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Ask questions first, and claim tax breaks later

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What should you do if you’re unsure about the potential tax ramifications of some financial move? The answer seems obvious, but many taxpayers still need a nudge.

Strategy: Obtain advice from a reputable pro. It’s not a cure-all if things turn sour, but it can help you avoid unnecessary tax penalties. On the other hand, you probably won’t be granted much leniency if you plow ahead on your own. And, if you do the bare minimum of due diligence—for instance, just a quick phone call to a single source—the results may be just as harsh.

New case: An investor participated in a promoted tax-shelter venture to offset dividend income from a family-owned corporation. He sought advice from his long-time accountant, who told him the tax shelter deal was aggressive. But the investor did not consult with any other professionals.

When the investor agreed to the deal, the venture required him to affirm that he had sufficient financial knowledge about the investment and was fully capable of evaluating its risks and merits. Yet he had no prior experience in the field (nor did he meet the suitability requirements for such an investment). The investor relied completely on the information in the offering memorandum and made no attempt to verify its validity.

Accordingly, the Tax Court determined that the investor’s failure to obtain tax advice was negligent. It added thousands of dollars in negligence penalties to the amount owed from the disallowance of losses and credits. (Greer, TC Memo 2007-119)

Tip: The negligence penalty generally equals 20% of the portion of the underpayment attributable to the negligence.

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