The Clinton administration renewed its war on illegal corporate tax shelters yesterday, warning that they remain a "very, very serious problem" and issuing a revised proposal to give the Treasury Department broad new authority to root out tax dodges.
Noting estimates that illegal tax shelters drain $10 billion or more a year from federal revenues and undermine confidence in the nation's tax system, senior Treasury officials said they had modified some of their earlier proposals, which businesses found too harsh, but retained the tough core of their plan.
In brief, Treasury's proposals would require businesses to disclose transactions that might be construed as tax shelters, levy substantial penalties against firms whose shelters were not allowed, and impose penalties on firms that market the shelters.
Currently, Treasury can challenge tax shelters in court under rules subject to broad interpretation. The test of a shelter's legitimacy is generally whether it is intended to produce actual economic benefit or whether the company entered into it purely for the tax savings. But this standard creates a broad, eye-of-the-beholder gray area.
One example of a shelter ruled to be illegal: An American company rented a Swiss city hall, then rented it right back to the Swiss. Taking advantage of a quirk in the tax law (later disallowed), the company took tax deductions upfront for the rent it planned to pay to the Swiss, while deferring all the taxes it would have to pay on the rental income from the Swiss.
In attempting to pin down its definition of a tax shelter, Treasury's new proposal quotes Yale University Prof. Michael Graetz, who said a shelter is "a deal done by very smart people that, absent tax considerations, would be very stupid."
In response to protests from accountants, lawyers and businesses, Treasury agreed to forgo penalties in some cases in which businesses disclosed shelters and had substantial reason to believe they were legitimate. However, it proposed adding a $100,000 penalty against firms that failed to disclose a shelter -- even if that shelter were determined to be legal.
"There are some teeth here," said a senior Treasury official who spoke on condition that he not be identified.
Treasury's broad-scale assault on illegal tax shelters has yet to catch fire on Capitol Hill, where tax-writing committees are poised to pass major tax bills later this month. Although Treasury could mandate some disclosure requirements on its own, most of its proposals require congressional approval.
Senate Finance Committee spokeswoman Ginny Flynn said that panel was unlikely to include anti-tax-shelter provisions in its measure, though it might return to the subject later this year. Trent Duffy, spokesman for the House Ways and Means Committee, said committee Chairman Bill Archer (R-Tex.) remains "wary of giving the IRS even greater authority than they have now. His primary concern is that legitimate business transactions not be impeded."
Rep. Lloyd Doggett (D-Tex.), a Ways and Means member and the sponsor of a bill that incorporates much of Treasury's plan, said the outlook for broad attacks on tax shelters is not very good. "We face a rather uphill battle in this Congress," he said.
Critics of Treasury's original proposal said the department had made some welcome concessions, but mostly "around the edges," said Mark Weinberger, a lawyer at the law firm Washington Counsel who represents a coalition of business groups.
Weinberger said the businesses still find it "an anathema" that Treasury wants to rewrite the law to establish strict standards to define tax shelters, which could sharply limit the latitude courts have to determine whether shelters are legitimate.
The administration first took detailed aim at proliferating tax shelters in its February budget proposal, acting to counteract what it said were burgeoning attempts by accountants and lawyers to market sophisticated tax shelters that go largely undetected by the IRS, since they are buried in complex corporate tax returns.
Rather than hunt down and attack the shelters one by one, the administration proposed requiring companies to disclose them upfront. In a proposal that businesses found particularly onerous, Treasury proposed to shift substantial authority from the courts to the department to determine whether a particular tax transaction was illegal.
To shoot down tax shelters, though, the IRS must first find them, and that has proven to be extremely difficult. Some estimates indicate that the government ferrets out or stumbles on barely one out of 10 shelters, while the rest stay hidden in tax returns that might never get audited.
As a result, there are no firm estimates of the amount of money the Treasury loses to illegal schemes. "The transactions that we find are huge," said a Treasury official, noting that the department uncovered five big shelters in recent years and successfully fought to have them disallowed. Just those five cost Treasury roughly $5 billion a year, the official said, which leads some analysts to suspect that illegal tax shelters cost the government far more than its estimate of $10 billion a year.