FROM THE OFFICE OF PUBLIC AFFAIRS

The Bush Administration has taken aggressive action to address the abusive tax shelter problem, more so than in any period in recent memory.  Tax shelters are being addressed effectively through increased disclosure by taxpayers and promoters, timely response by the Treasury Department and the IRS to transactions that are identified, and, where necessary, targeted legislative changes to the substantive tax laws.  The Administration’s actions to carry out each of these principles have been focused, significant, and effective:

· The Administration is taking vigorous enforcement action against abusive tax shelters.
· The Administration has increased the disclosure of abusive tax shelters.
· The Administration is using its regulatory authority to shut down abusive tax shelters.
· The Administration’s legislative proposals will:
- Shut down specific abusive tax shelters.
- Give the IRS important new tools and enhance its ability to combat abusive tax shelters.
- Enhance the IRS’ effectiveness without compromising taxpayer protections.
· The Administration is reining in international tax abuses.

So-called “technical tax shelters” proliferated in the 1990s because taxpayers and promoters believed that taxpayers could enter into aggressive transactions with little risk of detection and with little risk of owing anything more than the tax due and interest even if caught.  The Administration’s approach to tax shelters is changing completely the risk-reward calculus for taxpayers considering an abusive transaction.  The IRS’ audits of the promoters of these tax shelters over the past three years have been unprecedented.  Taxpayers and promoters no longer will be able to avoid detection.  The Treasury Department and the IRS will take the steps necessary to shut down tax shelters – including appropriate enforcement action against taxpayers and promoters – as they are identified.

Beginning back in early 2002, the Administration proposed significant legislation to end the “hide-and-seek” tactics of promoters and taxpayers involved in these abusive transactions.  In addition, the Administration is committed to providing the IRS with the resources and support needed to ensure that all taxpayers pay their fair share.  The Administration’s FY 2005 Budget includes an additional $300 million for IRS efforts to ensure compliance with the tax laws, and increases the total IRS budget by 4.8 percent – significantly above the average for non-defense, non-homeland security discretionary spending.  The budget continues a three year trend of increasing resources for the IRS to improve taxpayer compliance and to target abusive transactions, while maintaining customer service to taxpayers.

Shutting down abusive transactions is not amenable to an easy, “one size fits all” solution.  There simply is no “silver bullet” to the problem of tax shelters, and the Administration’s actions reflect the comprehensive steps needed to effectively address this problem.  Broad anti-abuse provisions, such as the proposed codification of the economic substance doctrine, may appear to be simple and attractive.  They would do more, however, to burden careful taxpayers and practitioners – and the IRS – than stop abusive transactions.  Complex rules would be needed to address the wide range of everyday business transactions that would be affected by a broad, anti-abuse rule.  But those regulations, in fact, would make the law less clear and more complex, and complex rules are more difficult for the IRS to administer fairly.  At the same time, it is impossible for statutory or regulatory rules to cover every factual situation.  A codified rule also would not stop those who are inclined to find economic substance and business purpose in virtually any transaction.  It is far preferable to leave the economic substance doctrine to the courts – where it was originally conceived in the 1930s – which are better suited to applying the doctrine with flexibility.  The judicial doctrine of economic substance requires an intensely factual inquiry, and these types of inquiries should be done by a court based on the actual facts of the case before it.

The specific steps taken by the Administration to address tax shelters are detailed below.

The Administration Is Taking Vigorous Enforcement Action Against Abusive Tax Shelters

Effective action against tax shelters requires effective tax administration.  Over the past three years, the Treasury Department and the IRS have been working closely together to implement an effective strategy for dealing with abusive transactions.  Although the actions described below relate to so-called “technical” tax shelters, the IRS also has an extensive program in place to address promoters of schemes and scams marketed primarily to individuals and small businesses, as well as the taxpayers who enter into those schemes and scams.

·  The IRS Is Implementing a Coordinated Strategy for Tax Shelters – Commissioner Mark Everson is focused on organizing and maximizing the effectiveness of the IRS’ efforts to combat tax shelters.  John Klotsche, a former chairman of a major international law firm, has joined the IRS as a Senior Advisor to the Commissioner and has responsibility over the coordination of the IRS’ efforts to combat tax shelters.  The Commissioner and Senior Advisor Klotsche are working to coordinate efforts within the agency, with the Treasury Department, and with the Department of Justice.

