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ROBERT E. MCKENZIE, ESQ.

ARNSTEIN & LEHR LLP


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Ads by Google Income Tax Rates Tax Lien Properties Employer Fica Tax Tax Laws

Robert E. McKenzie

© 2006

1. Overview - Abusive Tax Schemes

1.1 Since the mid-1990s, the IRS has witnessed a proliferation of abusive tax schemes, particularly those
with offshore components. Originally those schemes took the structure of abusive domestic and foreign trust
arrangements. However, abusive schemes are evolving into sophisticated arrangements that take advantage of
the financial secrecy laws of some foreign jurisdictions and the availability of credit/debit cards issued from
offshore financial institutions.

1.2 Anti-Tax Law Evasion Schemes - Facts

Since shortly after the federal income tax was enacted in 1913, some individuals and groups have encouraged
others not to comply with the law. There have been unsuccessful challenges about the applicability of tax laws
using a variety of arguments. There have been assertions that the sixteenth Amendment was not properly
ratified, the tax law was unconstitutional, the tax law did not apply to certain types of income, the tax law only
applied to certain individuals, and the tax law violated one or more constitutional rights.

1.3 Courts Have Consistently Rejected

Despite the courts having consistently rejected these arguments, their promoters continue to expound them, even
incurring penalties for bringing frivolous cases into court or for filing frivolous tax returns. They often present
their arguments in a pseudo-legal format, luring unsuspecting people into participating in their schemes to evade
taxes.
1.4 National Program

IRS Criminal Investigation (CI) has developed a nationally coordinated program to combat these abusive tax
schemes. CI's primary focus is on the identification and investigation of the tax scheme promoters as well as
those who play a substantial or integral role in facilitating, aiding, assisting, or furthering the abusive tax scheme
(e.g., accountants, lawyers). Secondarily, but equally important, is the investigation of investors who knowingly
participate in abusive tax schemes.

1.5 IRS Steps Against Noncompliance

The Internal Revenue Service has focused its efforts against noncompliance by adopting a multi-functional
compliance approach:

· Helping otherwise innocent taxpayers, who have been misled by others, to rejoin the system; and

· Vigorously pursuing enforcement actions against those who continue to promote schemes or entice
others to violate the law.

Regardless of the arguments used, they have two things in common:

· The arguments are consistently rejected by the courts; and

· The participants may face IRS enforcement.

The IRS has one of the highest conviction rates in federal law enforcement. In addition to serving substantial
prison sentences imposed by the courts, those convicted must also pay fines, taxes, civil penalties, and,
frequently, court costs.

1.6 What is an Abusive Tax Scheme?

The Abusive Tax Schemes program encompasses violations of the Internal Revenue Code (IRC) and related
statutes where multiple flow-through entities are used as an integral part of the taxpayer's scheme to evade
taxes. These schemes are characterized by the use of trusts, Limited Liability Companies (LLCs), Limited
Liability Partnerships (LLPs), International Business Companies (IBCs), foreign financial accounts, offshore
credit/debit cards and other similar instruments. The schemes are usually complex involving multi-layer
transactions for the purpose of concealing the true nature and ownership of the taxable income and/or assets.

1.7 Form Over Substance

Form over substance are the most important words to remember before buying into any arrangements that
promise to "eliminate" or "substantially reduce" your tax liability. The promoters of abusive tax schemes often
employ financial instruments such as trusts in their schemes. However, the instruments are used for improper
purposes including the facilitation of tax evasion.

Abusive Schemes

FY 2005 FY 2004 FY 2003


Investigations Initiated 197 131 79
Prosecution Recommendations 126 127 80
Indictments/Information 70 82 73
Sentenced 7 45 43
Incarceration Rate 82.9% 73.3% 79.1%
Avg. Months to Serve 38 36 47

Criminal Investigation Statistical Information

FY 2005 FY 2004 FY 2003


Investigations Initiated 4269 3917 4001
Prosecution Recommendations 2859 3037 2541
Information/Indictments 2406 2489 2128
Total Convictions 2151 2008 1824
Total Sentenced* 2095 1777 1768
Percent to Prison 83% 84% 84%
Criminal Investigations 10-1-05 to 12-31-05

Totals
Investigations Initiated 926
Prosecution Recommendations 731
Information/Indictments 519
Total Convictions 486
Total Sentenced* 554
Percent to Prison 81.0%
Average Months to Serve 52

2. Overview - Abusive Return Preparer

2.1 The IRS Criminal Investigation Return Preparer Program (RPP) was implemented in 1996, and
established procedures to foster compliance by identifying, investigating and prosecuting abusive return
preparers. The program was developed to enhance compliance in the return-preparer community by engaging in
enforcement actions and/or asserting appropriate civil penalties against unscrupulous or incompetent return
preparers. This is a significant problem for both the IRS and taxpayers. Abusive return preparers frequently
prepare bad returns for large numbers of taxpayers who, at best, are stuck with paying additional taxes and
interest and at worse, depending on culpability, are subject to penalties and maybe even criminal prosecution.

2.2 Return Preparer Fraud Return Preparer Fraud generally involves the preparation and filing of false
income tax returns by preparers who claim inflated personal or business expenses, false deductions, unallowable
credits or excessive exemptions on returns prepared for their clients. Preparers may also manipulate income
figures to obtain fraudulent tax credits, such as the Earned Income Tax Credit.

2.3 Taxpayer Must Pay In some situations, the client (taxpayer) may not have knowledge of the false
expenses, deductions, exemptions and/or credits shown on their tax returns. However, when the IRS detects the
false return, the taxpayer must pay the additional taxes and interest and may be subject to penalties and criminal
prosecution.

2.4 Enhancing Compliance The IRS Return Preparer Program focuses on enhancing compliance in the
return-preparer community by investigating and referring criminal activity by return preparers to the Department
of Justice for prosecution and/or asserting appropriate civil penalties against unscrupulous return preparers.

Abusive Preparers

FY 2005 FY 2004 FY 2003


Investigations Initiated 248 206 229
Prosecution Recommendations 140 167 169
Indictments/Information 119 121 109
Sentenced 118 90 49
Incarceration Rate* 85.6% 84.4% 83.7%
Avg. Months to Serve 18 19 19
3. Some Arguments – Non-filer Enforcement

3.1 Many groups continue to promote myths regarding the duty to file returns. None have ever prevailed in
civil litigation but many gullible taxpayers are persuaded to cease filing returns. Complicated arguments against
the American tax system are built by stringing together unrelated ideas plucked from widely conflicting court
rulings, dictionary definitions, government regulations and other sources. The Truth about Frivolous Tax
Arguments addresses false arguments about the legality of not paying taxes or filing returns. Some of the most
popular anti-taxation arguments include the following:

Constitutional Argument - Filing an IRS Form 1040 violates the Fifth Amendment right against
self-incrimination or the Fourth Amendment right to privacy.

The Truth: The courts have consistently held that disclosure of the type of routine financial information
required on a tax return does not incriminate an individual or violate the right to privacy.

Compensation Argument - Wages, tips and other compensation received for personal services are not
income because there is allegedly no taxable gain when a person "exchanges" labor for money.

The Truth: The Internal Revenue Code defines gross income as income from whatever source derived
and includes compensation for services.

Sixteenth Amendment Argument - The Constitutional Amendment establishing the basis for income tax
was never properly ratified.

The Truth: The 16th Amendment was properly ratified in 1913, and it states "The Congress shall have
power to lay and collect taxes on incomes, from whatever source derived, without apportionment among
the several States, and without regard to any census or enumeration."

Religious Arguments - Individuals invoke the Freedom of Religion clause of the First Amendment by
taking a vow of poverty or by fraudulently claiming charitable contributions of 50% or more of their
adjusted gross income.

The Truth: Taking a purported vow of poverty or claiming fraudulent contributions to filter income
through a church is not legal. Many fraudulent religious organizations use funds for personal expenses.
Internal Revenue Code Arguments -There is no Internal Revenue Code that imposes taxes; only
"individuals" are required to pay taxes; or IRS can only assess taxes against people who file returns;
income taxes are voluntary

The Truth: The tax law is found in Title 26 of the United States Code. The requirement to file an income
tax return is not voluntary and it is clearly set forth in the Internal Revenue Code (IRC) Sections 6011(a),
6012(a), et seq., and 6072(a). IRS was established July 1, 1862 by an act of Congress. Our system of
taxation allows taxpayers to determine the correct amount of tax and complete the appropriate forms
"voluntarily" rather than have the government do it for them.

