[Congressional Record Volume 147, Number 99 (Tuesday, July 17, 2001)]
[House]
[Pages H4023-H4028]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]
INTRODUCTION OF ABUSIVE TAX SHELTER SHUTDOWN ACT
The SPEAKER pro tempore. Under the Speaker's announced policy of
January 3, 2001, the gentleman from Texas (Mr. Doggett) is recognized
during morning hour debates for 5 minutes.
Mr. DOGGETT. Mr. Speaker, most of us can appreciate the feeling of
the fellow who declared, ``I am proud to be paying taxes, but I could
be just as proud for half the money!''
Some taxpayers have, in fact, discovered a way to get out for half
the money by exploiting abusive tax avoidance schemes, gimmicks, and
tax shelters. For the millions of Americans who are paying their fair
share of taxes, it is long past time to plug some of the loopholes and
eliminate the tax inequities that threaten public confidence in our tax
system.
Today, together with the gentleman from New York (Mr. Rangel), the
ranking member of the Committee on Ways and Means and a number of my
Democratic colleagues on the committee, I am introducing the Abusive
Tax Shelter Shutdown Act to address these concerns.
With the Bush administration already dipping into the Medicare trust
fund to pay for its many undertakings, we face a challenge. To
implement a patients' bill of rights, to ensure that the dipping into
the Medicare trust fund does not extend to an invasion of the Social
Security trust fund, and to provide reasonable tax relief, we must
ensure that lower tax revenues are offset. We must secure what are
known around this House as ``pay-for's'' to pay for the enactment of
any new initiatives.
With the bill that we are introducing today, we say: what better
place to start than with the high rollers who are cheating and gaming
our tax system.
This new bill represents a refinement of legislation that I
originally introduced in 1999. The Washington Post, the Los Angeles
Times, and several other newspapers have already endorsed that
initiative. The abuses that it addresses were first brought to my
attention by a constituent in Austin who directed my attention to this
Forbes magazine. Forbes, which proudly proclaims itself ``the
capitalist tool,'' did a cover story called ``Tax Shelter Hustlers''
with a fellow in a fedora on the cover, and stated, ``Respectable
accountants are peddling dicey corporate loopholes.'' Inside, that
cover story begins, ``Respectable tax professionals and respectable
corporate clients are exploiting the exotica of modern corporate
finance to indulge in extravagant tax dodging schemes.''
Forbes reported that Big 5 accounting firms require staffers, in one
case, to come up with at least one new corporate tax dodge per week.
The literal
[[Page H4024]]
hustling of these improper tax avoidance schemes is so commonplace
that the representative of one major Texas-based multinational
indicated that he gets a cold call every day from someone hawking such
shelters.
As Stefan Tucker, former Chair of the American Bar Association Tax
Section, a group comprised of 20,000 tax lawyers across the country,
told the Senate Finance Committee: ``[T]he concerns being voiced about
corporate tax shelters are very real; these concerns are not hollow or
misplaced, as some would assert. We deal with corporate and other major
taxpayer clients every day who are bombarded, on a regular and
continuous basis, with ideas or ``products'' of questionable merit.''
Two years later, we have this sequel from Forbes which raises the
question, ``How to cheat on your taxes?'' It concludes that the
marketing of push-the-edge and over-the-edge tax shelters ``represent
the most striking evidence of the decline in [tax] compliance'' in our
country today. The ``outrageous shelters'' that it reports about in its
cover story are literally ``tearing this country's tax system apart.''
It raises the question that more and more taxpayers are asking: ``Am I
a chump for paying what I owe?''
Here is basically what this bill seeks to do: First, it seeks to stop
these schemes that have no ``economic substance.'' That is, deals that
are done not to achieve economic gain in a competitive marketplace or
for other legitimate business reasons but to generate losses that offer
a way to avoid the tax collector.
Second, it prevents tax cheats from buying the equivalent of a ``get-
out-of-jail-free'' card to protect themselves in the unlikely event
that they get caught. Some fancy legal opinion cannot be used as
insurance against penalties for tax underpayments on transactions that
have no economic substance.
Third, the bill increases and tightens penalties for tax dodging so
that there is at least some downside risk to cheating.
Fourth, it requires the promoters and hustlers who market tax
shelters to share a little of the penalty themselves with the offending
taxpayer.
Fifth, it punishes the lawyers who write ``penalty insurance''
opinions that any reasonable person would know are unjustified.
Sixth, it penalizes those who fail to follow the disclosure rules. It
recognizes that too often secrecy is the growth hormone for these
complex tax-cheating shelter gimmicks.
Seventh, it expands the types of tax shelters that must be registered
with the IRS, thereby facilitating tax enforcement.