· The Treasury Department and the IRS Have Issued Proposed Ethical Rules and Opinion Standards for Tax Practitioners – Many promoters claim that they can provide taxpayers with opinions that will protect against penalties even if a tax shelter is successfully challenged by the IRS.  In December 2003, the Treasury Department and the IRS issued new proposed regulations that set out best practices for tax practitioners and provide minimum standards for tax opinions used to support tax shelters.  Finalizing these rules is a high priority for the Treasury Department and the IRS.

· The IRS Has Established Coordinated, Transaction-Specific Task Forces to Address Identified Tax Shelters – Beginning in 2002, the IRS began using transaction-specific task forces to coordinate activities to shut down tax shelters.  These task forces consist of attorneys from the IRS Operating Divisions, the IRS Office of Chief Counsel, the IRS’ Office of Tax Shelter Analysis (OTSA), and the Treasury Department.  These task forces allow the IRS to quickly develop and coordinate the legal response to a tax shelter.

· The IRS Has Expanded Its Partnership with States to Combat Tax Shelters – In 2003, the IRS entered into a nationwide partnership agreement with tax authorities in 40 states and the District of Columbia to share data and coordinate examination efforts to combat tax shelters.  This agreement recently was expanded to now cover 45 states, the District of Columbia and New York City, and the IRS has started sharing leads on more than 20,000 taxpayers. 

·  The IRS Has Initiated Over 130 Promoter Audits – Since the beginning of 2001, the IRS has initiated over 130 promoter audits, including audits of accounting firms, law firms, insurance companies, brokerage companies, banks, and other boutique and mid-size promoters.  These promoter audits will help ensure compliance with the promoter disclosure rules and will examine whether promoter penalties should be asserted against particular promoters.

·  The IRS Has Served Over 350 Administrative Summonses on Tax Shelter Promoters – Since the beginning of 2002, the IRS has served over 350 administrative summonses to tax shelter promoters and has referred over 120 summonses to the Department of Justice for enforcement.  The Department of Justice has commenced enforcement actions in court with respect to 67 of these summonses.  Administrative summonses have been, and will continue to be, an important source of information for the IRS regarding promoter activities and compliance.

· The IRS Has Sought Court Permission to Serve John Doe Summonses in Five Promoter Cases – Since the beginning of 2002, the IRS has sought, as required by statute, court permission to serve “John Doe” summonses in 5 promoter cases.  John Doe summonses are an important tool for identifying taxpayers who may have entered into potential tax shelters.

· The IRS Has Encouraged Voluntary Disclosure – In December 2001, the IRS began a disclosure initiative (Announcement 2002-2) to give taxpayers an incentive to disclose questionable transactions and other items that may have resulted in an underpayment of tax.  In order to obtain penalty relief under the initiative, a taxpayer was required to disclose all relevant information about the transaction, including the identity of any promoter.  The IRS has been using the information from the 1,689 disclosures received to identify new promoters and potential tax shelters for investigation and appropriate enforcement action.

· The IRS Is Using a Mandatory IDR to Identify Listed Transactions for LMSB Cases – Since April 2002, the IRS’ Large and Midsize Business Division (LMSB) has been using a uniform information document request (IDR) in all of its audits.  This mandatory IDR requests information regarding all “listed” transactions (i.e., specifically identified in published guidance as a tax avoidance transaction) reported by the taxpayer on its returns.  The mandatory IDR will ensure that all LMSB taxpayers under audit disclose listed transactions.

· The IRS Has Developed Mandatory Penalty Guidelines for Listed Transactions – The IRS issued penalty guidelines in December 2001 requiring the development of accuracy-related penalties for listed transactions.  These guidelines will help ensure that appropriate penalties are applied with respect to listed transactions.  