Forming a Trust Argument - Forming a business trust to hold your income and assets will avoid taxes. A
family estate trust will allow you to reduce or eliminate your tax liability.

The Truth: Although there are legitimate trusts and legitimate reasons why individuals establish trusts,
establishing a trust, foreign or domestic, for the sole purpose of hiding your income and assets from
taxation is illegal and will not absolve you of your tax liability. The underlying claims for many "untaxing"
trust packages rely on other frivolous arguments--arguments that have subjected promoters, as well as
willing participants, to criminal penalties.

Nonfilers

FY 2005 FY 2004 FY 2003


Investigations Initiated 549 417 536
Prosecution Recommendations 413 317 302
Indictments/Information 316 277 234
Sentenced 280 194 218
Incarceration Rate 78.2% 92.3% 81.7%
Avg. Months to Serve 34 36 40

3.2 Some "Tax Experts" Don't Follow Their Own Advice Some American citizens use these and other
arguments advocating non-compliance with the tax laws Inspect promotional material carefully. Aside from
being false and misleading, it often contains elaborate disclaimers such as "this report is offered as a vehicle for
discussion and debate and for general informational purposes only. It does not constitute legal or professional
advice and should not be relied on as a substitute for proper research and inquiries into original sources of
authority." Many of these "tax experts" don’t even follow their own advice but choose to file and pay their own
taxes.

4. The Dirty Dozen


Each year the IRS announces its Dirty Dozen and urges people to avoid these common schemes: The 2006 list is
as follows:

Zero Wages. In this scam, new to the Dirty Dozen, a taxpayer attaches to his or her return either a Form
4852 (Substitute Form W-2) or a “corrected” Form 1099 that shows zero or little wages or other income.
The taxpayer may include a statement indicating the taxpayer is rebutting information submitted to the
IRS by the payer. An explanation on the Form 4852 may cite "statutory language behind IRC 3401 and
3121" or may include some reference to the paying company refusing to issue a corrected Form W-2 for
fear of IRS retaliation. The Form 4852 or 1099 is usually attached to a “Zero Return.” (See number four
below.)

Form 843 Tax Abatement. This scam, also new to the Dirty Dozen, rests on faulty interpretation of the
Internal Revenue Code. It involves the filer requesting abatement of previously assessed tax using Form
843. Many using this scam have not previously filed tax returns and the tax they are trying to have abated
has been assessed by the IRS through the Substitute for Return Program. The filer uses the Form 843 to list
reasons for the request. Often, one of the reasons is: "Failed to properly compute and/or calculate IRC Sec
83––Property Transferred in Connection with Performance of Service."

Phishing. Phishing is a technique used by identity thieves to acquire personal financial data in order to
gain access to the financial accounts of unsuspecting consumers, run up charges on their credit cards or
apply for new loans in their names. These Internet-based criminals pose as representatives of a financial
institution and send out fictitious e-mail correspondence in an attempt to trick consumers into disclosing
private information. Sometimes scammers pose as the IRS itself. In recent months, some taxpayers have
received e-mails that appear to come from the IRS. A typical e-mail notifies a taxpayer of an outstanding
refund and urges the taxpayer to click on a hyperlink and visit an official-looking Web site. The Web site
then solicits a social security and credit card number. In a variation of this scheme, criminals have used
e-mail to announce to unsuspecting taxpayers they are “under audit” and could make things right by
divulging selected private financial information. Taxpayers should take note: The IRS does not use e-mail
to initiate contact with taxpayers about issues related to their accounts. If a taxpayer has any doubt
whether a contact from the IRS is authentic, the taxpayer should call 1-800-829-1040 to confirm it. On
March 27, 2006 the Internal Revenue Service announced that it has established an electronic mailbox for
taxpayers to send information about suspicious e-mails they receive which claim to come from the IRS.
Taxpayers should send the information to: phishing@irs.gov.

The IRS has seen a recent increase in these scams, many of which originate outside the United States. To
date, investigations by the Treasury Inspector General for Tax Administration have identified sites hosting
more than two dozen IRS-related phishing scams. These scam Web sites have been located in at least 20
different countries, including Argentina, Aruba, Australia, Austria, Canada, Chile, China, England,
Germany, Indonesia, Italy, Japan, Korea, Malaysia, Mexico, Poland, Singapore and Slovakia, as well as
the United States.

Zero Return. Promoters instruct taxpayers to enter all zeros on their federal income tax filings. In a twist
on this scheme, filers enter zero income, report their withholding and then write “nunc pro tunc”–– Latin
for “now for then”––on the return. They often also do this with amended returns in the hope the IRS will
disregard the original return in which they reported wages and other income.

Trust Misuse. For years unscrupulous promoters have urged taxpayers to transfer assets into trusts. They
promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift
taxes. However, some trusts do not deliver the promised tax benefits, and the IRS is actively examining
these arrangements. There are currently more than 200 active investigations underway and three dozen
injunctions have been obtained against promoters since 2001. As with other arrangements, taxpayers
should seek the advice of a trusted professional before entering into a trust.

Frivolous Arguments. Promoters have been known to make the following outlandish claims: the
Sixteenth Amendment concerning congressional power to lay and collect income taxes was never ratified;
wages are not income; filing a return and paying taxes are merely voluntary; and being required to file
Form 1040 violates the Fifth Amendment right against self-incrimination or the Fourth Amendment right
to privacy. Don’t believe these or other similar claims. These arguments are false and have been thrown
out of court. While taxpayers have the right to contest their tax liabilities in court, no one has the right to
disobey the law.

Return Preparer Fraud. Dishonest return preparers can cause many headaches for taxpayers who fall
victim to their schemes. Such preparers derive financial gain by skimming a portion of their clients’
refunds and charging inflated fees for return preparation services. They attract new clients by promising
large refunds. Taxpayers should choose carefully when hiring a tax preparer. As the old saying goes, “If it
sounds too good to be true, it probably is.” And remember, no matter who prepares the return, the
taxpayer is ultimately responsible for its accuracy. Since 2002, the courts have issued injunctions ordering
dozens of individuals to cease preparing returns, and the Department of Justice has filed complaints
against dozens of others. During fiscal year 2005, more than 110 tax return preparers were convicted of
tax crimes.

Credit Counseling Agencies. Taxpayers should be careful with credit counseling organizations that claim
they can fix credit ratings, push debt payment plans or impose high set-up fees or monthly service charges
that may add to existing debt. The IRS Tax Exempt and Government Entities Division is in the process of
revoking the tax-exempt status of numerous credit counseling organizations that operated under the guise
of educating financially distressed consumers with debt problems while charging debtors large fees and
providing little or no counseling.

Abuse of Charitable Organizations and Deductions. The IRS has observed increased use of tax-exempt
organizations to improperly shield income or assets from taxation. This can occur, for example, when a
taxpayer moves assets or income to a tax-exempt supporting organization or donor-advised fund but
maintains control over the assets or income, thereby obtaining a tax deduction without transferring a
commensurate benefit to charity. A “contribution” of a historic facade easement to a tax-exempt
conservation organization is another example. In many cases, local historic preservation laws already
prohibit alteration of the home’s facade, making the contributed easement superfluous. Even if the facade
could be altered, the deduction claimed for the easement contribution may far exceed the easement’s
impact on the value of the property.

Offshore Transactions. Despite a crackdown by the IRS and state tax agencies, individuals continue to
try to avoid U.S. taxes by illegally hiding income in offshore bank and brokerage accounts or using
offshore credit cards, wire transfers, foreign trusts, employee leasing schemes, private annuities or life
insurance to do so. The IRS and the tax agencies of U.S. states and possessions continue to aggressively
pursue taxpayers and promoters involved in such abusive transactions. During fiscal 2005, 68 individuals
were convicted on charges of promotion and use of abusive tax schemes designed to evade taxes.
Employment Tax Evasion. The IRS has seen a number of illegal schemes that instruct employers not to
withhold federal income tax or other employment taxes from wages paid to their employees. Such advice
is based on an incorrect interpretation of Section 861 and other parts of the tax law and has been refuted
in court. Lately, the IRS has seen an increase in activity in the area of “double-dip” parking and medical
reimbursement issues. In recent years, the courts have issued injunctions against more than a dozen
persons ordering them to stop promoting the scheme. During fiscal 2005, more than 50 individuals were
sentenced to an average of 30 months in prison for employment tax evasion. Employer participants can
also be held responsible for back payments of employment taxes, plus penalties and interest. It is worth
noting that employees who have nothing withheld from their wages are still responsible for payment of
their personal taxes.

