ABA Tax Section Queries Senate's Tax Shelter Law

by Glen Shapiro, LawAndTax-News.com, New York

12 January 2006

Dennis B. Drapkin, Chair of the American Bar Association's Taxation Section has written to senior US congressmen to complain about the effects of clauses in the Tax Relief Act of 2005, passed by the Senate late last year, which would codify the 'economic substance' doctrine in US tax law.

Mr Drapkin wrote among others to Senators Charles Grassley (Chairman of the Senate Committee on Finance) and Max Baucus (Ranking Member of the Senate Committee on Finance), as well as to House members William Thomas and Charles Rangel.

The letter identifies three provisions of the Act which would:

• codify the “economic substance” doctrine and create a 40% penalty for “noneconomic substance” transactions;
• require a 20%, nonrefundable down payment for certain offers in compromise; and
• create increased penalties and restrict access to judicial review in an attempt to reduce frivolous tax submission.

'However well intended,' writes Mr Drapkin, 'these provisions may have significant ramifications for bona fide business transactions that are far removed from the tax shelter transactions that are the intended target of the legislation. Moreover, the concerns that underlie this legislation were recently addressed by the tax shelter provisions enacted in October 2004 as part of the American Jobs Creation Act of 2004'.

The ABA supports legislation clarifying that when a court determines that the economic substance doctrine applies, the taxpayer must establish that the non-tax considerations in the transaction were substantial in relation to the potential tax benefits, and supports legislative clarification that in evaluating the potential economic profits of a transaction, all costs associated with the transaction, including fees paid to promoters and advisers, should be taken into account.

'To the extent that the legislation incorporates these concepts,' continues the letter, 'we believe it will improve the state of the law. In other respects, however, as we have previously written, we continue to oppose codification of the economic substance doctrine. We further believe that enactment of the separate penalty scheme tied to satisfaction of the economic substance doctrine would create unnecessary complexity and confusion.'

Mr Drapkin also expresses serious concerns about the requirement for a 20% non-refundable deposit: 'Because the 20 percent nonrefundable down payment requirement could dramatically reduce available outside funding for potential offers, there is a significant risk that the proposal could decrease the number of legitimate offers submitted, the number of offers accepted and the number of individuals reentering the tax system,' says the letter, which recommends that the proposal not be adopted or, at a minimum, that it be deferred for further consideration.

As regards frivolous conduct penalties, the letter suggests that they should be imposed upon taxpayers requesting CDP hearings 'only (i) where the request is based on arguments or positions the IRS has identified as frivolous in published pronouncements and (ii) after the taxpayer has been afforded the opportunity to withdraw the request or supplement it with information that would render the relevant published pronouncement inapplicable.'

The full text of the letter can be viewed on the ABA's web-site at http://www.abanet.org/tax/pubpolicy/2006/060104s2020.pdf.

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