Finally, it targets a few of what some might view as ``attractive
nuisances.'' That is, tax code provisions that are particularly subject
to manipulation and misuse.
Battling these shelters one at a time, through years of costly
litigation, has not prevented the steady growth in abusive practices.
Indeed, the creativity and speed with which new and more complicated
tax shelters are devised is remarkable. Following judicial and
administrative rulings, tax shelters are repackaged and remarketed with
creative titles like sequels to bad movies.
One type of gimmickery, called LILO, has been used by an American
company, which rents a Swiss town hall, not for any gathering, but only
to rent it immediately back to the Swiss. The corporation takes a
deduction from current taxable income for the total rental expense,
while deferring income from its ``re-rental'' until far into the
future. Within months of Treasury shutting down such abusive LILO
transactions, products were soon being sold as the ``Son of LILO,''
with only a modicum of difference from the previous version.
I have modified this legislation to take into account the comments
that were raised at a November 1999 Committee on Ways and Means
hearing. I have incorporated recommendations from the American Bar
Association tax section, and bipartisan suggestions from leaders of the
Senate Finance Committee last year. This bill has been carefully
designed to curtail egregious behavior without impacting legitimate
business deals.
Most of these refinements have had a very plain purpose: eliminate
the excuse for inaction. This bill should now be acceptable to everyone
but most blatant shelter hustlers. But that may not be the case.
Treasury Secretary Paul O'Neill recently gave an interview to a
London newspaper in which he favored eliminating corporate taxation. If
that is the ultimate objective, if he just waits a little while
maintaining the same attitude of indifference in the face of rapidly
proliferating shelter schemes it may eventually be accomplished. This
will leave just a few ``corporate chumps'' paying anything close to
their fair share.
Most taxpayers realize that if someone in the corporate towers or
just down the street is not paying their fair share, you and I, and the
others who play by the rules, must pay more to pick up the slack. And
that slack, that loss of revenue to abusive tax shelters, is not
estimated to exceed $10 billion per year.
And that lost revenue could be put to better use. The bipartisan
leaders of the managed care reform bill in the last Congress relied
upon this proposal to offset any reduced federal revenues associated
with adopting the Patients Bill of Rights. Although blocked
procedurally, Representative Charlie Norwood (R-GA) got it right in
telling the House Rules Committee, ``There is a large difference in
what you call a tax increase and stopping bogus tax shelters. That is
really two different things. They aren't just asking them to pay more
taxes, we are trying to keep them from cheating the system.''
Today, we sponsors of this legislation offer a constructive way of
correcting abusive tax shelters, described by former Treasury Secretary
Larry Summers as ``the most serious compliance issue threatening the
American tax system.'' Battling corporate tax cheats is not a partisan
issue, it is a question of fundamental fairness. This Congress should
promptly respond.
Technical Explanation of H.R. , the ``Abusive Tax Shelter Shutdown
Act of 2001''
TITLE I--CLARIFICATION OF ECONOMIC SUBSTANCE DOCTRINE (SEC. 101)
present law
In general
The Internal Revenue Code (``Code'') provides specific
rules regarding the computation of taxable income, including
the amount, timing, and character of items of income, gain,
loss and deductions. These rules are designed to provide for
the computation of taxable income in a manner that provides
for a degree of specificity to both taxpayers and the
government. Taxpayers generally may plan their transactions
in reliance on these rules to determine the federal income
tax consequences arising from the transactions.
Notwithstanding the presence of these rules for determining
tax liability, the claimed tax results of a particular
transaction may be challenged by the Secretary of the
Treasury. For example, the Code grants the Secretary various
authority to challenge tax results that would result in an
abuse of these rules or the avoidance or evasion of tax
(Secs. 269, 446, 482, 7701(l)). Further, the Secretary can
challenge a tax result by applying the so-called ``economic
substance doctrine.'' This doctrine has been applied by the
courts to deny unwarranted and unintended tax benefits in
transactions whose undertaking does not result in a
meaningful change to the taxpayer's economic position other
than a purported reduction in federal income tax. Closely
related doctrines also applied by the courts (sometimes
interchangeable with the economic substance doctrine) include
the so-called ``sham transaction doctrine'' and the
``business purpose doctrine''. (See, for example, Knetsch v.
United States, 364 U.S. 361 (1960) denying interest
deductions on a ``sham transaction'' whose only purpose was
to create the deductions.) Also, the Secretary can argue that
the substance of a transaction is different from the form in
which the taxpayer has structured and reported the
transaction and therefore, the taxpayer applied the improper
rules to determine the tax consequences. Similarly, the
Secretary may invoke the ``step-transaction doctrine'' to
treat a series of formally separate ``steps'' as a single
transaction if the steps are integrated, interdependent, and
focused on a particular result.
