Dangers of boat buying

[BandB]

There are many variations on this. Builders who go out of business. Brokers who don't pay builders. Dealers who never pay for the boat on their lot, having it on consignment and selling to you.

So, the case in the headlines now.

Buyers order new boats through Dealer. Many were already on order as spec boats. Buyer trades in boat as well. Dealer sends some money along the way to builder but not the full price of the boat. Builder won't turn boat over to buyer because they're still owed money even though buyer paid full amount with trade. Dealer claims builder owes them money for warranty claims and he's offsetting. Builder decides to sell boats to others since dealer is unwilling to finish paying. Oh, and dealer quickly closes and forms a new corporation and opens under that name. So buyer is out of their money and has no boat, not their old one or next one. Dealer and Builder both claim they're owed, builder owed $15 million on six boats. Dealer has no intention of paying and builder has none of releasing boats unpaid. Now, builder had terminated dealership months ago and tried to audit records per the agreement but dealer refused to allow. Meanwhile all parties suing each other. And, as if that isn't enough, the dealer placed liens on 30 more boats that they claim they are owed on the warranty service they performed.

What does the consumer do to protect themselves? On a used boat you make deposits only through Title companies who handle escrow and you always get a title search before releasing any funds.

On a new build, first you don't remit money to a dealer or broker. They have generally few assets to protect you and you have no way of being sure they're forwarding the funds. If you have a trade, do a buy and sell. Submit only to the builder and not their US affiliate either, to the ones with assets.

I suggest a Commercial Letter of Credit with a well written contract and releases only as they present evidence to the bank that they've met the milestones.

Otherwise, just a lot of due diligence and care. Perhaps performance insurance.

Today, there are persons who have paid $4-6 million and have no boat and no real hope of when it will all be resolved. It's been in court for months already and still just fights over procedure. There are 30 others now with liens on their boats.

 

[BruceK]

Buyers order new boats through Dealer. Many were already on order as spec boats. Buyer trades in boat as well. Dealer sends some money along the way to builder but not the full price of the boat. Builder won't turn boat over to buyer because they're still owed money even though buyer paid full amount with trade. Dealer claims builder owes them money for warranty claims and he's offsetting. Builder decides to sell boats to others since dealer is unwilling to finish paying. Oh, and dealer quickly closes and forms a new corporation and opens under that name. So buyer is out of their money and has no boat, not their old one or next one. Dealer and Builder both claim they're owed, builder owed $15 million on six boats. Dealer has no intention of paying and builder has none of releasing boats unpaid. Now, builder had terminated dealership months ago and tried to audit records per the agreement but dealer refused to allow. Meanwhile all parties suing each other. And, as if that isn't enough, the dealer placed liens on 30 more boats that they claim they are owed on the warranty service they performed.

The old "liquidate company 1 create company 2 with similar name", is called "phoenixing" here. Not a good sign. More so if it becomes a habit.
Major issue here is "co-mingling" of moneys. If the customer`s money was kept separate, perhaps in escrow, it would be way simpler, here money paid has found its way into the mire of claim and counterclaim between dealer and builder.
What a mess. Poor unfortunate customer.

 

[Boat]

People are amazing. This stuff happens constantly in all walks of life. It's no wonder the murder rate is so high. Hit men are much cheaper than lawyers.

 

[FF]

"It's been in court for months already and still just fights over procedure."


Probably still arguing over the shape of the table?

 

[BandB]

"It's been in court for months already and still just fights over procedure."


Probably still arguing over the shape of the table?

Even more elementary than that. Some of the arguments so far:

-Over whether Sunseeker International is even a party since they have no US presence and did no business with the buyer.

-Over the service of the summons and failure to properly serve.

-Over whether Obey can sue in court due to the arbitration requirement in the agreement.

-Then the typical delays as parties claim to need more time to respond or to gather information.

 

[MYTraveler]

I suggest a Commercial Letter of Credit with a well written contract and releases only as they present evidence to the bank that they've met the milestones.
.

