A mass-marketed tax-shelter industry that exploded in the boom years of the 1990s appears to be in retreat, driven by congressional action, a government crackdown and economic factors that have pushed major accounting firms back to their core businesses.
But tax experts warned yesterday that a new economic surge could bring back the shelter industry unless the Internal Revenue Service maintains and even strengthens its enforcement efforts.
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The IRS announced yesterday that it had collected a record $3.2 billion in taxes and penalties from participants in an abusive tax shelter known as Son of Boss. But Sheldon S. Cohen, a former IRS commissioner, said that shelter was so egregiously indefensible that it took little effort to convince its users that they had little choice but to give up their gains.
"Yeah, they can pick out Son of Boss and say, 'We're putting a hell of an emphasis on this.' But will they do it the next time? Will they do it consistently? Do they have the manpower?" Cohen asked. "Because the bad guys get it. They will behave according to the enforcement they see."
For now, IRS officials, congressional investigators and tax experts say the government has turned a corner in its battle with mass-marketed tax shelters. The largest accounting firms, including Ernst & Young International, PricewaterhouseCoopers International Ltd. and KPMG International, have scaled back their shelter creation and marketing divisions and moved back to their core business of corporate auditing, said Douglas A. Shackelford, an accounting professor at the University of North Carolina's Kenan-Flagler Business School.
The government will never stamp out all abusive tax shelters, congressional investigators conceded, but if it can keep the large accounting firms out of the business, it will have accomplished a great deal. Only firms like Ernst & Young and KPMG can leverage massive marketing efforts to sell tax shelters widely and use their corporate legal power to keep the IRS at bay.
"Having a tax shelter sold by a $4 billion entity is a lot different than some shady guy with a million-dollar operation on the West Coast," said one congressional tax investigator who was not authorized to speak on the record and so spoke only on condition of anonymity.
Washington has had an impact. The Justice Department and IRS launched a shelter crackdown in the late 1990s, and that effort was redoubled after the Senate permanent subcommittee on investigations launched a series of reports and hearings into the shelter business.
High-profile settlements between the federal government and Ernst & Young and PricewaterhouseCoopers forced those firms to forfeit their shelter client lists, handing IRS agents a goldmine of targets and spooking would-be shelter participants.
Finally, the Sarbanes-Oxley legislation, passed in the wake of the recent corporate scandals, created the Public Company Accounting Oversight Board to tighten regulations of the accounting industry. In February, the board unveiled proposed rules to limit tax services that accounting firms can offer their publicly traded audit clients.
In a letter to board Chairman William J. McDonough, Sen. Carl M. Levin (Mich.), the ranking Democrat on the investigations subcommittee, predicted the rules "would help . . . rein in abusive practices within the U.S. tax shelter industry."
But Sarbanes-Oxley had another, perhaps more important impact, Shackelford said. By the 1990s, corporate auditing had become so pro forma that it lost virtually all its profitability for the major accounting firms. They turned to higher "valued-added" efforts, such as consulting and tax shelters, to boost their bottom lines.
The plethora of new accounting regulations and penalties codified in Sarbanes-Oxley have once again made auditing a highly profitable business, Shackelford said. Not only do the big firms not need the money from their shelter business, they do not want to "slay the goose laying the golden egg" by jeopardizing their audit business with negative attention from the IRS, Shackelford said.
"They're walking the straight and narrow right now," he said.
The Son of Boss settlement, in which nearly 1,200 shelter customers came clean, also shows that the IRS is capable of settling a massive number of cases equitably, without having to litigate large numbers of them, said David A. Weisbach, a tax law professor at the University of Chicago. Now, Weisbach said, the IRS must apply the lessons of Son of Boss to the thousands of off-shore credit card accounts it is targeting.
In the credit card schemes, individuals funnel pretax income to bank accounts in offshore tax havens, where the balance remains tax-free. The account owners then use credit cards to live off their accounts. Those accounts are so plentiful that they would tie the court system up for years without a similar mass settlement.
But Cohen said the Son of Boss success does carry risks. That shelter was so clearly abusive that the IRS could establish a one-size-fits-all settlement and issue an ultimatum that Son of Boss clients had little choice but to take. But shelters that are closer to the line of legitimacy will take more manpower and more money to police, he added.
In recent years, neither the Bush administration nor Congress has been willing to make that kind of budgetary commitment, Cohen said.