Economic substance doctrine
The economic substance doctrine is a common law doctrine
denying tax benefits in transactions which, apart from their
claimed tax benefits, have little economic significance.
The seminal authority for the economic substance doctrine
is the Supreme Court and Second Circuit decisions in Gregory
v. Helvering (293 U.S. 465 (1935), aff'g 69 F.2d 809 (2d Cir.
1934). In that case, a transitory subsidiary was used to
effectuate a tax-advantaged distribution form a corporation.
Notwithstanding that the transaction satisfied
[[Page H4025]]
the literal definition of a tax-free reorganization, the
courts denied the intended benefits of the transactions,
stating: ``The purpose of the [reorganization] section is
plain enough, men [and women] engaged in enterprises--
industrial, commercial, financial, or an other--might wish to
consolidate, or divide, to add to, or subtract from, their
holdings. Such transactions were not to be considered
`realizing' and profit, because the collective interests
still remained in solution. But the underlying presupposition
is plain that the readjustment shall be undertaken for
reasons germane to the conduct of the venture in hand, not as
an ephemeral incident, egregious to its prosecution. To dodge
the shareholder's taxes is not one of the transactions
contemplated as corporate `reorganizations'.'' (69 F.2d at
811).
The economic substance doctrine was applied in the case of
Goldstein v. Commissioner (364 F.2d 734 (2d Cir. 1966))
involving a taxpayer who borrowed to acquire Treasury
securities. Under the law then in effect, she was able to
deduct a substantial amount of prepaid interest.
Notwithstanding that the Code allowed a deduction for the
prepaid interest, the Court disallowed the deduction stating:
``this provision [sec. 163(a)] should not be construed to
permit an interest deduction when it objectively appears that
a taxpayer has borrowed funds in order to engage in a
transaction that has no substance or purpose other than to
obtain the tax benefit of an interest deduction.''
Likewise in Shelton v. Commissioner (94 T.C. 738 (1990)), a
taxpayer borrowed money to purchase Treasury bills. Under the
law at that time, the interest on the borrowing was
deductible, but interest on the Treasury bills did not have
to be accrued currently. The taxpayer deducted the interest
on the borrowing currently and deferred the interest income.
The court, as in the Goldstein case, disallowed the interest
deduction because the transaction lacked economic substance.
Similarly, the economic substance doctrine has been applied
to disallow losses in cases where taxpayers invested in
commodity straddles (Yosha v. Commissioner, 861 F.2d 494 (7th
Cir. 1988)).
Recently, the courts have applied the economic substance
doctrine to deny the benefits of an intricate plan
principally designed to create losses by investing in a
partnership holding debt instruments that were sold for
contingent installment notes. Both the Tax Court and the
Court of Appeals for the Third Circuit held that the
transaction lacked economic substance and thus disallowed the
``artificial loss'' (ACM Partnership v. Commissioner, 157
F.3d 231 (3d Cir. 1998), aff'g 73 T.C.M. 2189 (1997)). The
Tax Court opinion stated: ``the transaction must be
rationally related to a useful nontax purpose that is
plausible in light of the taxpayer's conduct and useful in
the light of the taxpayer's economic situation and
intentions. Both the utility of the stated purpose and the
rationality of the means chosen to effectuate it must be
evaluated in accordance with the commercial practices in the
relevant industry . . . A rational relationship between
purpose and means ordinarily will not be found unless there
was a reasonable expectation that the nontax benefits would
at least be commensurate with the transaction costs.''
Courts have likewise denied the tax benefits in cases
involving the misuse of seller-financed corporate-owned life
insurance (Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C.
No. 21 (1999); American Electric Power Inc. v. United States
(S.D. Ohio, No. C2-99-724, Feb. 20, 2001)) and foreign tax
credits (Compaq Computer Corp. v. Commissioner, 113 T.C. No.
17 (1999). However, see IES Industries v. United States, 2001
U.S. App. LEXIS 12881 (8th Cir. June 14, 2001) for a contrary
decision) in transactions the court determined were lacking
economic substance.
Business purpose doctrine
The courts use the business purpose doctrine (in
combination with economic substance) as part of a two-prong
test for determining whether a transaction should be
disregarded for tax purposes: (1) the taxpayer was motivated
by no business purpose other than obtaining tax benefits in
entering the transaction, and (2) the transaction lacks
economic substance (Rice's Toyota World, 752 F.2d 89, 91
(1985)). In essence a transaction will be respected for tax
purposes if it has ``economic substance or encouraged by
business or regulatory realities, is imbued with tax-
independent consideration, and is not shaped solely by tax-
avoidance features that have meaningless label attached.''
