It’s a pretty safe bet that nobody really likes paying income taxes, which is why most people look for ways to lower their tax liability when filing returns.
There’s nothing wrong with finding ways to lower taxes — as long as what you do is allowed under federal and state tax rules. The problem comes when investors try to massage or even break those rules.
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Here are three things investors should never do to “lower” their taxes.
Ignore the ‘Economic Substance’ Rule
One thing you should never do when trying to lower your taxes is record transactions that don’t meet the IRS’ “economic substance” rule, Chad Cummings, a CPA and attorney at Cummings & Cummings Law who previously worked in finance and tax, told GOBankingRates.
In this case, “economic substance” means the transaction has a “practical financial and operational effect” and is not engineered for the sole purpose of reducing or avoiding taxes.
“If a transaction lacks economic substance and is later challenged by the IRS, the best-case scenario is that the deduction or exclusion will be disallowed,” Cummings said. “The worst case scenario — and this happens — is that the taxpayer will go to prison for tax fraud. Tax fraud has no statute of limitation.”
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Fall Prey to Tax Advisor Scams
Another “major red flag” is when a tax advisor tries to sell you a product that nobody else sells.
“I am working with two clients right now who fell victim to a credentialed tax preparer in Texas who sold a system of elaborate trusts to clients as a tax reduction product,” Cummings said. “That preparer is now on trial for tax fraud, and several of his clients are in dire straits after having relied on his advice.”
Rely On ‘Related-Party’ Transactions
When it comes to tax-filing traps, losses manufactured through related-party transactions top Cummings’ list.
“I watch investors sell depreciated assets to a family member or controlled entity, claim the loss, then reacquire the asset weeks later,” he said.
But as Cummings pointed out, Section 267 of the Internal Revenue Code “disallows losses between related parties,” while Section 1091 wash-sale rules extend to “substantially identical” securities.
“Investors who attempt this face loss disallowance, accuracy-related penalties of 20% under Section 6662, and potential fraud referral,” Cummings said.
Editor’s note: This article is for informational purposes only and does not constitute financial advice. Investing involves risk, including the possible loss of principal. Always consider your individual circumstances and consult with a qualified financial advisor before making investment decisions.
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This article originally appeared on GOBankingRates.com: I Asked a CPA What Investors Should Never Do To ‘Lower Taxes’
