American College of Physicians: Internal Medicine — Doctors for Adults ®

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Physicians beware: Tax scammers are now targeting you

Typical come-ons include offshore trusts and transactions, dubious charities and suspect insurance schemes

From the May ACP Observer, copyright 2005 by the American College of Physicians.

By William Bunch

For more than 30 years, physicians and dentists nationwide had become not only familiar with but comfortable seeing the name of Xelan, a financial services group that offered physician-specialized products. In fact, it had become almost impossible to attend a major medical convention or trade show in recent years without seeing a booth or listing sponsored by the San Diego-based outfit, touting its investment and asset protection services.

The last thing any of the company's 4,000 physician and dentist clients expected was that the company was behind an alleged massive tax fraud and unlawful tax-shelter scheme involving millions of dollars of physicians' assets.

Yet last fall, the U.S. Department of Justice accused Xelan of exactly that. Federal agents raided Xelan's main offices as part of an ongoing criminal probe. That same month, a federal judge moved to freeze assets—worth more than $500 million—that doctors had invested in Xelan tax shelters.

According to a Nov. 4 U.S. Department of Justice press release, the Internal Revenue Service (IRS) estimates that physicians affected by Xelan's alleged actions could owe up to $420 million in taxes, plus interest and penalties.

No indictments have been handed down, and officials of Xelan have denied any wrongdoing. However, four of Xelan's business units have filed for bankruptcy protection.

The Xelan case might turn out to be just the latest twist in an old story: Fast-talking financial "experts" preying on physicians by offering tax schemes that sound too good to be true—and are.

The headlines are just the latest indication of a trend the IRS wants to draw more attention to: scammers increasingly targeting busy medical professionals. At the same time, law enforcement officials are focusing on those services (and their physician "investors") in a widening crackdown on tax-evasion schemes.

MDs, not CPAs

According to IRS officials, the number of schemers promoting tax scams to physicians is on the rise. At the same time, said Scott Schmidt, director of the abusive transactions, small business self-employed division of the IRS, "we probably have four times as many civil investigations going on of physicians who use abusive promotions than we did a year and a half ago."

According to an IRS fact sheet on "Taxes and the Medical Profession" updated last December, the federal government over the last four fiscal years initiated more than 260 criminal investigations of physicians or dentists. Moreover, some 27 medical professionals were convicted on tax-related charges in fiscal 2004, with 84% of those incarcerated for an average of 44 months.

Why do physicians make good targets? First, there's the obvious fact that doctors weren't schooled in the intricacies of tax law when they were at medical school. Then there's the reality that many physicians—like other small-business owners—"have a great amount of control over the assets and expenditures of the business," said Dwight Sparlin, the IRS' director of operations, policy and support for criminal investigations. "They have the ability to control discretionary incomes, which they wouldn't have in a bigger, more centralized company."

And experts say it's actually easier now for scammers to find physicians than it was in the 1980s, when some doctors fell for exotic tax shelters like partnerships in jojoba bean research. The difference? The Internet.

In the past, said Robert L. Sommers, JD, a San Francisco-based tax attorney and columnist who runs the advice Web site called The Tax Prophet, tax scammers operated "out of a basement, but now all they have to do is put together a slick Web presentation." Largely because of the growing number of tax-scam promoters, the IRS has stepped up its efforts to warn taxpayers.

In February, the IRS updated its list of the so-called "Dirty Dozen" scams and prominently noted several that are pitched mainly to wealthy professionals like physicians. The following are schemes that experts say physicians in particular need to know about—and avoid:

  • Pure trusts. This may be the simplest tax scam around, which could explain why it is also the most common. Called by numerous names including "constitutional trust" or even "patriot trust," these schemes—which are often Internet-accessible-tell would-be victims about special "trust funds" that can shield the investor from not only unwanted creditors but from all federal personal and estate tax obligations. Simply put, there's no such thing.

    "We call these things 'con-trusts' for short, because that's just what they are: a pure con for the misguided and the nave," tax expert Jay Adkisson, JD, wrote on his popular fraud-busting Web site. "No legitimate U.S. or state court will recognize them." According to Mr. Adkisson, the IRS has never lost a single court case it's brought against one of these trusts.

    Yet, the pure trusts persist. In 2004, according to an announcement by federal prosecutors, a number of physicians were among the 650 taxpayers—most of them self-employed and earning high incomes—who tried unsuccessfully to hide millions of dollars through one pure trust scheme.

    The federal indictment said the principals in that case used seminars to attract wealthy clients, and then set up "domestic trusts" aimed at shielding income from U.S. taxes.

