Tax Shelters: Will They Stand Up?

The IRS has taken a predatory stance against tax shelters. But several court decisions have altered the rules of the chase.

Andrew Osterland (andrewosterland@cfo.com) is a senior editor at CFO.

Taxpayers on the Warpath

Recent court victories by corporate taxpayers.

Company Tax shelter at issue Court forum
Compaq Computer ADR arbitrage 5th Circuit
IES (now Alliant Energy) ADR arbitrage 8th Circuit
United Parcel Service Offshore subsidiary creation 11th Circuit
American Home Products Corporate installment sale notes D.C. Circuit
Florida Power & Light Offshore limited partnerships U.S. Tax

In Their Humble Opinion

When tax practitioners pitch a potential tax-saving investment to CFOs, they often supply an “opinion” on whether the transaction would hold up to an IRS challenge. These opinions usually protect taxpayers from possible underpayment penalties.

Many of the opinions, however, amount to rubber stamps, say critics, and involve little due diligence on the part of tax practitioners. “We’re concerned about potentially abusive transactions that have proceeded based on inadequate tax opinions,” says Herb Beller, chair-elect of the American Bar Association’s Section of Taxation.

In response, the Treasury Department has proposed amendments to Circular 230, the regulations that govern the conduct of tax practitioners. The new rules will impose a higher standard of due diligence on practitioners who provide opinions that a transaction is “more likely than not” to survive an IRS challenge. Not surprisingly, practitioners are nervous. The new rules could make them more vulnerable to censure, fines, and even disbarment for rendering opinions without adequately addressing all material facts of the transaction.

At the heart of their concerns is the Internal Revenue Code definition of a tax shelter as any transaction with a “significant purpose” of federal income tax avoidance. Prior to 1997, the definition was a transaction with the “principal purpose” of tax avoidance. Both the American Institute of Certified Public Accountants and the ABA argue that the new definition is too broad in the context of professional liability, and that it would apply to virtually everything tax practitioners do. “People are concerned that ‘significant’ sweeps in too many legitimate transactions,” says Beller.

Bare minimum, favorable opinions will be harder to come by. – A.O.

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