Ep.20 – How Small Tax Evasion Mistakes Can Cost Big: The Shocking Story of a client

Jamie Gruol: Welcome back to this edition of Diary of a Tax Practice Owner. I am your host, Jamie Gruol.

Jessica Smith: I am your co host Jessica Smith

Jamie Gruol: I’m so glad to have you here with us today. We are excited because this is a special series that Jessica and I had the idea for a few months back. And Jessica has been in the industry for a long time, and she’s worked with a lot of clients, and she has some very interesting stories. And so we thought it would be fun to spill some tea, to dish some dirt, and hear some stories about tax practice. Well, we might term crazy clients, but definitely risky clients, if you will. So, uh, Jess, I’m so excited to dig into this with you. We’re going to have a four part series, maybe some more, we’ll see if some more stories come to light. Uh, but we definitely have four sessions for you that we want to share and just start talking.

So Jess, tell us about our first client and the story that they have.

Jessica Smith: So I came prepared with my Let’s Commit Tax Fraud shirt.

Jamie Gruol: for those of you that are listening and not watching, Jessica is wearing a beautiful t shirt that says, let’s commit tax fraud. And it has a picture of 2 kiddos throwing money in the air. And maybe they’re not kiddos, but they’re probably supposed to tax.

Jessica Smith: I don’t know what this is for. My mom said this is like a Jack and Jane, like, spoof. I’m not really sure, but it’s, I got a handful of these and of course we are not. actually endorsing, uh, committing tax fraud. but I thought it was relevant given some of the topics that we’re going to cover today. so for, for our first story, I actually thought about something that has kind of, it’s been around for a long time, but I think that social media has really taken the way that misinformation and honestly.

Brodulent information is spread. And so we’re going to talk today about my experience working with someone who is a, or who was at the time a promoter of an abusive trust tax evasion scheme.

Jamie Gruol: Oh, so you mentioned that social media has made some of this stuff more prevalent, more pervasive. Uh, a lot of people thinking that because somebody that they trust around what clothes to buy should be giving out tax advice. So, uh, as somebody who is. You know, has a lot of education and a lot of experience. Tell us what this, uh, abusive tax scheme is in case somebody hasn’t heard of it and give a little bit of background.

Jessica Smith: Yeah, so the IRS has been aware of these schemes for decades. And one thing that a lot of people, I think, misunderstand is even though the IRS is outdated and they have antiquated systems and they don’t have the manpower to prosecute everyone, And realistically, the IRS doesn’t actually prosecute anyone.

It’s the Department of Justice, right? So, the IRS is going to, they have different methods for how they target what we call promoters. So, promoters is just anybody who is, Usually someone presenting themselves as like a, an expert in how to accomplish a scheme or, or, or, you know, tax evasion, right? And then while they don’t explicitly call it that, when you start to really peel back the layers of what they’re suggesting, there’s lots of case law and lots of, um, information that just kind of like debunks what is being spread about some of these things.

So, in the event of an abusive trust scheme, Um, the IRS has actually like a whole page dedicated to it, and I’m actually going to share some information about some cases that were recently, uh, kind of like hashed out from the Department of Justice, because this is again, this is not something that is new.

Um, but you guys have probably seen on social media. Um, So on tax Twitter, we call them whiteboard tax pros, right? They’re not really like tax professionals, but they’ve got like this whiteboard and, and we joke because like they draw circles and they do arrows to essentially like make the tax evaporate.

Right? So it’s just, it’s, it’s kind of funny. They’re like, Oh, here’s, here’s your trust. And I don’t own anything. My trust owns it. And the trust creates this veil around, um, My property now and it protects it from the government and then that’s that’s you know, that’s like one example But there’s a bunch of different ways that these are, you know promoted So so the IRS and I’m gonna get a look here off screen So the the IRS refers to abusive trust tax evasion schemes as You know, they’ve detected these schemes and they’re typically targeting wealthy individuals, small business owners, um, and professionals such as doctors and lawyers.

So usually these, these, um, kind of schemes, these structures, they suggest you set out or set up, they’re very expensive. Um, so for the most part, the people who could actually afford to like participate in something like this, they’re usually being charged six, seven, five to six figures, high fives, low six figures to have these set up.

And with the idea that, and, and what, what the IRS says, you know, it’s, it’s an attempt to reduce or eliminate income subject to tax. Deductions for personal expenses are, you know, then paid for by the trust. Um, depreciation deductions of an owner’s personal expenses that are paid for. By the dress by the trust, um, depreciation of the owner’s personal residence and furnishings.