    According to the indictment, the trusts' federal tax returns included allegedly false deductions for the cost of college tuition for clients' children, under the guise that those children would become trust directors in the future. Other false deductions from "domestic trusts" included the costs of vacations taken by clients, with the claim that, during those vacations, clients were looking for legitimate charities to which they could make donations.

  • Offshore trusts and transactions. Some physicians and other professionals have been convinced that transferring assets to trust funds in foreign countries or Caribbean islands will somehow protect them from having to pay taxes in the United States.

    Again, tax experts say that's simply not the case. A number of doctors—often with the help of financial planners or tax attorneys—have set up special accounts called offshore asset protection trusts. However, there is still considerable controversy within the financial and legal communities over how well these trusts can protect assets from malpractice suits or other court actions. And experts say that money diverted to an offshore trust is still subject to American taxes.

    Experts also note that some doctors are told they can place income in a tax-protected offshore trust and then use an overseas-issued debit card to make routine purchases in the United States.

    But both the IRS and the Justice Department have been able to subpoena the records of those debit-card transactions, bolstering their case that income stored in offshore trusts is taxable here. The IRS' Mr. Schmidt put it simply: "You should be very skeptical of any transaction of this type that purports to take your money offshore."

  • Insurance plans. Many physicians, especially those who manage a small office, have been sold either life insurance plans or employee benefit plans that were billed as offering federal tax advantages. However, the IRS recently has clamped down on such policies.

    Roccy DeFrancesco of the New Buffalo, Michigan-based Triarc Advisors, is author of "The Doctor's Wealth Preservation Guide." He recently wrote an article in Financial Planning magazine warning about a tax shelter known as a 412(i) defined benefit plan, which is often referred to as a "sponge" policy that allows a client to buy life insurance after five years at a huge discount. Unfortunately, he noted, the IRS ruled in February 2004 that many of these practices abuse the tax code.

    Another pitfall-laden scheme is the so-called 419 welfare benefit plan, also named for a federal tax code section. It aims to provide small-business employers with a tax-free way to provide themselves and their employees with life insurance—but the government has recently been stricter with its interpretations of the code.

    Mr. Sommers said that one problem with some doctor-designed tax-shelter type insurance programs is that when tax regulators review some of these investments, they find that they don't offer insurance at all. "They have a lot of provisions at the front end that make it look for real, but it's not really insurance," he said.

    Indeed, one aspect of the Xelan case that drew prosecutors' attention was its 419 insurance plan, which in its heyday in 2001 had 773 participants. Xelan allegedly told clients it was terminating the trust because IRS regulations had changed. The IRS, meanwhile, insists it had been issuing warnings to Xelan about the plan since 1995.

  • Donor-advised charities. A major issue in the Xelan case involved physicians who made charitable deductions through the Xelan Foundation. Xelan allegedly told physicians that their tax-deductible contributions to the foundation's "donor advised" funds—in which the donor, or a committee appointed by the donor, could recommend eligible charitable recipients for grants—could be used to compensate them for "teaching, research and other pro bono work" at their usual rate. Doctors were also purportedly told that funds could be used as loans for their children's education and might even be forgiven if the children did volunteer work.

    According to the Sept. 20, 2004, issue of Forbes, the IRS denied the more than $260,000 in charitable deductions made through the Xelan Foundation in 1998 that a South Florida neonatologist claimed against his income. The physician, who got hit with a 20% penalty, is fighting the bill in U.S. Tax Court.

So what does work for physicians? David K. Sebastian, a certified financial planner with the Physicians Wealth Management Group in Parsippany, N.J., said there's one key maxim to remember: "There's no free lunch." He also pointed out that if someone is peddling a one-size-fits-all, magic bullet solution to tax issues, it almost certainly doesn't work.

"The thing you should be most afraid of is somebody who's trying to sell you one solution," Mr. Sebastian said. Instead, the best strategy is to build a long-term relationship with a financial planner who can evaluate your needs, which will change due to factors such as age or the size or type of your medical practice. According to Mr. Sebastian, for instance, there are times when a 412 (i) insurance plan has advantages for a practice that has a handful of employees—but it depends on the circumstances.

According to the IRS' Mr. Sparlin, financial advice—just like medical advice—should often be subject to a second opinion. "People who have been in business the longest are generally a safe bet, but even that is no guarantee," he said. "Just make sure that anyone you're dealing with has a history of being reputable and that the tax advice they're offering can pass the sniff test."

With the number of tax-scam promoters and investigations on the rise, government officials have another piece of advice: Caveat emptor.

William Bunch is a freelance writer based in Philadelphia.

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