(Frank Lyon Co. v. Commissioner, 435 U.S. 561 (1978)).
explanation of provision
In general
Under the bill, the economic substance doctrine is made
uniform and is enhanced. The bill provides that in applying
the economic substance doctrine, a transaction will be
treated as having economic substance only if the transaction
changes in a meaningful way (apart from Federal income tax
consequences) the taxpayer's economic position, and the
transaction has a substantial nontax purpose which would be
reasonably accomplished by the transaction. This aspect of
the bill clarifies the judicial application of the economic
substance doctrine and would overturn the results in certain
court cases, such as the result in IES Industries (see
above). The bill provides that if a profit potential is
relied on to demonstrate that a transaction results in a
meaningful change in economic position (and therefore has
economic substance), the present value of the reasonably
expected pre-tax profit must be substantial in relation to
the present value of the expected net tax benefits that would
be allowed if the transaction were respected. The potential
for a profit not in excess of a risk-free rate of return will
not satisfy the test. In determining pre-tax profit, fees and
other transaction expenses and foreign taxes are treated as
expenses.
Under the bill, a taxpayer may rely on factors other than
profit potential for a transaction to have a meaningful
change in the taxpayer's economic position; the bill merely
sets forth a minimum profit potential if that test is relied
on to demonstrate a meaningful change in economic position.
In applying the profit test to the lessor of tangible
property, depreciation and tax credits (such as the
rehabilitation tax credit and the low income housing tax
credit) are not to be taken into account in measuring tax
benefits. Thus, a traditional leveraged lease is not affected
by the bill to the extent it meets the present law standards.
Except as the bill otherwise specifically provides,
judicial doctrines disallowing tax benefits for lack of
economic substance, business purpose, or similar reasons will
continue to apply as under present law.
Transactions with tax-indifferent parties
The bill also provides special rules for transactions with
tax-indifferent parties. For this purpose, a tax-indifferent
party means any person or entity not subject to Federal
income tax, or any person to whom an item would have no
substantial impact on its income tax liability, for example,
by reasons of its method of accounting (such as mark-to-
market). Under these rules, the form of a financing
transaction will not be respected if the present value of the
tax deductions to be claimed is substantially in excess of
the present value of the anticipated economic returns to the
lender. Also, the form of a transaction with a tax-
indifferent party in excess of the tax-indifferent party's
economic gain or income or if it results in the shifting of
basis on account of overstating the income or gain of the
tax-indifferent party.
effective date
The provision applies to transactions after the date of
enactment.
TITLE II--PENALTIES
1. Modifications to accuracy-related penalty (sec. 201)
present law
A 20-percent penalty applies to any portion of an
underpayment of income tax required to be shown on a return
to the extent that it is attributable to negligence or to
a substantial understatement of income tax. For purposes
of the penalty, an understatement is considered
``substantial'' if it exceeds the greater of (1) 10
percent of the tax required to be shown on the return, or
(2) $5,000 ($10,000 in the case of a C corporation that is
not a personal holding company).
The penalty does not apply if there was reasonable cause
for the understatement and the taxpayer acted in good faith
with respect to the understatement. In addition, except in
the case of a tax shelter, the substantial understatement
penalty does not apply if there was substantial authority for
the tax treatment of an item or if there was adequate
disclosure of the item and reasonable basis for the treatment
of the item. In the case of a tax shelter of a noncorporate
taxpayer, the substantial authority exception applies if the
taxpayer reasonably believed that the claimed treatment was
more likely than not the proper treatment. For this purpose,
a tax shelter means a partnership or other entity, plan or
arrangement, if a significant purpose of the entity, plan or
arrangement was the avoidance or evasion of Federal income
tax.
explanation of provision
Enhanced penalty for disallowed noneconomic tax attributes
The bill increases the accuracy-related penalty for
underpayments attributable to disallowed noneconomic tax
attributes. The rate of the penalty is increased to 40
percent unless the taxpayer discloses to the Secretary of the
Treasury or his delegate such information as the Secretary
shall prescribe with respect to such transaction. No
exceptions (including the reasonable cause exception) to the
imposition of the penalty will apply in the case of
disallowed noneconomic tax attributes.
The enhanced penalty applies to the extent that the
underpayment is attributable to the disallowance of any tax
benefit because of a lack of economic substance (as provided
by the bill), because the transaction was not respected under
the rules added by the bill relating to transactions with
tax-indifferent parties, because of a lack of business
purpose or because the form of the transaction does not
reflect its substance, or because of any similar rule of law
disregarding meaningless transactions whose undertaking were
not in the furtherance of a legitimate business or economic
purpose.