· The IRS Has Conducted Three Settlement Initiatives – In November 2002, the IRS announced three settlement initiatives to resolve, on a basis that is fair, cases involving three widely-marketed tax shelters:  the Section 302/318 “basis shift” transaction, the Section 351 contingent liability transaction, and the highly-leveraged corporate-owned life insurance (COLI) transaction.  These initiatives have allowed the IRS to resolve a significant number of cases on a basis that is fair to the government and taxpayers.  These initiatives permit the IRS to focus its resources on other tax shelters.

· The IRS Has Revised Its Tax Accrual Workpaper Policy to Request These Documents From Taxpayers Who Engage in Listed Transactions – Tax accrual workpapers normally are prepared by taxpayers and their independent auditors to evaluate the taxpayer’s tax reserves for financial accounting purposes.  Starting in 2002, the IRS changed its policy so that it now may request these workpapers from taxpayers who have engaged in listed transactions.  This change in policy is a significant disincentive for taxpayers considering entering into a listed transaction.

· The IRS Has Entered into an Agreement with a Major Professional Firm to Ensure Compliance with the Disclosure Rules – As a result of the IRS’ audits of promoters of technical tax shelters, one large professional firm has agreed to work with the IRS to ensure ongoing compliance with the registration and list maintenance provisions of the Internal Revenue Code and regulations.  The IRS’ agreement with this firm will ensure the highest standards of practice and future compliance with the law and regulations.  The IRS expects to use this agreement as a model for agreements with other practitioners.

The Administration Has Increased Disclosure Of Abusive Tax Shelters

Taxpayers will be far less willing to engage in tax shelters if they believe that their transactions will be identified and that they will have to defend their transactions to the IRS and in the courts.  The early disclosure of tax shelters also will allow the Treasury Department and the IRS to respond to abusive transactions before they spread throughout the market.  Over the past two years the Administration has significantly overhauled rules requiring disclosure of abusive transactions by taxpayers and promoters.  In addition, the Administration has proposed statutory changes that will further expand and strengthen the disclosure system.  The Treasury Department originally announced these proposed statutory changes in March 2002, and the Administration remains committed to working with Congress to ensure that these important proposals are enacted into law.

·  Expanded and Simplified the Taxpayer Return Disclosure Regulations – Temporary regulations issued in February 2000 required the disclosure of potentially questionable transactions.  These rules, however, were limited to corporate taxpayers and were complex and subjective.  The Treasury Department and the IRS finalized new disclosure regulations in February 2003 to increase disclosure and make the regulations easier to apply and administer.  These new regulations contain straightforward, objective rules with no subjective exceptions.  They apply to all taxpayers, including individuals, trusts, and partnerships.

· Expanded and Simplified the Promoter List-Maintenance Regulations – Temporary regulations issued in February 2000 required promoters to maintain lists of taxpayers who participated in potentially questionable transactions.  These rules were complex and subjective.  The Treasury Department and the IRS finalized new list-maintenance regulations in February 2003 to broaden the list-maintenance requirements.  These new regulations contain straightforward, objective rules that work with the new disclosure regulations to give the IRS multiple sources of information on a potential tax shelter.  Coordinated rules for taxpayers and promoters will end the “conspiracy of silence” that made it more difficult for the IRS to identify and take action against tax shelters.

· Issued Final Regulations for Promoter Registration of Certain Tax Shelters – Temporary regulations issued in February 2000 required promoters to register certain tax shelters with the IRS.  The Treasury Department and the IRS finalized the registration regulations in February 2003.  When the Administration’s proposal to amend the underlying statute is enacted into law, the Treasury Department and the IRS will issue new registration regulations to fully coordinate the three sets of disclosure rules:  taxpayer return disclosure, promoter registration, and promoter list-maintenance.

·  Issued Final Penalty Regulations to Address Taxpayers Who Fail to Disclose Potential Tax Shelters – In the absence of a specific penalty for the failure to disclosure a transaction on a return, some taxpayers were choosing to not disclose the transaction and to rely on an opinion to avoid any penalties if the transaction is successfully challenged by the IRS.  In December 2003, the Treasury Department and the IRS issued final penalty regulations limiting the penalty defenses for taxpayers who fail to disclose potential tax shelters or positions based on advice that a regulation is invalid.