“No Gain” Deduction. Filers attempt to eliminate their entire adjusted gross income (AGI) by deducting it
on Schedule A. The filer lists his or her AGI under the Schedule A section labeled “Other Miscellaneous
Deductions” and attaches a statement to the return that refers to court documents and includes the words
“No Gain Realized.”

Two Fall Off The List. Two noteworthy scams have dropped off the “Dirty Dozen” this year: “claim of
right” and “corporation sole.” IRS personnel have noticed less activity in these scams over the past year
following court cases against a number of promoters.
5. Sham Trusts

5.1 The Internal Revenue Service is cautioning the small business community and public in general about
schemes that create “sham” trusts in an attempt to evade federal taxes. In the last few years the IRS has detected
a proliferation of abusive trust tax avoidance schemes. Since October of 2001, the courts have issued 19
permanent and 2 preliminary injunctions against promoters of these abusive trusts.

5.2 Responsibility and Control Generally, a trust is a form of ownership that separates responsibility and
control of assets from the benefits of ownership. Sham trusts deliberately hide the true ownership and control of
the trust assets and income in order to avoid correct federal taxation rules.

5.3 Abusive Trust Schemes In abusive trust schemes, bogus or inflated expenses are often charged against
trust income. After the deduction of these expenses, the remaining income is distributed to another trust, and the
process is repeated. The result of the distributions and deductions is a decrease in the amount of income
ultimately reported to the IRS.

5.4 Components These schemes may be promoted with domestic components, offshore components, or a
combination of the two. Often, the trusts involved in the scheme, whether foreign or domestic, are vertically
layered with each entity distributing income to another layer. Nondeductible or bogus expenses are often
charged against the income throughout the layers. No economic purpose or substantial change in the economic
relationship is present, although they give the appearance the taxpayer or small business has given up control of
the assets when in reality they have not. The result of these arrangements is intended to substantially reduce the
amount of income reported to the IRS.

5.5 Illusive Tax Benefits Abusive trust arrangements will not produce the tax benefits advertised by their
promoters and the Internal Revenue Service is actively examining these types of trust arrangements.
Furthermore, taxpayers, small businesses and/or the promoters of these trust arrangements may be subject to
civil and/or criminal penalties.

6. Types of Trusts: Good & Bad

Common Law Trust Contrary to the claims of promoters, "common law trusts" no longer exist since all
states now have statutes relating to the creation and operation of trusts.

Foreign Trust Through 1996, a trust was foreign if the trustee, corpus, and administration were foreign.
Since 1996, a trust is foreign unless a U.S. court supervises the trust and a U.S. fiduciary controls all
substantial decisions. U.S. taxpayers are subject to filing Form 3520, Creation of or Transfer to Certain
Foreign Trusts, Form 3520-A, Annual Return of Foreign Trust With U.S. Beneficiaries, and Form 926,
Return by a Transferor of Property to a Foreign Estate or Trust, when contributing property to a foreign
trust. These trusts are usually U.S. tax neutral and are treated as grantor trusts with income taxed to the
grantor.

Income Attributable to U. S. Sources Foreign trusts that have income attributable to U.S. sources and
are not grantor trusts are required to file Form 1040NR, U.S. Nonresident Alien Income Tax Return.
Foreign trusts that have income attributable to U.S. sources and are grantor trusts would have that income
directly attributable to the grantor (if U.S. grantor income, it must be included on Form 1040; if
nonresident alien grantor income, it must be included on Form 1040NR).

Personal Residence Trust A personal residence trust involves the transfer of a personal residence to a
trust with the grantor retaining the right to live in the residence for a fixed term of years. Upon the shorter
of the grantor's death or the expiration of the term of years, title to the residence passes to beneficiaries of
the trust. This is an irrevocable trust with gift tax implications.

Qualified Personal Residence Trust A qualified personal residence trust (QPRT) involves the transfer
of a personal residence to a trust with the grantor retaining a qualified term interest. If the grantor dies
before the end of the qualified term interest, the value of the residence is included in the grantor's estate. If
the grantor survives to the end of the qualified term interest, the residence passes to beneficiaries of the
trust. A QPRT is a grantor trust, with special valuation rules for estate and gift tax purposes, governed
under IRC 2702.

Grantor Retained Income Trust In a grantor retained income trust, the grantor creates an irrevocable
trust and retains the right to all trust income for: (a) the earlier of a specified term or the death of the
grantor; or (b) a specified term. If the grantor survives the specified term, the trust principal passes to
others according to the terms and provisions of the trust instrument. For federal tax purposes, this trust is
treated as a grantor trust.

Grantor Retained Annuity Trust In a grantor retained annuity trust, the grantor creates an irrevocable
trust and retains the right to receive, for a specified term, an annuity based on specified sum or fixed
percentage of the value of the assets transferred to the trust. A grantor retained annuity trust is specifically
authorized by Internal Revenue Code Section 2702(a)(2)(B) and 2702(b). For federal tax purposes, this
trust is treated as a grantor trust.

Grantor Retained Unitrust A grantor retained unitrust is similar to a grantor retained annuity trust.
However, in a grantor retained unitrust, the grantor creates an irrevocable trust and retains, for a specified
term, an annual right to receive a fixed percentage of the annually determined net fair market value of the
trust assets (Treasury Regulation Section 25.2702-(c)(1)). For federal tax purposes, this trust is treated as a
grantor trust.
Charitable Lead Trust A charitable lead trust pays an annuity or unitrust interest to a designated charity
for a specified term of years (the "charitable term") with the remainder ultimately distributed to
non-charitable beneficiaries. There is no specified limit for the charitable term. The donor receives a
charitable deduction for the value of the interest received by the charity. The value of the non-charitable
beneficiary's remainder interest is a taxable gift by the grantor.

Charitable Lead Annuity Trust A charitable lead annuity trust is a charitable lead trust paying a fixed
percentage of the initial value of the trust assets to the charity for the charitable term.

Charitable Lead Unitrust A charitable lead unitrust is a charitable lead trust paying a percentage of the
value of its assets, determined annually, to a charity for the charitable term.

Charitable Remainder Trust In a charitable remainder trust, the donor transfers assets to an annuity
trust or unitrust. The trust pays the donor or another beneficiary a certain amount each year for a specified
period. In an annuity trust, the payment is a specified dollar amount. In a unitrust, the payment is a
percentage of the value of the trust, as valued each year. The term of the trust is limited to 20 years or the
life of the designated recipients. At the end of the term of the trust, the remaining trust assets must be
distributed to a charitable organization. Contributions to the charitable remainder trust can qualify for a
charitable deduction. This charitable contribution deduction is limited to the present value of the charitable
organization's remainder interest. Revenue Procedures 89-20, 89-21, 90-30, and 90-31 provide sample
trust forms that the Service will recognize as meeting charitable remainder trust requirements.

Pooled Income Fund Trust A pooled income fund is an unincorporated fund set up by a public charity to
which a person transfers property, reserving an income interest in, and giving the charity the remainder
interest in that property. The Code and Regulations under Section 642 establish trust requirements. These
funds file Form 1041.

Life Insurance Trust An insurance trust is generally an irrevocable trust that owns insurance on the life
of the grantor or grantor and spouse. The trust is designed to avoid federal estate taxation of the insurance
proceeds on the deaths of the grantor or spouse. When premium payments or other gifts to the trust are
made, the trust instrument grants specified beneficiaries Crummey withdrawal rights over the gifts so that
they will qualify for the federal gift tax annual exclusion. These trusts would generally file a Form 1041 as
a complex trust, if the $600 income requirement were met.

Qualified Subchapter S Trust (QSST) A QSST is a statutory creature established by IRC Section
1361(d)(3). By meeting the requirements of a QSST, a trust may own S Corporation shares. An election
must be made to be treated as a QSST and once made is irrevocable.

