Contrary to what has been reported in the media, however, the IRS does not “ban” tax shelters. Whether a shelter qualifies as a tax deduction is, like any other point of law, adjudicated in court. But BLIPS, FLIP, OPIS and the other tax shelters in this case have never been brought before a judge, so their legality and legitimacy has never been settled as a point of law.
Never. The way tax law has usually developed in this country is that the IRS issues its point of view on a shelter, putting taxpayers who use it on notice. If the IRS then takes the taxpayer to court over the shelter, he has the chance to respond before a judge, who makes a ruling and precedents are thus established. In this case, the IRS has called in the prosecutors first.
This in itself is striking. Despite some recent legal setbacks, the IRS has an excellent track record of obtaining favorable rulings on tax shelters it dislikes. Yet no taxpayer has been brought to court over these shelters, and no judge has ruled on whether they “work,” in the jargon of the tax-shelter business. In America, last we checked, the accused are innocent until proven guilty. That gives this KPMG trial an Alice-in-Wonderland quality; the accused are on trial for promoting a fraudulent tax shelter that has never been proved to be fraudulent in the first place.
This is not the first time the Justice Department has taken this route, and recent history suggests it may have a tough road ahead. Last November, Justice froze $500 million in assets at Xelan, a charitable trust set up for doctors in California, alleging that the trust was a vehicle for tax fraud. Six weeks later, the Federal Court for the Southern District of California threw out the case, noting, among other shortcomings, that the prosecutors could not show that any court had ever ruled that Xelan’s activities were illegal under the tax code.
Category: Taxes
Massive Offshore Tax Giveaway
As mentioned here, I, too, would like the 5.25% tax rate that our good Senators Russ Feingold and Herb Kohl supported (to repatriate foreign profits via a one year tax break). Timothy Aeppel looks at the results:
But it’s far from clear whether the spending has spurred the job growth that backers of the break touted.
A law signed by President Bush shortly before the 2004 election allows companies to transfer profit from overseas operations back to the U.S. this year at a special low tax rate of 5.25%. Businesses often keep such funds outside the country in part to avoid paying taxes in the U.S., where the effective rate on repatriated profit for many companies is normally closer to 25%. Backers said the measure would provide an incentive to companies to invest those funds in U.S. operations.
Most companies using the break have offered only broad outlines for how they intend to use their windfall. For the most part, they say they are using the bulk of the money for tasks such as paying down debt and meeting payrolls. Direct job creation rarely appears on the list.
Some companies are even bringing home piles of cash while continuing to downsize. Colgate-Palmolive Co., of New York, said in July that it planned to repatriate $800 million, at a time when the company also is pursuing plans to shut a third of its factories and eliminate roughly 12% of its work force, or 4,450 people, over four years.
Bush Tax Cuts = Tax Increase for Some
Over the next 10 years, Americans will not receive nearly $750 billion in tax cuts sponsored by President Bush because the cuts will be offset by the alternative minimum tax, a new report by Congressional tax specialists shows. The report, prepared by the staff of the Congressional Joint Committee on Taxation, said that from 2006 to 2015, Americans would pay as much as $1.1 trillion more under the alternative minimum tax, partly as a result of the Bush tax cuts. The Bush tax cuts reduced the bill for millions of taxpayers to a level that will subject them to the alternative minimum tax instead of the standard tax rate. As a result, the report said, their tax savings would be reduced by a total of $739.2 billion over the 10 years. Congress has passed a modest adjustment to the alternative minimum tax to allow more taxpayers to take advantage of the Bush tax cuts, but that expires at the year-end. Even if it is extended, the report said, the alternative minimum tax would take away $628.5 million in tax savings, with $416.5 billion of that attributable to the Bush tax cuts over the 10 years. George K. Yin, the joint committee’s chief of staff, wrote that the Bush tax cuts of 2001 and 2003 account for just under two-thirds of the increase in collections under the alternative tax. The report was prepared in response to a request from John Buckley, chief tax lawyer for Democrats on the House Ways and Means Committee. Families with children who own their homes will be hit hardest by the increased alternative tax.
Tax Shelter Proceedings Begin in NY
Judge Kaplan also showed a hint of testiness about the pace of the government’s case, commenting that if prosecutors could spend a year and a half investigating before bringing one criminal charge, they should not need another three months to add any new charges or new defendants. He also warned prosecutors against lengthy proceedings. Prosecutors said they anticipated a three-month trial.
A complex case would confuse jurors and make it harder for them to convict, Judge Kaplan said. “The idea of a three- or four-month tax trial, well, it’s a daunting prospect” for potential jurors, he added.
Inside the Tax Shelter Mess
Some very useful questions and answers from Business Week:
Are the deals illegal?
The IRS says so, but the courts have not yet ruled on the matter. The IRS has a mixed record in shuttering such transactions. Under what is known as the economic-substance test, the IRS has claimed that shelter deals done solely to reduce taxes are improper. But federal courts have sometimes ruled that such transactions are O.K., even if they carry no economic risk or opportunity for reward beyond their tax savings.