I don't see how that is different than wiring money as you go. Either way, the builder has your money. The letter of credit does give the builder the assurance that the buyer can pay but that doesn't really help the buyer. Further, the issuing bank will not allow draw terms that require it to make a factual determination beyond paying upon receipt of instruction to do so. Someone must make the determination that the payment milestone has been met. Unless the buyer owns the boat and has protected against lien claims, the buyer is at risk to losing the boat to the builder's other creditors, with only the right to pursue a breach of contract claim. And taking title to the boat while it is under construction presents its own set of liability and risk concerns.
A letter of credit (or other security enhancement) in favor of the buyer, with the right to draw to satisfy any judgment that the buyer might recover against the builder is, I believe, the safest way to go. And if the builder is creditworthy, that LC shouldn't cost more than 50 bps/year.

 

[boathealer]

Slightly off-topic, but relevant


Even Super Rich Rethink Yacht Buying Amid Economic Uncertainty

 

[BandB]

I don't see how that is different than wiring money as you go. Either way, the builder has your money. The letter of credit does give the builder the assurance that the buyer can pay but that doesn't really help the buyer. Further, the issuing bank will not allow draw terms that require it to make a factual determination beyond paying upon receipt of instruction to do so. Someone must make the determination that the payment milestone has been met. Unless the buyer owns the boat and has protected against lien claims, the buyer is at risk to losing the boat to the builder's other creditors, with only the right to pursue a breach of contract claim. And taking title to the boat while it is under construction presents its own set of liability and risk concerns.
A letter of credit (or other security enhancement) in favor of the buyer, with the right to draw to satisfy any judgment that the buyer might recover against the builder is, I believe, the safest way to go. And if the builder is creditworthy, that LC shouldn't cost more than 50 bps/year.

The bank doesn't make the factual determination. They pay upon receipt of signed and approved documents, either approved by buyer or by third party such as an engineer or surveyor.

Buyer's risk is reduced by a lien against the boat from the start of the build, a construction lien. Buyer doesn't actually take title.

Then there is the possibility of insurance, a performance bond. It's a surety that you describe in your last paragraph.

It all goes back to getting quality legal advice and review of all documents and arrangements. It also goes to knowing who you're dealing with but that knowledge is often beyond what is available to an average buyer.

Someone mentioned to that draws should not be so aggressive that the builder is paid substantially more in progress payments than completed work. It's one thing to fund your build, but builders often have you funding a previous buyer's build.

One additional comment is legal entities. They're very important. You think you're buying from Dreamboats, an Italian builder, but your contract is with Dreamboats USA. They have no assets. And this issue has existed even in the same country. A previous US yacht builder had all sales being made by a related sales company. Your contract wasn't with the builder. In the case that made me post this thread, the contract wasn't with the builder at all but with the dealer. Between the dealer and the builder you had a US Distributor too. You think this is a big builder, financially strong, but that's not even relevant when that's not who your contract is with.

One builder previously the subject of a lawsuit in Florida had seven legal entities with nearly identical names. Here you have Dreamboat China, Dreamboat Factory China, Dreamboat USA, Dreamboat Florida, Dreamboat Sales, Dreamboat United, Dreamboat Midwest. Buyer sued all simply knowing that they'd try to dodge responsibility. Might not still have worked except builder claimed contract was with Dreamboat Sales and contract read Dreamboat LLC which was a non-existent entity.

Understand that the contracts and the builder's way or, in the case of used, broker's way of doing business are all designed by their lawyers to protect them and not for your benefit. You must be skeptical or take a skeptical approach even if you trust them completely. They may sell the business tomorrow. I know of those who placed orders a couple of years ago from (names changed to protect the guilty) Hill's Marine which was then bought prior to delivery by Super Marine which then refused to honor many aspects of the agreements.

I dealt with these issues while in business, making huge deposits on equipment being purchased. However, typically they went into Escrow plus the equipment manufacturers were far more substantial than most boat builders. A $20 million purchase sounds enormous but not when it's from a company with revenues of $20 billion and annual profits of $700 million. Unlike buying a 120' yacht for $10 million from a company whose revenues are $60 million and profits are $1 million. Far unlike making a deposit to a broker who is near bankruptcy.

