May 2000

Corporate Tax Shelters Continue to Draw Scrutiny

Congress, the Clinton administration, and the Internal Revenue Service continue to grapple with how to eliminate corporate tax shelters. Recent actions include Senate Finance Committee hearings held March 89 and new rules to curb corporate tax shelter practices proposed by the administration, which last year withdrew a proposed definition of tax shelter in the wake of public criticism.

In February, the IRS addressed corporate tax shelters through three "temporary and proposed" regulations, which means that they are immediately effective and that the IRS will gather public comment before publishing the final regulations. Treasury Regulations section 301.6111.2T requires tax shelter promoters to register certain transactions with the IRS: transactions structured for the significant purpose of tax evasion, transactions offered to corporations under conditions of confidentiality, and transactions for which promoters may receive fees greater than $100,000.

Treasury Regulations section 301.6112-1T requires promoters to keep investor lists and promotional materials available for inspection. This requirement applies to all transactions structured for the significant purpose of avoiding or evading tax.

Treasury Regulations section 301.6111-4T requires corporations to disclose "reportable transactions" in their tax returns. Generally, reportable transactions reduce income tax by $5 million in a single year or $10 million over several years and have tax shelter characteristics. The IRS reduced these threshold limitations for certain listed transactions outlined in its Notice 2000-15, including lease in/lease out (LILO) transactions and bond and option sales (BOSS) transactions.

Senate Finance Committee Chair William Roth Jr. noted at the onset of the March hearings on penalties and interest that he has worked diligently to shut down what he termed "abusive transactions."

"The reason why is simple," Roth said. "Corporations that abuse the laws to shelter their income from taxation place an unfair burden on the backs of individual taxpayers--our families and small businesses."

Similar to the administration, the Senate's efforts are likely to focus on increased disclosure requirements for promoters and taxpayers, methods to discourage shelter promoters, and additional limits on taxpayers' ability to rely on accounting or law firm opinion letters.

David A. Lifson, chair of the AICPA Tax Executive Committee, testified on March 9.

"We believe that the Treasury's proposed penalty structure is much too broad and will adversely affect too many innocent taxpayers," Lifson said.

He stated that the AICPA disagrees with the administration's efforts to codify the economic substance doctrine because the proposal could trap millions of innocent taxpayers.

Tax litigator Lawrence M. Hill, in his December 1999 column in the Journal of Tax Practice Management, argued that legislation to curb corporate tax shelters is not necessary because the IRS has been successfully litigating cases against corporate tax shelters using existing legislation.

"The economic substance doctrine has become a 'doomsday device' in the hands of the IRS," Hill wrote. "It has enabled the IRS to attack transactions in essentially a retroactive legislative manner when they otherwise arguably appear to satisfy the unambiguous statutory regime established by Congress. The Winn-Dixie decision is particularly illustrative of the IRS's use of the economic substance doctrine as a statutory trump card."

The Winn-Dixie case (113 TC __, No. 21, Dec. 53,589) involved the propriety of an interest deduction relating to loans on the cash value of life insurance contracts. The taxpayer had taken all the steps required to establish the deduction but the Tax Court ruled that the scheme lacked economic substance and business purpose, and in result the court considered the transaction a sham.

The corporate tax shelter phenomenon may have led to an increased rift between the accounting and law professions. Prominent New York tax lawyer Peter Faber, in testimony before the Finance Committee, stated that he believes accounting firms that promote corporate tax shelters to their audit clients create conflicts of interest and professionalism suffers in the process. Kenneth Kies, formerly chief of staff for the Joint Tax Committee and currently a co-managing partner of the Washington, D.C., office of PricewaterhouseCoopers, countered that the conflict of interest issue "has to be looked at, but rarely arises."

Lindy Paull, Kies's successor as Joint Tax Committee chief of staff, differed with her predecessor. Paull testified that penalty rules should be tightened and a new penalty at least as severe as the ones imposed on taxpayers should be imposed on tax practitioners who promote corporate shelters. *