Modifications to substantial understatement penalty
The bill makes several modifications to the substantial
understatement penalty. First, the bill treats an
understatement as substantial if it exceeds $500,000,
regardless of whether it exceeds 10 percent of the taxpayer's
total tax liability. Second, the bill treats tax shelters of
noncorporate taxpayers the same as the present law treatment
of corporate tax shelter; thus the exception from the penalty
for substantial authority (under section 6662(b)(2)(B)(i))
will not apply.
[[Page H4026]]
Third, the bill provides that the determination of the amount
of underpayment shall not be less than the amount that would
be determined if the items not attributable to a tax shelter
or to a transaction having disallowed noneconomic tax
attributes (discussed below) were treated as being correct.
Finally, an underpayment may not be reduced by reason of
filing an amended return after the taxpayer is first
contacted by the IRS regarding the examination of its return.
effective date
The enhanced penalty applies to transactions after the date
of enactment. The modifications to the substantial
understatement penalty apply to taxable years ending after
the date of enactment.
2. Promoter penalties (sec. 202)
present law
Any person who (1) organizes any partnership, entity, plan,
or arrangement, or (2) participates in the sale of any
interest in such a structure, and makes or furnishes a
statement (or causes another to make or furnish a statement)
with respect to any material tax benefit attributable to the
arrangement or structure that the person knows (or has reason
to know) is false or fraudulent is subject to a penalty. The
amount of the penalty is equal to the lesser of (1) $1,000 or
(2) 100 percent of the gross income derived by the promoter
from each activity (sec. 6700(a)). There is no statute of
limitations on the assessment of a penalty under section 6700
(Capozzi v. Commissioner, 980 F.2d 872 (2nd Cir. 1992); Lamb
v. Commissioner, 977 F.2d 1296 (8th Cir. 1992)).
explanation of provision
The bill imposes a penalty on any substantial promoter of a
tax avoidance strategy if the strategy fails to satisfy any
of the judicial doctrines that may be applied in the
disallowance of noneconomic tax attributes (as described in
section 201 of the bill).
A tax avoidance strategy means any entity, plan,
arrangement, or transaction a significant purpose of which is
the avoidance or evasion of Federal income tax. A substantial
promoter means any person (and any related person) who
participates in the promotion, offering, or sale of a tax
avoidance strategy to more than one potential participant and
for which the person expects to receive aggregate fees in
excess of $500,000.
The IRS can assess a penalty on a promoter independent of
the taxpayer's audit, and the promoter can challenge the
penalty prior to a final determination with respect to the
taxpayer's disallowed tax benefit. The promoter can challenge
the imposition of the penalty in court independent of any
litigation with the taxpayer.
The amount of the penalty equals 100 percent of the gross
income derived (or to be derived) by the promoter from the
strategy. This would include contingent fees, rebated fees,
and fees that are structured as an interest in the
transaction. Coordination rules are provided to avoid the
imposition of multiple penalties on promoters (i.e., the
penalty does not apply if a penalty is imposed on the
substantial promoter for promoting an abusive tax shelter
under present-law section 6700(a)). As under present-law
section 6700, there is not statute of limitations on the
assessment of the penalty.
The bill also increases the present-law promoter penalty to
the greater of $1,000 or 100 percent of the gross income
derived (or to be derived) by the promoter from each
activity.
effective date
The penalty for promoting tax avoidance strategies applies
with respect to any interest in a tax avoidance strategy that
is offered after the date of enactment. The increase in the
present-law penalty for promoting abusive tax shelters
applies to transactions after the date of enactment.
3. Modifications to the aiding and abetting penalty (sec. 203)
present law
A penalty is imposed on any person who aids, assists in,
procures, or advises with respect to the preparation or
presentation of any return or other document if (1) the
person knows (or has reason to believe) that the return or
other document will be used in connection with any material
matter arising under the tax laws, and (2) the person knows
that if the portion of the return or other document were so
used, an understatement of the tax liability would result
(sec. 6701). An exception is provided for individuals who
furnish mechanical assistance with respect to a document.
The amount of the penalty is $1,000 for each return or
other document ($10,000 in the case of returns and documents
relating to the tax of a corporation).
explanation of provision
The bill modifies the aiding and abetting penalty as it
relates to any person who offers an opinion regarding the tax
treatment of an item attributable to a tax shelter or any
other transaction involving a noneconomic tax attribute.
Under the bill, a penalty is imposed on any person who is
involved in the creation, sale, implementation, management,
or reporting of a tax shelter, or of any partnership, entity,
plan or arrangement that involves the disallowance of a
noneconomic tax attribute (as described in section 201 of the
bill), but only if (1) the person opines, advises, or
indicates that the taxpayer's treatment of an item
attributable to such a transaction would more likely than not
prevail or not give rise to a penalty, and (2) the opinion,
advice, or indication is unreasonable. If the opinion
involved a higher standard (for example, a `should opinion),
and the opinion was unreasonable, then the person who offered
the opinion would be subject to the proposed penalty. An
opinion would be considered unreasonable if a reasonably
prudent and careful person under similar circumstances would
not have offered such an opinion.
