Summary:
Distinctions between valid tax shelters and fraudulent shelters. This includes investment shelters, fake churches and bogus trusts that IRS might challenge.

Is it a valid tax shelter or is it bogus?

A shelter huckster might tell you:

• Never pay taxes again.
  
• Deduct personal expenses.
  
• The IRS doesn't want you to know about this.
  
• This is so new, your CPA doesn't know about it yet.
  

If he tells you any of these, hold on to your checkbook and run.

Fake shelter buyers will surely be audited. When the Internal Revenue Service catches one shelter customer, this leads it to the promoter. After it examines his customer list, the agency starts auditing everyone on the list.

How do you recognize bogus tax shelters?

Investment shelters. During the early 1980's, the popular shelter was an investment in a movie, gold mine, painting or building where promoters promised immediate deductions far exceeding the money invested. Shelters typically involved assets with inflated values paid with phantom debt, due only if the investment succeeded, an unlikelihood.

The IRS considers these factors indicate a bogus shelter:

• Promotional material, contains little mention of an opportunity for gain, emphasizes tax benefits.
  
• Neither the taxpayer nor his consultant investigates profit opportunity.
  
• Inflated asset values and no personal liability on notes taxpayer signed.
  

The courts consider these factors indicate a bogus shelter:

• The transaction had no consequence other than tax.
  
• The taxpayer had no business purpose, such as making a profit, for engaging in the transaction.
  
• The taxpayer had neither economic risk nor prospect of gain.
  

Whereas, according to the courts, these factors show a bona fide investment:

• The sponsor had expertise and a favorable track record in the shelter industry.
  
• The income and expense projections were reasonable and showed a profit potential.
  
• The sponsor operated the shelter like a business.
  

Fake churches and bogus trusts. Besides investment shelters, you see tax avoidance schemes using bogus trusts and fake churches. These generally result in no meaningful change in taxpayer's control over or benefit from his assets or income.

One popular scam involves mail-order churches. Taxpayers form these churches by buying a "certification of ordination" and "church charter." Church membership is usually limited to family members. The taxpayer ostensibly contributes his assets and paychecks, but continues to use those assets and defrays living expenses out of paychecks donated.

A common thread in bogus trusts is that the taxpayer transfers personal or business assets or income into the trust. The taxpayer, the promoter or someone taxpayer can control is named trustee. The transfer disguises that, in reality, nothing of practical significance changed. The taxpayer continues to control the assets and to benefit from the trust's contents. Usually, the taxpayer deducts unallowable personal expenses or doesn't report income.

While many trusts are legitimate ways to save taxes, sham trusts are not.

THE MORAL: If it's too good to be true, don't trust it.

Suggestion. If you have any doubt about the shelter, get advice from someone independent of the sponsor. Talk to a reputable tax CPA or tax attorney. Or check it out with the IRS: call 202-283-8740 or E-mail irs.tax.shelter.hotline@irs.gov. Or you can look at a list of tax frauds at www.treas.gov/irs/ci.

More at Fraud and Scams.