Trying To Outfox Uncle Sam

Jamie and Christina Lancaster were perfectly happy with their accountant. Then the couple, both Virginia Beach real-estate agents, attended a seminar by Sanford Botkin, president of the Tax Reduction Institute. For seven hours Botkin, a former IRS attorney, paced the ballroom inside a Norfolk, Va., hotel, rattling off ways self-employed people can dramatically cut their tax bills. Botkin's techniques--totally legitimate, he insists--help people find new write-offs for cars, restaurant meals, haircuts and even vacations. The Lancasters loved what they heard. They're already planning to deduct up to $7,000 for their two Ford Expeditions, thanks to an arcane rule about depreciation schedules for extra-heavy vehicles. And they've rearranged a trip to London to make it tax-deductible. They also fired their accountant for failing to show them these loopholes. Says Jamie: "Now we're going to go to Disneyland and find a way to write that off, too."

In the 15 years since Congress eliminated many tax shelters, deducting your way to a lower tax bill has become an elusive pursuit, especially for rank-and-file employees. But tax gurus like Botkin are aggressively pushing new ways to help Americans reduce taxes: by embracing deductions created for small businesses. And as freelancing and moonlighting have gone mainstream, more people are in a position to utilize them. Last week the U.S. Senate held hearings on the proliferation of Internet sites promoting tax fraud, some of which advise setting up fake businesses to create deductions. Botkin's techniques, mostly aimed at real-estate agents, salespeople and other legitimate business owners, don't push the envelope that far. But in a world where audits are becoming a rarity and some 20 million people now work for themselves, some tax experts see a system that's ripe for exploitation. Says Donald Alexander, a former IRS commissioner: "These people... are a real problem for an ever-shrinking IRS." And Botkin couldn't be happier. "If everyone knew these rules, President Bush wouldn't need his tax cut," he says.

Those boasts are a cornerstone of the act--part accounting arcana, part schlocky standup--Botkin, 52, has been perfecting since he quit the IRS 17 years ago. Botkin's tax-cut strategy relies on three elements: an expansive definition of business expenses, relentless record-keeping and lax enforcement. Consider meals, entertainment and travel. Botkin insists that the slightest mention of work--"I'd love some referrals"--can turn a meal or a night at the theater with friends into a business expense. "Vacations are not deductible, but if you do a minimal amount of work and plan in advance, they are," Botkin says, describing ways to tuck some quick meetings into family vacations. During business trips, he says, haircuts and manicures are deductible. He also tells people how to boost automobile and home-office deductions and set up pension plans. To document all those expenses, he prescribes a regimen of meticulous note taking in the $95 "audit-proof" tax diary he sells. "It takes a minute a day to keep the IRS away," he says, claiming people who attend his $395 seminar average $18,500 in new deductions.

Botkin is one of the leaders of a cottage industry devoted to promoting tax loopholes. "There's almost nothing you spend money on, if you're self-employed and structure it appropriately, that I can't make legitimately deductible," says Jeff Schnepper, author of "How to Pay Zero Taxes." For instance, to clothe his children, Schnepper once bought sweatshirts printed with ASK MY DAD HOW TO PAY ZERO TAXES, and deducted them as advertising expenses. Botkin throws parties where he takes Polaroids of friends looking at his marketing materials, so he can deduct the food and drinks. Even well-known tax services teach some of these tricks, such as hiring spouses and children to reduce taxes and benefit costs. "We've been touting that one ourselves," says Maggie Doedtman, H&R Block's tax-training manager.

The new tax avoiders aren't shy about showing off the money they're saving. Dennis Ankeney, a Newport News insurance broker, has just begun deducting his $850 Virginia football tickets as "client entertainment." Kevin Miller, a Denver marketing consultant, says he now employs his daughter Nishann, 6, to answer phones and clean his home office. Shirley Parisi, a Williamsburg real-estate agent, is considering amending last year's return to write off a cruise she took to St. Croix. "I really did stop in at a real-estate company and get some brochures," she says.

Although the gurus insist their methods are airtight, other experts aren't so sure. The IRS declined to comment on Botkin's advice, so NEWSWEEK asked three former IRS commissioners to review parts of his workbook. They found nothing illegal, but stopped well short of endorsing his methods. Margaret Richardson, IRS commissioner under President Clinton, deemed the material "straightforward," much of it right out of IRS publications. The two others felt Botkin took liberties. Alexander, commissioner during the Nixon administration, saw "strong implications that you can get away with deducting a lot of personal expenses" by using dishonest justifications to call them business. Says Sheldon Cohen, IRS commissioner under Lyndon Johnson: "Many of the things he talks about are completely legitimate... but he's pointing out ways to fudge." Both men were concerned, for instance, about people who take lavish vacations to visit rental properties, and whether child employees really do any work. Despite footnotes citing case law, neither is certain all the deductions would hold up under heavy IRS scrutiny.

Botkin and his competition insist they're completely legit. Only deduct kids' pay if they actually work, Botkin says; only deduct trips if you really do some business. "Obviously there are people who take advantage of any system, but that's not what I encourage," he says. "There are enough legal ways to reduce your taxes, why do anything illegal?" But even if some people stretch the rules, they're likely to get away with it--a fact Botkin promotes in his seminars. "If you do get audited, it's going to be by a bozo who's not going to catch you," he yells at the crowd. "Don't be afraid--be as aggressive as physically possible!" As audit rates plummet--the average taxpayer now has a 1-in-500 risk of a face-to-face audit--tax evasion can become a rational economic decision. "Given the odds and given the penalties, tax evasion as a gamble looks very, very good," says University of Michigan tax expert Joel Slemrod, who doesn't recommend it, despite the odds.

Yet for every aggressive tax avoider, experts say there are many more self-employed folks whose timidity, ignorance or poor record keeping dooms them to miss more deductions than they take. Danae Powers, a Pennsylvania physician, admits she's neglected to write off legitimate business trips and office equipment because she didn't know the rules. For most entrepreneurs, "taxes are more of a nasty afterthought, a kind of omnipresent hassle rather than a way to get away with something," says Daniel Pink, author of "Free Agent Nation," a new book about rising self-employment. Says Sara Horowitz, who runs an advocacy group for solo workers: "Only a small percentage of people are either savvy enough or are getting accountants to figure this out." Until they do, Sandy Botkin stands ready to proselytize.