1

 This testimony may be cited as follows: Joint Committee on Taxation, Testimony of

the Staff of the Joint Committee on Taxation Before the House Committee on Ways and Means

(JCX-82-99), November 10, 1999.

2

 Joint Committee on Taxation, Study of Present-Law Penalty and Interest Provisions as

Required by Section 3801 of the Internal Revenue Service Restructuring and Reform Act of 1998

(Including Provisions Relating to Corporate Tax Shelters) (JCS-3-99), July 22, 1999 (“Joint

Committee staff study”).

3

 Joint Committee on Taxation, NIPA and Federal Income Tax Receipts Data (JCX-83-

99), November 10, 1999.

4

 Joint Committee on Taxation, Description and Analysis of Present-Law Tax Rules and

Recent Proposals Relating to Corporate Tax Shelters (JCX-84-99), November 10, 1999.

Joint Committee on Taxation

November 10, 1999 

JCX-82-99 

TESTIMONY OF THE 

STAFF OF THE JOINT COMMITTEE ON TAXATION

BEFORE THE

COMMITTEE ON WAYS AND MEANS

My name is Lindy Paull. As Chief of Staff of the Joint Committee on Taxation, it is my

pleasure to present the written testimony of the staff of the Joint Committee on Taxation (the

“Joint Committee staff”) at this hearing before the House Committee on Ways and Means

concerning corporate tax shelters.1

My testimony today focuses on recommendations made by the Joint Committee staff with

respect to corporate tax shelters, which are contained in Part VIII of the study prepared by the

Joint Committee staff regarding the present-law penalty and interest provisions.2 Two

attachments supplement my testimony. The first attachment provides data on Federal income tax

receipts and corporate income.3 The second receipt attachment is our staff’s further analysis of

the issues presented by corporate tax shelter proposals and recommendations.4

I. BACKGROUND

Section 3801 of the Internal Revenue Service Restructuring and Reform Act of 1998

directed the Joint Committee on Taxation and the Secretary of the Treasury to conduct separate

studies of the present-law interest and penalty provisions of the Internal Revenue Code (“Code”)

and to make any legislative or administrative recommendations to the House Committee on
5

 Code section 6662.

6

 Code sections 6694 and 6695.

7

 Code section 6701.

8

 Code section 6700.

9

 Code sections 6111 and 6112.

10 Code sections 6707 and 6708.

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Ways and Means and the Senate Committee on Finance that are deemed appropriate to simplify

penalty and interest administration or reduce taxpayer burden. The Joint Committee staff study

makes a number of recommendations with respect to non-corporate tax shelter penalties and

interest that will be the subject of a separate hearing by the Subcommittee of Oversight of the

House Committee on Ways and Means.

The Joint Committee staff recommendations regarding corporate tax shelters were the

product of an extensive review and analysis of the present-law system of penalties and interest in

the Code. The Joint Committee staff study focused on sanctions in the Code that relate to the

collection of the proper amount of tax liability, such as penalties relating to payment of the

proper amount of tax, reporting of income, and failure to provide information returns or reports.

The penalty provisions reviewed by the Joint Committee staff relating to tax shelters

include the following:

(1) The accuracy-related penalty imposes a 20 percent penalty on any substantial

understatement of income tax that, among other things, is attributable to corporate

tax shelters.5

(2) Income tax return preparers may be liable for a penalty with respect to an

understatement of a taxpayer’s liabilities.6

(3) Penalties may be imposed on those who aid and abet a taxpayer with respect to a

return that results in an understatement of tax liability.7

(4) Penalties may be imposed on those who promote abusive tax shelters.8

(5) Registration requirements apply with respect to tax shelters9 and penalties are

imposed for failing to comply with the registration requirements.10

The Joint Committee staff concluded after reviewing the above provisions that a
11 Code sections 269, 446, 482 and 7701(l).

12 The common-law doctrines include the sham transaction doctrine, the economic

substance doctrine, the business purpose doctrine, the substance over form doctrine, and the step

transaction doctrine.

13 See regulations found in Title 31, Part 10 of the Code of Federal Regulations. In

addition, the Joint Committee staff reviewed various standards of practice and rules of

professional conduct of the American Bar Association, the American Institute of Certified Public

Accountants, and general state licensing authorities.