The amount of the penalty is 100 percent of the gross
proceeds derived by the person from the transaction. In
addition, upon the imposition of this penalty, the Secretary
is required to notify the IRS Director of Practice and any
appropriate State licensing authority of the penalty and the
circumstances under which it was imposed. Also, the Secretary
must publish the identity of the person and the fact that the
penalty was imposed on the person.
effective date
The provision applies to transactions entered into after
date of enactment.
4. Penalty for failure to maintain list of investors (sec. 204)
Present Law
Any person who organizes a potentially abusive tax shelter
or who sells an interest in such a shelter must maintain a
list that identifies each person who purchased an interest in
the shelter (sec. 6112). A potentially abusive tax shelter
means (i) any tax shelter with respect to which registration
is required under section 6111, and (ii) any entity,
investment plan or arrangement, or any other plan or
arrangement that is of a type that has a potential for tax
avoidance or evasion and that is designated in regulations
issued by the Secretary. The investor list must include the
name, address and taxpayer identification number of each
purchaser, as well as any other information that the
Secretary may require. The lists must generally be maintained
for seven years.
The penalty for any failure to meet any of the requirements
of this provision if $50 for each person with respect to whom
there is a failure, up to a maximum of $50,000 in any
calendar year. The penalty is not imposed where the failure
is due to reasonable cause and not due to willful neglect.
This penalty is in addition to any other penalty provided by
law.
explanation of provision
The bill increases the penalty for the failure to maintain
investor lists in connection with the sale of interests in a
tax shelter (as defined in section 6662(d)(2)(C)(iii) or in
any partnership, entity, plan or arrangement that involves
the disallowance of a noneconomic tax attribute (as described
in section 201 of the bill). In these cases, the penalty is
equal to the greater of 50 percent of the gross proceeds
derived (or to be derived) from each person with respect to
which there was a failure (with no maximum limitation).
effective date
The increased penalty applies to transactions entered into
after date of enactment.
5. Penalty for failure to disclose reportable transactions (sec. 205)
present law
A taxpayer must file a return or statement in accordance
with the forms and regulations prescribed by the Secretary
(including any required information). (See Section 6011). In
February 2000, the Treasury Department issued temporary and
proposed regulations under section 6011 that require
corporate taxpayers to include in their tax return
information with respect to certain large transactions with
characteristics that may be indicative of tax shelter
activity.
Specifically, the regulations require the disclosure of
information with respect to ``reportable transactions.''
There are two categories of reportable transactions. The
first category covers transactions that are the same as (or
substantially similar to) tax avoidance transactions the IRS
has identified in published guidance (a ``listed''
transaction) and that are expected to reduce a corporation's
income tax liability by more than $1 million in any year or
by more than $2 million for any combination of years. (Treas.
Reg. sec. 1.6011-4T(b)(2) and -(b)(4)). The second category
covers transactions that are expected to reduce a
corporation's income tax liability by more than $5 million in
any single year or $10 million for any combination of years
and that exhibit at least two of six enumerated
characteristics. (Treas. Reg. sec. 1.6011-4T(b)(3) and -
(b)(4)).
There is no penalty for failing to adequately disclose a
reportable transaction. However, the nondisclosure could
indicate that the taxpayer has not acted in ``good faith''
with respect to the underpayment. (T.D.8877).
explanation of provision
The bill imposes a penalty for failing to disclose the
required information with respect to a reportable transaction
(unless the failure was due to reasonable cause and not due
to willful neglect). The amount of the penalty is equal to
the greater of (1) five percent of any increase in Federal
income tax which results from a difference between the
taxpayer's treatment of the items attributable to the
reportable transaction and the proper tax treatment of such
items, or (2) $100,000. If the failure to disclose relates to
a listed transaction (or a substantially similar
transaction), the percentage rate is increased to 10 percent
of any increase in tax from the transaction (or, if greater,
$100,000).
[[Page H4027]]
The penalty for failure to disclose information with
respect to a reportable transaction is in addition to any
accuracy-related penalty that may be imposed on the taxpayer.
effective date
The provision applies to transactions entered into after
date of enactment.
6. Registration of certain tax shelters offered to non-corporate
participants (sec. 206)
present law
A promoter of a confidential corporate tax shelter is
required to register the tax shelter with the IRS (sec.
6111(d)). Registration is required not later than the next
business day after the day when the tax shelter is first
offered to potential users. For this purpose, a confidential
corporate tax shelter includes any entity, plan, arrangement
or transaction (1) a significant purpose of which is the
avoidance or evasion of Federal income tax for a direct or
indirect participant that is a corporation, (2) that is
offered to any potential participant under conditions of
confidentiality, and (3) for which the tax shelter promoters
may receive aggregate fees in excess of $100,000.
