Scheming Off the Top? Congress takes steps to uncover businesses' secret stash.

The Senate Finance Committee is expected to continue to push fora crackdown on abusive tax shelters. It issued a set of legislativeproposals in the last Congress that called for tough new fines onthese schemes and a hefty increase in penalties on shelterpromoters. If the legislation passes, tax strategies for businessowners may well be affected.

The committee's plan is a direct response to a TreasuryDepartment request for Congress to take legislative steps to reinin abusive shelters. The Treasury claims these shelters are themost serious tax enforcement problem now facing the government, atcosts of tens of billons of dollars in lost revenue over the past10 years.

The proposals target shelters that help generate a loss forcompanies or individual taxpayers in a tax year that otherwisewould have produced a taxable gain, says Mark Luscombe, principalfederal tax analyst with CCH Inc., a Riverwoods, Illinois-basedprovider of tax and business law information. "This isaccomplished by using a combination of fairly complicatedtransactions and borrowings," he says.

One shelter that the courts considered abusive involves astrategy in which a company purchases life insurance on itsemployees, then borrows money against the insurance. As a result,itrealizes more in tax savings than the cost of the insurance. Otherexamples involve participating in foreign entities that are taxeddifferently from U.S. entities and using not-for-profit entitiesthat are tax exempt to shelter income, says Luscombe.

Needless to say, some accountants and businesses arguelegislation is not needed and may damage legitimate businessdealings if enacted. In addition, they contend the Treasuryisn't doing all it can to enforce the laws currently on thebooks.

The Pain is In the Detail

Under the Senate Finance Committee proposal, a new class of taxshelter known as "abusive tax shelter devices" would becreated. If the IRS determines a shelter is abusive, the proposalcalls for a strict penalty of 40 percent of the tax understatement.The committee defines "abusive tax shelter devices" asdevices that lack economic substance or material business purposeother than to avoid paying taxes.

The proposal also calls for fines of 10 percent if a taxpayerhas a transaction with significant business purpose and fails todisclose that information to the IRS. "This proposal is broadenough to mean the establishment of a deferred compensation schemeor qualified pension plan," explains Clint Stretch, directorof tax policy in the Washington, DC, office of accounting firmDeloitte & Touche. "Anything you do in the business worldis going to have a significant tax element to it."

Compromise Ahead

Because it's so broad and far-reaching, the committee'sproposal is far from a sure thing. But Stretch predicts there willbe some compromise between Washington and the private sector on theplan because the political sentiment seems to be moving in thatdirection. "Members of Congress are sensitive to the realneeds here," says Stretch. "They believe taxpayers oughtnot to be asked to pay more than their fair share, and they oughtto be allowed to rely on the tax code where it legitimately givesthem a benefit."

Joan Szabo is a writer in Great Falls, Virginia, who hasreported on tax issues for more than 14 years.