 

[BandB]

As disclosure, I'm posting more as a matter of general concern and precaution but the answers are not easy. In fact, we purchased a boat from the builder that's a subject of this matter less than 4 years ago. We did refuse to go through the broker. We did buy direct from the foreign builder. I did know and understand the parent company of the builder and the fact they were financially strong so did not have a problem making progress payments directly to the builder. Probably unwise. The builder itself isn't financially strong and the parent company was until the Chinese government forbid China owned banks from making loans to private companies and suddenly they were short billions.

So far no defaults, but I can picture the parent company walking away from the builder at any time and the finances of the builder are extremely disappointing for one of the largest builders in the world.

So, perhaps we did 2/3 of it right but not necessarily the other 1/3.

 

[Dawdler]

Great advice. Thanks B&B

 

[BandB]

Slightly off-topic, but relevant


Even Super Rich Rethink Yacht Buying Amid Economic Uncertainty

Very relevant. 2006 all was considered safe. 2007-8 the industry collapsed. You have so much economic uncertainty combined with tariff wars and other political issues impacting boat builders. Ferretti and Sunseeker are two of the top five builders in the world and owned by Chinese companies. Very strong Chinese companies who had financing pulled on order of the Chinese government deciding they didn't want to loan money for investments in other countries.

One of the leading topics at FLIBS was all those building in China extremely panicked over the tariff situation. It's no coincidence that Nordhavn has their new model being built in Turkey, just not sure that's any safer. Nordhavn, Marlow, and Hampton were just three discussing tariffs as if they're hit by a 25% tariff, then no shipments to the US. On the other hand, they also have contingencies for shipping elsewhere and flagging offshore. There has been little reason to flag elsewhere, little reason to receive and commission elsewhere, but this would definitely give good reason.

While the article is about super rich, the issues and potential problems are all the way down to every boat buyer.

 

[BandB]

Great advice. Thanks B&B

Thanks but I'm far less sure of the advice than simply highlighting the risks. Over and over throughout the country (and world I'm sure) we've had cases of brokers absconding with funds and of builders not delivering.

 

[MYTraveler]

In my business life, my goal is to reduce and shift risk, so I find this fascinating. Please don't be offended by my persistence.

The bank doesn't make the factual determination. They pay upon receipt of signed and approved documents, either approved by buyer or by third party such as an engineer or surveyor.

Actually, that is a factual determination, and a thorny one at that. Someone must make that determination, but the bank, in my experience, will only look at documents that purport to be in a specified form. By hypothesis, we can't trust the builder, so I still fail to see any advantage (especially to the buyer) of an LC. The buyer would be better off wiring the money when the condition, whatever it may be has been satisfied. The builder, of course, would prefer that the buy not have any discretion at all, and an LC serves the builder's purpose in that respect very well.

Buyer's risk is reduced by a lien against the boat from the start of the build, a construction lien. Buyer doesn't actually take title.

The problem with a lien is that it requires foreclosure and if there is any factual dispute, it will take years to resolve. And during that time, the boat will deteriorate. Moreover, who wants to foreclose on a partially completed boat.

Then there is the possibility of insurance, a performance bond. It's a surety that you describe in your last paragraph.

I am utterly unfamiliar with any insurance against a business dispute, though I did recently purchase my first policy insuring against an adverse IRS determination.

Gotta go, but to be continued (maybe). Hopefully, somewhere below you explain the advantage to the buyer of giving the seller a letter of credit. I may learn something valuable!

 

[BandB]

In my business life, my goal is to reduce and shift risk, so I find this fascinating. Please don't be offended by my persistence.


Actually, that is a factual determination, and a thorny one at that. Someone must make that determination, but the bank, in my experience, will only look at documents that purport to be in a specified form. By hypothesis, we can't trust the builder, so I still fail to see any advantage (especially to the buyer) of an LC. The buyer would be better off wiring the money when the condition, whatever it may be has been satisfied. The builder, of course, would prefer that the buy not have any discretion at all, and an LC serves the builder's purpose in that respect very well.