The penalty for failing to timely register a confidential
corporate tax shelter is the greater of $10,000 or 50 percent
of the fees payable to any promoter with respect to offerings
prior to the date of late registration unless due to
reasonable cause (sec. 6707(a)(3)). Intentional disregard of
the requirement to register increases the 50-percent penalty
to 75 percent of the applicable fees.
explanation of provision
The bill deletes the requirement that a direct or indirect
participant must be a corporation. Thus, the provision
extends the present-law registration requirements to include
a promoter of any confidential tax shelter (regardless of the
participant). The penalty for failing to timely register a
confidential tax shelter remains unchanged (i.e., the greater
of $10,000 or 50 percent of the fees payable to any promoter
with respect to offerings prior to the date of late
registration).
Effective Date
The provision applies to any tax shelter interest that is
offered to potential participants after the date of
enactment.
TITLE III--LIMITATIONS ON IMPORTATION AND TRANSFER OF BUILT-IN LOSSES
1. Limitation on importation of built-in losses (sec. 301)
present law
Under present law, the basis of property received by a
corporation in a tax-free incorporation, reorganization, or
liquidation of a subsidiary corporation is the same as the
adjusted basis in the hands of the transferor, adjusted for
gain or loss recognized by the transferor (Secs. 334(b) and
362(a) and (b)). If a person or entity that is not subject to
U.S. income tax transfers property with an adjusted basis
higher than its fair market value to a corporation that is
subject to U.S. income tax, the ``built-in'' loss would be
imported into the U.S. tax system, and the transferee
corporation would be able to recognize the loss in computing
its U.S. income tax.
explanation of provision
The bill provides that if a net built-in loss is imported
into the U.S. in a tax-free organization or reorganization
from persons not subject to U.S. tax, the basis of all
properties so transferred will be their fair market value. A
similar rule will apply in the case of the tax-free
liquidation by a domestic corporation of its foreign
subsidiary.
Under the bill, a net built-in loss is considered imported
into the U.S. if the aggregate adjusted bases of property
received by a transferee corporation subject to U.S. tax from
persons not subject to U.S. tax with respect to the property
exceeds the fair market value of the properties transferred.
Thus, for example, if in a tax-free incorporation, some
properties are received by a corporation from U.S. persons,
and some properties are relieved from foreign persons not
subject to U.S. tax, this provision applies to the aggregate
properties relieved from the foreign persons. In the case of
a transfer by a partnership (either domestic or foreign),
this provision applies as if the properties had been
transferred by each of the partners in proportion to their
interests in the partnership.
Effective Date
The provision applies to transactions after the date of
enactment.
2. Disallowance of partnership loss transfers (sec. 302)
present law
Contributions of property
Under present law, if a partner contributes property to a
partnership, generally no gain or loss is recognized to the
contributing partner at the time of contribution (Sec. 721).
The partnership takes the property at an adjusted basis equal
to the contributing partner's adjusted basis in the
property (Sec. 723). The contributing partner increases
its basis in its partnership interest by the adjusted
basis of the contributed property (Sec. 722). Any items of
partnership income, gain, loss and deduction with respect
to the contributed property is allocated among the
partners to take into account any built-in gain or loss at
the time of the contribution (Sec. 704(c)(1)(A)). This
rule is intended to prevent the transfer of built-in gain
or loss from the contributing partner to the other
partners by generally allocating items to the
noncontributing partners based on the value of their
contributions and by allocating to the contributing
partner the remainder of each item. (Note: where there is
an insufficient amount of an item to allocate to the
noncontributing partners, Treasury regulations allow for
reasonable allocations to remedy this insufficiency.
Treas. Reg. sec. 1-704(c) and (d)).
If the contributing partner transfer its partnership
interest, the built-in gain or loss will be allocated to the
transferee partner as it would have been allocated to the
contributing partner (Treas. Reg. sec. 1.704-3(a)(7). If the
contributing partner's interest is liquidated, there is no
specific guidance preventing the allocation of the built-in
loss to the remaining partners. Thus, it appears that losses
can be ``transferred'' to other partners where the
contributing partner no longer remains a partner.
Transfers of partnership interests
Under present law, a partnership does not adjust the basis
of partnership property following the transfer of a
partnership interest unless the partnership has made a one-
time election under section 754 to make basis adjustments
(Sec. 743(a)). If an election is in effect, adjustments are
made with respect to the transferee partner in order to
account for the difference between the transferee partner's
proportionate share of the adjusted basis of the partnership
property and the transferee's basis in its partnership
interest (Sec. 743(b)). These adjustments are intended to
adjust the basis of partnership property to approximate the
result of a direct purchase of the property by the transferee
partner. Under these rules, if a partner purchases an
interest in a partnership with an existing built-in loss and
no election under section 754 in effect, the transferee
partner may be allocated a share of the loss when the
partnership disposes of the property (or depreciates the
property).