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comprehensive study of the present-law penalty provisions of the Code relating to tax shelters

was appropriate.

II. METHODOLOGY

The Joint Committee staff conducted a comprehensive review of the penalty and interest

rules applicable to corporate tax shelters and evaluated their effectiveness in dealing with

modern-day corporate tax shelter transactions. As part of the review process, the Joint

Committee staff analyzed: 

(1) The substantive laws in the Code that are designed to, among other things, deter

tax-shelter transactions11 and their interaction with the penalty and interest rules, 

(2) The various common-law doctrines used by the courts to evaluate and potentially

disallow tax benefits claimed in tax shelter transactions12 and the imposition of

penalties with respect to these transactions, and

(3) The standards of practice that affect certain advisors in connection with tax shelter

activity and which are intended to have certain deterrent and punitive aspects.13

The Joint Committee staff spent considerable time analyzing a variety of recent

transactions that have given rise to recent Congressional or Administrative responses. The Joint

Committee staff economists analyzed the economic considerations that affect corporate

taxpayers’ decisions with respect to engaging in tax shelter activity. The Joint Committee staff

consulted with representatives of the Treasury Department, and reviewed various comments and

proposals that have been put forward with regard to corporate tax shelters, including:

(1) The Administration’s proposals that were included in the FY 2000 Budget, as

supplemented by the Treasury White Paper on corporate tax shelters,

(2) H.R. 2255, The Abusive Tax Shelter Shutdown Act of 1999, introduced on June

17, 1999 by Congressman Doggett and others,
14 Monthly Treasury Statement regarding Budget Results for Fiscal Year 1999,

Department of the Treasury (October 27, 1999).

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(3) Comments and recommendations submitted by various groups to this Committee

and the Senate Committee on Finance, including groups such as the Tax

Executives Institute, the American Bar Association Section of Taxation, the New

York State Bar Association Tax Section, and the American Institute of Certified

Public Accountants, and

(4) Comments that were submitted to the Joint Committee staff in connection with

the Joint Committee staff study.

III. ANALYSIS

In analyzing the effectiveness of the present-law penalty provisions with respect to

corporate tax shelters, the Joint Committee staff first addressed two fundamental questions. The

first question is whether there is, in fact, a corporate tax shelter problem. If there is a corporate

tax shelter problem, the second question is why such a problem exists. 

A. The Corporate Tax Shelter Problem

The Joint Committee staff believes that there is a corporate tax shelter problem -- more

corporations are entering into arrangements principally to avoid tax. The Joint Committee staff

believes the problem is becoming widespread and significant.

Some commentators and interested parties question whether there is a corporate tax

shelter problem. They contend that the heightened scrutiny the issue has received this year is

mostly attributable to recent press reports. These commentators cite the lack of economic data

showing a decline in corporate tax receipts as an indication that no problem exists.

Admittedly, much of the evidence in this area is anecdotal, as one might expect, but the

importance of this evidence should not be discounted. The parties involved in developing,

marketing, or implementing a tax shelter generally benefit by keeping its existence confidential. 

For example, some firms intentionally limit the sale of a corporate tax shelter that involves tens

of millions of dollars in tax savings to only a few taxpayers in an attempt to shield the

arrangement from scrutiny by the Congress and the Treasury Department. The existence of the

tax shelter is revealed only when a potential customer or a competitor anonymously disclosed the

arrangement to a government official.

Recent data would suggest that corporate tax receipts are not keeping pace with a growing

economy. Data just released shows that for fiscal year 1999, corporate income tax receipts

actually fell by approximately $4 billion, representing a decline of approximately two percent,

from the prior fiscal year.14 The last year in which there was a decline in corporate tax receipts
15 157 F.3d 231 (3d Cir. 1998), aff’g 73 T.C.M. (CCH) 2189 (1997).

16 113 T.C. No. 17 (September 21, 1999).

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was in fiscal year 1990, a period in which the economy was softening and entering the brief

recession which began in the last half of 1990.

Commentators and interested parties have relied on macroeconomic data to reach

differing opinions regarding whether there is a corporate tax shelter problem. The Joint

Committee staff believes that the data are not sufficiently refined to provide a reliable measure of

the corporate tax shelter activity. Many tax shelter transactions distort the reported measure of

corporate profits in a manner similar to their impact on the corporate tax base. Other factors

include year-to-year changes in corporate economic losses and the increased use of non-corporate

entities.

The Joint Committee staff believes that direct measurement of corporate tax shelter

activity through macroeconomic data is not possible. Instead of focusing on macroeconomic

data, a more instructive approach is to analyze specific tax shelter transactions that have come to

light and evaluate their effect on corporate receipts. Because this approach only considers a few

of the corporate tax shelter transactions, it necessarily understates the size of the corporate tax

shelter problem. This approach, nonetheless, provides a useful reference point for consideration

of the size of the problem. In the past two years, the courts have disallowed tax benefits in

several high-profile corporate tax shelter cases. For example, in ACM Partnership v.

Commissioner,

15 the Third Circuit Court of Appeals disallowed a capital loss claimed in 1991

from a partnership arrangement because the arrangement lacked economic substance. The

amount of the tax savings with respect to this case was approximately $30 million. The Joint

Committee staff understands that there are at least eight other cases which raise issues similar to

those described in the ACM case. The Joint Committee staff further understands that the amount

in controversy from these cases (which may span several tax years), when added to the tax

benefit at issue in ACM, would total approximately $1 billion in taxes.

A second recent corporate tax shelter case is Compaq Computer Corp. v.

Commissioner.

16 In the Compaq case, the Tax Court disallowed a foreign tax credit claimed in

1992 with respect to a dividend from stock in a foreign corporation. The taxpayer bought and

sold the stock within one hour in an arrangement that was structured to eliminate the taxpayer’s

economic risk from owning the stock. The disallowed tax credit in the Compaq case would have

resulted in a tax benefit of approximately $3 million. The Joint Committee staff understands that 

there may be at least 15 other cases which raise issues similar to those described in the Compaq

case. The Joint Committee staff further understands that, when added to amount at issue in the

Compaq case, the total amount in controversy with respect to these cases, which may span

several tax years, is approximately $60 million in taxes.
17 113 T.C. No. 21 (October 19, 1999).

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A third recent corporate tax shelter case is Winn-Dixie Stores, Inc. v. Commissioner.

17 In

the Winn-Dixie case, the Tax Court disallowed the interest deductions attributable to the

taxpayer’s 1993 leveraged corporate-owned life insurance (“COLI”) program on the grounds that

it lacked both economic substance and business purpose. The amount of purported tax savings in

the Winn-Dixie case was approximately $1.6 million for one year of an arrangement that was

intended to yield tax benefits annually over a 60-year period. The Joint Committee staff

understands that there may be as many as 100 cases in controversy which raise issues similar to

those described in the Winn-Dixie case. The Joint Committee staff also understands that the

amount in controversy with respect to these cases, which may span several tax years, is expected

to approach approximately $6 billion in taxes.

Looking only at the three arrangements that were at issue in these cases, it is estimated

that these cases represent over $7 billion in unpaid corporate taxes (approximately $1 billion

from ACM and similar cases, approximately $60 million from Compaq and similar cases, and

approximately $6 billion from Winn-Dixie and similar cases). Although these cases represent

different tax years, this amount most likely represents a fraction of the corporate tax that the

Federal government is not collecting because of corporate tax shelters. In many cases, the

corporation that claims the tax benefits from a tax shelter escapes audit, or the tax shelter

arrangement goes undetected during an audit. Even when the corporation is audited and the

transaction is discovered, the hazards of litigation, the complexities of these transactions, and

other factors are such that the IRS often may opt for a negotiated settlement. Only a fraction of

tax shelter activity actually results in a judicial determination. In addition, as the these cases

illustrate, several years may pass before a judicial determination is made with respect to a

corporate tax shelter transaction, during which time similar transactions go undeterred. Thus,

even though the outcome of the recent cases generally is favorable to the government, the case

law (1) cannot be viewed to be representative of the full magnitude of the problem, and (2)

cannot be considered as evidence that the corporate tax shelter problem is being contained.

