Dodge the Loopholes but Lower Your Tax

The week after Tax Filing Day is frequently a time when taxpayers are inspired to "do something" about the amount of tax they have to pay.

This is a good thing when it leads to better planning, better understanding of the tax laws and ways to get a better return from the dollars extracted from us by local, state and federal governments.

It's not such a good thing when it makes us susceptible to the blandishments of promoters of tax shelters that don't work. And despite the efforts of the Internal Revenue Service and the adverse publicity showered on these promoters -- who in recent years have included accounting firms, lawyers and investment banks that one might have thought of as reputable -- they are still out there.

Indeed, IRS Commissioner Mark W. Everson recently expressed concern that while it appears that the big, well-known firms that got exposed by the Senate permanent subcommittee on investigations a couple of years ago have pulled back, smaller players marketing to less-sophisticated taxpayers are still in the business.

Small businesses and sole proprietors seem especially vulnerable to these marketers. Typically, these taxpayers work hard and many, frankly, resent the taxes they pay. They also hear a lot about "loopholes for the rich" -- a term often thrown about loosely in the media -- so when they get a pitch that throws around terms such as "charitable trust" and "managing director" and "international business company," plus a lot of legal-sounding mumbo-jumbo, they can persuade themselves that there really is a way to exempt themselves from the tax laws.

But buying into these schemes often means buying into trouble.

This month, the U.S. Tax Court whacked two insurance agents, one in California, the other in Ohio, who had tried setting up trusts and doing business through them. One argued that while his income might be taxable to somebody -- perhaps the trust -- it wasn't to him. The other set up a series of trusts, which the court concluded were designed to hide income, and indeed marketed the setup to others.

Both ended up liable for thousands of dollars in back taxes, penalties and interest.

So what can an ordinary taxpayer do that's both legal and helpful?

The first step is to understand the law, or at least its broad outlines.

Today, certain kinds of income -- capital gains and many corporate dividends -- are taxed at lower rates than wages, interest and other "ordinary income." At the same time, the Alternative Minimum tax (AMT), which is hitting more and more individuals and families, means that many of the old rules of thumb don't work as well as they used to.

So here are three steps to take to ease your pain next April 15: