US Treasury Department Cracks Down On Abusive Tax Shelter

by Mike Godfrey, Tax-News.com, Washington

30 July 2001

The US Treasury Department and the Internal Revenue Service shut down a tax shelter last week involving the creation of an artificially high tax basis in stock which is then sold at a loss. It is the first tax shelter to be closed under the Bush administration.

The Treasury has warned that it intends to challenge all taxpayers who have engaged in what is known as a 'basis-shifting' arrangement involving transactions with offshore corporations that are designed to appear as losses on paper. The Department has issued an official notice that informs corporate taxpayers of their obligation to disclose their participation in such transactions and informs promoters of their obligation to register the transactions and keep lists of customers that engage in such transactions.

In this type of tax shelter, typically, a US taxpayer who owns stock options to purchase 50% or more in a foreign corporation ("first corporation") is considered a related party to the first corporation for tax purposes. The US taxpayer and the first corporation then each buy, or already own, stock in a second corporation.

That second corporation then redeems its stock held by the first corporation and the first corporation treats the redemption as a dividend because it is related to the US taxpayer. The taxpayer then claims that the first corporation's cost for the redeemed stock attaches to the taxpayer's stock in the second corporation. This allows the taxpayer to sell the stock of the second corporation and claim a loss.

The government's crack down on tax shelters follows on from the Clinton administration which set in place initiatives allowing it to launch an aggressive campaign against abusive tax shelters. 'It's an example of the system catching things we hoped that it would catch,' said Mark Weinberger, assistant Treasury secretary for tax policy.

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