An additional observation regarding the effect of tax shelters on corporate tax receipts

bears discussion. The magnitude of the problem, be it a $10 million loss or a $10 billion loss, is

in some respects a secondary issue. Practitioners indicate they are spending more of their time

advising corporate clients regarding arrangements that are highly suspect, and tax executives

complain they are getting “pitched” more and more “aggressive” transactions from promoters

and advisors that are solely motivated to reduce the corporation’s effective tax rate without any

relation to a nontax business purpose or economic substance. Practitioners and corporate tax

executives feel pressured to participate in such transactions, particularly when it appears that the

corporation’s competitor is doing a similar transaction and getting professional advice that such a

transaction can avoid penalties because the professional advisor is willing to opine that the

transaction is “more likely than not” to succeed. The perception of potentially becoming

competitively disadvantaged by others engaging in a tax-motivated transaction could result in

more corporations and tax advisors engaging in these types of transactions. If one corporation is
16 The Joint Committee staff study identified other factors that have contributed to the

increasing trend of corporate tax shelter activity. These factors are: (1) the emerging view of a

corporate tax department as a profit center; (2) the relatively insufficient risk of penalties or other

significant deterrents for entering into such transactions; (3) the role of tax advisor opinions in

mitigating any risk of penalties; and (4) the insufficiency of standards of practice and the lack of

enforcement of such standards.

17 Corporations do not act alone in designing ways to avoid paying their fair share of

taxes. Many other parties act in concert with the corporate taxpayer to facilitate such devices. 

As a result, the Joint Committee staff study recommends that the stakes (and standards) should

be raised for these other participants as well, and disclosure should be required of promoters of

corporate tax shelter activity.

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permitted to claim an unwarranted tax benefit that its competitors are reluctant to claim, then, in

essence, the corporations (and their advisors) that “play by the rules” are being penalized.

Many prominent professional associations, such as the American Bar Association, the

New York State Bar Association, the American Institute of Certified Public Accountants, and the

Tax Executives Institute, have voiced their concerns with the growing presence of corporate tax

shelters and their potentially harmful effects on the Federal income tax system.

B. Why a Corporate Tax Shelter Problem Exists

Critical to a corporation’s decision of whether to enter into a tax shelter arrangement is a

comparison of the expected net tax benefits with the expected costs of the arrangement. Such a

“cost-benefit” analysis takes into account a corporate participant’s economic risks in the event

the expected net tax benefits fail to materialize. The imposition of a penalty should be a

significant feature of the “cost” side of the equation, and the Joint Committee staff focused on

the cost-benefit analysis in determining the effectiveness of the present-law penalty regime.

The Joint Committee staff believes present law does not provide sufficient disincentives

to engaging in these types of transactions.16 The cost-benefit analysis is skewed in favor of

investing in corporate tax shelter transactions. There are significant potential benefits from

entering into a corporate tax shelter transaction with little corresponding cost. The chances of a

corporation being subject to a penalty from a corporate tax shelter are small. The Joint

Committee staff believes that the cost of entering into abusive tax arrangements should be

increased to deter this type of activity.17 The most effective means of realigning the cost-benefit

calculus is to clarify and enhance the present-law penalty regime.

C. Clarifying and Enhancing the Present-Law Penalty Regime

Although the present-law penalty regime includes certain specific provisions aimed at

corporate tax shelters, the Joint Committee staff believes that the present-law structure is
18 Treas. Reg. sec. 1.6664-4(e).

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ineffective at deterring inappropriate corporate tax shelter activity. Nevertheless, the present-law

penalty regime provides a useful framework from which refinements and improvements can be

made. Moreover, because the policy considerations that gave rise to enactment of that

framework in the first place (i.e., deterrence of tax shelter activity) is just as true today, the

present-law penalty regime appears to be the appropriate starting point in addressing the

undesirable corporate shelter activity. The Joint Committee staff recommendations therefore

focus on clarifying and enhancing the present law corporate tax shelter penalty regime. A

meaningful penalty regime would alter the cost-benefit analysis of corporate participants in a

manner that will discourage abusive transactions without interfering with legitimate business

activity.

