How To Avoid Yachting §183 Tax Fraud

How To Avoid A Yacht Charter Tax Fraud Conspiracy

Not to accuse anyone, but to warn everyone - Don't be a victim or a perpetrator

Might you be liable when improper yacht charter business deductions become tax fraud?

To quote criminal defense attorney Frank Stanley:

"However, some people misuse those deductions or maybe even outright lie in order to reduce tax liability. Intentionally manipulating the tax system through lies or misrepresentation to reduce what you should pay could constitute a crime. In those scenarios, the person who prepared the taxes or provided the information could wind up facing charges of tax fraud." (Emphasis Added)

It's just human nature, especially with lax oversight and the right incentives, that sometimes a lot of smart people can do a lot of not so smart things- at least for a while:

Yacht brokers recklessly providing inadequate, inaccurate, insufficient, and inappropriate information promoting yacht charter tax deductions as a scheme for yacht owners to defray the expense of yacht ownership and the luxury lifestyle so brokers can sell more yachts and get more yachts to manage,

CPAs that recommend yacht charter or file federal income taxes for yacht charter clients that do not regularly and consistently make a significant net after tax net profit,

Yacht owners - or someone thinking about buying a yacht- and using yacht charter "business deductions" to off set the purchase and operational costs.

Remember Son Of Boss. The largest criminal tax case was a fraudulent tax scheme marketed to thousands of sophisticated high net worth individuals by leading CPA and law firms that generated at least $11 billion of illegal tax losses. Many prominent tax professionals were indicted including KPMG's former deputy chairman, two former heads of KPMG's tax practice and a former tax partner in the New York office of a prominent national law firm.

Could you now be one of the many yacht owners, brokers, CPAs & other advisors that may be guilty of participating in a conspiracy to commit tax fraud by promoting & facilitating illegal business deductions- perhaps without even knowing it?

Why would an innocent person risk tax fraud when better tax deductions are available without the risk?

The Tax Code Is Clear

Contrary to the rampant half-truths, inaccurate and specious claims on line, about tax deductions for yacht owners, the tax code is unambiguous. Specifically IRC § 183 Activities Not Engaged In For Profit. Also known as the Hobby Loss Rules.

1) You can't take business deductions if you don't have a business.

2) Taking business deductions when there is no business is the very definition of tax fraud.

3) There is no business unless the primary purpose of the activity is earning a net after tax profit.

4) If the primary purpose of the activity is anything other than earning a net after tax profit, the activity is a hobby.

How many yacht owners buy a yacht with the primary purpose to earn a net after tax profit from charter?

The tax code classifies economic activities - such as yacht charter- as either a business or hobby. To be eligible to take business deductions- the primary motive must be a profit motive - not to defray costs or personal enjoyment.

If the economic activities in question have not made a significant net after tax profit 3 our of the last 5 years, or 5 out of 7 for horse breeding, then the presumption is that the activities constitute a hobby and not a business. Hobby expenses are not deductible as business expenses but have their own separate provisions.

How many yacht charter enterprises make a significant after tax profit 3 out of the last 5 years?

The IRS recognizes that some legitimate business enterprises might not make a profit 3 out of 5 years- especially during the start up phase. Thus to refute the presumption that the unprofitable activities are hobbies but are in fact a legitimate business enterprise with the primary purpose being a profit motive - the burden is on the tax payer & must prove it to the satisfaction of the IRS, a tax court and then a federal court.

These tend to be experienced professionals with highly developed Bulls*** detectors.

Being able to prove that the primary purpose of the unprofitable economic activities in question is to make a profit is determined by the specific facts and circumstance of each individual tax payer - each individual unique tax payers expertise and situation.

Obviously, the easiest - and quickest - way to avoid tax fraud is for the yacht charter to consistently earn a significant net after tax profit. That's a win - win for everyone, the yacht owner, the yacht sale and charter broker and the CPAs.

Alternatively, if the yacht charter is unprofitable, the yacht owner has the burden of proving that the primary purpose of buying and operating the yacht charter is to earn a net after tax profit- not just to mitigate the cost.

26 U.S. Code §183 And The Business Plan Scam

To say the least, it's widely acknowledged that yacht charter can be a challenging business.

It's also widely acknowledged that many if not most yacht owners don't really operate their yachts to earn a net profit. Most yacht owners only charter their yacht for the tax deductions and some income to help cover the costs of their luxury lifestyle.

In fact, a complete cottage industry has developed to game the tax code.

Specifically IRC § 183 Activities Not Engaged In For Profit. Also known as the Hobby Loss Rules reads in part:

(b) Relevant factors. In determining whether an activity is engaged in for profit, all facts and circumstances with respect to the activity are to be taken into account. No one factor is determinative in making this determination. In addition, it is not intended that only the factors described in this paragraph are to be taken into account in making the determination, or that a determination is to be made on the basis that the number of factors (whether or not listed in this paragraph) indicating a lack of profit objective exceeds the number of factors indicating a profit objective, or vice versa. Among the factors which should normally be taken into account are the following:

Manner in which the taxpayer carries on the activity.
The expertise of the taxpayer or his advisors.
The time and effort expended by the taxpayer in carrying on the activity.
Expectation that assets used in activity may appreciate in value.
The success of the taxpayer in carrying on other similar or dissimilar activities.
The taxpayer's history of income or losses with respect to the activity.
The amount of occasional profits, if any, which are earned.
The financial status of the taxpayer.
Elements of personal pleasure or recreation.

The basis of the tax scam seeks to exploit the factor of the manner in which the taxpayer carries on the activity.

It seems that for many, the magic words seem to be "create a business plan". Admittedly, the lack of a business plan may well suggest the lack of a profit motive, but having a business plan is just the bare minimum and can in fact- be the proof of a lack of a profit motive.

