Abusive Tax SheltersAbusive Tax Shelters

Debbie Langsea Debbie Langsea

California Franchise Tax BoardCalifornia Franchise Tax Board

October 28, 2004October 28, 2004

National Abusive Tax Shelter ProblemNational Abusive Tax Shelter Problem

FEDERAL: up to FEDERAL: up to $85 billion$85 billion loss over last loss over last decade decade (GAO estimate)(GAO estimate)

ALL STATES: up to ALL STATES: up to $12 billion$12 billion corporate corporate loss in 2001 loss in 2001 (MTC estimate)(MTC estimate)

CALIFORNIA: $600 million to CALIFORNIA: $600 million to $1 billion$1 billion loss annually loss annually (FTB estimate)(FTB estimate)

California General Fund RevenuesCalifornia General Fund Revenues

$33

$6

$22

$5

Personal Income Tax

Bank and Corporation

Sales and Use Tax

Other

(Amount in billions)

Capital Gains and Options Income Capital Gains and Options Income 1998 - 2002 ($ Billions)1998 - 2002 ($ Billions)

$58$94

$118

$50 $49

$35

$70

$44 $31

$82

$0

$50

$100

$150

$200

$250

1998 1999 2000 2001 2002

Capital Gains Options

Definition – Abusive Tax Shelter Definition – Abusive Tax Shelter

promoted with the promise of tax benefitspromoted with the promise of tax benefits predictable tax losses or consequences predictable tax losses or consequences no true or correlating economic loss of no true or correlating economic loss of

income or assetsincome or assets follows literal reading of the tax statute, but follows literal reading of the tax statute, but

applies the meaning inconsistent with the applies the meaning inconsistent with the purpose or intent of the tax statute purpose or intent of the tax statute

Characteristics – Abusive Tax SheltersCharacteristics – Abusive Tax Shelters

Separation of income and expensesSeparation of income and expenses Use of pass-through entitiesUse of pass-through entities Use of third-party accommodatorsUse of third-party accommodators Offshore foreign account or accommodatorOffshore foreign account or accommodator Double benefit for the same tax lossDouble benefit for the same tax loss Conducted over a short period of timeConducted over a short period of time

California Abusive Tax Shelter California Abusive Tax Shelter Compliance ProgramCompliance Program

Voluntary ComplianceVoluntary Compliance

DetectionDetection

EnforcementEnforcement

Voluntary ComplianceVoluntary Compliance

Educational Efforts: Educational Efforts: U.S. Senate Hearings, Press Conferences, Press U.S. Senate Hearings, Press Conferences, Press

Releases, Newspapers, Symposiums, Tax News, Releases, Newspapers, Symposiums, Tax News, and Presentationsand Presentations

Internet (Internet (www.ftb.ca.govwww.ftb.ca.gov), VCI e-mail address ), VCI e-mail address and telephone numberand telephone number

32,000 Letters: Taxpayers, Preparers, Promoters, 32,000 Letters: Taxpayers, Preparers, Promoters, and Accounting/Law Firm Employeesand Accounting/Law Firm Employees

40,000 Brochures, Quick References40,000 Brochures, Quick References

Voluntary Compliance Initiative Voluntary Compliance Initiative

California’s 106-Day VCI Program:California’s 106-Day VCI Program:

$1.4 Billion Additional Tax Revenues$1.4 Billion Additional Tax Revenues 1,200 Taxpayers1,200 Taxpayers 2,100 Tax Years2,100 Tax Years

VCI by TaxpayersVCI by Taxpayers

857

340

PIT CORP

VCI by RevenueVCI by Revenue

(in Million Dollars)

$972

$462

PIT CORP

VCI by Tax YearsVCI by Tax Years(in millions)

$4$16

$48

$248

$375

$216

$66

$20$10

$37$17

$58

$90

$119 $115

$0

$50

$100

$150

$200

$250

$300

$350

$400

1990 - 1995 1996 1997 1998 1999 2000 2001 2002

Tax YearPIT CORP

VCI by States

Amounts = $0Amounts < $1 MillionAmounts > $1 MillionAmounts > $1 Billion

Detection – Information SharingDetection – Information Sharing

IRS ATAT Memorandum of Understanding IRS ATAT Memorandum of Understanding (Sept. 2003)(Sept. 2003)

States ATAT Memorandum of Agreement States ATAT Memorandum of Agreement (Feb. 2004)(Feb. 2004)

Detection – Reportable TransactionsDetection – Reportable Transactions

6 Reportable Transaction Categories:6 Reportable Transaction Categories: Listed TransactionsListed Transactions Confidential TransactionsConfidential Transactions Transactions with Contractual Protections Transactions with Contractual Protections

(contingency fees)(contingency fees) Loss TransactionsLoss Transactions Transactions with Significant Book-Tax Transactions with Significant Book-Tax

DifferencesDifferences Transactions with Brief Asset Holding PeriodTransactions with Brief Asset Holding Period

Detection - TaxpayersDetection - Taxpayers

INVESTORS INVESTORS

NEW Registration and Reporting Requirements:NEW Registration and Reporting Requirements:

Disclose Reportable TransactionsDisclose Reportable Transactions Disclose Listed Transactions from 2/28/00Disclose Listed Transactions from 2/28/00