D. Alternative Responses

Maintaining the status quo

Some argue that no legislative response to the corporate tax shelter problem is necessary;

the present-law penalty regime would be effective in deterring corporate tax shelter activity if

only (1) the Treasury Department would issue long-overdue guidance with respect to the penalty

regime, and (2) the IRS would enforce the existing rules. The Joint Committee staff believes the

present-law penalty structure contains a number of structural weaknesses that significantly

undermine its effectiveness. Some of the weaknesses may be attributable to a lack of statutory

guidance with respect to recent legislation regarding corporate tax shelters. For example, the

Taxpayer Relief Act of 1997 amended the definition of a corporate tax shelter to cover any entity,

plan or arrangement entered into by a corporate participant if a “significant purpose” is the

avoidance or evasion of Federal income tax. However, there appears to be much uncertainty,

both in the Treasury Department and in the business community, as to what constitutes a

“significant purpose” and no guidance has been issued by the Treasury Department. At the same

time, the lack of statutory guidance could subject any regulatory guidance to criticism for

exercising too much discretion and exceeding statutory authority in resolving these issues.

In addition, it appears that penalties are rarely collected in connection with tax shelters. 

The lack of imposition of present-law penalties may be, in part, a result of a lack of statutory

guidance. For example, the facts and circumstances necessary to satisfy the reasonable cause

exception to the substantial understatement penalty attributable to corporate tax shelters18 is

widely disputed. Some tax professionals believe an opinion from a tax advisor is all that is

necessary. Others believe that if the test in the regulations were enforced, few taxpayers would

ever avoid this penalty. Given the wide range of interpretations, it is not surprising that the IRS

generally waives the imposition of this penalty whenever a corporate taxpayer produces a

favorable opinion letter from a professional tax advisor.

Another shortcoming of the section 6662 penalty for corporate tax shelters is that the
19 Joint Committee staff study includes a recommendation that would eliminate the

substantial understatement penalty attributable to corporate tax shelters only if the corporate

participant is “highly confident” (i.e., reasonably believes that there is at least 75-percent chance

that the tax treatment would be sustained on the merits). In addition, the Joint Committee staff

recommends raising the minimum standards for tax return positions for both taxpayers and tax

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penalty generally applies (in the absence of negligence) only if the understatement of tax is

“substantial.” For a corporation, an understatement is substantial only if it exceeds 10 percent of

the tax that is required to be shown on the return (or if greater, $10,000). A corporation therefore

can engage in corporate tax shelter activities knowing that it will not be subject to an

understatement penalty provided that the tax benefit does not exceed this 10 percent threshold. 

For a large corporation, this can represent a significant amount. In addition, the penalty applies

only if there is an overall underpayment of income tax for the taxable year, regardless of whether

the tax return understates taxable income with respect to a specific transaction. As a result, a

taxpayer could use overpayment items to offset the underpayment from a corporate tax shelter

and thereby avoid a penalty.

Maintaining the status-quo also results in greater pressure to address each specific tax

shelter transaction separately. Although in recent years there has been a flurry of legislative

activity aimed at specific corporate tax shelters, such ad-hoc responses, by their very nature,

rarely are enacted in a timely manner. These responses typically do not occur until after there has

been significant loss in revenue. Also, because legislative changes generally apply on a

prospective basis, corporations that engage in this activity early during the “life cycle” of a

corporate tax shelter often retain the inappropriate tax savings. When the changes are not

entirely prospective, a fairness concern is raised insofar as taxpayers may not have sufficient

notice that the legislative changes will have affected their transaction. And as a realistic matter,

the government may never become aware of some transactions that would be considered as

abusive corporate tax shelters. 

Changing the cost-benefit calculus should deter taxpayers from entering into corporate

tax shelters. While it is true that the IRS has won several recent tax shelter cases, litigation is an

inefficient deterrent (because of the uncertainties of the audit process, the costs and hazards of

litigation, delays in resolution, and similar reasons previously discussed), and the status quo does

not provide sufficient disincentives for taxpayers to engage in tax shelter transactions.

The problems with the present law penalty regime extend beyond taxpayer sanctions. 

