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Introduction A brief review of the place of tax shelters in the American corporate landscape.

The Treasury's 2003 Offensive There was a kind of amnesty in 2002; and in 2003 the Treasury issued new guidance on tax sheltering.

Under the terms of the new registration rules introduced in this year, advisers were obliged to report to the IRS any tax minimization products and services offered which the tax agency had dubbed 'abusive tax shelters'.

The reporting rules require tax professionals to file a Reportable Transaction Disclosure Statement 8886 with clients' tax returns for each year that they have participated in the tax sheltering arrangement, and with the Office of Tax Shelter Analysis for their first year of involvement in the scheme. The new list maintenance rules require that tax advisers maintain lists of participants in so-called abusive tax shelters for possible future inspection by the tax authority.

In January, 2004, the Treasury Department announced a raft of legislative proposals to be included in President Bush’s 2005 budget aimed at closing tax loopholes, nullifying tax shelters, and simplifying the taxation system.

Commenting on the series of new proposals, which aimed to clamp down on tax abuse on a broad front, then Treasury Secretary John Snow remarked: “The laws must ensure that those who would shirk their civic responsibilities cannot do so by exploiting unintended loopholes, and the IRS must ensure that taxpayers do not engage in abusive tax avoidance transactions.”

“We are committed to restoring confidence in the tax system by ending the proliferation of abusive tax avoidance transactions and simplifying the tax code,” added Treasury Assistant Secretary for Tax Policy Pam Olson. “Ultimately, there is no “silver bullet” or “one-size-fits-all” solution addressing abusive tax avoidance transactions — other than continuing to simplify the tax code and ensure that the tax results match the economic realities of the transactions,” she observed.

Meanwhile, IRS Commissioner at the time, Mark W. Everson hoped that a new policy of tougher penalties would help to drive home the administration’s zero-tolerance message, which it intended to send out with the glut of new proposals.

According to the Treasury, it would seek to:

• Impose Penalties on the Failure to Disclose Potentially Abusive Transactions;
• Permit Uniform Disclosure Rules for Potentially Abusive Transactions;
• Permit Injunction Actions against Promoters who Repeatedly Disregard the Registration and List-Maintenance Requirements;
• Impose a Penalty for the Failure to Report an Interest in a Foreign Financial Account;
• Curb Abusive Income-Separation Transactions;
• Eliminate Obstacles to Disclosure;
• Increase Penalties for False or Fraudulent Statements Made to Promote Abusive Tax Avoidance Transactions;
• Eliminate Abusive Transactions Involving Foreign Tax Credits;
• Stop Abusive Leasing Transactions with Tax-Indifferent Parties;
• Require Charitable Deductions to Reflect Accurately the Value of the Donation;
• Prevent Misuse of Tax-Exempt Casualty Insurance Companies;
• Address the Tax Consequences of Changing Beneficiaries of a Section 529 College Savings Plan;
• Tighten the Deduction Limitation for Interest Paid to Related Parties;
• Prevent Avoidance of U.S. Tax on Foreign Earnings Invested in U.S. Property;
• Modify Tax Rules for Individuals Who Give Up U.S. Citizenship or Green Card Status;
• Curb Frivolous Returns and Submissions;
• Terminate Instalment Agreements when Taxpayers Fail to File Returns or Make Tax Deposits;
• Streamline the Handling of Collection Due Process Cases;
• Improve Procedures for Taxpayers Seeking to Resolve Their Tax Liabilities;
• Make the Payment of FMS (Financial Management Services) Fees for Levies More Efficient;
• Expand the Use of Electronic Filing;
• Permit Private Collection Agencies to Support the IRS’ Collection Efforts

“I’m very pleased the administration is continuing its attacks on illicit tax shelters,” noted Senator Charles Grassley. "The administration should receive high marks for its anti-tax shelter efforts. It’s issued numerous shelter regulations over the past year and laid down a solid response to attacking this problem. Congress needs to back up these efforts by passing tax shelter legislation,” he observed.

Later in January, tax collectors in twelve states, including California and New York, met with representatives from the Federation of Tax Administrators and the Multistate Tax Commission to discuss how to combat tax sheltering on a broad front.

"California is joining forces with other states to crack down on abusive tax shelters, and we're putting our collective resources to work," commented Californian State Controller Steve Westly. "We're going to use the best ideas from every state to find and prosecute tax cheats," he added.

The other participating states and cities included Colorado, Connecticut, Illinois, Massachusetts, Michigan, Minnesota, New Jersey, Ohio, Tennessee, and Wisconsin, as well as New York City.

California also offered a Voluntary Compliance Initiative for taxpayers who invested in abusive tax shelters. Taxpayers had until April 15 to correct their tax returns and make full payment of the taxes owed or face new harsh penalties. The Californian Franchise Tax Board claims the state loses $600 million to $1 billion in tax money annually through abusive tax sheltering.

In 2003, 41 states, among them New York and California, signed a Memorandum of Understanding with the IRS allowing federal and state tax collection agencies to pool their collective information on delinquent taxpayers and concentrate the battle against abusive tax shelters.

In May, 2004, the IRS announced a new amnesty scheme for taxpayers who may have employed a tax minimisation technique commonly referred to as ‘Son of Boss,’ which the agency claimed had deprived the government of some $6 billion in tax revenues. The so-called Son of Boss scheme was derived from an earlier scheme known as ‘Boss’ (bond and option sales strategy), and was commonly used in the late 1990s to offset large one-off gains such as the sale of a business.