Detection - PromotersDetection - Promoters

PROMOTERSPROMOTERS

NEW Registration and Reporting Requirements:NEW Registration and Reporting Requirements:

Register Tax Shelters or Listed Transactions (from Register Tax Shelters or Listed Transactions (from 2/28/00)2/28/00)

Provide List of Investors for Reportable Provide List of Investors for Reportable

Transactions or LTransactions or Listed Transactions (from isted Transactions (from 2/28/00)2/28/00)

EnforcementEnforcement

Conduct investor and promoter auditsConduct investor and promoter audits Establish Abusive Tax Shelter UnitEstablish Abusive Tax Shelter Unit Pursue leads, investors lists, registrations, and Pursue leads, investors lists, registrations, and

other informational sourcesother informational sources Issue subpoenasIssue subpoenas Focus on promoters, firms, financial Focus on promoters, firms, financial

intermediaries, and insurance companiesintermediaries, and insurance companies Assess abusive tax shelter penaltiesAssess abusive tax shelter penalties Evaluate for criminal prosecutionEvaluate for criminal prosecution

Enforcement - TaxpayersEnforcement - Taxpayers

Investor PenaltyInvestor Penalty AmountAmount

Noneconomic SubstanceNoneconomic Substance 20%-40%20%-40%

Reportable TransactionReportable Transaction 20%-30%20%-30%

Interest Based Interest Based 100% interest100% interest

Failure to Disclose TransactionFailure to Disclose Transaction $15,000-$30,000$15,000-$30,000

Accuracy RelatedAccuracy Related 20%20%

Enforcement - PromotersEnforcement - Promoters

Promoter PenaltyPromoter Penalty AmountAmount

Failure to Register ReportableFailure to Register Reportable $15,000$15,000

Failure to Register Listed TransactionFailure to Register Listed Transaction$100,000 or 50%-75% $100,000 or 50%-75%

gross incomegross income

Failure to Maintain Investor ListFailure to Maintain Investor List $10,000/day$10,000/day

Failure to Provide Listed TransactionFailure to Provide Listed Transaction $100,000 or 50%$100,000 or 50%

PreparerPreparer $1,000-$5,000$1,000-$5,000

PromoterPromoter 50% gross income50% gross income

Enforcement - OtherEnforcement - Other

Other Abusive Tax Shelter Curtailments:Other Abusive Tax Shelter Curtailments: No suspension of interestNo suspension of interest Doubles statute of limitations to 8 yearsDoubles statute of limitations to 8 years Enhances subpoena provisionsEnhances subpoena provisions Ability to enjoin promoters Ability to enjoin promoters Increases interest on amended returns Increases interest on amended returns Eliminates accountant confidentialityEliminates accountant confidentiality

Recent Updates Recent Updates

Federal Tax Shelter LegislationFederal Tax Shelter Legislation Federal District Court DecisionsFederal District Court Decisions Federal SettlementsFederal Settlements Federal De-listed TransactionFederal De-listed Transaction

Comparison of Tax Shelter LawsComparison of Tax Shelter LawsProvisionProvision CA LawCA Law Federal LawFederal Law

Noneconomic SubstanceNoneconomic Substance 20-40% of understatement20-40% of understatement NoneNone

Interest Based PenaltyInterest Based Penalty 100% of interest100% of interest NoneNone

Reportable TransactionReportable Transaction 20-30% of understatement20-30% of understatement SameSame

Failure to DiscloseFailure to Disclose $15,000 $15,000 $30,000 for Listed$30,000 for ListedOnly certain taxpayersOnly certain taxpayers

$10,000-$50,000$10,000-$50,000Up to $200,000 for Up to $200,000 for Listed.Listed.

Failure to RegisterFailure to Register $15,000$15,000$100,000 or 50% gross $100,000 or 50% gross income if Listed.income if Listed.

Repealed registration Repealed registration regime and associated regime and associated penalties. penalties.

Failure to File Information Failure to File Information Return for Reportable Return for Reportable TransactionTransaction

NoneNone $50,000$50,000$200,000 or 50% gross $200,000 or 50% gross income if Listed.income if Listed.

Statute of LimitationsStatute of Limitations 8 years after return filed8 years after return filed Extended 1 year after Extended 1 year after disclosure if originally disclosure if originally undisclosed.undisclosed.

What’s New Summary?What’s New Summary?Investors Beware? Investors Victory?

Black & Decker vs. IRSBlack & Decker vs. IRS– Summary decision held Summary decision held

Black & Decker contingent Black & Decker contingent liability transaction had liability transaction had economic substanceeconomic substance

– Judge did not perform any Judge did not perform any analysis of profit motiveanalysis of profit motive

– IRS is reviewing appeal IRS is reviewing appeal optionsoptions

Delisting of the PORC Delisting of the PORC transactiontransaction

Long Term Capital Long Term Capital Management vs. IRS – Management vs. IRS – – Penalties can be applicable Penalties can be applicable

even with a legal opinion even with a legal opinion regarding the transactionregarding the transaction

Revision to IRS settlement Revision to IRS settlement terms – cost to settle with terms – cost to settle with the IRS has gone upthe IRS has gone up

Federal legislation passed Federal legislation passed enhancing penalties and enhancing penalties and registration requirementsregistration requirements

Additional information can be Additional information can be found on our website at:found on our website at:

www.ftb.ca.govwww.ftb.ca.gov