For those of us who lived through it, and survived to tell the tale, the Turn of the Century brought about an interesting period in American tax law.
Accounting giant Deloitte & Touche created what was to become known as the "Predator Group", which was a group of tax shelter specialists whose goal was to pitch aggressive tax transactions to large businesses and wealthy individuals, with the idea being that those firms and persons would then move their lucrative audit work to D&T.
But the Predator Group took on a life of its own, as D&T had underestimated the market's appetite for aggressive tax transactions, and soon the enormous profits generated by the Predator Group started to overshadow the profits of the firm's traditional audit work.
D&T of course had no monopoly on this practice, and soon it seemed like every large and even middlin' accounting firm was out pitching identical or similar tax shelters, both to keep their existing clients and to poach from others. KPMG jumped into the business whole hog, and eventually became the most industrious of the tax shelter promoters.
Thus, the tax shelter boom of the late 1990s and early 2000s exploded on a Nation that had lots of folks looking to shelter income from both the Dot.com boom and the post-9/11 recovery.
Most of these shelters were just plain goofy. In one, money would pass to Japan, be churned on some currency options there, and then returned in the same amount to the U.S., but quite artificial "losses" on the options would then be used to offset business income.
The scale of the tax shelter boom staggered the mind. This was not some doctor trying to squirrel away $20,000 on some bogus oil & gas partnership as had previously defined the tax shelter market. Instead, many individual shelters ran into the hundreds of millions, and all the shelters in the aggregate exceeded hundreds of billions.
Though goofy and utterly devoid of anything like economic substance (which is required for a loss to be valid), these tax shelters all had three things in common:
(1) The shelters all relied on the extremely low audit rates for the IRS to catch the transaction.
(2) The shelters all had quite lengthy and technical Opinion Letters issued by either the large accounting firms or certain tax law firms to protect the taxpayer from penalties should they get caught.
(3) The shelters were given cool-sounding acronyms for marketing purposes, such as CARDS, BLIPS, or BOSS.
The tax shelter boom in fact created a huge problem for the IRS. The truth is that audit rates were (and still are) very low, and the IRS would only pick up a small portion of the shelters by conducting routine audits. Plus, the Opinion Letter ensured that the IRS would be in for a long and protracted fight against each and every taxpayer, something that it simply didn't have the resources to take on.
So, instead of taking on these shelters taxpayer-by-taxpayer, the IRS instead simply dropped what turned out to be The Big One on the entire tax shelter industry.
The Big One was the listing of certain transactions by the IRS as, essentially, presumed tax shelters -- officially, a transaction that is the same or substantially similar to one that the IRS has identified as a tax shelter through an IRS notice or other publication. Or, in the IRS's own words:
A "listed transaction" is a transaction that is the same as, or substantially similar to, one that the IRS has determined to be a tax avoidance transaction and identified by IRS notice or other form of published guidance. The parties who participate in listed transactions may be required to disclose the transaction as required by the regulations, register the transaction with the IRS, or maintain lists of investors in the transactions and provide the list to the IRS on request.
About as importantly, taxpayers who engage in a listed transaction must file a Form 8886, which is titled the "Reportable Transaction Disclosure Statement". The failure to file the Form 8886 at the time of the transaction has potentially very serious financial consequences.
In 2004, Congress passed the American Jobs Creation Act which codified huge penalties on taxpayers who participated in undisclosed abusive transactions. The penalties were amended in 2010 in the Small Business Act so as to be not quite so onerous for smaller participants, but the penalties are still intense -- as much as $100,000 for individuals and $200,000 for business entities and the like, which are tacked on top of pre-existing penalties (such as substantial underpayment penalties) that usually exist in such cases.
Here is what happens: A bunch of taxpayers engage in a particular tax shelter sold to them by a tax professional. The IRS gets wind of the tax shelter, and makes it a listed transaction. The IRS also issues a subpoena for the client lists of the promoter, and start individual audits of taxpayers.
When told that they might have been involved in a reportable transaction, the taxpayers then rescind the deal and cut a deal with the IRS. The taxpayers then sue the promoters and everybody who supported the promoters, such as attorneys who issued opinion letters, accountants who signed off on audits, banks that provided transaction services, etc. The litigation gets ugly, financially wrecks the promoters and utterly ruins their reputations, and makes those who might support such future promoters understandably gun shy about getting involved in anything that might get them involved in such litigation ever again.
For listed transactions involving large numbers of taxpayers, class action lawsuits are almost a certainty, and since the IRS first started listing transactions, settlements in these lawsuits have cumulatively run into the billions.
From 2000 to 2004, the IRS listed transactions at a prolific rate, identify about 25 transactions as abusive. But by 2005, the listing of transactions became a rarity, mainly because the tax shelter industry had dissolved and most of those involved with it were less concerned with trying to create new shelters as they were with dodging process servers.
By his time, Jenkens & Gilchrist, one of the largest tax law firms that was neck-deep in the tax shelter business, had begun to dissolve (it would eventually do so in 2007 after paying a $76 million fine to the IRS, leaving four of its former partners to face criminal prosecution and eventual conviction for their role in the tax shelter business). For its part, KPMG avoided criminal prosecution only by paying a whopping $456 million for its role in the shelter boom, with numerous of its former partners headed to Club Fed.
