Lieberman Says Tax Shelters Must Have Economic Substance To Deter Industry Built Around Tax Evasion

WASHINGTON – Governmental Affairs Committee Ranking Member Joe Lieberman, D-Conn., Tuesday called for fundamental changes in the tax code to prevent the kind of abuse that has allowed for an entire industry to develop around helping wealthy taxpayers evade taxes.

According to a recent GAO study, abusive tax shelters cost the nation $85 billion. “Average American taxpayers have to reach into their own pockets to make up for $85 billion lost because of tax shelter schemes,” Lieberman said. Criticizing the Bush Administration for failing to adequately police these shelters, Lieberman offered a series of short-term prescriptions – such as imposing stiffer penalties and encouraging more prosecutions of wrongdoers. But he said the system would continue to be abused without a long-term plan. “The current tax system lets tax evaders beat the system by closely following detailed rules set up for legitimate transactions even though they are being used for no genuine economic purpose except to avoid paying taxes,” Lieberman said. “We should insist that whatever the taxpayer has done to reduce his or her tax liability must be intended to change his or her economic position in a meaningful way and must have a substantial, non-tax, economic purpose for the transaction.” He added, “This economic test must be applied to curtail these tax shelter ‘mills’ otherwise they will continue to soak the vast majority of American taxpayers who have to pay higher taxes because of them.” Below is the Senator’s statement, submitted into the record of the Permanent Subcommittee on Investigation hearing on The U.S. Tax Shelter Industry: The Role of Accountants, Lawyers and Financial Professionals: Thank you, Mr. Chairman, for convening this series of hearings on how the complexity of our tax law has been twisted and exploited to allow for the growth of a full-blown tax shelter industry based not on economic substance but on greed, alone. Last year, over 130 million Americans filed individual tax returns. Some of the wealthiest were able – with the help of accountants, lawyers, banks, and financial advisors – to take advantage of schemes constructed for no other purpose than to help them evade paying their fair share of taxes. Today and Thursday, the Senate Governmental Affairs Committee’s Permanent Subcommittee on Investigations will hear testimony about this burgeoning tax shelter industry which has corrupted the integrity and professional standards of a number of accounting, banking, and legal practitioners in order to make millions of dollars for themselves, save hundreds of millions of dollars for their clients, and force the rest of the tax-paying public to shoulder billions of dollars more of the burden. I want to commend Senator Levin, the ranking member of the Subcommittee and his staff for leading this groundbreaking investigation. And I want to commend Senator Coleman, the chairman of the Subcommittee, and his staff for a truly bi-partisan effort. You have all made a valuable contribution to our understanding of how and by whom tax shelters are manufactured and marketed. In the same way the Subcommittee’s investigation into Enron’s financial dealings revealed the role of accounting firms, banks and financial institutions in helping Enron manipulate its balance sheet, this investigation reveals the role that accounting firms, law firms, banks and financial institutions play in helping wealthy taxpayers avoid taxes. Among the astounding revelations we will hear about is that these tax shelter promoters go so far as to telemarket their illicit wares, as if they were selling shares in a vacation home or magazine subscriptions. How big is this business of greed? It’s hard to say, but a recent General Accounting Office report tells us the Internal Revenue Service believes almost 300 firms are in the business of promoting tax shelter abuses and that potential losses to the Treasury could be as high as $85 billion. The few schemes investigated by this Subcommittee peddled by just one accounting firm appear to have cost the Treasury hundreds of millions in lost taxes and the firm that developed and manufactured these shelters developed and manufactured some 500 others, selling them to thousands of taxpayers. The IRS has been stepping up its actions against taxpayers who manipulate the rules to avoid taxes. But the Subcommittee’s investigation reveals that the problem isn’t limited to taxpayers. It extends to a legion of firms aggressively trying to convince taxpayers they can and should evade the law. In the short-term, more must be done to reign in those who develop, promote, and market tax shelters. For example: · Penalties and sanctions against tax shelter promoters must be increased so that they truly deter wrongdoers. Although the IRS and the Treasury Department have proposed higher penalties and sanctions against tax shelter promoters, their proposals do not go far enough. Based on the Subcommittee’s investigation, promoters earn many, many times more in fees from unlisted tax shelters then they would pay in penalties for not reporting them under the