While business owners may be encouraged by two recent court decisions that overturned Washington's drive to crack down on abusive tax shelters, experts say they shouldn't be too encouraged. That's because these defeats may prompt Congress to take legislative steps against shelters, says Thomas P. Ochsenschlager of accounting firm Grant Thornton LLP.
In one case, a federal appeals court rejected the U.S. Tax Court's opinion that UPS used a sham insurance policy to avoid paying millions of dollars in corporate income taxes. (Transactions whose only purpose is to avoid the payment of taxes are considered "shams.") In the other case, a court of appeals overturned a federal district court ruling that IES Industries Inc. took part in sham stock trading to keep from paying nearly $100 million in taxes.
Until these decisions, the IRS was winning major legal victories limiting the use of tax shelters. But that trend may be reversing. "These cases indicate the courts might be relaxing their view of what is economic substance and business purpose," says Mark Luscombe, principal federal tax analyst with CCH Inc., a provider of tax and business law information. In the IES case, says Luscombe, the appeals court found "that some risk of loss, even if it is a small risk, might be enough to support the economic substance of a transaction."
Despite these decisions, however, the pendulum has not swung entirely back in the direction of companies. As Congress searches for revenue to pay for tax relief for businesses, lawmakers may turn their attention to abusive tax shelters. Says Ochsenschlager: "Politically speaking, [tax shelters] are one of the easiest sources of revenue now."