With the recent focus in the media on abuse of the tax laws and the continuing Internal Revenue Service crackdown on tax shelters, pressure is building in Congress to provide the IRS with some additional tools to address abusive tax shelters, post-Enron corporate governance, and expatriation issues. The Senate included a fairly significant package of provisions covering each of these areas in the international tax reform legislation that it passed on May 11, 2004.
The House, which has been struggling to find an international tax reform bill that can attract sufficient votes for passage, now appears to be moving toward a consensus bill using the Senate bill as a guide. The draft House proposal also includes a number of provisions related to tax shelters, expatriation and corporate governance, although it is generally viewed as more restrained than the Senate version.
The IRS has been fairly successful in the courts in pursuing promoters of allegedly abusive tax shelters for violations of list-keeping requirements and for disclosure of clients utilizing particular tax shelters. The IRS’s recent settlement offer with respect to “Son of Boss” transactions was less generous than its prior offers for other transactions. Yet the IRS still insists that it needs additional legislative tools to effectively battle tax shelters.
Another factor weighing in favor of passage of these provisions is that they are, in general, revenue raisers. As such, they help pay for other popular provisions that members of Congress want to include in the legislation but that, in these times of growing deficits, need to be paid for.
Tax shelter provisions
Both Senate Bill 1637 and House Bill 4520 contain provisions imposing penalties for failing to disclose reportable transactions, and accuracy-related penalties for listed transactions and other reportable transactions having a significant tax avoidance purpose. Penalty provisions in both bills also address the failure to maintain lists of investors by promoters of tax shelters, substantial understatements with respect to non-reportable transactions, and failure to report interests in foreign financial accounts.
Both bills also include provisions with respect to tax shelter exceptions to confidentiality privileges relating to taxpayer communications, the disclosure of reportable transactions, failure to furnish information with respect to reportable transactions, and revised statutes of limitations for tax years in which listed transactions are not reported. Finally, both bills address modifications of actions to enjoin certain conduct related to tax shelters and the regulation of individuals authorized to practice before the IRS.
Provisions included in the Senate measure but not the House bill include the codification of the economic substance doctrine and related penalties for understatements attributable to transactions lacking economic substance.
Other Senate provisions not picked up by the House address understatement of taxpayer’s liability by a tax return preparer and frivolous tax submissions. The Senate bill also includes provisions denying the deduction of interest on underpayments attributable to non-disclosed reportables and non-economic substance transactions, and penalties for aiding and abetting the understatement of tax liability.
Both the House and Senate bills include provisions addressing sale-in/lease-out, or SILO, transactions, though the Senate bill would impose an earlier effective date, and the House bill would make additional modifications to the leasing rules.
Both the House and Senate bills include a package of post-Enron corporate governance provisions, including the repeal of special rules for financial asset securitization investment trusts and prohibitions on the reduction of basis under Code Section 734 for stock held by a partnership in a corporate partner. Significantly, however, the House bill does not include the Senate provision requiring declarations by the chief executive officer with respect to the federal annual income tax return of a corporation.
Both House and Senate bills also include provisions addressing expatriation. Both bills include an excise tax on the stock compensation of insiders in expatriated corporations. Both bills also include provisions addressing reinsurance of U.S. risks in foreign jurisdictions and the reporting of taxable mergers and acquisitions.
While the Senate bill would treat inverted corporations as domestic corporations, the House bill denies tax-free treatment for the inversion and only applies to inversions after a certain date. The Senate bill imposes earnings-stripping limits on corporate inversions, but the House bill does not include a similar provision.
The Senate bill addresses individual expatriation with a tax on the net unrealized gain on the expatriate’s property as if the property had been sold for fair market value on the date of expatriation. The House bill replaces the current subjective test for expatriation with an objective test based on annual income and net worth.
While it is rare for the Senate to take the lead on tax legislation due to the constitutional requirement that revenue bills originate in the House, in the current political climate it is often the Senate provisions in tax legislation that are most closely watched because it is the Senate that has the most difficulty attracting a majority to pass tax legislation.
With this international tax reform legislation originating in the Senate, while the House follows the Senate lead as it tries to craft its own compromise version of the bill, the common provisions of this particular legislation appear very likely to survive to the final vote. With both bills including significant provisions addressing tax shelters, corporate governance and expatriation, the final version of the legislation appears likely to include at least the common provisions in all three areas.
George G. Jones, JD, LL.M., is managing editor, Tax & Accounting, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, Tax & Accounting, at CCH Inc.
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