The problem with a lien is that it requires foreclosure and if there is any factual dispute, it will take years to resolve. And during that time, the boat will deteriorate. Moreover, who wants to foreclose on a partially completed boat.


I am utterly unfamiliar with any insurance against a business dispute, though I did recently purchase my first policy insuring against an adverse IRS determination.

Gotta go, but to be continued (maybe). Hopefully, somewhere below you explain the advantage to the buyer of giving the seller a letter of credit. I may learn something valuable!

Commercial letter of credit requires signoff for releases. Not just the seller present the documents, but that either the buyer or a third party sign off that they are satisfied they meet the requirements. It is typically an engineer or other professional mutually agree to. The factual determination the bank must make is only that the documents are presented and properly signed. They do not have to determine any fact of work or performance, just documents. The benefit for the seller is advance knowledge that the funds are available.

Now we actually built a boat using the same principles as a commercial letter of credit but just handling release of funds ourselves. However, we did have a surveyor who the builder agreed to who signed off on each stage of completion. So documents and invoice created, given to surveyor, surveyor signs off, sent to us and we pay, same as a bank would on a commercial letter of credit.

The insurance I refer to is a Performance Bond. A performance bond will protect against possible losses in a case a contractor fails to perform or is unable to deliver the project as per established and the contract provisions. Now that doesn't mean it's simple to collect it either. It's fairly easy in the event the contractor, in this case the builder, goes out of business or declares bankruptcy. However, failure to complete by a pre-determined deadline can also merit payment, you don't have to wait forever. Now, performance bonds are only going to be available for relatively stable contractors. They are used regularly in construction projects. They typical cost of a performance bond is about 1% but can be as high as 2%. The terms of the bond are very critical and if not carefully stated can lead to extreme difficulty in collecting.

While I've used these over the years in business, I'm not nearly as expert as the combination of our Director of Risk Management and our Attorneys combined.

And I'm unfamiliar with policies on adverse IRS rulings, even though I'm familiar with the theory that ultimately anything can be insured for a price.

The liens I've seen exercised during the builds of boats accomplished only one thing. During a bankruptcy of the builder, they shielded the boat from being included as an asset of the builder, but made it a secure asset going to the lienholder. Now it still can become a court battle if the builder claims the asset is worth more than the buyer has paid to this point.

It's a shame one needs to ever use any of these tools, but it's also ashamed when you see a battle like the one today where the broker/dealer and the builder are not the ones hurt, but the boat buyers are caught in the middle of a huge mess. One that I'd never heard of happening is liens put on boats that previously had warranty service done on them. That's outrageous. I can't imagine those liens are valid but it will take courts to rule they aren't. The dealer is using mechanic's liens for non payment.

 

[BruceK]

You can insure here for the expense associated with an ATO Audit (Aust Tax Office= IRS).
I cannot imagine you can insure for the tax and associated penalties raised from an adverse audit result.If you could, you could make the most outrageous income reducing assertions to the Tax Office and when it said NO!, claim the "lost" amounts you were not entitled to, from the insurer.
The Audit process can be expensive, in terms of Accountancy and Legal advice, representation, etc.
Australia has a "self assessment" tax return regime, they accept what you say,(except if patent rubbish or they have a current blitz on something). But every now and then, someone gets audited.......

 

[BandB]

You can insure here for the expense associated with an ATO Audit (Aust Tax Office= IRS).
I cannot imagine you can insure for the tax and associated penalties raised from an adverse audit result.If you could, you could make the most outrageous income reducing assertions to the Tax Office and when it said NO!, claim the "lost" amounts you were not entitled to, from the insurer.
The Audit process can be expensive, in terms of Accountancy and Legal advice, representation, etc.
Australia has a "self assessment" tax return regime, they accept what you say,(except if patent rubbish or they have a current blitz on something). But every now and then, someone gets audited.......

