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Corporate tax shelters and you

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Corporate Tax Shelters and You
by Lee Drutman
Published by Tom Paine

How is it possible that individual Americans shoulder a disproportionately large part of the overall tax burden while the portion paid by corporations is at its second lowest level in U.S. history? Complexity, plain and simple. By cooking up tax shelter concoctions that are difficult to understand, Michigan Senator Carl Levin says, corporations are able to “escape scrutiny and public ire.” Exact calculations of how much corporate tax shelters cost the U.S. Treasury are hard to come by, but estimates put the loss of tax revenue as high as $18 billion a year.

Though corporations trying to avoid taxes is an old story, what is new is the rise of so-called "tax products"—essentially schemes designed by morally-challenged tax professionals who then peddle them aggressively to corporations looking for an extra tax savings boost.

The ranking Democrat on a panel investigating tax havens, Levin described the tax shelter business in a recent hearing: "The tax shelter industry of today is fundamentally different than it was a few years ago. Instead of individuals and corporations going to their accountant or lawyer and asking for tax advice, the engine driving the tax shelter industry today is the effort of a horde of tax advisors cooking up one complex scheme after another. . . and then using elaborate marketing schemes to peddle these products across the country."

KPMG Lightens Its Load

The dense report that Levin's Permanent Subcommittee on Investigations put out a few weeks ago does not make for light reading. It explores, in painstaking detail, how just one firm, KPMG, set up four tax shelters that cost the U.S. Treasury $1.4 billion with the help of a cadre of lawyers, bankers and financial professionals. These schemes—whose playful names (BLIPs, FLIPs, OPIS and SC2) belie their tax-avoiding prowess—helped KPMG pull in $124 million from 350 clients.

And though the devil may indeed be in the details, when it comes to corporate tax shelters, the devil is pretty much everywhere else, too. What's not complicated to see is that tax shelters are increasingly big business for accounting firms, lawyers and financial professionals. And, as the hearings made clear, the IRS is woefully ill-equipped to fight back, trying to stop a $18 billion leak (the estimated annual cost of tax shelters to the U.S. Treasury) with a weak $1,000 plug (the IRS fine for tax shelter promoters). Worse, some of these schemes are perfectly legal abuses of an incredibly complicated tax code rife with special exceptions and loopholes.

Still, the most disturbing trend may be the aggressive way that tax professionals are now peddling these schemes. One e-mail, dug up in the year-long investigation that produced the report, reveals the importance of aggressive marketing campaigns to push these products: "I want to personally thank everyone for their efforts during the approval process of this strategy," reads the e-mail. "It was completed very quickly and everyone demonstrated true teamwork. Thank you! Now let's SELL, SELL, SELL!!"

"These are the tactics you might expect out of a boiler-room operation selling phony land deals," Levin said in a recent speech. "But here they are coming from people in our top professions."

At the hearings, KPMG executives attempted to distance themselves from the tax schemes under heated questioning. They said they had gotten out of the tax shelter business, and besides, those schemes were primarily investment strategies. Of course, KPMG could pass these schemes off as legit because they were lent legitimacy by respected investment firms, like Presidio Advisors (which took a percentage of all tax savings), by respected law firms like Brown & Wood (which made more than $12 million providing 250 opinion letters at $50,000 a pop), and even by respected banks like Deutsche Bank and Hypo-und Vereinsbank (which together made more than $5 billion helping clients finance the tax shelters).

Indeed, as the report concludes: "Dubious tax shelters are no longer the province of shady fly-by-night companies with limited resources. They are now big business, assigned to talented professionals at the top of their fields and able to draw upon vast resources and reputations of the country's largest accounting firms, law firms, investment advisory firms, and banks." According to a recent GAO report, an estimated 6,400 individuals and corporations have bought tax shelter "products" from more than 300 firms.

Toothless Penalties

So how are all these professionals getting away with this? Well, to start, the fine for tax shelter promoters is a measly $1,000 per offense. Compare that to the $124 million KPMG earned from just four shelters, and you can see why perhaps a $1,000 fine might not be a deterrent.

And that's when the IRS even catches the promoters. Right now, the IRS's main detection weapons are weakly enforced laws that require tax professionals to register tax products. However, asking tax professionals to tell the IRS when they are breaking the law does not appear to work that well. For example, of KMPG's 500 active tax products, exactly zero are registered.

In the larger context, tax shelters are one part of a massive effort by corporations to lower their tax bills, an effort that has been quite successful in recent years. In 2003, for example, corporate tax revenues fell to only 7.4 percent of federal tax receipts, the second-lowest level on record. (In the 1940s, corporations contributed almost half of federal taxes.) And though corporations are technically taxed at 35 percent, large corporations on average pay about half that. All this while the federal deficit sinks deeper into the red and government dollars dry up for education, health care and other essential social programs. Because abusive tax shelters are pursued so brazenly, and as a form of tax evasion they are among the most egregious, they’re a good place to start cracking down. Still, righting the tax shelter ship is not going to be easy. The federal government needs to make a serious effort to give the IRS the tools and resources it needs. One obvious place to start, however, would be to hike the fines for tax shelter promoters. The government also needs to devote more resources to detecting tax shelters, working with federal bank regulators and the Department of Justice. Meanwhile, accounting regulators need to start cracking down on accounting firms, who earn billions each year by selling tax products. These firms are supposed to guarantee honest financial statements, not abet tax shelter abuse.

Finally, the rules on what counts as an illegal tax shelter need to be tightened. Many of the tax schemes peddled these days skirt the boundaries of legality by exploiting loopholes for purposes never intended. Though they are sometimes technically legal, the IRS can crack down using what is known as the "economic substance" doctrine, which basically disallows transactions that are done purely for tax purposes and have no legitimate economic substance. Strengthening this "economic substance" doctrine is an important way to battle tax shelter abuse.

At stake are basic issues of economic justice and tax fairness. There is simply no justification why honest, working-class taxpayers should have to shoulder more of the burden while greedy corporations and their avaricious accountants, lawyers and financial professionals are FLIPing and BLIPing their way to new heights of tax trickery.

Lee Drutman is communications director for Citizen Works.

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