Administration’s proposal. · The IRS must do more to step up its enforcement activities. It created a new Office of Tax Shelter Analysis (OTSA) in February 2000 to substantially increase its ability to identify tax shelters, but the agency only has 25 tax shelters, of the hundreds now operating, on its watch list. · The Inspector General for Tax Administration should examine the effectiveness of the IRS’ tax shelter strategy, focusing on promoters. · The Justice Department should increase its prosecution of tax shelter promoters. The IRS has identified 300 firms it believes promotes tax shelters, yet the Tax Division of the Justice Department is pursuing enforcement actions against only a handful of promoters. Without prosecutions, we won’t deter the bad players But cracking down on tax evaders and tax shelter promoters is little more than a stopgap strategy to stem the abuse. Unless the government fundamentally changes the rules of the game, it will always be playing catch up. It’s clear that, in the long-term, we need to change the way the tax code is written. The current tax system lets tax evaders beat the system by closely following detailed rules set up for legitimate transactions even though they are using them for no genuine economic purpose except to avoid paying taxes. We must shift the emphasis away from detailed prescriptive rules and instead focus on the true reason the taxpayer is entering into the transaction in the first place. In other words, we should insist that whatever the taxpayer has done to reduce his or her tax liability must be intended to change his or her economic position in a meaningful way and must have a substantial, non-tax, economic purpose for the transaction. This is known as the economic substance doctrine, and the courts have upheld its use by the IRS. In the 1998 case ACM Partnership v. Commissioner, the Third Circuit Court of Appeals found that “a rational relationship between the purpose and means (of the scheme) ordinarily will not be found unless there was a reasonable expectation that the non-tax benefits would be at least commensurate with the transaction costs.” On this basis, it sided with the IRS and largely invalidated the taxpayer-structured capital loss. This decision came 10 years after the abusive tax shelter had been concocted and implemented. Additionally, the Joint Tax Committee has found that codification of the economic substance doctrine could raise more than $11.4 billion for the Treasury over 10 years. I am pleased to say that the Senate Finance Committee and the full Senate support implementation of the economic substance doctrine. In fact, the revenue offset used to fund the CARE Act (S.476), of which I am a principal sponsor, is a well-crafted codification of the economic substance doctrine. The Senate passed the CARE Act 95-5 last April. The same provision is incorporated in the legislation recently reported by the Finance Committee to replace the FSC/ETI (S. 1637). Unfortunately, the Administration, House Republicans, and the tax shelter lobby present stiff opposition to codifying the economic substance doctrine. Speaking for the Administration at a March 28 conference, Treasury Deputy Assistant Secretary for Tax Policy Greg Jenner tried to shelter the tax shelters. He said codification moves from an inherently flexible doctrine “to one that is pretty rigid, but that is nevertheless impossible to understand.” Assistant Treasury for Tax Policy, Secretary Pam Olson agreed that codifying the economic substance doctrine would drive tax shelters further underground. House Republicans twice killed the doctrine when Democrats offered it as amendments – first to the Taxpayer Protection and IRS Accountability Act (H.R. 1528) and again to the House version of the CARE Act. House Republicans rejected it again when they rejected a motion to recommit the Jobs and Growth Reconciliation Act (H.R. 2). It will also come as no surprise that the House version of the pending business tax bill (to replace the FSC/ETI) doesn’t include the doctrine either. The tax shelter lobby has also weighed in strongly against the economic substance doctrine. The American Institute of Certified Public Accountants, Financial Executives International, the Financial Services Roundtable, and the Tax Executives Institute all oppose it. If we choose, we can opt out of the revolving door of shelters, periodic crackdowns, and new shelters. But to do so, we must change the rules of the game and eliminate the advantages tax shelter promoters prey upon. We must decrease their incentives and increase the chances they will be caught. It will not be easy to reverse the tide on tax shelters. But this subcommittee’s work is a powerful testament to the systemic corruption that plagues the accounting, legal and financial communities in the pursuit of tax shelters. There’s an old saying that “We are born brave, trusting and greedy, and most of us remain greedy.” Certainly that is true for the ranks of lawyers, accountants, and financial consultants who have abused the law and their own professional ethics simply for the sake of huge sums of money to be made helping their clients evade taxes. Thank you, Mr. Chairman.