There is little guidance and enforcement of standards for tax shelter opinions. If an advisor

provides an opinion to protect a taxpayer from penalty, there is little or no risk of sanction to the

advisor if the opinion is later determined to be improper. The American Bar Association Tax

Section recently suggested changes to the standards of practice before the IRS, known as Circular

230, which imposes some standards on tax shelter opinions. These suggestions are a good first

step. However, the ABA Tax Section’s suggestions are predicated on the present-law “more

likely than not” standard, which the Joint Committee staff believes should be raised.19 The Joint
preparers. 

20 See Barton Massey, “Circular 230 Changes Unlikely to Address Shelters or Practice of

Law,” 1999 TNT 206-5, (Doc 1999-34521), October 26, 1999.

21 The imposition of penalties may be a continuing issue in the ACM case.

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Committee staff study includes recommendations on how the current rules under Circular 230

should be revised to regulate the conduct of practitioners as it relates to corporate tax shelters. 

Unfortunately, the IRS Director of Practice recently stated that, although the IRS could be

proposing changes to Circular 230 next spring, these proposals are unlikely to tackle any

“controversial issues” such as modifications to tax shelters.20 Such a noncommittal response

illustrates that Congress should provide the IRS with strong guidance on how to address the tax

shelter issue.

A substantive law change

Some believe that clarifying and strengthening the penalty rules would be insufficient

unless changes are also made to substantive tax law. The Joint Committee staff believes the

substantive rules, including the common law doctrines, provide a sufficient, well-developed body

of law for corporations to consider when evaluating tax shelter arrangements. The problem is not

that the IRS lacked the necessary tools to challenge the transaction, nor can it be said that each

taxpayer was unaware of the common-law doctrines. For example, the courts in each of the cases

previously discussed -- the ACM case, the Compaq case, and the Winn-Dixie case -- relied on

well-known, long-standing common-law doctrines to disallow the claimed tax benefits. The

problem is that, from an economic (i.e., cost-benefit) perspective, the taxpayer concluded that it

had little (if any) financial risk by going forward with the transaction. One only needs to look at

the imposition of penalties in the cases. Neither the ACM case nor the Winn-Dixie case makes

reference to penalties.21 In the Compaq case, the Tax Court imposed a negligence penalty under

section 6662, though the facts are somewhat unusual in that the taxpayer did not seek an opinion

of counsel, and the court noted how the corporate officer did little due diligence (and shredded

the spreadsheet). In other words, there seems to be sufficient, well-developed case law that is

flexible and adaptable to address the substantive issue of whether a tax shelter exists. What is

lacking is a meaningful penalty structure that would significantly alter the cost-benefit calculus.

Another important concern with enacting a substantive rule is the inherent difficulty of

crafting a rule that is sensitive to the tax system’s reliance on objective, rule-based criteria while

at the same time does not impede legitimate business transactions from going forward. A

substantive law change should be precise so as to target abusive transactions but not affect

legitimate business transactions. The difficulty lies in crafting a definition of a “tax shelter.” 

There can be significant disputes as to whether a particular transaction is a tax shelter. This is

why the Joint Committee staff study identifies certain common characteristics of corporate tax
22 The Joint Committee staff study identified five common characteristics of modern

corporate tax shelter transactions. These characteristics are: (1) an arrangement in which the

reasonably expected pre-tax profit is insignificant when compared with the expected tax benefits;

(2) the involvement of a tax-indifferent participant; (3) the use of guarantees, tax indemnities and

similar arrangements, including contingent fee structures; (4) a difference between tax reporting

and financial statement reporting, especially where permanent differences arise; and (5) the lack

of any appreciable change in economic position, particularly when a corporation does not take on

any additional economic risk. Any corporate transaction which exhibits one of these

characteristics (“tax shelter indicator”) should be considered to have a significant purpose of

avoiding or evading Federal income tax for purposes of an understatement penalty.

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shelter arrangements, referred to as “tax shelter indicators,”22 which, if present in an arrangement,

would result in an understatement penalty only after a determination that the arrangement caused

an understatement of the corporate participant’s tax liability. Thus, it is not enough that the

arrangement appears to be a tax shelter; there must be a determination that the tax treatment was

improper and the taxpayer must have had less than a high level of confidence that the tax

treatment was proper in order for a penalty to be imposed. This relieves much of the pressure of

crafting a precise definition of a corporate tax shelter, which would exist if a substantive law

change was adopted.

