THE NEWS HAS BEEN full of stories on tax shelters recently, and anyone who's dutifully amassing W-2 forms and getting ready to tackle this year's taxes should be livid. First there's the extraordinary, year-long detective job by the congressional Joint Committee on Taxation on tax manipulations that enabled Enron Corp. to operate tax-free for years, saving some $2 billion. The cover sheet of one shelter plan was headlined "Show Me the Money!" Senate Finance Committee Chairman Charles E. Grassley (R-Iowa) said the three-volume study "reads like a conspiracy novel." Montana Sen. Max Baucus, the panel's ranking Democrat, rightly called it a "wake-up call" on corporate tax abuse.
The other big story involves Sprint Corp. The company's departing chief executive, William T. Esrey, and its president and chief operating officer, Ronald T. LeMay, bought tax shelters from Ernst & Young to avoid paying taxes on the $311 million paper profit they made on Sprint options. The tax shelters (supposedly) allowed the executives to put off paying taxes on that profit for 30 years, saving a combined $123 million. Now the Internal Revenue Service is questioning the arrangement -- and Sprint stock is in the tank, meaning that the executives' holdings now are worth $55 million less than their possible tax bill. Whoops.
The Sprint and Enron stories underscore three important changes -- regulatory, legislative and budgetary -- that would limit these abusive schemes. First, the proliferation of shelters should finally demonstrate to the Securities and Exchange Commission that there is an insurmountable conflict faced by corporate auditors who also stand to profit by selling "tax services" to the companies whose books they review (or to the senior executives who hire them). These shelters are a cash cow for accounting firms, which have charged some clients $1 million just to hear a sales pitch and which pocket a percentage of the tax savings.
At Sprint, Ernst & Young made more money in 2000 peddling its tax shelter to the executives ($5.8 million) than auditing the firm ($2.5 million, plus $2.6 million for audit-related services). Enron paid its tax advisers $88 million over six years in a relationship that congressional investigators called "incestuous." Scared off by the accounting industry, Congress and the SEC have backed away from keeping auditors out of the tax business. The new accounting oversight board needs to act, and the SEC's incoming chairman, William H. Donaldson, should review the matter. Meanwhile, corporate audit committees should just say no to auditors' dual roles.
Second, Congress should pass the legislation to combat tax shelters that emerged from the Senate Finance Committee this month. Among other things, the measure would reduce the ability of people like Mr. Esrey to use a lawyer's letter attesting to a shelter's validity as a kind of get-out-of-jail-free card; now, such letters, for which law firms charge $50,000 and more, often shield clients from having to pay any penalties along with the back taxes, making the use of the shelters essentially a risk-free gamble. The bill would require shelter arrangements to have at least some economic benefit in addition to the tax savings -- a problem highlighted by the Enron situation, where investigators found that the company's tax savings "were mostly from internal machinations where we couldn't find any benefit to the company," according to committee chief of staff Lindy L. Paull. The Enron report may point to other legislative reforms.
Finally, the Bush administration and Congress should give the IRS, which is to be commended for increasing aggressiveness in this area, the resources it needs to go after the shelters. While President Bush's budget would boost funding to audit such shelters, the recently departed IRS commissioner, Charles O. Rossotti, has said even more is needed. Mr. Rossotti warned last year that the IRS "is simply outnumbered" in its efforts to pursue tax cheats and said that people were encouraged to buy these shelters "based on the simple premise they can get away with it." It's the government's job to make sure they can't.