We’ve got things like a step up in basis for property that isn’t transferred to the trust will also see that it’s an attempt to reduce or eliminate self employment taxes and then some of the other things they see are a reduction or elimination of gift and estate taxes. So those are the examples that the IRS provides.

And the interesting thing is the way that these are promoted. Right? So if we’re looking at. The reduction or elimination of income, otherwise subject to tax trusts have a tax rate and it’s higher in many ways than individuals. And I’m not a trust expert. Um, I do understand that a trust that has income of any form of 600 Or more is required to file the, uh, trust income tax return.

They can be different forms, but they have a filing requirement and they there’s possibility that there is a, a tax connected to it. So, the, the, the way that we’ll see these schemes. Like, play out is a lot of the times. Especially when they’re targeting, like, small business owners, they, the suggestions are that the trust is a majority owner.

In an LLC, um, and by the ownership of that, uh, of the trust in that manner, then the trust is, is then diverted through a K1 of some sort. A portion of the income, right? And, and, and by doing that, the income is no longer taxable. Which is just, which just isn’t true. We just have money that’s being like literally transferred from the hands of one person to the other.

Um, and it, moving, moving income to be reportable by a trust does not change the underlying character of the income. So the idea that, Oh, well my, my trust now has these assets or this income, and it’s not taxable. If you have a business that is subject to self employment tax and income tax, Putting that money to where your trust owns has an ownership in that business.

Does it mean that it goes away? It just means that now the trust is responsible for filing and reporting it and then paying any related tax. So we’ll also see things where a personal vehicle or personal residence, you know, you, you, you, you title that in your trust. And then now the trust is allowed to magically depreciate a personal residence, take expenses, Off of like the trust income and what’s what I think is so strange about that is The way that these are promoted is that by putting the money?

In the trust that taxes go away. So if, so if you are not having to pay taxes on that income, why would you need deductions as well?

Jamie Gruol: Right.

Jessica Smith: I’m using, I’m using my critical thinking brain here, right? Like if I am being sold that having this trust set up magically makes the income that I put into the trust tax free, why would I need to get deductions from that income if I’m not paying taxes on it?

So already. on its face. There’s, there’s just, there’s not a logical component to how these things are being presented to the public. Right. And, and it’s, it’s interesting to kind of see it play out on social media. Cause I feel like some of the guys that promote it are like kind of goofy. Like there’s this one guy who calls himself the wealth wrangler, I think.

And he’s like a total, like by you, I’m a total redneck too. So this is not like degrading to him. I’m a redneck. I’m a girl. Like You’re good. But this man is in his cowboy hat talking about being the wealth wrangler and running a business, you know, through a trust, which the IRS has said on many occasions, and also state law kind of dictates these as well.

But there aren’t many states that actually allow trusts to run businesses in the manner that it’s being suggested. Um, so it’s really interesting. To see how these people are promoting this. Um, and

Jamie Gruol: So tell me about your client. Like what was the story with your client? So we have the background, we have kind of like the lay of the land, but I want to hear what happened in your, your client’s

Jessica Smith: so this was, this was probably, gosh, this sounds so weird to say, this was probably. just about eight years ago. This is a long time ago because I haven’t worked for the firm that many for that long, uh, recently. Um, but I worked for a tax law firm and we did high volume tax representation only. We also did represent criminal matters before, um, the department of justice for, um, just all kinds of things.

Usually it was actually, you know, Preparers who were, um, under scrutiny from, uh, from prosecution for illegally preparing tax returns and all that kind of stuff. So in, in that environment, in a representation, like tax law firm, where you have actual criminal activity or criminal exposure, you know, we had a team of like 12 attorneys at some point and so we were responsible for.

communicating with the IRS during different exams. And so this particular individual was under an exam for their own trust scheme. Now, normally, you know, someone falls victim to that. They’re not going to walk away scot free, but typically the people who are otherwise like the victims, like the taxpayers, because at the end of the day, these people are falling victim to someone who is not on the up and up, right?

So while the IRS is often looked at to be a very aggressive agency. Overall, they’re very forgiving. If you don’t willfully, knowingly, right, we’re looking at like all these things that rise to a level of like, Hey, this was actually significant involvement. Like you really knew what was going on kind of thing.

So he came in, he was under exam. They were reviewing the trust, um, because I believe it started at his individual return. And then there was Um, you know, when, when exams happen, they look at everything. And so I think that led to some uncovering of some other Um, Situation that was going on. And so then the trust issue also came up.

So, so we were going through the information and we’re trying to, you know, respond to the audit and provide the documentation. And essentially what happened is part of his business came directly from the promotion of how to set up these abusive trust schemes.