E. Summary

In summary, the cost-benefit analysis should be altered to discourage corporations from

entering into abusive transactions without affecting legitimate business transactions. An

enhanced penalty structure with more detailed disclosure requirements and more stringent

standards for other participants in the corporate tax shelter would strike the appropriate balance

and alter the cost-benefit analysis in a manner that would provide a sufficient deterrent effect. 

IV. SPECIFIC RECOMMENDATIONS

Consistent with its analysis and conclusions, the Joint Committee staff recommends the

following with respect to corporate tax shelters.

Recommendations that affect corporations which participate in corporate tax shelters

A. Clarify the definition of a corporate tax shelter for purposes of the understatement

penalty with the addition of several “tax shelter indicators.” This

recommendation builds on the present-law definition of a corporate tax shelter

found in section 6662 (the accuracy related penalty). Under that definition, a tax

shelter exists if a significant purpose of a partnership, or other entity, plan, or

arrangement is the avoidance or evasion of Federal income tax. The

recommendation expounds upon that definition by providing certain “indicators”

that if present will cause a partnership, or other entity, plan or arrangement in
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which a corporation is a participant to be considered to have a significant purpose

of avoidance or evasion of Federal income tax. 

The indicators were developed from what we found to be common characteristics

of corporate tax shelters. At the same time, so as to ensure that there will be no

interruption to legitimate business activity, the list excludes many common

characteristics and is narrowly tailored to avoid any overreaching. Most

importantly, the indicators themselves do not cause a penalty to be created. The

penalty is imposed only if an understatement exists--meaning that a determination

has been made (for example, by losing in court) that the tax benefits related to a

transaction were improper an not permitted under present law. The indicators

are:

(1) The reasonably expected pre-tax profit from the arrangement is

insignificant relative to the reasonably expected net tax benefits.

(2) The arrangement involves a tax-indifferent participant, and the

arrangement (1) results in taxable income materially in excess of economic

income to the tax-indifferent participant, (2) permits a corporate

participant to characterize items of income, gain, loss, deductions, or

credits in a more favorable manner than it otherwise could without the

involvement of the tax-indifferent participant, or (3) results in a

noneconomic increase, creation, multiplication, or shifting of basis for the

benefit of the corporate participant, and results in the recognition of

income or gain that is not subject to Federal income tax because the tax

consequences are borne by the tax-indifferent participant.

(3) The reasonably expected net tax benefits from the arrangement are

significant, and the arrangement involves a tax indemnity or similar

agreement for the benefit of the corporate participant other than a

customary indemnity agreement in an acquisition or other business

transaction entered into with a principal in the transaction.

(4) The reasonably expected net tax benefits from the arrangement are

significant, and the arrangement is reasonably expected to create a

“permanent difference” for U.S. financial reporting purposes under

generally accepted accounting principles.

(5) The reasonably expected net tax benefits from the arrangement are

significant, and the arrangement is designed so that the corporate

participant incurs little (if any) additional economic risk as a result of

entering into the arrangement.
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B. An entity, plan, or arrangement can still be a tax shelter even though it does not

display any of the tax shelter indicators, provided that a significant purpose is the

avoidance or evasion of Federal income tax.

C. Modify the penalty so that, with respect to a corporate tax shelter, there would be

no requirement that the understatement be substantial.

D. Increase the understatement penalty rate from 20 percent to 40 percent for any

understatement that is attributable to a corporate tax shelter. The IRS would not

have the discretion to waive the understatement penalty in settlement negotiations

or otherwise for corporate tax shelters.

E. Provide that the 40-percent penalty could be completely abated (i.e., no penalty

would apply) if the corporate taxpayer establishes that it satisfies certain

abatement requirements. Foremost among the abatement requirements is that the

corporate participant believes there is at least a 75-percent likelihood that the tax

treatment would be sustained on the merits. Another requirement for complete

abatement involves disclosure of certain information that is certified by the chief

financial officer or another senior corporate officer with knowledge of the facts.

F. Provide that the 40-percent penalty would be reduced to 20 percent if certain

required disclosures are made, provided that the understatement is attributable to a

position with respect to the tax shelter for which the corporate participant has

substantial authority in support of such position.