It's Not A One Size Fits All- The Business Plan Scam

At the minimum, not only should every charter business have a business plan but it's imperative that the owner must also execute the business plan. Having a business plan, but failing to follow and execute the business plan is not evidence of a profit motive, but proof of a lack of a profit motive.

Likewise, a legitimate business, that is not profitable, will amend its business plan. A business plan that does not change to increase profits - proves a lack of a profit motive.

But the real tell between a fraudulent business plan and a true plan is that the business plan must be appropriate for the yacht owner- reflecting his skill & how they do business.

Many of the yachting brokers and advisors offer business plan services which are of questionable value because one size - or one plan - does not fit - or is not appropriate for everyone.

There is clearly a wide range of entrepreneurial skills and objectives. An offering of a business in box or a business plan out of a box is certainly not operating a yacht charter business in businesslike manner.

What is usually lost on most of the fraudsters, is that what constitutes operating a charter activity in a businesslike manner is unique to each yacht owner / entrepreneur.

Ironically, the more successful and accomplished the yacht owner, the more difficult it will be to convince the IRS of a true profit motive when it's likely clear that he conducts his yachting activities differently from his other for profit endeavors.

It's really obvious if you think about it. The IRS measure to determine a true profit motive is the Manner in which the taxpayer carries on the activity.

The more sophisticated and successful the yacht owner, the higher the bar he will be to establish how "the taxpayer" conducts business.

Hanover v Commissioner

Anyone that is financially successful, that is or plans to be the owner of a yacht and or charter business, or anyone that plans to sell or manage a yacht to put in a yacht charter business, or anyone that does the taxes for such a person or activity should read Hanover v Commissioner- in its entirety.

The issues for decision were (1) whether Mr. Hanover's yacht activity was an activity not engaged in for profit pursuant to section 183, and (2) whether Mr. Hanover is liable for the accuracy-related penalty of section 6662(a).

Reading the findings of fact and opinion, is embarrassing for Hanover. It's clear why the Judge ruled against Hanover and in favor of the IRS.

The hurdles of trying to prove a profit motive are simply too much to overcome- especially for financially successful and sophisticated business professionals when it's evident that they do not operate their yacht charter activities in a similar manner to how they operate their other for profit endeavors.

It should also be just as clear to any CPA or yacht broker that is familiar with the yacht owner and how the charter activities are conducted.

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While That's No Defense- There Are A Few Immediate Solutions

When wrongdoers are caught, human nature seems to have some basic excuses:

"That's the way everyone does it."

"That's how the industry has done it for years."

"I didn't know. No one told me. I relied on the experts, and they didn't tell me."

Or some variations thereof. Regardless none of these is any legitimate defense.

Sometimes, if you rely on the advice of legal counsel, it can be a mitigating factor in some rare circumstances for criminal liability but not of tax penalties. But it is unlikely you will find a tax attorney or criminal attorney to advise you to take such improper deductions.

However, if you can find a tax attorney willing to issue you a favorable opinion specific to your facts and circumstances for your unprofitable yacht charter activities- be sure to have them issue a tax indemnification.

Otherwise there are a few things you should do immediately.

Amend Your Business Plan - Get Documents In Order

A good start would be to ask yourself these 20 questions.

Then prepare for an IRS document request.

Also, make sure there are no glaring tells and that all your documents are consistent like your insurance, loan documents and any other operational arrangements reflect that your primary purpose is to earn a net after tax profit - and not just to minimize your cost of operations.

Since most yacht charter owners are not really trying to earn a net profit but to cover operational expenses of their luxury lifestyle it's common to try to minimize expenses.

For example, getting a personal loan as opposed to a business loan or getting the cheapest insurance when it would not be appropriate for a business trying to earn a profit.

As the yacht insurance broker B&R Marine Insurance explains about the specific types of coverage:

Part Time Charter Coverage
This is a private pleasure yacht policy that has an endorsement to allow for a certain number of days of charter in a policy period. Depending on the company, the number of days allowed is between 10 and 20 days a year.

Not many business can earn a net profit operating less than 3 weeks per year. It's almost impossible for a yacht charter company to make a net after tax profit with only 10 -20 days of charter per year!

Supplement Your Advisory Team To Start Making A Profit

As good as your current team may be, one thing is irrefutable - they don't know how to make your yacht charter activities profitable. If they did, they would have already told you by now - wouldn't they?

YES, Yacht Charter Can Be Profitable.

Not only does adding new members to your advisory team make your yacht charter profitable - but it immediately acts as a form of IRS audit risk insurance.

A legitimate business with a profit motive keeps the same managers doing the same thing for years if they aren't profitable. By adding new advisors - especially if they are compensated by a percent of the net profits - is strong proof of a true profit motive - and acts to deter any additional IRS scrutiny.

Look For Other - Better Ways To Reduce Your Taxes

Better Tax Deductions

If tax breaks are important to a yacht owner, or are a key factor in the decision to buy a yacht, there are many other - much better ways to reduce taxes than trying to claim yacht charter deductions as a business when the yachting activities are clearly a hobby and not a business with a profit motive.

In fact, many other tax saving provisions are not as limited as charter deductions may be.

Business deductions for yacht charter must clear numerous hurdles to have much practical real value including but not limited to hobby loss rules, passive verses active, at risk limits, excess business loss rules, etc.

Conversely, without any of those possible limitations of yacht charter deductions, a yacht owner can reduce their total tax rate against their total Adjusted Gross Income (AGI) to less than 5%.

If your combined federal and state tax rate is less than 5%, do you really need any yacht charter deductions?

It really makes no logical sense. Attempting to claim any possible tax deductions from a yacht charter business or hobby is of little to no value- and certainly not worth the risk.