Electing Small Business Trust (ESBT) An ESBT is a statutory creature established by IRC Section
641(d). By meeting the requirements of an ESBT, a trust may own S Corporation shares. ESBT's must file
Form 1041 and the S Corporation income is taxed at the trust's highest marginal rate. No income
distribution deduction is allowed to beneficiaries. To be treated as an ESBT, an election must be made.

Funeral Trust This is an arrangement between the grantor and funeral home/cemetery to allow for the
prepayment of funeral expenses. The funeral trust is a "pooled income fund" set up by a funeral
home/cemetery to which a person transfers property to cover future funeral and burial costs. These are
grantor trusts with the grantor responsible for reporting income. The trustee may make an election on
qualified pre-need funeral trusts to not be treated as a grantor trust, with the tax being paid by the trustee.

Rabbi Trust An irrevocable trust that functions as a type of retirement plan or deferred compensation
arrangement that offers a limited amount of security to the deferring employee.

Business Trust The term "business trust" is not used in the Internal Revenue Code. The regulations
require that trusts operating a trade or business be treated as a corporation, partnership, or sole
proprietorship, if the grantor, beneficiary or fiduciary materially participates in the operations or daily
management of the business. If the grantor maintains control of the trust, then grantor trust rules will
apply. Otherwise, the trust would be treated as a simple or complex trust, depending on the trust
instrument.

Pure Trust The term "pure trust" is not used in the Internal Revenue Code. Whatever the name of the
arrangement, however, the taxation of the entity must comply with the requirements of the Internal
Revenue Code. The requirements are based on the economic reality of the arrangement, not its
nomenclature. If the pure trust meets the definition of a trust, then it would be taxed under simple,
complex, or grantor trust rules, depending on the trust instrument.

Illinois Land Trust In Illinois, and in five other states, legislation has been enacted that creates a special
type of trust, commonly referred to as an "Illinois Land Trust". These trusts are designed to house real
estate within a grantor trust and provide limited access to grantor or beneficiary information contained in
the trust instrument or known to the trustee. Once a land trust is established, the ability to trace property
transactions becomes limited as state law establishes the right of the trustee not to disclose the true owner
of the property or those with a beneficial interest. The "land trust" has no special distinction in the Internal
Revenue Code and would be a simple, complex, or grantor trust depending on the terms of the trust
instrument. Filing requirements would depend on the type of trust.

Delaware Business Trust or Alaska Business Trust A trust established to hold and invest assets with
greater flexibility than allowed by most trusts. Permits limited liability, creditor protection, and valuation
discounts. These trusts are a creation of the Delaware and Alaska legislatures and have no impact on
taxation of trusts for federal purposes. These "business trusts" have no special distinction in the Internal
Revenue Code and would be a simple, complex, or grantor trust depending on the terms of trust
instrument. The regulations require that trusts operating a trade or business be treated as a corporation,
partnership, or sole proprietorship, if the grantor, beneficiary or fiduciary materially participates in the
operations or daily management of the business. Filing requirements would depend on this classification.
Unincorporated Business Organization (UBO) A term used by trust promoters to identify trusts they
sell and to disguise the fact that it is a trust. This term and the term "Massachusetts Business Trust" are
often used interchangeably. These are not terms used by the Internal Revenue Code.

7. Money Laundering

7.1 The term “money laundering” refers to the activities and financial transactions that are undertaken
specifically to hide the true source of the income. In most cases, the money involved is earned from an illegal
enterprise and the goal is to give that money the appearance of coming from a legitimate source.

7.2 Why is IRS Involved in Money Laundering Investigations? One look at the daily news is proof that
the crimes dealing with or motivated by money make up the majority of criminal activity in the nation. Tax
evasion, public corruption, health care fraud, money laundering and drug trafficking are all examples of the types
of crimes that revolve around money. In these cases, a financial investigation often becomes the key to a
conviction. For this reason, IRS is one of the key agencies involved in money laundering investigations.

7.3 Complex Crime Money laundering is a very complex crime involving intricate details, often involving
numerous financial transactions and financial outlets throughout the world. Criminal Investigation has the
financial investigators and expertise that is critical to “follow the money trail.”

7.4. Income Tax Laws Criminal investigation focuses on money laundering where the underlying conduct is a
violation of the income tax laws. According to the IRS, money laundering is the means by which criminals
evade paying taxes on illegal income by concealing the source and the amount of profit. Money laundering is in
effect tax evasion in progress.

7.5 Illegal Income When a criminal has a large amount of illegal income, they have to do something with it
in order to hide it from the IRS. They attempt to launder it to make it appear as if it was from a legitimate source,
allowing them to spend it or invest it in assets without having to worry about the IRS and tax consequences.

7.6 Send Dollars Abroad One of the ways to launder illegal proceeds is to move the money out of the
United States and then bring it back in a clean form, often disguised as loan proceeds. Another method is to
channel or co-mingle the money through various business activities to give the appearance that the money was
derived from a legal source. Money laundering creates an underground, untaxed economy that harms our
country’s overall economic strength. It is a global threat that erodes our financial systems.

How to Interpret Criminal Investigation Data


Since actions on a specific investigation may cross fiscal years, the data shown in cases initiated may not always
represent the same universe of cases shown in other actions within the same fiscal year.
FY 2005 FY 2004 FY 2003
Investigations Initiated 1639 1789 1590
Pros. Recommendations 1338 1515 1141
Indictments/Information 1147 1304 1041
Sentenced* 782 687 667
Incarceration Rate 88.4% 89.1% 89.2%
Average months to Serve 62 63 66
*Includes confinement to federal prison, halfway house, home detention or a combination thereof.

Bank Secrecy Act (BSA) Investigations FY 2005

Investigations Initiated 546


Prosecution Recommendations 379
Indictments/Information 359
Sentenced 310
Incarceration Rate* 83.2%
Average Months to Serve 42

Currency Reporting - Money Laundering

The Currency Transaction Report (CTR) came into existence with the passage of the Currency and Foreign Transactions Reporting
Act, better known as the Bank Secrecy Act (BSA), in 1970.

When the first version of the CTR was introduced the only way a suspicious transaction of less than $10,000 was reported to the
government was if a bank teller called an agent and provided the information. This was due, primarily, to the concern by financial
institutions about the Right to Financial Privacy. On October 26, 1986, with the passage of the Money Laundering Control Act, the
Right to Financial Privacy was no longer an issue. As part of the Act, Congress had stated that a financial institution could not be
held liable for releasing suspicious transaction information to law enforcement. As a result, the next version of the CTR had a
suspicious transaction check box at the top. This was in effect until April 1996 when the Suspicious Activity Report (SAR) was
introduced.

Currency reporting has changed since its introduction in 1970. There are now several different requirements for several different
types of financial institutions as well as non-financial institutions.

The various currency forms, their reporting requirements, and the number filed in calendar year 2004 are shown in this chart:
Report Requirements Filed in CY 2004
Currency Transaction Report Filed by financial institutions that engage in a currency transaction in 13,588,109
excess of $10,000
(CTR)
Currency Transaction Report Filed by a casino to report currency transactions in excess of 524,537
$10,000.
Casino (CTRC) (Includes both

Form 8362 & Form 8852)