However, according to then IRS Chief Mark W. Everson: “Son of Boss deals had only one purpose – the elimination of tax. These transactions were developed and marketed by an interlocking network of commercial interests, including leading law firms, accounting firms and investment banks.”

The IRS claimed that many transactions undertaken through Son of Boss schemes generated tax losses of between $10 million and $50 million leading to a total understatement of tax in excess of $6 billion.

Under the terms of the amnesty, which were a lot less generous than previous amnesty programs, eligible taxpayers were obliged to concede 100% of the claimed tax losses, pay all applicable interest, and accept the imposition of a penalty unless they had previously disclosed their participation in the transaction.

However, participating taxpayers were allowed to deduct as a loss their out of pocket transaction costs, typically promoter and professional fees.

Everson pointed out that taxpayers would remain able to contest the IRS in court over such issues, although he warned that the government would “vigorously pursue the full tax due”, plus full interest and penalty payments owing. However, IRS officials revealed to the Washington Post that taxpayers would be barred from using the agency's normal appeals process to contest such cases.

Confirming the agency's tough stance on the subject, IRS Chief Counsel Donald Korb added that taxpayers "should not expect to settle court cases on terms more favorable than those offered in the IRS settlement initiative.”

Also in May of that year, law firm Jenkens and Gilchrist was ordered by a federal judge to hand over the names of clients who invested in tax schemes formulated by its Tax and Estate Planning Practice Group and its Structured Investment Practice, between June 1998 and June 2003. The ruling marked the conclusion of a five year battle between the firm and the Internal Revenue Service.

Ruling at the Northern District of Illinois court, US District Judge James Moran granted permission for the law firm's clients to raise claims of attorney-client privilege. However, he observed that there "does not appear to be...sustainable grounds for the assertion of privilege for the great majority of client materials", and warned that clients would be penalised for bringing frivolous privilege claims.

Ruling in September in Manhattan's district court in the case of Seippel v. Jenkens and Gilchrist, Southern District Judge Shira A. Scheindlin allowed fraud and recission claims against the Sidley Austin Brown & Wood law firm to proceed.

Telecommunications executive, William Seippel participated in a tax sheltering arrangement known as COBRA (Currency Options Bring Reward Alternatives), which was developed by Jenkens & Gilchrist in conjunction with Brown & Wood, prior to the latter's merger with Sidley & Austin in 2001.

Following an Internal Revenue Service investigation into the shelter which led to Mr Seippel and his wife paying more than $5 million in taxes, penalties and fees, the couple sued the law firms in question alleging fraud, infringement of the Racketeer Influenced and Corrupt Organizations (RICO) Act, legal malpractice, breach of contract, negligent misrepresentation, and breach of fiduciary duty.

Although Judge Scheindlin dismissed the RICO, malpractice, breach of contract, negligent misrepresentation and breach of fiduciary duty claims, she allowed the fraud and recission of fees actions to continue, observing that:

"The fact that the Seippels may not ultimately owe the tax authorities additional taxes does not mean that their action is not ripe. The Seippels allege that they have been damaged, and continue to be damaged, as a result of the defendants' conduct."

She continued: "Their damages include the fees paid to defendants, losses incurred in the transactions, expenses paid to accountants and attorneys that are assisting the Seippels in defending the audits, losses caused as a result of being forced to sell assets at distressed prices to meet tax obligations, and tax penalties already assessed and paid."

The IRS scored a success in December when a federal jury convicted six people in a $120 million tax shelter scheme described by the authorities as one of the most extensive cases of its type ever tried. The case involved the Washington state-based firm Anderson Ark and Associates, which charged around 1,500 clients fees ranging from $50,000 to $250,000 for tax shelter plans that helped them take income tax deductions in the period form 1997 to 2001.

The schemes, which were sold over the internet, involved transactions using shell companies and loans connected to Costa Rican bank accounts to create the appearance that clients had legitimate tax-deductible business expenses. Six defendants were convicted of a number of offences after the seven-week trial, including filing false tax returns, mail fraud, wire fraud, and money laundering.

Welcoming the verdict, then IRS Commissioner Mark W. Everson noted that the case represented“a real blow to promoters of shady offshore tax schemes." The authorities are considering re-filing charges against four defendants about whom the jury was unable to reach a verdict. 

Rounding off a busy year for the tax avoidance industry, the US government issued final regulations amending Treasury Department Circular 230, which apply to attorneys, accountants and other tax professionals who practice before the IRS, providing standards of practice for written advice that reflect current best practices, and are intended to restore and maintain public confidence in tax professionals.

The revisions aim to ensure that tax professionals do not provide inadequate advice, and to increase transparency by requiring tax professionals to make disclosures if the advice is incomplete. Welcoming the new measures, Mark Everson commented: “These new standards send a strong message to tax professionals considering selling a questionable product to clients. The new provisions give us more tools to battle abusive tax avoidance transactions and to rein in practitioners who disregard their ethical obligations.”

Ensuring that attorneys, accountants and other tax practitioners adhere to professional standards was one of the IRS’s top four stated enforcement goals, and the agency considered the Circular 230 revisions a key component of this strategy.

The final regulations provided best practices for all tax advisors, mandatory requirements for written advice that presents a greater potential for concern, and minimum standards for other advice.

“These revisions to Circular 230 strike an appropriate balance between tightening practitioner standards and minimizing burden on everyday advice,” noted Assistant Secretary for Tax Policy Greg Jenner. “These rules target the types of written advice that present a significant cause for concern and avoid undue interference with the practitioner-client relationship,” he added.

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