G. Require a corporate participant that must pay an understatement penalty of at least

$1 million in connection with a corporate tax shelter to disclose such fact to its

shareholders. The disclosure would include the amount of the penalty and the

factual setting under which the penalty was imposed.

Recommendations that affect other parties involved in corporate tax shelters

A. Increase the penalty for aiding and abetting with respect to an understatement of a

corporate tax liability attributable to a corporate tax shelter from $10,000 to the

greater of $100,000 or one-half the fees related to the transaction.

B. Expand the scope of the aiding and abetting penalty to apply to any person who

assists or advises with respect to the creation, implementation, or reporting of a

corporate tax shelter that results in an understatement penalty if (1) the person

knew or had reason to believe that the corporate tax shelter could result in an

understatement of tax, (2) the person opined or advised the corporate participant

that there existed at least a 75-percent likelihood that the tax treatment would be

sustained on the merits if challenged, and (3) a reasonable tax practitioner would
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not have believed that there existed at least a 75-percent likelihood that the tax

treatment would be sustained on the merits if challenged.

C. Require the publication of the names of any person penalized under the aiding and

abetting provision and an automatic referral of the person to the IRS Director of

Practice.

D. Clarify the U.S. government’s authority to bring injunctive actions against persons

who promote or aid and abet in connection with corporate tax shelters.

E. Include the explicit statutory authorization for Circular 230 in Title 26 of the

United States Code and authorize the imposition of monetary sanctions.

F. Recommend that, with respect to corporate tax shelters, Treasury amend Circular

230 generally to (1) revise its definitions, (2) expand its scope, and (3) provide

more meaningful enforcement measures (such as the imposition of monetary

sanctions, automatic referral to the Director of Practice upon the imposition of any

practitioner penalty, publication of the names of practitioners that receive letters

of reprimand, and automatic notification to state licensing authorities of any

disciplinary actions taken by the Director of Practice).

Disclosure and registration obligations

A. Corporate taxpayer disclosure

(1) 30-day disclosure.--Arrangements that are described by a tax shelter

indicator and in which the expected net tax benefits are at least $1 million

would be required to satisfy certain disclosure requirements within 30-

days of entering into the arrangement.

• The 30-day disclosure would include a summary of the relevant

facts and assumptions, the expected net tax benefits, each tax

shelter indicator that describes the arrangement, the analysis and

legal rationale, the business purpose, and the existence of any

contingent fee arrangements.

• The chief financial officer or another senior corporate officer with

knowledge of the facts would be required to certify, under penalties

of perjury, that the disclosure statements are true, accurate, and

complete.

(2) Tax-return disclosure.--Arrangements that are described by a tax shelter

indicator (regardless of the amount of net tax benefits) would be required
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to satisfy certain tax-return disclosure requirements.

• The tax-return disclosure would include a copy of any required 30-

day disclosure.

• The tax-return disclosure also would identify which tax shelter

indicators describe one or more arrangements reflected on the

return.

B. Tax shelter registration

(1) Modify the present-law rules regarding the registration of corporate tax

shelters by (1) deleting the confidentiality requirement, (2) increasing the

fee threshold from $100,000 to $1 million, and (3) expanding the scope of

the registration requirement to cover any corporate tax shelter that is

reasonably expected to be presented to more than one participant.

(2) Require additional information reporting with respect to the registration of

tax shelter arrangements that are described by a tax shelter indicator. The

additional information would include the claimed tax treatment and

summary of authorities, the tax shelter indicator(s) that describes the

arrangement, and certain calculations relating to the arrangement.

V. CONCLUSION

The Joint Committee staff believes that a corporate tax shelter problem exists, and the

problem is becoming widespread and significant. The Joint Committee staff further believes that

increasing the penalties for engaging in corporate tax shelters would sufficiently alter the costbenefit analysis with respect to engaging in such transactions and would provide a measured

response to the corporate tax shelter problem. The Joint Committee staff’s analysis and specific

recommendations are discussed in more detail in the Joint Committee staff study. 

I thank the Committee for the opportunity to present the Joint Committee staff

recommendations on corporate tax shelters, and I would be happy to answer any questions the

Committee may have at this time and in the future.