US has a variety of methods. They have some totally random audits, often used to train new agents. They then also have audit precipitated by computer programs sending the return for review. Then the reviewer decides an audit is in line. Audits are down a bit since the current administration reduced funding for the IRS. Then there are businesses over a certain size that have perpetual audits. At one time 96% of Corporate Giants were audited every year. Now that's only around 50%, due to an increase in giants and a reduction in agents. Seems like a rather foolish decrease when they recovered $10.4 billion on the 331 giants they audited last year. Then there is the "Wealth Squad", officially the Global High Wealth Industry Group. Scary but they make a lot of sense as the wealthy tend to have a lot of complex financial, business and investment arrangements with complicated legal structures and tax issues. Every major accounting firm is constantly suggesting strategies as they would politely call them while others of us might call them shelters or loopholes. The IRS has to work hard to keep up with them all. Now, rest assured once they find one client of a huge accounting firm using one of the schemes, they then look for every client of that firm using it. There's an important reason the IRS requires preparer identification. Helps to chase down these strategies while at the lower income level helps to identify fraudulent tax preparers.

Some interesting data. The IRS audits about 1 million returns a year which is about 1/2 % of those filed. Of those, 75% are audited by correspondence and only 25% are field audits. 30,000 of those audits result in refunds or additional refunds to taxpayers totaling about $6 million a year. Many audits are just corrections. Recommended additional taxes are $26.5 million.

2.2% of those with income from $1 to $5 million are audited, 4.2% of those from $5 to $10 million, 6.7% of those with income over $10 million. Around 10% of businesses with assets between $50 million and $1 billion are audited, 12.6% between $1 billion and $5 billion, 26.2% between $5 billion and $20 billion, and 49.3% over $20 billion. 31% of estates over $10 million are also audited. Small Businesses have well under a 1% rate of audit.

By increasing the audits just of wealthy individuals and Giant Corporations we could easily generate an additional $10 billion a year in net revenue through the IRS.

When I first started my career the company I worked for was audited annually, just a continual audit. Now, largest adjustment ever made when I was involved was disallowing $2400 in travel expenses. That was the difference in the price of a single room and a room with two people when employees took their spouses with them on business trips. I would say auditing us every year, based on our record, made no sense. Neither my wife nor I have ever been audited by the IRS, but we were audited by NC the year we moved to FL on July 1. They didn't like that they couldn't tax the post July 1 income and required proof of the move. Part of that is many people who actually live in states like NY but have vacation homes in FL will change their residence to FL to avoid or reduce state taxes when they haven't really moved as their businesses and work life are still in NY and they still own their NY home.

 

[catalinajack]

BandB - your review of what IRS does is almost perfect. You sound as if you are, or were, an insider. I was. I will point out one inaccuracy. IRS does have a program of random audits (National Research Program) that is used to validate and update the computer program (DIF - Discriminant Function) it uses to select individual returns for examination. The NRP examinations are NEVER conducted by new agents for training. In fact, IRS endeavors to use only experienced agents because the results from those examinations will be used for many years until the next time the DIF program needs to be updated.

The actual calculation of the DIF score is closely guarded to prevent an incentive for impropriety. If a taxpayer’s DIF score indicates that there is a potential issue, the return is then reviewed by a revenue agent or tax compliance officer who then makes the decision on whether to refer the return to an audit office. Returns are then prioritized and assigned to auditors. Some returns may also be screened out at this point.

US has a variety of methods. They have some totally random audits, often used to train new agents. They then also have audit precipitated by computer programs sending the return for review. Then the reviewer decides an audit is in line. Audits are down a bit since the current administration reduced funding for the IRS. Then there are businesses over a certain size that have perpetual audits. At one time 96% of Corporate Giants were audited every year. Now that's only around 50%, due to an increase in giants and a reduction in agents. Seems like a rather foolish decrease when they recovered $10.4 billion on the 331 giants they audited last year. Then there is the "Wealth Squad", officially the Global High Wealth Industry Group. Scary but they make a lot of sense as the wealthy tend to have a lot of complex financial, business and investment arrangements with complicated legal structures and tax issues. Every major accounting firm is constantly suggesting strategies as they would politely call them while others of us might call them shelters or loopholes. The IRS has to work hard to keep up with them all. Now, rest assured once they find one client of a huge accounting firm using one of the schemes, they then look for every client of that firm using it. There's an important reason the IRS requires preparer identification. Helps to chase down these strategies while at the lower income level helps to identify fraudulent tax preparers.

