Another potential problem for the planner, an advisor said, are schemes that call for spending huge amounts on premium life insurance that can be deducted in lieu of large contributions made to qualified retirement plans.
"Someone might actually make this work, but I wouldn't take the risk," Ruhlin says. "I simply don't think you can write these things off." Advisors and clients are heading for problems whenever they try to hide or disguise income, she warns.
Take every deduction that you can, but you must have some reasonable basis, some precedent to cite, she adds. "Otherwise you're going to have the IRS cite you for fraud, and they will do that," Ruhlin says. She also says that she had heard "anecdotally" that the IRS is cracking down on tax shelter vehicles for the rich. She also said that these gimmicky tax shelters are often offered to individuals who have suddenly had a windfall.
"My clients, who have generally made their money over long periods, are not interested in these kinds of things," Ruhlin explained. Nevertheless, everyone who has large incomes would love to keep Uncle Whiskers from eating too much of their pie. So how can advisors help?
Stanasolovich says that his firm, in avoiding the controversial approaches, is trying instead to use maximum tax reduction strategies that have little potential for abuse. "We have a lot of business owners as clients. So we typically try to be a little more aggressive by setting up retirement plans for which you can get bigger deductions," according to Stanasolovich. He said many owners have simple plans. But he advises the client, whenever possible, to use profit-sharing plans in which the owner can sock away $40,000 a year. He adds that also fully funding IRAs is another effective, noncontroversial way to avoid the AMT.
Delgass says his clients are using derivatives strategies, which include the complex use of puts and collars. He sees them, at least for now, as a less controversial way to cut down on their tax bills. They work, in part, "because they are just not very well understood by the IRS and they're not crossing the line. There is no sale on many of these transactions because there still is investment risk." As long as the investor has some downside risk-even if it is hedged-the investor is protected, according to Delgass.
And then there are the garden-variety tax reduction approaches. Many of them still can work very effectively, Stanasolovich contends.
"These are areas in which we tend to be a bit aggressive. And we also encourage them [business owners] to look at all employee benefits that may benefit them and their employees at the same time," he says. Family tax strategies, such as the full funding of a child's education account, are also popular these days, according to Stanasolovich. These are reasonable ways to reduce taxation. But Stanasolovich says some tax reduction ideas advisors and their clients should never go near, such as buying large amounts of cash-value insurance in lieu of making normal retirement plan contributions.
"Some of these methods are legitimate. But the vast majority of these are not going to be accepted by the IRS," he says. They are as worrisome as the Son of the Boss scheme, he adds. While Delgass agrees this is bad, he says the use of foreign counter parties with IRAs is just as dangerous.
The scheme calls for the American party to shift the gains of an IRA to another person, "a tax indifferent party, that is living in another country and is not covered by American tax law," he explains. Even if that foreign country has a tax convention with the United States, it may not be complete.