A federal judge has ruled that the Internal Revenue Service went too far in retroactively banning the "Son of Boss" tax shelter.

For the past six years, the IRS has been battling the tax shelters -- a form of which prompted an investigation of KPMG and resulted in a $456 million fine for the firm and the indictment of 16 former partners. The IRS says the Son of Boss shelter generated artificial tax losses that cost the federal government at least $6 billion in revenues through the late 1990s.

In a judgment released last week, Judge T. John Ward of the U.S. District Court for the Eastern District of Texas said the regulations didn't apply to taxpayers who used the tax shelters before the IRS issued new rules targeted the shelters in August 2000. Ward wrote that retroactive application of the rules was an abuse of discretion.

What the judge's decision means to prosecutors in the KPMG case remains to be seen. Prosecutors have said that they will argue the shelter itself was technically valid, but that the way the defendants carried it out was not. The IRS considers tax shelters with no economic substance or business purpose to be invalid, and Ward did not rule on whether the shelter meets that test. Lawyers for the defendants have already argued in the press that no court has ever ruled any of the shelters in question to be illegal.

Ward's ruling could also raise questions about IRS settlements in 2004 that raised $3.7 billion in unpaid taxes from more than 1,200 investors who had participated in similar tax shelters.

Previously on WebCPA:

IRS Wins First 'Son of Boss' Case (April 25, 2006)

Strong Response to Stock Option, Son of Boss Initiatives (July 13, 2005)

Treasury, IRS Whack "Son of Boss" (July 25, 2003)

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