From the October 2005 issue of Entrepreneur

Entrepreneurs should be wary of the new tax shelter- reporting requirements lurking in the American Jobs Creation Act of 2004. Proliferation of abusive shelters led Congress to strengthen the law by imposing stiff penalties for taxpayers who fail to follow the rules or who incorrectly report shelter activities.

Under the new rules, taxpayers must file an annual informational return (IRS Form 8886), which discloses each reportable transaction or tax shelter they are involved in. The form must be attached to your annual income tax return, and a copy must be filed with the Office of Tax Shelter Analysis in the first year you invest.

The IRS requires this information on several types of shelter transactions, including: confidential transactions, in which the creator of a tax strategy requires its client to keep the strategy secret; transactions involving a brief asset-holding period in which the taxpayer claims a tax credit over $250,000, and the asset generating the credit is held for 45 days or less; or listed transactions, which are those the IRS has already publicly identified as being abusive (for example, avoiding tax on S-corporation income by having almost all shares owned by a charity, while most of the corporation's economic value is held by individuals). Any federal tax avoidance using listed transactions is generally not allowed, according to the IRS.

Before the act, no penalties existed for taxpayers failing to report tax shelters. But now the IRS has information about investors who are putting money into these deals and the advisors who offer them, says tax attorney Jonathan B. Dubitzky with Sullivan & Worcester LLP in Boston.

The penalties for not complying with the new rules are stiff. The IRS imposes a $10,000 fine for each reportable transaction a taxpayer fails to disclose. The fine for failing to disclose a listed transaction can be as much as $100,000. Investors who understate taxes as a result of investing in a shelter can be hit with additional penalties. The penalties are effective for reportable transactions filed after October 22, 2004.

The reporting rules are so tough that many investors will probably avoid shelters in the future, says Dubitzky. But if you're still interested in tax-avoidance transactions, the IRS recommends you hire a qualified tax professional to direct you. This is one area where you don't want to go it alone.

Great Falls, Virginia, writer Joan Szabo has reported on tax issues for 18 years.