Report of Foreign Bank and Financial Filed by individuals to report a financial interest in or signatory 217,699
Accounts (FBAR) authority over one or more accounts in foreign countries, if the
aggregate value of these accounts exceeds $10,000 at any time during
the calendar year.
IRS Form 8300, Report of Cash Filed by persons engaged in a trade or business who, in the course of 152,982
Payments Over $10,000 Received in a that trade or business, receives more than $10,000 in cash in one
Trade or Business transaction or two or more related transactions within a twelve month
period.
Suspicious Activity Report (SAR) Filed on transactions or attempted transactions involving at least 380,162
$5,000 that the financial institution knows, suspects, or has reason to
suspect the money was derived from illegal activities. Also filed when
transactions are part of a plan to violate federal laws and financial
reporting requirements (structuring)
Suspicious Activity Report Casino Filed on transactions or attempted transactions if it is conducted or 5,821
(SARC) attempted by, at, or through a casino, and involves or aggregates at
least $5,000 in funds or other assets, and the casino/card club knows,
suspects, or has reason to suspect that the transactions or pattern of
transactions involves funds derived from illegal activities. Also filed
when transactions are part of a plan to violate federal laws and
transaction reporting requirements (structuring).
Registration of Money Services Each Money Services Business (MSB), except one that is a money 12,411
Business (RMSB) services business solely because it serves as an agent of another
MSB, must register.
Suspicious Activity Report by Money Filed on transactions or attempted transactions if it is conducted or 304,242
Services Businesses attempted by, at, or through a MSB, involving or aggregating funds
or other assets of at least $2,000 in funds or other assets, and the
(MSB) (SARM) MSB knows, suspects, or has reason to suspect that the transactions
or pattern of transactions involves funds derived from illegal
activities. Also filed when transactions are part of a plan to violate
federal laws and transaction reporting requirements (structuring) or
when the transaction has no business or apparent lawful purpose and
the MSB know of no reasonable explanation for the transaction after
examining the available facts. When transactions are identified from a
review of records of money orders or travelers checks that have been
sold or processed, an issuer of money orders of traveler's checks
shall be required to report a transaction or a pattern of transactions
that involves or aggregates funds or other assets of at least $5000.
Suspicious Activity Report by the Filed on transactions, or attempted transactions, if it is conducted by, 5,656
Securities & Futures Industries at, or through a broker-dealer, it involves aggregates funds or other
assets of at least $5,000, and the broker-dealer knows, suspects, or
has reason to suspect that the transaction involves funds derived from
illegal activities or is intended or conducted in order to hide or
disguise funds or assets derived from illegal activity. Also filed when
transactions are designed, whether through structuring or other
means, to evade filing requirements. Also filed when transaction has
no business or apparent lawful purpose or is not the sort in which the
particular customer would normally be expected to engage, and the
broker-dealer knows of no reasonable explanation for the transaction
after examining the available facts. Also filed when the transaction
involves the use of the broker-dealer to facilitate criminal activity
Designation of Exempt Person Used by bank or other depository institution to designate an eligible 78,539
customer as an exempt person from currency transaction reporting
rules.

EXAMPLES

· Defendant Used Internet Auction Web Sites to Carry Out Scam On December 19, 2005, in Seattle,
WA, Evangelos Dimitrios Soukas was sentenced to 92 months in prison to be followed by three years
supervised release. Soukas was sentenced for submitting fraudulent claims to the IRS, identity fraud and
conspiracy to commit wire and mail fraud. According to court documents, Soukas admitted to using a
variety of schemes from 1999 to 2004, in his attempts to defraud his victims of more than $1.1 million
dollars. Soukas posted false and fraudulent advertisements for merchandise on various internet auction
web sites, knowing he did not have the merchandise and having no intention of delivering it. Soukas
advertised expensive electronic equipment such as laptop computers, camcorders and cell phones. But,
after purchasers mailed Soukas checks or paid into a Paypal account, they never received the
merchandise. Soukas also used at least 15 victims' names, Social Security Numbers and dates of birth to
open bank accounts, to apply for lines of credit and loans on the internet, and to purchase merchandise.
Using the false identities, Soukas also filed false income tax returns in his victims' names in an attempt to
obtain tax refunds to which he was not entitled.
· International Business Consultant Goes To Jail On December 16, 2005, in Oakland, CA, Yogesh
Gandhi was sentenced to serve two years in prison for structuring monetary transactions on four different
occasions between October 25, 2001 and February 20, 2002, totaling $156,000. In addition to jail time,
Gandhi was sentenced to three years supervised release and fined $4,000. Gandhi pleaded guilty to the
charges in June 2005 to the structuring to avoid having the financial institutions file Currency Transaction
Reports. He admitted that he had his nephews make certain cash deposits at several different Citibank
Federal Savings Bank branches throughout Contra Costa County to avoid suspicion.

8. Financial Crimes Enforcement Network

As reflected in its name, the Financial Crimes Enforcement Network (FinCEN) is a network, a means of bringing
people and information together to fight the complex problem of money laundering. Since its creation in 1990,
FinCEN has worked to maximize information sharing among law enforcement agencies and its other partners in
the regulatory and financial communities. Working together is critical in succeeding against today's criminals.
No organization, no agency, no financial institution can do it alone. Through cooperation and partnerships,
FinCEN's network approach encourages cost-effective and efficient measures to combat money laundering
domestically and internationally.

9. Patriot Act

USA PATRIOT Act Section 314(b) permits financial institutions, upon providing notice to the United States
Department of the Treasury, to share information with one another in order to identify and report to the federal
government activities that may involve money laundering or terrorist activity.

10. Employment Tax Evasion Schemes

Employment tax evasion schemes can take a variety of forms. Some of the more prevalent methods of evasion
include pyramiding, employee leasing, paying employees in cash, filing false payroll tax returns or failing to file
payroll tax returns.

Pyramiding "Pyramiding" of employment taxes is a fraudulent practice where a business withholds taxes
from its employees but intentionally fails to remit them to the IRS. Businesses involved in pyramiding
frequently file for bankruptcy to discharge the liabilities accrued and then start a new business under a
different name and begin a new scheme.

Employment Leasing Employee leasing is another legal business practice, which is sometimes subject to
abuse. Employee leasing is the practice of contracting with outside businesses to handle all administrative,
personnel, and payroll concerns for employees. In some instances, employee-leasing companies fail to pay
over to the IRS any portion of the collected employment taxes. These taxes are often spent by the owners
on business or personal expenses. Often the company dissolves, leaving millions in employment taxes
unpaid.

Paying Employees in Cash Paying employees in whole or partially in cash is a common method of
evading income and employment taxes resulting in lost tax revenue to the government and the loss or
reduction of future social security or Medicare benefits for the employee.

Filing False Payroll Tax Returns or Failing to File Payroll Tax Returns Preparing false payroll tax
returns understating the amount of wages on which taxes are owed, or failing to file employment tax
returns are methods commonly used to evade employment taxes.

Employment Tax Evasion

FY 2005 FY 2004 FY 2003


Investigations Initiated 108 113 104
Prosecution Recommendations 101 97 66
Indictments/Information 82 71 44
Sentenced 52 51 45
Incarceration Rate 90.4% 86.3% 75.6%
Avg. Months to Serve 30 18 20

11. Abusive Home-Based Business Tax Schemes

The IRS is providing information about abusive Home-Based Business schemes to help taxpayers avoid the
pitfalls of these schemes:

These schemes are abusive because they manipulate and misinterpret tax laws.

Don't be fooled by home-based business schemes that claim taxpayers can deduct most, or all, of their
personal expenses as business expenses.

Be wary of promoters who claim otherwise.

The IRS and other federal agencies are aggressively pursuing and successfully prosecuting promoters of
schemes and scams, including abusive home-based business schemes.
Participating in these schemes can result in repayment of taxes owed with interest and penalties, and
possibly imprisonment and fines.

Even innocent taxpayers involved in these schemes can face a staggering amount of back interest and
penalties.

Taxpayers involved in one of these schemes should correct any improper tax return filings.

Preparers face penalties and sanctions

12. Misuse of the Law

The IRS has uncovered a number of schemes that claim to allow deductions for personal living expenses.
Taxpayers should consider these points before investing in a possible abusive scheme:

Any investment scheme or promotion that claims to allow a federal income tax deduction for normal
personal expenses should be considered highly suspect.

A business must truly exist prior to claiming expenses.

In order to be deductible, the expenses must be ordinary and necessary expenses paid or incurred in
carrying on a trade or business.

Personal, family and living expenses are not deductible business expenses.

12.1 Pass-through Entity Forming an S corporation, partnership, or any other pass-through entity does not
cause personal, living and family expenses to become deductible; nor do incorporation, the existence of board
minutes, and partnership agreements authorizing personal, living or family expenses cause these expenses to
become deductible

12.2 Examples of misuse of the law:


· TRAVEL – Deducting travel, meals, and entertainment under the guise that everyone is a potential
client.

· AUTO – Excessive car and truck expenses when the asset has been used for both business and
personal use.

· PAYMENTS TO FAMILY MEMBERS – Deducting payments to family members for routine


household tasks that are not ordinary and necessary to the operation of the business, such as taking
out the trash, mowing the lawn, washing the car, answering the telephone, etc. Also payments to
family members that are excessive in relation to the services performed.