States Expand Push for Internet Taxes
In yet another example of our confused tax system:
Going online to buy the latest bestseller or those photos from summer vacation may be tax free for most people today, but it won’t last forever. Come this fall, 13 states will start encouraging – though not demanding – that online businesses collect sales taxes just as Main Street stores are required to do, and more states are considering joining the effort
Congress and KPMG
Wall Street Journal:
The IRS’s standard in evaluating tax shelters is whether the transaction serves a “legitimate economic purpose,” or is crafted entirely to avoid taxes. Senators Carl Levin (D., Mich.) and Norm Coleman (R., Minn.) have proposed legislation that would enshrine that doctrine in law.
Speaking on the Senate floor last month, Mr. Levin described the distinction: “Abusive tax shelters are very different from legitimate tax shelters, such as deducting the interest paid on home mortgage or Congressionally approved tax deductions for building affordable housing. Abusive tax shelters are complicated transactions promoted to provide large tax benefits unintended by the tax code” (our emphasis). In other words, it’s OK to avoid taxes in any of the myriad ways Congress approves of. It’s abusive if Congress didn’t intend it — assuming anyone can ever figure out what Congress really intends.
Take the scheme known as SC2, one of those KPMG has come under fire for marketing. As reported in the Los Angeles Times, SC2 involved donating nonvoting shares in a Subchapter S corporation to a nonprofit entity; KPMG’s nonprofit of choice was the Los Angeles Fire and Police Pension System. The pension system would accept the shares, making them 90% owners of an S Corporation that would then retain the Corporation’s profits for several years. At that point, the pension fund would sell the shares back to the original owners. The pension plan pockets the proceeds while the S Corporation owners have converted the firm’s profits from regular income into long-term capital gains, taxed at a lower rate.
Does SC2 serve an “economic interest”? Well, the participant in the scheme does pay the pension system for the shares when he buys them back, benefiting the firemen and policemen’s pension fund. The fund adds money to its coffers, and the taxpayer lowers his tax bill. Whether that’s abuse is for a judge or jury to decide, but Mr. Levin’s test — that Congress didn’t intend S corporations to be used that way — doesn’t seem adequate here.
More on the Tax System Mess: KPMG Indictments
Quite a bit of news Monday on the ongoing US Government Tax Shelter Investigations:
- TaxProf links to statements, resolutions and indictments.
- Jonathan D. Glater discusses the Southern District of New York’s Indictments and notes that:
As part of its agreement with the government, KPMG issued a strongly worded acknowledgment of wrongdoing, which can be used by prosecutors in their criminal case against the individual partners, as well as against the firm in the event it violates the terms of the deferred- prosecution agreement. Lawyers for the former partners criticized the firm’s statement as meaningless.
“The government held a gun to KPMG’s head and said, ‘Say what we want or we will put you out of business,” said Robert H. Hotz Jr., a lawyer at Akin Gump Strauss Hauer & Feld who is representing Mr. Lanning. “KPMG’s statements in court were the product of extreme duress and are not worth the paper they are printed on.”
So far, no court has ruled that the shelter transactions themselves were improper – a fact that lawyers for the accused former KPMG partners were quick to emphasize. - Carrie Johnson on the Indictments
- Attorney General Alberto Gonzales’ statement
- Michigan’s Senator Carl Levin commented:
Senator Carl Levin of Michigan, the senior Democrat on that committee, said in a statement that KPMG’s agreement and the indictments “send a powerful message to the promoters, aiders and abettors of abusive tax shelters that they can no longer expect to be let off the hook.”
I find Levin’s statement somewhat ironic, given the recent evidently unintended huge SUV tax subsidies that provided a significant benefit to Michigan manufacturers at the cost of national fuel efficiency and lost tax income.
Ironically, the Supreme Court overturned the US Department of Justice’s indictment of Andersen, which cost thousands of people their jobs:
While hearing arguments in Andersen’s appeal, Justice Antonin Scalia at one point described the government’s theory of the case as “weird,” according to The New York Times.
What’s more, the justices “were so clearly sympathetic” to the former Big Five accounting firm, that the only question remaining at the end of the session was how quickly the Court would overturn the conviction, the paper added.
Of course, even if the conviction is overturned, it would not be much help to the thousands of former employees who lost their jobs and the former partners who lost their equity.
Real tax reform is long overdue. Will we see it from our politicians? Unlikely, when both Feingold and Kohl are supporting bills like this very large, multinational corporation tax giveaway.
I’ve known Bob Pfaff, indicted today, for 20 years and have always found him to be a great friend and honorable man. I’ve posted a few items on this previously here. The recent Kelo Case is also worth watching in this context.
IRS: 4.6 Billion Disclosures of Tax Return Information in 2004
The report reveals that the IRS made 4.6 billion disclosures of tax return information to federal and state agencies. Here are the Top 5 recipients of taxpayer information:
More on the Tax Shelter Controversy
TaxProf summarizes a number of recent articles and documents regarding the ongoing IRS battle with the major accounting firms over 1990’s Tax Shelters. Perhaps most interesting is this 6MB PDF memo sent by several current and former KPMG partners to the US DOJ and the media. This is a fascinating look at the internal politics of a large organization. Lynnley Browning has more:
The accounting firm KPMG is quietly putting the boxing gloves back on. Even as KPMG is in discussions with federal prosecutors to settle a criminal investigation over its sale of what the Internal Revenue Service says are bogus tax shelters, the firm has been taking on former clients who have sued it over those same shelters.