California Reaffirms Zero Tolerance Of Tax Shelters

by Mike Godfrey, Tax-News.com, Washington

07 August 2003

In a statement of intent against 'abusive' tax shelters, the state of California Franchise Tax Board (FTB) has announced a new round of audits that will target 150 suspected users of tax schemes, in its ongoing campaign to stamp out the activity.

"California has zero tolerance for people who cheat the system through illegal tax shelters," State Controller and Chair of the Franchise Tax Board Steve Westly announced at a news conference this week. "I will do everything in my power to recover taxes legally owed but not paid," he warned.

According to FTB estimates, California, which is facing a $38 billion budget deficit crisis, loses around $600 million annually as a result of illegal tax sheltering. The penalties imposed by the Board in cases it considers to have used abusive tax shelters equate to 20% of the unpaid tax.

Legislation is reported to be in the pipeline which will extend the period that the FTB has in which to investigate tax shelter cases.

Tax shelters currently being subjected to particular scrutiny by the FTB include Basis Shifting, Inflated Basis and Commercial Domicile schemes.

Basis Shifting involves the use of offshore foreign corporations to artificially increase and shift the basis of foreign stock to stock owned by US shareholders. The US taxpayer then sells the stock at an inflated loss though incurring no actual economic loss from the transaction.

Inflated Basis schemes meanwhile use "contingent" transactions to exaggerate the owner's basis in a 'pass through' entity investment. The artificially inflated losses are ultimately used to offset against the investor's tax liability.

Commercial Domicile schemes attempt to avoid state income tax by re-incorporating in states that do not levy income tax such as Nevada and Delaware. However, the authorities maintain that a California resident is liable for tax on income obtained from all sources.

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