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Beware of syndicated conservation easement tax deductions and other red flags

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Professional skepticism is an attitude that includes a questioning mind and a critical assessment of the evidence. In exercising professional skepticism, one should not be satisfied with less than persuasive evidence because of a belief that the source is honest. In the world of accounting, this concept is a ubiquitous mindset among auditors verifying financial statements and sniffing out fraud. But what does a term normally reserved for auditing have to do with your company?

As a business owner, it is nearly impossible to be proficient in the everchanging nuances of tax law and regulatory compliance while also balancing the day-to-day operational demands of your organization. Rightfully so, you likely rely on the consultation of an expert in the tax industry to guide you through your business strategy. It is not uncommon for a tax professional to uncover or propose an opportunity for tax savings that you were previously unaware of; perhaps you should defer revenue, adjust your depreciation methods, or etc. However, like a salesman selling snake oils, sometimes an opportunity sounds too good to be true. This is where professional skepticism comes in.

To encourage the preservation of significant land and buildings for future generations, Congress allowed an income tax deduction for owners of these properties to wave certain rights of ownership. This deduction is otherwise known as a conservation easement. While this tax provision has resulted in successes of its intended goal, it also opened the door for fraud that compromises the intention of Congress. Enter, the syndicated conservation easement (SCE); an opportunity for a taxpayer to purchase a portion, or share, of conservation property and claim a deduction for an easement, thereby avoiding tax.

Unfortunately for those who have invested in these syndicated conservation easement tax shelters, this type of strategy is fraudulent, and the IRS has taken notice.

In situations where the IRS has investigated, they have determined that the exchange of funds for a share of these easements serves no business purpose but is solely intended to avoid taxes. The result has been substantial penalties for taxpayers, as well as indictments and criminal conspiracy charges for CPAs involved with these transactions. The IRS has been very successful in litigating SCE transactions, and while promoters have tried disputing their situations by claiming their transactions do not contain the same flaws as compared to previously decided cases, the IRS has many grounds for disallowing these deductions.

So, a tax professional is offering up an opportunity for substantial tax savings and it sounds too good to be true, what do you do next? Be skeptical.

Here are 6 red flags to look for in a fraudulent planning strategy:

1. A promoter is involved. Promoters frequently receive commissions, this may incentivize them to operate in their own interest, not yours.

2. A signed confidentiality agreement is required to learn about the strategy. Confidentiality agreements create an aura of exclusivity, but they may also be an attempt to prevent the IRS from getting wind of a potential strategy.

3. Professionals associated with the strategy are paid a higher-than-customary fee. While the professionals may have invested considerable time and resources in developing the tax planning strategy, fees should be like those for other strategies.

4. The strategy is overly complex. Is the “loophole” the strategy is trying to fit through so narrow that a complex structure must be created to meet the exception? If many attorneys, CPAs, and other advisers are involved, perhaps.

5. Contracts with the promoter attempt to limit damages. Beware of provisions purporting to limit recoverable damages if the transaction fails under scrutiny and have all such contracts reviewed by legal counsel prior to execution. Check for disciplinary actions or complaints against the promoter.

6. The strategy appears to run afoul of one or more judicial doctrines. Federal court decisions have established various judicial tax doctrines. If a transaction does not withstand scrutiny under one or more of these doctrines, it is less likely to be upheld upon examination.

    • The substance-over-form doctrine allows the IRS to ignore the legal form of a transaction and examine whether its substance results in improper tax avoidance.
    • The step-transaction doctrine treats a series of separate steps as a single transaction to determine the underlying intent.
    • The business-purpose doctrine invalidates a transaction if it appears that it has no substantial business purpose other than to obtain tax benefits.
    • The sham-transaction doctrine identifies transactions where the economic activities purported to give rise to the tax benefits do not occur.
    • The economic substance doctrine invalidates a transaction if the transaction lacks economic substance independent of the tax considerations.

In short, go with your gut. If something seems too good to be true, it probably is. Especially in the realm of tax deductions. Aggressive tax strategies such as the SCE are under intense scrutiny from the IRS, and that does not appear to be diminishing any time soon. The Office of Fraud Enforcement was recently established and is working with the National Fraud Counsel, examining agents, and Chief Counsel attorneys to canvas cases for additional fraud considerations. If approached with a lucrative tax opportunity, use professional skepticism, ask questions, and get a second opinion. Our tax professionals at Wegner CPAs are here to help you.

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