Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
2006 Erwin N. Griswold Lecture Before the American College of Tax Counsel:
Now That You’ve Caught the Bus, What Are You Going to Do with It? Observations
From the Frontlines, the Sidelines, and Between the Lines, So to Speak
Pamela F. Olson*
* Partner, Skadden, Arps, Slate, Meagher & Flom LLP, Washington, DC; University of Minnesota, B.A., 1976; University of Minnesota, J.D., 1980; University of Minnesota, M.B.A., 1984. (Ms. Olson was Deputy Assistant Secretary of the Treasury for Tax Policy from 2001 to 2002 and Assistant Secretary from 2002 to 2004.)
First, let’s start with the adult attention deficit disorder version:
1. The tax shelter war is over. The government won.
2. There is no one-size-fits-all solution to abusive tax shelters of the future or tax avoidance concerns.
3. Tax avoidance is not inherently evil.
4. The weapons used to win the abusive tax shelter war will be of limited use in addressing tax compliance concerns of today and tomorrow.
5. The tax system is in serious need of repair.
Now you can go back to your blackberries.
I. The tax shelter war is over. The government won.
Taxpayers may have won a skirmish here and there, the paths may have been uncertain, but the outcome was never in doubt.
How do we know the war is over?
On the corporate side, companies are too busy complying with Sarbanes-
Oxley, electronically filing their Schedules M-3 and Forms 8886, and implementing FIN 48 to have time for tax shelters. A recent survey by accounting firm Ernst & Young confirms this. The survey, which was based on data from 474 companies, indicated corporate tax departments were spending 23% of their time on tax financial reporting requirements in 2006, compared to 9% in 2004. During the same period, the time spent on tax planning decreased from 28% to 20%. The increased demands in financial reporting and tax compliance will continue to reduce companies’ ability to plan or implement tax minimization strategies, legitimate or otherwise.
On the individual side, the promoters, by and large, have been decommissioned. Commissioner Mark Everson stated in written testimony before the Senate Homeland Security and Governmental Affairs Committee, “[w]e are seeing evidence of changed behavior in the marketplace on the part of tax professionals, including accountants and lawyers. No longer are abusive tax shelters being marketed by top level accounting firms.” Commissioner Everson is not known for his optimism about the government’s ability to quell tax shelters, but his statement, which he reiterated at the Tax Section’s breakfast yesterday morning, recognized that the government had turned the corner.
The lack of product affects both businesses and individuals but has a more significant impact on the individual side. Individuals are less likely to cook up tax shelters on their own. They need inspiration.
How did the government win the war?
It took the consistent efforts of multiple parties. Former Commissioner Charles Rossotti laid the groundwork by revitalizing and reorganizing the agency. Every Commissioner, it is said, “reorganizes” the agency, but Commissioner Rossotti did not just move boxes around on an organizational chart. He put a structure in place that allowed the Service to pursue tax shelters in a centralized, coordinated, and organized way that shut the sheltering activities down.
After considerable hand-wringing about its lack of tools to address tax shelters, the Treasury Department began using the authority it had to create an effective disclosure regime for identifying and addressing tax shelter transactions. It is worth noting that while the first regime was not all that effective in surfacing problems, it laid down a marker, and a review of its shortcomings led the Treasury Department in a brief period of time to the development of a more effective regime.
Commissioner Everson’s commitment to enforcing the law unequivocally put words into action. With a firm view that paying one’s taxes is a civic obligation that ought not be shirked, Commissioner Everson has pursued enforcement tenaciously and has been willing to let the chips fall where they may. Building on the reorganization Commissioner Rossotti put in place, Commissioner Everson has succeeded in forcing the agency to rethink its goals and how it goes about achieving them. A recent New York Times news article—and I use the term “news” loosely—illustrates how difficult it is to reform an agency of individuals who would prefer to keep doing business the comfortable way they have always done business without regard to the harm their old ways cause the tax system. The Commissioner and I do not always agree on tax administration, but I admire what he has tried to accomplish in reshaping the agency.
I hesitate to give Congress any credit, since I believe they helped create the problem through actions like the 1997 Senate Finance Committee hearings, but ultimately Congress’s support for the Treasury’s tax shelter proposals and the Service’s compliance programs sent a powerful message that tax shelter activities had risen to a level of nonsense that even Congress would not tolerate. I would add that tax shelters were largely a thing of the past by the time the 2004 tax shelter legislation was finally enacted.
Tax practitioners, particularly members of the Bar, also played an important role by speaking out against tax shelter transactions and advocating for anti tax shelter measures.
Armed with arguments carefully honed by government lawyers, the courts backstopped the Service’s efforts, not quite universally, but with more than enough frequency for taxpayers to realize the courts were an unreliable refuge. Despite the fact that there are still billions of dollars in tax shelter transactions pending resolution in the courts, the clear trend has been in favor of the government.
Finally, the transparency brought about by the tax shelter disclosure web, Schedule M-3, and Sarbanes-Oxley had an effect similar to the passive loss rules of section 469 enacted in 1986. The new regime was not as prophylactic as section 469, but the added risk of detection reduced the benefit and the likelihood of benefit, eliminating much of the incentive for corporations to engage in tax shelter transactions.
A telling sign of the impact of the government’s success is the result of the Service’s Son of BOSS settlement initiative announced in May 2004. Over 1,000 taxpayers responded, conceding 100% of the tax owed, and paying the Service over $3 billion in tax, interest, and, in almost all cases, penalties.
It is important to remember two points about the tax shelter activities that I believe are a thing of the past—for now. The first is that they were but a part of an anything-goes attitude that infected many businesses, professional services firms, and individuals during the 1990s. Viewing these tax shelters as limited to an attack on the tax system misses the broader context in which tax shelters had to be understood and addressed. The second is the fact that tax shelter activities were aided and abetted by the regulators—Treasury and the Service, in this case—talking tough but wringing their hands in lieu of acting. (That is not intended as a criticism of the regulators but rather the environment in which they found themselves—particularly the political environment. If I’d been in the government following the 1997 hearings, sitting on my hands may well have looked like a prudent course of action.) The problem is that the regulators’ tough words weren’t matched by tough actions and that emboldened the fast and loose.
The facts tell the story of the results of inaction. From 1997 to 2000, over 3,000 transactions were registered with the Service by promoters. The Service issued a number to the promoter for the transaction, which the promoter flashed to potential investors like a good housekeeping seal of approval, and then the Service put the registrations in a file drawer to gather dust. Even promoters who knew the registration number did not reflect the Service’s approval took the lack of any action as acquiescence to the purported tax consequences of the transaction. Taking inaction as tacit acquiescence ultimately was a mistake with serious consequences for many promoters. But the Service empowered promoters by failing to act while it had it within its power to rein in tax shelter activities before they got completely out of control. Of course no one living in the real world today would accuse the Service of sitting on its hands. Rather the issue for those giving it serious consideration is what the Service is, and should be, doing.Despite the evidence of success, there continues to be legislative interest in doing something final, something definitive, something dramatic, that will kill all shelters for all times. There is reason for concern about the government’s penchant for fighting the battles of the past rather than focusing on the future. The continuing fascination with codification of the economic substance doctrine illustrates that penchant well.