Distributions of partnership property
With certain exceptions, partners may receive distributions
of partnership property without recognition of gain or loss
by either the partner or the partnership (Sec. 731 (a) and
(b)). In the case of a distribution in liquidation of a
partner's interest, the basis of the property distributed in
the liquidation is equal to the partner's adjusted basis in
its partnership interest (reduced by any money distributed in
the transaction) (Sec. 732(b)). In a distribution other than
in liquidation of a partner's interest, the distributee
partner's basis in the distributed property is equal to the
partnership's adjusted basis in the property immediately
before the distribution, but not to exceed the partner's
adjusted basis in the partnership interest (reduced by any
money distributed in the same transaction )(Sec. 734(a)).
Adjustments to the basis of the partnership's undistributed
properties are not required unless the partnership has made
the election under section 754 to make basis adjustments
(sec. 734(a)). If an election is in effect under section 754,
adjustments are made by a partnership to increase or decrease
the remaining partnership assets to reflect any increase or
decrease in the adjusted basis of the distributed properties
in the hands of the distributee partner (Sec. 734(b)). To the
extent the adjusted basis of the distributed properties
increases (or loss is recognized) the partnership's adjusted
basis in its properties is decreased by a like amount;
likewise, to the extent the adjusted basis of the
distributed properties decrease (or gain is recognized),
the partnership's adjusted basis in its properties is
increased by a like amount. Under these rules, a
partnership with no election in effect under section 754
may distribute property with an adjusted basis lower than
the distributee partner's proportionate share of the
adjusted basis of all partnership property and leave the
remaining partners with a smaller net built-in gain or a
larger net built-in loss than before the distribution.
description of provision
Contributions of property
Under the bill, a built-in loss may be taken into account
only by the contributing partner and not by other partners.
Except as provided in regulations, in determining the amount
of items allocated to partners other than the contributing
partner, the basis of the contributed property shall be
treated as the fair market value on the date of contribution.
Thus, if the contributing partner's partnership interest is
transferred or liquidated, the partnership's adjusted basis
in the property will be based on its fair market value at the
date of contribution, and the built-in loss will be
eliminated. (Note: it is intended that a corporation
succeeding to attributes of the contributing corporate
partner under section 381 shall be treated in the same manner
as the contributing partner).
Transfers of partnership interests
The bill provides that the basis adjustment rules under
section 743 will be required in the case of the transfer of a
partnership interest with respect to which there is a
substantial built-in loss. For this purpose, a substantial
built-in loss exists where the transferee partner's
proportionate share of the adjusted basis of the partnership
property exceeds 110 percent of the transferee partner's
basis in the partnership interest in the partnership. Thus,
for example, assume that partner A sells his partnership
interest to B for its fair market value of $100. Also assume
that B's proportionate share of the adjusted basis of the
partnership assets is $120. Under the bill, section 743(b)
will apply and require a $20 decrease in the adjusted basis
of the partnership assets with respect to B, so that B
[[Page H4028]]
would recognize no gain or loss if the partnership
immediately sold all of its assets for their fair market
value.
Distribution of partnership property
The bill provides that the basis adjustments under section
734 are required in the case of a distribution with respect
to which there is a substantial basis reduction. A
substantial basis reduction means a downward adjustment to
the partnership assets (had a section 754 election been in
effect) greater than 10 percent of the adjusted basis of the
assets.
Thus, for example, assume that A and B each contributed $25
to a newly formed partnership and C contributed $50 and that
the partnership purchased LMN stock for $30 and XYZ stock for
$70. Assume that the value of each stock declined to $10.
Assume LMN stock is distributed to C in liquidation of its
partnership interest. As under present law, the basis of LMN
stock in C's hands if $50. C would recognize a loss of $40 if
the LMN stock were sold for $10.
Under the bill, there is a substantial basis adjustment
because the $20 increase in the adjusted basis of asset 1
(sec. 734(b)(2)(B)) is greater than 10 percent of the
adjusted basis of partnership assets of $70. Thus, the
partnership would be required to decrease the basis of XYZ
stock (under section 734(b)(2)) by $20 (the amount by which
the basis LMN stock was increased), leaving a basis of $50.
If the XYZ stock were then sold by the partnership for $10, A
and B would each recognize a loss of $20.
effective date
The provision applies to contributions, transfers, and
distributions (as the case may be) after date of enactment.
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