Some interesting data. The IRS audits about 1 million returns a year which is about 1/2 % of those filed. Of those, 75% are audited by correspondence and only 25% are field audits. 30,000 of those audits result in refunds or additional refunds to taxpayers totaling about $6 million a year. Many audits are just corrections. Recommended additional taxes are $26.5 million.

2.2% of those with income from $1 to $5 million are audited, 4.2% of those from $5 to $10 million, 6.7% of those with income over $10 million. Around 10% of businesses with assets between $50 million and $1 billion are audited, 12.6% between $1 billion and $5 billion, 26.2% between $5 billion and $20 billion, and 49.3% over $20 billion. 31% of estates over $10 million are also audited. Small Businesses have well under a 1% rate of audit.

By increasing the audits just of wealthy individuals and Giant Corporations we could easily generate an additional $10 billion a year in net revenue through the IRS.

When I first started my career the company I worked for was audited annually, just a continual audit. Now, largest adjustment ever made when I was involved was disallowing $2400 in travel expenses. That was the difference in the price of a single room and a room with two people when employees took their spouses with them on business trips. I would say auditing us every year, based on our record, made no sense. Neither my wife nor I have ever been audited by the IRS, but we were audited by NC the year we moved to FL on July 1. They didn't like that they couldn't tax the post July 1 income and required proof of the move. Part of that is many people who actually live in states like NY but have vacation homes in FL will change their residence to FL to avoid or reduce state taxes when they haven't really moved as their businesses and work life are still in NY and they still own their NY home.

 

[Mako]

Audits are down a bit since the current administration reduced funding for the IRS.

Woohoo. Goooo TRUMP! Keep it going, baby!

 

[BandB]

BandB - your review of what IRS does is almost perfect. You sound as if you are, or were, an insider. I was. I will point out one inaccuracy. IRS does have a program of random audits (National Research Program) that is used to validate and update the computer program (DIF - Discriminant Function) it uses to select individual returns for examination. The NRP examinations are NEVER conducted by new agents for training. In fact, IRS endeavors to use only experienced agents because the results from those examinations will be used for many years until the next time the DIF program needs to be updated.

The actual calculation of the DIF score is closely guarded to prevent an incentive for impropriety. If a taxpayer’s DIF score indicates that there is a potential issue, the return is then reviewed by a revenue agent or tax compliance officer who then makes the decision on whether to refer the return to an audit office. Returns are then prioritized and assigned to auditors. Some returns may also be screened out at this point.

Thank you for the clarification. I'm sure the use of trainees has changed since my one encounter with one nearly 30 years ago.

One thing I found interesting from the data is how seldom S Corporations and Partnerships are audited as they are nontaxable returns, only 2/10 of 1%. I'm sure the theory is the personal return audit covers them. Of course I do suspect larger S Corporations run a higher risk than small ones. I know of S corporations with sales over $1 Billion and Assets that would put them in the 10% audit category if a C Corporation.

When I was in industry working for someone else, our corporate returns were audited at least 10-14 times between 1989 and 2012. My wife and I own S Corporations and their return has never been audited.

Interestingly in 2018, there were math errors found on 2.5 million 2017 returns and nearly .5 million 2016 returns. Surprised me with all the computerized filing.

For anyone interested, here is the link to the IRS data book.

https://www.irs.gov/statistics/soi-tax-stats-irs-data-book-index-of-tables

 

[catalinajack]

Woohoo? T,he little people like you and I are rarely audited anymore due to budget reductions. The dempgraphic now being neglected is the affluent. But, perhaps you are one of the "affluent". Here's a challenge. How many folks do you know have ever been audited? Pretty much, bejcause of budget cuts taxpayers can cheat almost at will. IRS is facing another $300 million cut in the next budget. This is not good for the honest folks like you and I.