·  Proposed a New Schedule M-3 to Prioritize Book-Tax Differences – The Schedule M-1 that is part of the corporate income tax return requires taxpayers to identify differences between their taxable income and their financial, or book, income.  The rules for disclosing these book-tax differences are unclear.  The Treasury Department and the IRS recently proposed a new corporate income tax form to make book-tax differences more transparent.  The new Schedule M-3 will allow the IRS to more quickly identify differences that may have resulted from an aggressive tax position or a potential tax shelter.  Better disclosure of book-tax differences will allow the IRS to focus its resources more efficiently on potentially significant, emerging issues.

· Proposed Legislation to Fully Coordinate the Disclosure Rules – Disclosure works best when the IRS has multiple sources of information about a tax shelter that form a complete web of disclosure.  Existing statutes do not permit uniform and consistent rules.  The Administration’s FY 2005 Budget again proposes to change the promoter registration and list-maintenance statutes to permit uniform and consistent taxpayer and promoter disclosure rules.

· Proposed Legislation to Impose Meaningful Penalties on Taxpayers who Fail to Disclose – A taxpayer currently faces no penalty for the failure to disclose a potentially abusive transaction on a return.  Only Congress may provide for a nondisclosure penalty.  The Administration’s FY 2005 Budget again proposes penalties of up to $200,000 for taxpayers who fail to disclose potential tax shelters.  In addition, public companies would be required to disclose in their SEC filings any penalties for failing to disclose a transaction that the Treasury Department and the IRS have identified as a “tax avoidance” (or “listed”) transaction.

· Proposed Legislation to Increase Penalties on Promoters who Fail to Register a Transaction – The Administration’s FY 2005 Budget again proposes to increase the existing penalties for a promoter’s failure to register a transaction with the IRS.  Along with the Administration’s proposal to broaden the reach of the promoter registration statute, this proposal will impose meaningful penalties on promoters who fail to register a potential tax shelter.

· Proposed Legislation to Increase Penalties on Promoters who Fail to Maintain Lists of Taxpayers who Have Engaged in Potential Tax Shelters –  Existing penalties on promoters who fail to maintain lists of participating taxpayers are insufficient.  The Administration’s FY 2005 Budget again proposes significant penalties of $10,000 per day on promoters for the failure to provide the IRS with lists of taxpayers who have engaged in potential tax shelters.

The Administration Is Using Its Regulatory Authority To Shut Down Abusive Tax Shelters

The Treasury Department and the IRS have used the authority under section 6011 to identify in published guidance (or “list”) specific “tax avoidance” transactions.  The recently revised disclosure and list-maintenance rules impose stringent disclosure requirements on taxpayers and promoters for listed transactions.  These listing notices also make clear to taxpayers and promoters that the Treasury Department and the IRS are aware of these abusive transactions and that the IRS is committed to taking appropriate enforcement action against participating taxpayers and promoters.  Listing notices have been one of the most effective actions taken over the past three years to stop tax shelters.  Over the past three years, the Administration has listed the following transactions:

·  Abusive Foreign Tax Credit Transactions – These transactions involve a domestic corporation’s transitory ownership of a foreign target corporation when, pursuant to a prearranged plan, the domestic corporation acquires the stock of the target corporation and then all or substantially all of the target corporation’s assets are sold in a transaction that gives rise to foreign tax without a corresponding inclusion of income for U.S. tax purposes.  The Treasury Department and the IRS issued Notice 2004-20 to shut down these transactions.  The Treasury Department and the IRS at the same time also issued Notice 2004-19, which details the legislative and regulatory approaches that the Treasury Department and the IRS are using to address other abusive foreign tax credit transactions.

· Abusive Excess Life Insurance in Defined Benefit Pension Plans – These arrangements involve specially designed life insurance policies intended primarily to benefit highly-compensated employees through a retirement plan.  The Treasury Department and the IRS issued Rev. Rul. 2004-20 to shut down abusive excess life insurance arrangements.

