The Senate Finance Committee is expected to continue to push for a crackdown on abusive tax shelters. It issued a set of legislative proposals in the last Congress that called for tough new fines on these schemes and a hefty increase in penalties on shelter promoters. If the legislation passes, tax strategies for business owners may well be affected.
The committee's plan is a direct response to a Treasury Department request for Congress to take legislative steps to rein in abusive shelters. The Treasury claims these shelters are the most serious tax enforcement problem now facing the government, at costs of tens of billons of dollars in lost revenue over the past 10 years.
The proposals target shelters that help generate a loss for companies or individual taxpayers in a tax year that otherwise would have produced a taxable gain, says Mark Luscombe, principal federal tax analyst with CCH Inc., a Riverwoods, Illinois-based provider of tax and business law information. "This is accomplished by using a combination of fairly complicated transactions and borrowings," he says.
One shelter that the courts considered abusive involves a strategy in which a company purchases life insurance on its employees, then borrows money against the insurance. As a result,it realizes more in tax savings than the cost of the insurance. Other examples involve participating in foreign entities that are taxed differently from U.S. entities and using not-for-profit entities that are tax exempt to shelter income, says Luscombe.
Needless to say, some accountants and businesses argue legislation is not needed and may damage legitimate business dealings if enacted. In addition, they contend the Treasury isn't doing all it can to enforce the laws currently on the books.
The Pain is In the Detail
Under the Senate Finance Committee proposal, a new class of tax shelter known as "abusive tax shelter devices" would be created. If the IRS determines a shelter is abusive, the proposal calls for a strict penalty of 40 percent of the tax understatement. The committee defines "abusive tax shelter devices" as devices that lack economic substance or material business purpose other than to avoid paying taxes.
The proposal also calls for fines of 10 percent if a taxpayer has a transaction with significant business purpose and fails to disclose that information to the IRS. "This proposal is broad enough to mean the establishment of a deferred compensation scheme or qualified pension plan," explains Clint Stretch, director of tax policy in the Washington, DC, office of accounting firm Deloitte & Touche. "Anything you do in the business world is going to have a significant tax element to it."
Because it's so broad and far-reaching, the committee's proposal is far from a sure thing. But Stretch predicts there will be some compromise between Washington and the private sector on the plan because the political sentiment seems to be moving in that direction. "Members of Congress are sensitive to the real needs here," says Stretch. "They believe taxpayers ought not to be asked to pay more than their fair share, and they ought to be allowed to rely on the tax code where it legitimately gives them a benefit."
Joan Szabo is a writer in Great Falls, Virginia, who has reported on tax issues for more than 14 years.