· BUSINESS USE OF HOME - Abusive promoters often advise taxpayers to deduct excessive costs
associated with the operation of the home. The promoters claim that the “exclusive use” restriction
can be avoided by placing business-related items in each room of the house. A deduction for the
business use of a home is limited to that area of the home that is used regularly and exclusively for
business purposes (Internal Revenue Code Section 280A). For example, merely placing a calendar or
file cabinet in a room does not satisfy the “regular and exclusive business use” requirement.

· EDUCATION EXPENSES - Some schemes advise taxpayers that they may claim up to $5,250 per
year in educational expenses for each family member. There are specific requirements that preclude
virtually all investors in this scheme from qualifying for this deduction (Internal Revenue Code
Section 127).

· MEDICAL REIMBURSEMENT PLANS - Abusive promoters assert that taxpayers can make their
family’s medical expenses 100 percent deductible merely by employing their family member(s). In
order for the medical expenses to be deductible under a self-insured medical reimbursement plan, a
bona fide employer-employee relationship must exist. In addition, the plan has to meet other
requirements (Treasury Regulation Section 1.105-11).

· RECORD KEEPING - Taxpayers in these schemes are advised to maintain detailed records of all
expenses incurred. The existence of such records does not negate the requirement that expenses be
“ordinary and necessary” in relation to a legitimate business activity. The expenses must also satisfy
any other deductibility requirements (Internal Revenue Code Section 274).
13. EP Abusive Tax Transactions

The IRS is engaged in extensive efforts to curb abusive tax shelter schemes and transactions. The Tax Exempt
and Governmental Entities Division of the IRS, including the office of Employee Plans, participates in this
IRS-wide effort by devoting substantial resources to the identification, analysis, and examination of abusive tax
shelter schemes and promotions.

14. Listed Transactions

The IRS periodically lists transactions which it believes to abusive. The promoter of such tax shelters is required
to maintain investor lists and is subject to promoter penalties. The taxpayer is required to fully disclose such
transactions on her tax return. You can find a listing of abusive transactions at:

http://www.irs.gov/businesses/corporations/article/0,,id=120633,00.html.

15. Slavery Reparation Scam

The Internal Revenue Service issued a nationwide warning for taxpayers not to be misled into filing slavery
reparation claims. There is no provision in the tax law that allows African-Americans to get tax credits or
refunds related to slavery reparations.

16. Arguments Related to the Internal Revenue Code

These false arguments claim that:

There is no Internal Revenue Code that imposes taxes;

Only "individuals" are required to pay taxes;

Code Section 861 limits taxable income to certain sources which do not apply to most U.S. citizens; or

The government can assess taxes only against people who file returns.
The tax law is found in Title 26 of the United States Code.

Section 6012 of the Code makes clear that only people whose income falls below a certain minimum level
do not have to file returns.

Sections 861 through 865 determine whether income is from a U.S. or foreign source - they do not in any
way exclude income from taxation for a U.S. citizen or resident.

Section 6201 of the Code states that the Secretary of the Treasury is required to make assessments "of all
taxes imposed by this title".

17. Constitution-Related Arguments

17.1 First Amendment These arguments focus on using the Freedom of Religion clause of the First
Amendment to reduce income tax liability. A common scheme calls for individual taxpayers to obtain minister's
credentials and a church or religious order charter by mail for a fee. The individuals set up a new organization
that purports to be a church, religious order, or other religious organization. They then take a "vow of poverty"
and assign their assets and income to the new organization. However, filtering money through a purported
church to fraudulently claim charitable contribution deductions is illegal. The tax law affords benefits to
churches and other religious organizations and to those who make gifts or contributions to these organizations.
The law requires, however, that such organizations actually be operated for religious purposes and not for the
private benefit of individuals.

17.2 Fourth and Fifth Amendments These arguments claim that filing an income tax return violates the
Fourth Amendment right to privacy or the Fifth Amendment right against self-incrimination. However, the courts
have consistently held that disclosure of routine financial information required on a tax return does not
incriminate an individual or violate the right to privacy.

17.3 Sixteenth Amendment These arguments claim that the constitutional amendment establishing the basis
for income tax was never properly ratified. However, the courts have held that none of the points presented
undermine the fact that the Sixteenth Amendment was indeed ratified in 1913.

18. The Voluntary Nature of the Federal Income Tax System

Contention: The filing of a tax return is voluntary Some assert that they are not required to file federal tax
returns because the filing of a tax return is voluntary. Proponents point to the fact that the IRS itself tells
taxpayers in the Form 1040 instruction book that the tax system is voluntary. Additionally, the Supreme Court's
opinion in Flora v. United States, 362 U.S. 145, 176 (1960), is often quoted for the proposition that "our system
of taxation is based upon voluntary assessment and payment, not upon distraint."

The Law: The word "voluntary," as used in Flora and in IRS publications, refers to our system of
allowing taxpayers to determine the correct amount of tax and complete the appropriate returns,
rather than have the government determine tax for them. The requirement to file an income tax
return is not voluntary and is clearly set forth in Internal Revenue Code §§ 6011(a) , 6012(a) , et
seq., and 6072(a). See also Treas. Reg. § 1.6011-1(a).

Any taxpayer who has received more than a statutorily determined amount of gross income is
obligated to file a return. Failure to file a tax return could subject the noncomplying individual to
criminal penalties, including fines and imprisonment, as well as civil penalties. In United States v.
Tedder, 787 F.2d 540, 542 (10 th Cir. 1986), the court clearly states, "although Treasury
regulations establish voluntary compliance as the general method of income tax collection,
Congress gave the Secretary of the Treasury the power to enforce the income tax laws through
involuntary collection . . . . The IRS' efforts to obtain compliance with the tax laws are entirely
proper."

19. The Meaning of Income: Taxable Income and Gross Income

19.1 Contention: Wages, tips, and other compensation received for personal services are not income
This argument asserts that wages, tips, and other compensation received for personal services are not income,
because there is allegedly no taxable gain when a person "exchanges" labor for money. Under this theory, wages
are not taxable income because people have basis in their labor equal to the fair market value of the wages they
receive; thus, there is no gain to be taxed. Some take a different approach and argue that the Sixteenth
Amendment to the United States Constitution did not authorize a tax on wages and salaries, but only on gain or
profit.

The Law: For federal income tax purposes, "gross income" means all income from whatever
source derived and includes compensation for services. I.R.C. § 61. Any income, from whatever
source, is presumed to be income under section 61, unless the taxpayer can establish that it is
specifically exempted or excluded. In Reese v. United States, 24 F.3d 228, 231 (Fed. Cir. 1994),
the court stated, "an abiding principle of federal tax law is that, absent an enumerated exception,
gross income means all income from whatever source derived."

19.2 All compensation for personal services, no matter what the form of payment, must be included in gross
income. This includes salary or wages paid in cash, as well as the value of property and other economic benefits
received because of services performed, or to be performed in the future. Furthermore, criminal and civil
penalties have been imposed against individuals relying upon this frivolous argument.
19.3 Contention: Only foreign-source income is taxable Some maintain that there is no federal statute
imposing a tax on income derived from sources within the United States by citizens or residents of the United
States. They argue instead that federal income taxes are excise taxes imposed only on nonresident aliens and
foreign corporations for the privilege of receiving income from sources within the United States. The premise for
this argument is a misreading of sections 861, et seq., and 911, et seq., as well as the regulations under those
sections.

The Law: As stated above, for federal income tax purposes, "gross income" means all income
from whatever source derived and includes compensation for services. I.R.C. § 61. Further,
Treasury Regulation § 1.1-1(b) provides, "[i]n general, all citizens of the United States, wherever
resident, and all resident alien individuals are liable to the income taxes imposed by the Code
whether the income is received from sources within or without the United States." I.R.C. sections
861 and 911 define the sources of income (U.S. versus non-U.S. source income) for such
purposes as the prevention of double taxation of income that is subject to tax by more than one
country. These sections neither specify whether income is taxable, nor do they determine or
define gross income. Further, these frivolous assertions are clearly contrary to well-established
legal precedent. "Recently the IRS explained its position on the I.R.C. 861 argument in Rev. Rul.
2004-30 and on the I.R.C. 911 argument in Rev. Rul. 2004-28."

19.4 Contention: Federal Reserve Notes are not income Some assert that Federal Reserve Notes currently
used in the United States are not valid currency and cannot be taxed, because Federal Reserve Notes are not
gold or silver and may not be exchanged for gold or silver. This argument misinterprets Article I, Section 10 of
the United States Constitution.