Jamie Gruol: Oh,

Jessica Smith: So by nature of him being a promoter and somebody who was outwardly teaching people how to do.

Absolutely not within the letter of the law for what Is allowable with this type of transaction. He was now under significant scrutiny for being a promoter. So if you, so if anything, if you’re going to commit tax fraud, like don’t be the one promoting it, right? Like, so all these people on social media who are getting on their high horse saying, Oh, my tax guy did this.

My tax guy did that. You do the, the IRS is absolutely like the, they’re undercover. People are absolutely on the internet. They’re, they’re looking at social media. They look primarily.

Jamie Gruol: easy. I mean, people are like just showing their cards

Jessica Smith: yeah. Well, and. And, and I think that people misunderstand that like, it’s on the internet. Like forever and and if you are in any kind of situation where you are under scrutiny from you know, from the IRS or potentially from the DOJ, whether you know it or not, um, they’re going to look into all things that you are doing, including your online activity.

And we see this a lot, at least in my field, where people who are currently in trouble with the IRS because they have unpaid taxes and they’re trying to state to the IRS that they don’t have the financial means to pay their taxes in full. They’re in a financial hardship, but then you go online to their social media and they have, they’re looking for hidden assets.

Like it’s, it’s kind of crazy to me, um, to see people who are somewhat disconnected from like how information is shared. On the internet and then who is allowed to use public public information to then potentially prosecute someone So because he was a promoter and he had unfortunately a whole history of different events that he has held.

I mean he had So many records and the really awful part was he actually believed it was legal At least that’s how he presented it. He truly believed that this was not illegal. This was totally within What the irs allows and he? You He would talk a lot as if he was trying to sell us. And, you know, our, our responsibility as legal counsel was, Hey, we need you to be upfront with us.

So that we know how to defend you in the event that this goes sour. Right. And so we already had the issue of him being a promoter. So in those situations, at least from like an IRS examination perspective for like how lenient they’re going to be on what kind of assessments are going to take place. If you are a promoter.

You are at the highest level of like, they’re not going to give any leniency. It’s the same thing with me as being a professional. If I said, Hey Jamie, um, we’re just not going to report a million dollars of income. And it’s totally fine because they don’t know, and it’s cash, and I don’t care that you bought a million dollar yacht, I don’t even know if you can buy a yacht for a million dollars, but I don’t know if you bought, if you, I don’t care if you bought a million dollar yacht with your cash, like, it’s cash, right?

Like, we don’t have to worry about it. I am going to be held to a far more significant standard, like, the IRS is not going to give me any leniency, because I, Know the tax law. So the same thing goes for these people who are promoting these. Like, they are so ingrained in this. And the IRS, in all cases, believes that tax payers and tax professionals have a due diligence to research these laws and make sure that they’re doing things correctly.

Jamie Gruol: Also, you even if he didn’t know. So what can I ask? What was his. Line of business, like if he was promoting them, but what was he doing with the cause? It sounds like he was using them as like leads for his actual business, but what was he

Jessica Smith: So he, um, so he would receive payment for the actual, um, creation of these structures. Now the interesting thing was he’s just a regular Joe. He’s not an attorney. He’s not a tax professional.

Jamie Gruol: Like he just found a niche that he got told you can make 5, 000 a

Jessica Smith: Mm hmm.

Jamie Gruol: all you can.

Jessica Smith: Exactly. So, and he just, he was just a great salesman, right? Like he just very charismatic, like had a way with words and he was, you know, in, in the area where he was promoting these things.

He had a lot of people. But I mean he was he was making a lot of money I I was I was kind of floored because I was like there can’t be this many stupid people and unfortunately You know, they did they were they were sold a total dream that just on you know when you when you get it in front of a An agency to actually see if this is legitimate.

It just completely falls apart It crumbles completely and it’s unfortunate because the taxpayers are the ones who get harmed. Um, eventually You They do go after those people, whether it be through just finding them from a, a income tax perspective in the event of an exam. Or like this case that I am looking at there.

This is from April of 2024. So this is this is recent. Um, so in, uh, in Colorado, um, there were 4 co conspirators charged and allege nationwide abusive trust trust abuse. tax shelter scheme. And, um, so the defendants have allegedly caused more than tens of millions in unpaid federal income taxes due to their involvement, um, in these schemes.

And you can read, these cases are all public. You can read all about them. If you are to look up like abusive trust tax schemes, you’re going to find hundreds, hundreds of cases. And they tell you, they literally tell you how. They did it and how it was not allowable, which is like, if you really want to know, look at how these people are being prosecuted and the, and they will tell you how, why, and what they caught them for.

