided by the promoter.

Consequences of Participation

Legal and Financial Repercussions

Did you receive a letter or notice from the IRS?Taxpayers involved in these schemes are held accountable for inaccuracies in their tax returns. Consequences include:

  • Reassessment of the correct tax amount owed.
  • Penalties and interest.
  • Potential fines and imprisonment.

IRS Actions

The IRS is actively combating these schemes through:

  • Thorough audits of tax returns.
  • Investigations into promoters.
  • Criminal convictions and civil injunctions.

For example, in recent cases:

  • A Florida attorney received an eight-year prison sentence for fraudulent charitable contributions (read more here).
  • Tax attorneys and insurance agents were convicted in a tax shelter scheme (details available here).
  • A client pleaded guilty to obstruction in a similar scheme (full story).

Properly Claiming Charitable Contributions

Steps to Ensure Compliance

Taxpayers can legitimately claim deductions for donations of closely held business interests by adhering to the following:

  1. Document the Contribution:
    • Record the name and address of the charitable organization.
    • Note the date and description of the donated property.
  2. Meet Valuation Requirements:
  3. Secure Acknowledgment:
    • For contributions of $250 or more, obtain written acknowledgment from the charity before filing the tax return.

Valuation Guidelines

For detailed valuation requirements, taxpayers should refer to IRS Publication 561, Determining the Value of Donated Property. This includes instructions on:

  • Qualified appraisals.
  • Proper valuation methods for donated business interests.

Safeguarding Against Fraud

Identifying Abusive Schemes

Taxpayers should be vigilant about any scheme involving:

  • Retention of control over donated assets.
  • Loans or personal use of donated assets.
  • Arrangements to buy back donated interests at discounted rates.
  • Charities with no real control over donated LLC assets.

Reporting Suspicious Activities

To report suspected tax fraud, taxpayers can:

The Role of Charities

Responsibilities of Charities

Charitable organizations must:

  • Avoid knowingly participating in abusive schemes.
  • Ensure they have genuine control over donated assets.
  • Decline contributions that involve retention of control by the donor.

Failure to comply can jeopardize the charity’s tax-exempt status and result in legal consequences.

Conclusion

Charitable contributions are a meaningful way to give back and reduce tax liabilities. However, taxpayers must exercise due diligence to avoid falling prey to fraudulent schemes. By understanding the warning signs and adhering to IRS guidelines, individuals can ensure their charitable acts remain legitimate and impactful.

For more information, visit the IRS website or consult a qualified tax professional.

 

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