The Law: Congress is empowered "[t]o coin Money, regulate the value thereof, and of foreign
coin, and fix the Standard of weights and measures." U.S. Const. Art. I, § 8, cl. 5. Article I,
Section 10 of the Constitution prohibits the states from declaring as legal tender anything other
than gold or silver, but does not limit Congress' power to declare the form of legal tender. See 31
U.S.C. § 5103; 12 U.S.C. § 411. In United States v. Rifen, 577 F.2d 1111 (8 th Cir. 1978), the
court affirmed a conviction for willfully failing to file a return, rejecting the argument that Federal
Reserve Notes are not subject to taxation. "Congress has declared Federal Reserve notes legal
tender . . . and federal reserve notes are taxable dollars." Id. at 1112. The courts have rejected this
argument on numerous occasions.

20. The Meaning of Certain Terms Used in the Internal Revenue Code

20.1 Contention: Taxpayer is not a "citizen" of the United States, thus not subject to the federal income
tax laws Some individuals argue that they have rejected citizenship in the United States in favor of state
citizenship; therefore, they are relieved of their federal income tax obligations. A variation of this argument is
that a person is a freeborn citizen of a particular state and thus was never a citizen of the United States. The
underlying theme of these arguments is the same: the person is not a United States citizen and is not subject to
federal tax laws because only United States citizens are subject to these laws.
The Law: The Fourteenth Amendment to the United States Constitution defines the basis for
United States citizenship, stating, "[a]ll persons born or naturalized in the United States, and
subject to the jurisdiction thereof, are citizens of the United States and of the State wherein they
reside." The Fourteenth Amendment therefore establishes simultaneous state and federal
citizenship. Claims that individuals are not citizens of the United States but are solely citizens of a
sovereign state and not subject to federal taxation have been uniformly rejected by the courts.

20.2 Contention: The "United States" consists only of the District of Columbia, federal territories, and
federal enclaves Some argue that the United States consists only of the District of Columbia, federal territories
(e.g., Puerto Rico, Guam, etc.), and federal enclaves (e.g., American Indian reservations, military bases, etc.)
and does not include the "sovereign" states. According to this argument, if a taxpayer does not live within the
"United States," as so defined, he is not subject to the federal tax laws.

The Law: The Internal Revenue Code imposes a federal income tax upon all United States
citizens and residents, not just those who reside in the District of Columbia, federal territories, and
federal enclaves. In United States v. Collins, 920 F.2d 619, 629 (10 th Cir. 1990), cert. denied,
500 U.S. 920 (1991), the court cited Brushaber v. Union Pac. R.R., 240 U.S. 1, 12-19 (1916), and
noted the United States Supreme Court has recognized that the "Sixteenth Amendment authorizes
a direct nonapportioned tax upon United States citizens throughout the nation, not just in federal
enclaves. " The courts have uniformly rejected this frivolous contention.

20.3 Contention: Taxpayer is not a "person" as defined by the Internal Revenue Code, and thus is not
subject to the federal income tax laws Some maintain that they are not a "person" as defined by the Internal
Revenue Code, and thus not subject to the federal income tax laws. This argument is based on a tortured
misreading of the Code.

The Law: The Internal Revenue Code clearly defines "person" and sets forth which persons are
subject to federal taxes. Section 7701(a)(14) defines "taxpayer" as any person subject to any
internal revenue tax and section 7701(a)(1) defines "person" to include an individual, trust, estate,
partnership, or corporation. Arguments that an individual is not a "person" within the meaning of
the Internal Revenue Code have been uniformly rejected. A similar argument with respect to the
term "individual" has also been rejected.

20.4 Contention: The only "employees" subject to federal income tax are employees of the federal
government Some argue that the federal government can tax only employees of the federal government;
therefore, employees in the private sector are immune from federal income tax liability. This argument is based
on an apparent misinterpretation of section 3401, which imposes responsibilities to withhold tax from "wages."
That section establishes the general rule that "wages" include all remuneration for services performed by an
employee for his employer. Section 3401(c) goes on to state that the term "employee" includes "an officer,
employee, or elected official of the United States, a State, or any political subdivision thereof".

The Law: Section 3401(c) defines "employee" and states that the term "includes an officer,
employee or elected official of the United States . ." This language does not address how other
employees' wages are subject to withholding or taxation. Section 7701(c) states that the use of
the word "includes" "shall not be deemed to exclude other things otherwise within the meaning of
the term defined." Thus, the word "includes" as used in the definition of "employee" is a term of
enlargement, not of limitation. It clearly makes federal employees and officials a part of the
definition of "employee", which generally includes private citizens.

21. Constitutional Amendment Claims

21.1 Contention: Federal income taxes constitute a "taking" of property without due process of law,
violating the Fifth Amendment. Some assert that the collection of federal income taxes constitutes a "taking"
of property without due process of law, in violation of the Fifth Amendment. Thus, any attempt by the Internal
Revenue Service to collect federal income taxes owed by a taxpayer is unconstitutional.

The Law: The Fifth Amendment to the United States Constitution provides that a person shall not
be "deprived of life, liberty, or property, without due process of law . . . ." The U.S. Supreme
Court stated in Brushaber v. Union Pacific R.R., 240 U.S. 1, 24 (1916), that "it is . . . well settled
that [the Fifth Amendment] is not a limitation upon the taxing power conferred upon Congress by
the Constitution; in other words, that the Constitution does not conflict with itself by conferring
upon the one hand a taxing power, and taking the same power away on the other by limitations of
the due process clause." Further, the Supreme Court has upheld the constitutionality of the
summary administrative procedures contained in the Internal Revenue Code against due process
challenges, on the basis that a post-collection remedy (e.g., a tax refund suit) exists and is
sufficient to satisfy the requirements of constitutional due process. Phillips v. Commissioner, 283
U.S. 589, 595-97 (1931).

21.2 The Internal Revenue Code provides methods to ensure due process to taxpayers:

The "refund method," set forth in section 7422(e) and 28 U.S.C. §§ 1341 and 1346(a), where a taxpayer
must pay the full amount of the tax and then sue in a federal district court or in the United States Court of
Federal Claims for a refund; and

The "deficiency method," set forth in section 6213(a), where a taxpayer may, without paying the
contested tax, petition the United States Tax Court to redetermine a tax deficiency asserted by the IRS.
Courts have found that both methods provide constitutional due process.

Generally, the IRS must provide taxpayers notice and an opportunity for an administrative appeals hearing upon
the filing of a notice of federal tax lien (section 6320) and prior to levy (section 6330).
Taxpayers also have the right to seek judicial review of the IRS's determination in these due process proceedings.
I.R.C. § 6330(d). These reviews can extend to the merits of the underlying tax liability, if the taxpayer has not
previously received the opportunity for review of the merits, e.g., did not receive a notice of deficiency. I.R.C. §
6330(c)(2)(B). However, the Tax Court has indicated that it will impose sanctions pursuant to section 6673
against taxpayers who seek judicial relief based upon frivolous or groundless positions.

21.3 Contention: Taxpayers do not have to file returns or provide financial information because of the
protection against self-incrimination found in the Fifth Amendment. Some argue that taxpayers may refuse
to file federal income tax returns, or may submit tax returns on which they refuse to provide any financial
information, because they believe that their Fifth Amendment privilege against self-incrimination will be
violated.

The Law: There is no constitutional right to refuse to file an income tax return on the ground that
it violates the Fifth Amendment privilege against self-incrimination. In United States v. Sullivan,
274 U.S. 259, 264 (1927), the U.S. Supreme Court stated that the taxpayer "could not draw a
conjurer's circle around the whole matter by his own declaration that to write any word upon the
government blank would bring him into danger of the law." The failure to comply with the filing
and reporting requirements of the federal tax laws will not be excused based upon blanket
assertions of the constitutional privilege against compelled self-incrimination under the Fifth
Amendment.

21.4 Contention: Compelled compliance with the federal income tax laws is a form of servitude in
violation of the Thirteenth Amendment. This argument asserts that the compelled compliance with federal tax
laws is a form of servitude in violation of the Thirteenth Amendment.