With the tax shelter boom having gone bust, the IRS listed only one abusive transaction in 2005 (SILO -- Sale-In Lease Out transactions), and none in 2006. In 2007, the IRS listed two new shelters: The Loss Importation Transaction, and certain abusive Welfare Benefit Trust arrangements (so-called "419 plans"). In 2008, the IRS listed only transaction: the so-called Distressed Asset Trust.
After 2008, the IRS listed no new transactions, and by 2015 many tax professionals had blissfully presumed that the IRS had gotten out of the business of listing abusive transactions. They were wrong.
What happened is that as the economy deflated during and after the Great Recession beginning in 2007-8, most businesses and their owners simply didn't have any significant income that they needed to shelter. To the contrary, most of them had losses that they were in many cases able to preserve and then later "harvest" (trigger the loss in a good year to offset income). But none of this had anything to do with the IRS's methods for attacking abusive transactions.
Fast forward to 2015.The economy has been on pretty decent footing for the last couple of years, and companies and individuals are once again starting to show profits. Whenever there are profits there are taxes, and whenever there are taxes there are tax shelters. And so once again, the tax shelter promoters slither out from under their rocks to start offering new and exciting transactions to folks interested in shorting Uncle Sam.
After a seven-year hiatus, the IRS added so-called Basket Option Contracts to their list of abusive tax transactions, through Notices 2015-47 and 2015-48 released July 8, 2015. These contracts involved complicated contractual derivative arrangements used by investors to, essentially, avoid having to characterize certain trading as being in equity (taxed at long-term capital gains rates) as opposed to options (taxed as ordinary income).
But the point of this article is not Basket Option Contracts, but that the IRS has decided to once more unsheathe the listing of transactions to take on the next wave of tax shelters.
Indeed, there are once again a lot of hinky transactions making the rounds. They all sound too good to be true, and they are. As with Basket Option Contracts, many of these new tax shelters purport to magically convert ordinary income into capital gains, for a small fee of course. It is exactly these sorts of strategies have long drawn the attention of the IRS.
It is also with not just a small amount of amazement that recently I have seen some old tax shelters reappear with new packaging and slightly (but only slightly) different structuring. Taxpayers who engage in these transactions have little chance of avoiding the worst penalties should the IRS put the promoters in their bullseye.
On the other hand, there is still a lot of legitimate, conservative tax planning that taxpayers may engage in, and of course taxpayers are not sufficiently skilled in our Byzantine tax laws to be able to know the difference. But taxpayers can protect themselves against these transactions, and the heartaches that usually follow, by the simply expedient of getting a truly-independent second opinion from a reputable tax law firm. That means somebody that the taxpayer finds themselves, and is not suggested to them by the promoter (who will almost always be a shill).
Some more friendly advice from somebody who has been through a tax shelter wave before:
(1) That "everybody is doing it" doesn't mean that it is any safer, but exactly the contrary: Whatever it is has probably become such a large blip in the IRS's radar screen that they can no longer ignore it.
(2) That a tax opinion letter is 80-pages thick still doesn't mean that it is worth the paper that it is printed upon.
(3) If you can't explain a transaction in a few minutes to the average fifth-grader, don't do it.
(4) The promoter may believe 110% that what they are selling is fully compliant with the tax code, but that has utterly no relationship to whether it is.
(5) Any arrangement where you are charged a percentage of tax savings, directly or indirectly, is inherently a very bad one, and may in fact be a tax shelter per se even if otherwise legal.
(6) A transaction that involves the use of an offshore tax haven (a "zero tax" jurisdiction), or a U.S. territory, such as the Virgin Islands, Puerto Rico, or Guam, is not only probably a very bad one, but may also expose you to criminal prosecution if it blows up.
(7) Don't rely just upon your local planner giving a thumbs-up to the transaction, because the odds are good that they don't really understand it either, but are themselves simply relying upon the promoter's representations.
(8) If something looks like it is very close to a listed transaction, but the promoter tells you that it is slightly different, the odds are that it is really the same, keeping in mind that listed transaction encompass not only identified transactions but also similar transactions.
(9) Arrangements that seek to convert ordinary income to capital gains are probably tax shelters, even if they have not been specifically identified as a tax shelter yet.
(10) If anybody says, "It's hard for the IRS to even pick up this transaction", run. Fast.
While everybody, including me, desires to save as much on taxes as legally possible, you simply can't let that desire overwhelm your good common sense and the need to protect yourself against bad ideas pitched as a highly-sophisticated transactions. Be skeptical, and get an independent second opinion -- that will be the best money that you ever spend on such a deal.
It has long been a curiosity to me that successful business owners will squander their limited time and resources engaging in aggressive transactions, and then defending against them before finally paying the taxes that they owed in the first place, instead of applying that energy to simply making more money. I've seen this happen time after time, and it still doesn't make any sense.
Often it is better to concentrate on what you know than what you don't.
This article at http://onforb.es/1PX3i2O and http://goo.gl/ml8JFm