Woohoo. Goooo TRUMP! Keep it going, baby!

 

[catalinajack]

Audits of S Corps and especially pertnerships with many partners are very resource intensive.

Thank you for the clarification. I'm sure the use of trainees has changed since my one encounter with one nearly 30 years ago.

One thing I found interesting from the data is how seldom S Corporations and Partnerships are audited as they are nontaxable returns, only 2/10 of 1%. I'm sure the theory is the personal return audit covers them. Of course I do suspect larger S Corporations run a higher risk than small ones. I know of S corporations with sales over $1 Billion and Assets that would put them in the 10% audit category if a C Corporation.

When I was in industry working for someone else, our corporate returns were audited at least 10-14 times between 1989 and 2012. My wife and I own S Corporations and their return has never been audited.

Interestingly in 2018, there were math errors found on 2.5 million 2017 returns and nearly .5 million 2016 returns. Surprised me with all the computerized filing.

For anyone interested, here is the link to the IRS data book.

https://www.irs.gov/statistics/soi-tax-stats-irs-data-book-index-of-tables

 

[MYTraveler]

Audits of S Corps and especially pertnerships with many partners are very resource intensive.

Under the new rules the number of partners becomes irrelevant.

 

[BandB]

Under the new rules the number of partners becomes irrelevant.

I think there are a number of reasons for minimal audits of S Corps and Partnerships. Primary is that they are pass through entities, so ultimately examined at the taxpayer level. I would argue though that philosophy misses a lot on complex entities.

Another thing is that you have two basic groups of pass through entities. The first is the large number that are little more than proprietorship's, just different legal structures. Simple. The other group is that of many levels and numbers of pass through entities. I know of one S Corp that the consolidated return reflects well over 100 entities.

Then it seems individual audit frequency is based on income while business audits are based on assets. Most S Corps and Partnerships have relatively small amounts of assets so even if they were C Corporations their likelihood of audit would be slim. I would say S Corps with over $250 million of assets would be far more likely to be audited.

 

[catalinajack]

Under the new rules the number of partners becomes irrelevant.

Hardly irrelevant. A change to the taxable distribution of a partnership with 250 partners requires a change to the returns of 250 other entities. That means legal notices to 250 entities and, at the very least, 250 proposals of additional tax or adjustments to the taxable distribution of wait, another partnetship. And, those 250 entities, well, IRS may see something on the return of one or more of those entities that sparks a full audit rather than just effecting the pass-through adjustments. So, not irrelevant.

 

[BandB]

Hardly irrelevant. A change to the taxable distribution of a partnership with 250 partners requires a change to the returns of 250 other entities. That means legal notices to 250 entities and, at the very least, 250 proposals of additional tax or adjustments to the taxable distribution of wait, another partnetship. And, those 250 entities, well, IRS may see something on the return of one or more of those entities that sparks a full audit rather than just effecting the pass-through adjustments. So, not irrelevant.

Very similar impact as cases where a specific shelter is used by a client of a large accounting firm. They know that if one client used this technique, then many more did so every client of that firm who did use it is now an audit candidate, at least partial for that one shelter.

Perhaps the most famous case was EY was promoting the use of four major tax shelters between 2000 and 2004. There were 4 major shelters that deferred, reduced or eliminated $2 billion in taxes for 200 EY clients. They were called COBRA, CDS, CDS Add-On, and PICO. EY agreed in 2013 finally to pay the IRS $123 million to avoid criminal prosecution although some of their partners were criminally prosecuted. Needless to EY's payout to the clients for penalties and interest incurred was huge.

These shelters were described as investment driven when, in fact, they served no purpose other than taxes. Any transaction that serves no purpose other than tax avoidance is by regulation ignored for tax purposes.

On a bit lower level there was a famous raffle by a very large Catholic Church. Tickets were $7 each. Raffle tickets are gambling, not donations. Once one purchaser was audited, it was easy to run a program for all persons with "donations" to the church divisible by 7.