The Law: The Thirteenth Amendment to the United States Constitution prohibits slavery within
the United States, as well as the imposition of involuntary servitude, except as punishment for a
crime of which a person shall have been duly convicted. In Porth v. Brodrick, 214 F.2d 925, 926
(10 th Cir. 1954), the Court of Appeals stated that "if the requirements of the tax laws were to be
classed as servitude, they would not be the kind of involuntary servitude referred to in the
Thirteenth Amendment." Courts have consistently found arguments that taxation constitutes a
form of involuntary servitude to be frivolous.

21.5 Contention: The Sixteenth Amendment to the United States Constitution was not properly ratified,
thus the federal income tax laws are unconstitutional.

This argument is based on the premise that all federal income tax laws are unconstitutional because the Sixteenth
Amendment was not officially ratified, or because the State of Ohio was not properly a state at the time of
ratification. This argument has survived over time because proponents mistakenly believe that the courts have
refused to address this issue.
The Law: The Sixteenth Amendment provides that Congress shall have the power to lay and
collect taxes on income, from whatever source derived, without apportionment among the several
states, and without regard to any census or enumeration. U.S. Const. Amend. XVI. The Sixteenth
Amendment was ratified by forty states, including Ohio, and issued by proclamation in 1913.
Shortly thereafter, two other states also ratified the Amendment. Under Article V of the
Constitution, only three-fourths of the states are needed to ratify an Amendment. There were
enough states ratifying the Sixteenth Amendment even without Ohio to complete the number
needed for ratification. Furthermore, the U.S. Supreme Court upheld the constitutionality of the
income tax laws enacted subsequent to ratification of the Sixteenth Amendment in Brushaber v.
Union Pacific R.R., 240 U.S. 1 (1916). Since that time, the courts have consistently upheld the
constitutionality of the federal income tax.

21.6 Contention: The Sixteenth Amendment does not authorize a direct non-apportioned federal income
tax on United States citizens. Some assert that the Sixteenth Amendment does not authorize a direct
non-apportioned income tax and thus, U.S. citizens and residents are not subject to federal income tax laws.

The Law: The courts have both implicitly and explicitly recognized that the Sixteenth
Amendment authorizes a non-apportioned direct income tax on United States citizens and that the
federal tax laws as applied are valid. In United States v. Collins, 920 F.2d 619, 629 (10 th Cir.
1990), cert. denied, 500 U.S. 920 (1991), the court cited Brushaber v. Union Pac. R.R., 240 U.S.
1, 12-19 (1916), and noted that the U.S. Supreme Court has recognized that the "Sixteenth
Amendment authorizes a direct nonapportioned tax upon United States citizens throughout the
nation."

22. Fictional Legal Bases

22.1 Contention: The Internal Revenue Service is not an agency of the United States. Some argue that the
Internal Revenue Service is not an agency of the United States but rather a private corporation, because it was
not created by positive law (i.e., an act of Congress) and that, therefore, the IRS does not have the authority to
enforce the Internal Revenue Code.

The Law: There is a host of constitutional and statutory authority establishing that the Internal
Revenue Service is an agency of the United States. The U.S. Supreme Court stated in Donaldson
v. United States, 400 U.S. 517, 534 (1971), "[w]e bear in mind that the Internal Revenue Service
is organized to carry out the broad responsibilities of the Secretary of the Treasury under §
7801(a) of the 1954 Code for the administration and enforcement of the internal revenue laws."

Pursuant to section 7801, the Secretary of Treasury has full authority to administer and enforce
the internal revenue laws and has the power to create an agency to enforce such laws. Based
upon this, the Internal Revenue Service was created. Thus, the Internal Revenue Service is a body
established by "positive law" because it was created through a congressionally mandated power.
Moreover, section 7803(a) explicitly provides that there shall be a Commissioner of Internal
Revenue who shall administer and supervise the execution and application of the internal revenue
laws.

22.2 Contention: Taxpayers are not required to file a federal income tax return, because the instructions
and regulations associated with the Form 1040 do not display an OMB control number as required by the
Paperwork Reduction Act.

Some argue that taxpayers are not required to file tax returns because of the Paperwork Reduction Act of 1980,
44 U.S.C. § 3501, et seq. ("PRA"). The PRA was enacted to limit federal agencies' information requests that
burden the public. The "public protection" provision of the PRA provides that no person shall be subject to any
penalty for failing to maintain or provide information to any agency if the information collection request
involved does not display a current control number assigned by the Office of Management and Budget [OMB]
Director. 44 U.S.C. § 3512. Advocates of this contention claim that they cannot be penalized for failing to file
Form 1040, because the instructions and regulations associated with the Form 1040 do not display any OMB
control number.

The Law: The courts have uniformly rejected this argument on different grounds. Some courts
have simply noted that the PRA applies to the forms themselves, not to the instruction booklets,
and because the Form 1040 does have a control number, there is no PRA violation. Other courts
have held that Congress created the duty to file returns in section 6012(a) and "Congress did not
enact the PRA's public protection provision to allow OMB to abrogate any duty imposed by
Congress." United States v. Neff, 954 F.2d 698, 699 (11 th Cir. 1992).
23. Talking Points

23.1 All citizens must comply with the requirements of the tax law to file returns and pay taxes. Fortunately,
the vast majority of Americans recognizes their civic duty and voluntarily complies with their tax-filing
obligation. Taxpayers who fail to file income tax returns and pay taxes pose a serious threat to tax administration
and the American economy. Their actions undermine public confidence in the Service's ability to administer the
tax laws fairly and effectively.

23.2 Whether because of an inability to pay or severe procrastination, some citizens drop out of the tax system.
The IRS has made attempts to make it easier for persons to voluntarily comply with the tax laws and to bring
themselves current on any outstanding filings or tax due. Assistance is provided to those persons to resolve issues
that caused them to drop out of the tax system and bring them back into compliance.

23.3 When the Sixteenth Amendment to the Constitution was ratified (February 3, 1913) giving Congress the
power "to lay and collect taxes on incomes", citizens began arguing that it was not properly ratified and income
taxes are illegal. Unfortunately, some citizens continue to raise such arguments in spite of the fact that they have
no basis in law and the courts have repeatedly rejected their arguments as frivolous.

23.4 Unscrupulous promoters and their followers have long employed frivolous arguments concerning the
legality of the income tax as pretexts to enrich themselves or evade their taxes. Their motivation is usually
monetary, not some legitimate purpose or belief. Anti-taxation groups have been around for a long time. They
are small but vocal. Though the leadership of these movements used different arguments to gain followers, they
all share one thing in common; they received substantial sentences in a federal prison for their activities. Their
followers paid a steep price for following bad advice. Some were prosecuted, many more were involved in years
of litigation and ultimately had to pay all taxes owed along with penalties and interest.
10 Year Statistics

FY FY FY FY FY FY FY FY FY FY
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Investigations

Initiated
Tax Investigations 3278 3049 2461 1916 1785 1851 2466 2446 2163 2631
Other Financial Crimes 2056 2286 2194 2036 1587 1433 1440 1555 1754 1638
Total 5334 5335 4655 3952 3372 3284 3906 4001 3917 4269

Prosecution
Recommendations
Tax Investigations 1944 1813 1726 1358 1043 1002 1025 1353 1461 1454
Other Financial Crimes 1661 2004 1801 1762 1391 1333 1108 1188 1576 1405
Total 3605 3817 3527 3120 2434 2335 2133 2541 3037 2859

Indictments/

Information
Tax Investigations N/A 1673 1445 1260 1122 998 954 1036 1114 1195
Other Financial Crimes N/A 1858 1735 1692 1347 1294 970 1092 1375 1211
Total 3274 3531 3180 2952 2469 2292 1924 2128 2489 2406

Sentenced
Tax Investigations 1488 1484 1482 1167 1134 906 1023 835 855 1015
Other Financial Crimes 1289 1525 1492 1452 1341 1332 1178 933 922 1080
Total 2777 3009 2974 2619 2475 2238 2201 1768 1777 2095

Special Agents 3335 3158 3004 2850 2740 2800 2903 2805 2796 2843

Corporate Fraud

FY 2005 FY 2004
Investigations Initiated 102 107
Prosecution Recommendations 115 78
Indictments/Information 69 57
Sentenced 51 18
Incarceration Rate* 80.4% 61.1%
Average Months to Serve 23 34
"REPRESENTING THE AUDITED TAXPAYER BEFORE THE IRS"

AND

REPRESENTATION BEFORE THE COLLECTION DIVISION OF

THE IRS
07/16/2009