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Beware: Too-good-to-be-true tax avoidance plans often are

There is tax evasion and then there is tax avoidance. The former isn’t something anyone with experience in tax law would recommend. The latter is legal, but the caveat is that there are limits to what is possible.

The IRS has its own notions about what those limits are. And those with experience in tax law know that following strategies that breach those limits often leave Minnesota and Wisconsin residents facing tax disputes. The audits and possible litigation that follow can wind up costing them more in taxes than what they sought to avoid.

Tax collectors are particularly attuned to one possible tax avoidance method — “captive” insurance companies. The way they work is this. Say a business has a unique risk issue for which regular insurance is hard to obtain. It may be able to set up its own insurance business to cover that risk. Premiums paid to the captive company can generate a tax deduction.

However, the IRS says the model is sometimes abused, leading the agency to include it on the list of tax scams to avoid again this year. It’s the third year running that sketchy “micro-captive” insurance practices have made the list.

What makes for an abusive structure? Officials say what catches their eyes are things like:

  • If the insurance is for a far-fetched risk and leads to extremely high premiums
  • If the designated captive company is insuring against a risk that is already covered by a policy from another insurer
  • If the captive elects to limit tax collections to only taxable investment income

Those are just a few of the flags the IRS looks for as part of its collection efforts. Knowing about such things can help prevent tax disputes from happening. When disputes do surface, you will want to get things resolved as quickly as possible, and that it is something to do with the help of a skilled attorney.

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