Jamie Gruol: Yeah. I think it’s important for people to be aware of that there are resources like that out there. If anything ever smells fishy, Google it. See if you can find something that like talks about it. And to your point, the department of justice, where they’re actually telling you the actual case and giving all the details, you can start sniffing things out real quick.

And I think it’s important as professionals that when you are carrying that burden of. Proof that something is legitimate. You need to be responsible for it and not just take people’s word. You need to go and do your research. You need to go do your due diligence, not just rely on a mentor or somebody who has come into your world and said, no, no, no, this is true.

This is true. No matter how good a salesperson they are, you need to make sure that you’re doing the due diligence and going to the proper. authorities and resources to confirm it. So, so tell us what happened to this guy. What, what ended up being his, his punishment for doing this?

Jessica Smith: So if I remember correctly, I don’t believe that it was, as far as I’m aware, um, because these things take so long to prosecute, and the timing for when he came to the firm to the time that I left was only a couple of years, I, I can’t recall if there was any criminal proceedings. Um, I do recall that at the time, um, that we were working on his matter, um, we were just really clawing at anything to try to mitigate, um, A massive adjustment, but also like a massive preparer fine, because he at that point, whether or not he was legally a preparer or a promoter, you are still subject to those fines if the IRS considers you to have been somebody who is Is a preparer or promoter.

So, yeah, they, they also, I believe, in, imposed other fines that were related to fraudulent, uh, preparation. So I believe, too, there’s also a frivolous. there are frivolous tax return penalties. Um, and those are typically civil penalties. And in many cases, civil penalties are not eligible for bankruptcy.

Um, so, so many civil penalties are only eligible for, um, for, uh, discharge through an offer and compromise if you qualify. So they typically don’t qualify for, uh, Any type of abatement, um, or, or discharge through bankruptcy, which can be pretty scary because like the,

Jamie Gruol: Yeah.

Jessica Smith: the, the fraudulent, or I believe the frivolous, uh, frivolous fraud penalty, 75 percent of the tax.

That you owe, so, you know, in the event of, let’s say, 100, 000 dollars, you’re going to have a 75, 000 dollar penalty. For, you know, the, the fraud for defrauding, you know, the government in that stage. So yeah, it’s, and I’m seeing these all over social media and I understand the elimination of, of income tax is incredibly appealing to a lot of people.

There are so many legal ways. to minimize the tax that you’re going to pay. In some cases it can be eliminated, but kind of what I find is a lot of the things that take people who are making, making enough money to where they actually have a significant amount to pay. It’s usually, um, tax reduction strategies that just kick the can a little bit further.

Hopefully,

Jamie Gruol: Yeah.

Jessica Smith: to say hopefully that sounds wrong, but it kicks the can a little bit further in the event so that if that person were to then pass away, then those taxes that are otherwise deferred. Kind of like get eliminated through a potential step up in basis, which is beneficial to anybody who inherits some of those, those, those things.

Um, but yeah, it’s, you know, the, the elimination of, of tax sounds so great on its face, but to do so at, honestly, at the risk of having to pay 175 percent of it back, no, thank you. No, thank you.

Jamie Gruol: Well, yeah, I mean, if it sounds good to be true, it’s not true, you know, and as an old saying goes, and I think people, you have to use your, your, Common sense in some ways. And there’s only two things that are certain in life, death and taxes.

Jessica Smith: Yeah,

Jamie Gruol: You, you can’t fully escape it. And if you are, then you’re probably paying a lot of money to escape

Jessica Smith: exactly.

Jamie Gruol: at that point,

Jessica Smith: Exactly.

Jamie Gruol: well, that’s very interesting. Well, thank you, Jess, for educating us on, uh, abusive tax schemes. That

Jessica Smith: That’s what I’m here for. Let’s commit tax fraud.

Jamie Gruol: that is an interesting one. And, do come back. We are going to have more of these, crazy stories in the, the series. And let me tell you, there’s some juicy ones.

So you’re going to want to come back and listen to the other one. If you have a friend that you think would love to hear these stories or learn something new about abusive tax schemes, please share this podcast with them. We appreciate it. And as always. Leave us a review. We want to know that you’re listening and that you’re enjoying this and we will keep making more of these podcasts.

We’re really enjoying the process of it and knowing what you are liking and what you want more of will help us make sure that we’re delivering to your needs. All right, we will see you in the next episode and until then have a wonderful

Jessica Smith: Bye.