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Tread with caution when you recommend certain strategies under IRS scrutiny. But don’t be afraid to tread at all!
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Take It to the Limit

On November 15, 1975, the Eagles released “Take It to the Limit,” the third single from their One of These Nights album. (Glenn Frey joked that his wife called it “the credit card song.”) Lead singer Randy Meisner hated singing it in concert because he struggled to hit the high notes at the end – his refusal to sing it at a 1977 concert led to a fight with Frey, which in turn led to him leaving the band. But you can be sure he never imagined we’d use it as a metaphor for a common tax-planning challenge nearly 50 years later.

Here’s the dilemma. Clients want to pay the least tax legally possible. But the law is full of gray areas. We want to “take it to the limit” for our clients. But we don’t want to cross any lines. And sometimes the client, the IRS, and even we don’t agree on those lines.

“Abuses” shouldn’t scare planners away from using legitimate strategies. Plenty of clients abuse S corporation rules by failing to pay themselves reasonable compensation for the work they do for their business. That doesn’t scare experienced tax professionals away from S corps entirely.

But some strategies may seem closer to intrinsically sketchy. How do you handle those without giving up legitimate, ethical opportunities to help your client pay less?

Last week, the IRS concluded their 2021 “Dirty Dozen” list of tax scams with a warning about promoted abusive arrangements (IR-2021-144). The list includes three strategies that many TMN members have used with clients: syndicated conservation easements, “abusive” micro-captive arrangements, and “improper” monetized installment sales.

Does that mean we can’t recommend those strategies anymore? At first glance, you might think so. But a closer look suggests there’s still room for them in your toolbox – as long as you dot your I’s, cross your t’s, and disclose the risks to your clients. There’s nothing wrong with taking it to the limit – even the limit of the law – if you do the homework to define that limit. (Fifteenth-century world maps used to warn, “here be dragons” so mariners wouldn’t sail off the edge of the earth – you don’t want clients sailing into dragon territory!)

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Let’s take a closer look at the IRS announcement, specifically where captives are concerned. The news release states, “In abusive ‘micro-captive’ structures, promoters, accountants or wealth planners persuade owners of closely held entities to participate in schemes that lack many of the attributes of insurance. For example, coverages may “insure” implausible risks, fail to match genuine business needs or duplicate the taxpayer’s commercial coverages.”

That certainly sounds abusive, and the Tax Court hasn’t been shy about striking down arrangements that don’t constitute “real” insurance. But it leaves the door to bona fide insurance coverage for genuine risks (which have been redefined by Covid), satisfy genuine business needs, and supplement the taxpayers’ commercial coverages. In other words, just because careless or unethical promotors have abused the rules doesn’t mean you can’t do it right. Our recommended vendor loves the cases striking down abusive arrangements because “every time they tell us what we can’t do, they’re also telling us what we can.”

The situation is similar with “improper” monetized installment sales. Monetized installment sales have become an increasingly popular tool for deferring tax on capital gains. Office Depot (NASDAQ: ODP) used it to defer tax on $1.47 billion in timber sales, which suggests their inside and outside counsel felt comfortable enough with it to proceed even knowing it would be disclosed in securities filings. The IRS’s use of the term “improper” monetized installment sales logically suggests that there are also “proper” sales.

If the IRS wanted to just ban monetized installment sales, they could do it. Up until 2006, a group called the National Association of Financial and Estate Planning offered clients something called a “private annuity trust” (PAT) to defer tax by converting sale proceeds into annual annuity installments. On October 18, 2006, the IRS announced they would no longer recognize tax deferral on those arrangements. But they grandfathered PATs created before that date. (Ironically, many of the planners who had used PATs with their clients wound up adopting the monetized installment sale as a “go-to” alternative.)

An outright ban on monetized installment sales would probably wind up in court, and might or might not hold up. But the fact that the IRS isn’t taking that step, when they could take it, suggests the Service sees room to use them legitimately.

Where does this leave us? I’d suggest these rules for taking it to the limit with your clients:

1. Do your homework. Make sure you understand the technical details of any strategy that reaches into gray areas, whether it’s under IRS scrutiny or not.

2. Ask for help. Consider looking to outside advisors, like an attorney who can write an opinion letter shielding your client from penalties if a transaction is unwound at audit.

3. Disclose, disclose, disclose! It’s unethical at best to push clients outside their comfort zone. Sometimes they feel more comfortable with a strategy than you, and sometimes you might feel more comfortable than them. But it’s your obligation to make sure your clients understand what they’re getting themselves into when it comes to taking it to the limit with their planning.

Bottom line: some strategies require you to tread with caution. But that doesn’t have to mean you shouldn’t tread at all!

Edward Lyon

Edward Lyon

Edward A. Lyon is CEO of the Tax Master Network, where he's coached tax professionals to add planning and financial services to their business since 2005. Go here to join the network. Go here to upgrade your membership or discuss opportunities in financial services.
Edward Lyon

Edward Lyon

Edward A. Lyon is CEO of the Tax Master Network, where he's coached tax professionals to add planning and financial services to their business since 2005. Go here to join the network. Go here to upgrade your membership or discuss opportunities in financial services.

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Previous Issues of Tax Tactics

Take It to the Limit

Tread with caution when you recommend certain strategies under IRS scrutiny. But don’t be afraid to tread at all!

Taking the Hit

It seems counter-intuitive in the world of tax planning, but what happens when tax savings interferes with a client’s financial goals?

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