INVESTING: Use tax laws to your advantage, but don’t go overboard

Taxes may be one of two guarantees in life. But that doesn’t mean we have no control over how much we pay. History shows we’ll go to great lengths to trim our tax bill.

Since the U.S. government enacted the income tax shortly before World War I, Americans have been changing their behavior to avoid paying taxes. In most cases, people act in ethical and legal ways because the government creates a tax incentive to do certain things.

IRA retirement accounts are a common example. Or a corporation might open a factory because a town will provide a huge tax break for doing so. The recent lowering of taxes investors pay on stock dividends has caused corporations to increase their dividend payout ratios and sparked increased investor interest in companies that pay higher dividends.

Through the years, wealthy people have hired attorneys to uncover legal ways to pay lower taxes. Various tax shelters were popular in the 1970s and early 1980s, when top marginal income tax rates were extremely high.

You may remember that oil-and-gas trusts and property-rental developments were the rage before President Reagan cut taxes and did away with the shelters. The American government has become efficient at eliminating all remaining shelters except one. I’ll talk about the last great shelter next week.

Some people engage in outright taxavoidance schemes. The American court system is replete with examples, and the stories are as colorful as the characters who dream them up.

I read about one case where the defendant argued the IRS didn’t adequately define income. Maybe not, but it adequately defined his jail time.

Another case involved setting up offshore banks to allow U.S. citizens to avoid paying income taxes. The originator of the scheme ended up serving two years in prison.

Through the use of insurance products, you can legally use offshore accounts to decrease estate taxes. But it is barely worth the effort after all the set-up costs are factored in.

Not to mention that IRS agents can hop on a plane as easily as you can. Only days after a hurricane hit the Cayman Islands in 2004, the IRS had several agents swarming through the records of the islands’ banks.

Perhaps the greatest schemes are perpetrated by the largest of operators. KPMG, the nation’s fourth-largest accounting firm, recently paid a $456 million fine after admitting to assisting clients set up structures to avoid taxes.

Court records allege KPMG helped create more than $1 billion in fraudulent tax losses for wealthy individuals, generating $125 million in fees for the firm. Here’s the most disturbing part: KPMG, one of the few firms that audits publicly traded companies, arranged the losses for company officers.

The upshot here is that investors need to be flexible enough to profit from changing tax laws, and intelligent enough to stay away from what seems like a silver bullet. Remember, there are two things you can be sure of in life. Might as well roll with it.