Tax Shelters in the 1990s; Rumors of the Death of Tax Shelters May Be Greatly Exaggerated (1991)

KEN MILANI, CPA, Phd, is professor of accountancy in the College of Business Administration, the University of Notre Dame, Notre Dame, Indiana. He is a menber of the American Institute of CPAs.JOHN J. CONNORS, CPA, LLM, is associate professor, director of tax research and coordinator of tax programs at Bryant College in Smithfield, Rhode Island. He is a ember of the AICPA. Rumors of the death of tax shelters may be greatly exaggerated. There's little question tax shelters took a beating during the 1980s. A primary source of this punishment was the changes in the tax laws that made many shelters unattractive by reducing, restricting or repealing certain key tax benefits. As a result, not much has been written about tax shelters in the last few years. However, tax shelters do still exist. Those who look favorably on them describe shelters as investment opportunities that provide substantial tax benefits. Others look askance and claim shelters are loopholes in the Internal Revenue Code that siphon away revenues needed to reduce the national debt. This article covers the tax and nontax benefits, risks and other aspects of tax shelters in today's complex economic environment. TAX REFORM ACT OF 1986 The Tax Reform Act of 1986 took dead aim at tax shelters and restricted several benefits that had been available for many years. Tax shelter opportunities are still available, however. A common organizational vehicle for such investments is the limited partnership. This structure appeals to certain investors; it is especially attractive to investors lacking the time or expertise to pursue opportunities that (1) yield special tax advantages, (2) limit liability and (3) are economically feasible relative to the risk involved. Other shelter formats, such as S corporations and individual investments, also are available, but currently the limited partnership represents the most common structure. Exhibit 1, page 42, lists some of the most common limited partnership tax shelter investments. When examining a potential tax shelter opportunity, there are several actions investors and their advisers should take: * Identify the risks. * Detail the tax benefits and burdens. * Analyze the shelter's income, loss and profit projections. * Determine how appropriate the investment is, given the needs and circumstances of the potential investor. For a more complete discussion of how to evaluate a tax shelter, see the sidebar on page 43. BENEFITS OF A TAX SHELTER A tax shelter must be an economically sound investment. If the venture is otherwise viable, tax benefits will only add to its value. But if tax benefits are essential to make the shelter an attractive investment, this raises questions about the overall soundness of the shelter. Some of the more important benefits tax shelters offer are described below. Leverage. Leverage enables investors to make a relatively low cash outlay to garner substantial gains and other tax benefits. The benefits of leveraging occur, for example, when an investment of only a modest down payment in real estate triggers depreciation or tax credits. Regular or non-recourse debt (in the case of real estate) is used to finance the balance of the transaction. When recourse financing is involved, investors carry personal and unlimited liability for the debt, while non-recourse financing limits personal liability to the specific assets acquired. The short-run benefits include * Positive cash flow. * Tax losses that can be applied against other income. * Tax credits. Exhibit 2, page 44, illustrates the benefits of leverage in a limited partnership. Leverage continues to be an attractive feature of many tax shelters, even in the face of changes in the tax laws. Consider, for example, what happened with the Revenue Reconciliation Act of 1990. Ordinary tax rates were increased from 28% to 31% for some taxpayers. …