· Abusive S Corporation ESOP Arrangements – These arrangements are intended to assist companies in avoiding tax rules designed to protect rank-and file participants in employee stock ownership plans (“ESOPs”).  The Treasury Department and the IRS issued Rev. Rul. 2003-6 and Rev. Rul. 2004‑4 to stop these abuses and protect rank-and-file participants in S corporation ESOPs.

· Abusive Roth IRA Transactions – These arrangements involve the contribution of property to an IRA through a transaction that disguises the value of the contribution to circumvent Roth IRA contribution limits.  The Treasury Department and the IRS issued Notice 2004-8 to stop abusive structures designed to avoid the contribution limits that apply to Roth IRAs.

· Abusive Offsetting Foreign Currency Option Contract Transactions – These transactions involve two pairs of offsetting foreign currency options.  Two of the offsetting options are assigned to a charity, and the taxpayer claims an immediate loss on one option without recognizing the offsetting gain on the other.  The Treasury Department and the IRS issued Notice 2003-81 to shut down these transactions.

· Abusive Contested Liability Transactions – These transactions involve the purported establishment of trusts to accelerate deductions for liabilities that a taxpayer is contesting under section 461(f).  The trusts, however, do not comply with the requirements of that section because the taxpayer either retains control over the trust assets or transferred its own stock or the stock or note of a related party.  The Treasury Department and the IRS issued Notice 2003-77 to prevent the use of trusts to accelerate deductions.

· Abusive Stripping Transactions – These transactions improperly separate income from related deductions.  Some of these transactions, for example, are structured to have a tax-indifferent party realize the taxable income while the taxpayer claims deductions related to that income, such as depreciation or rental expenses.  The Treasury Department and the IRS issued Notice 2003-55 to shut down these transactions.

· Abusive Option Sales to Family Limited Partnerships – These arrangements involve the purported sale of compensatory stock options to a limited partnership owned by the taxpayer’s family members to avoid income and employment taxes on the exercise of the options.  The Treasury Department and the IRS issued Notice 2003-47 to shut down these transactions.

· Abusive Welfare Benefit Funds – These transactions are designed to avoid the applicable deduction limits on contributions to welfare benefit funds.  Taxpayers claim that the benefits are being provided under a collective bargaining agreement.  The Treasury Department and the IRS issued Notice 2003-24 stop these abuses and further addressed these transactions in final regulations issued July 2003.

· Abusive Offshore Deferred Compensation Arrangements – These transactions are designed to avoid income and employment taxes by utilizing a purported lease of the right to a taxpayer’s services in the United States through a foreign leasing company.  The proceeds of the leasing arrangement are transferred to an offshore trust maintained on behalf of the taxpayer.  The Treasury Department and the IRS issued Notice 2003-22 to shut down these abusive offshore employee leasing arrangements.

· Abusive Producer Owned Reinsurance Company (“PORC”) Arrangements – These insurance arrangements involve a foreign corporation established to reinsure the policies sold by a taxpayer in connection with the sale of products or services.  The taxpayers utilize various exemptions of income for insurance companies to divert portions of the premiums paid to the PORC and pay little or no tax on the diverted funds.  The Treasury Department and the IRS issued Notice 2002-70 to shut down these arrangements.

· Abusive Lease-In/Lease-Out (“LILO”) Transactions – LILOs involve a lease of property from a tax-indifferent party (e.g., a foreign party or a tax-exempt party), and a simultaneous lease of the same property back to the tax-indifferent party to generate substantial deductions of the lease payments.  The Treasury Department and IRS issued Rev. Rul. 2002-69 to supersede earlier guidance issued to shut down these transactions. 

· Abusive Partnership Straddle Tax (“Eliminator”) Transactions – These transactions involve the use of a straddle, a tiered partnership structure, a transitory partner, and the partnership allocation rules to generate purported permanent non-economic tax losses for the taxpayer. The Treasury Department and the IRS issued Notice 2002-50 to shut down these transactions.

· Abusive Passthrough Entity Straddle Transactions – These transactions involve the use of a straddle, one or more transitory S corporation shareholders, and the rules of subchapter S to allow a taxpayer to claim an immediate loss while deferring an offsetting gain.  The Treasury Department and the IRS issued Notice 2002-65 to shut down these transactions.

· Abusive Common Trust Fund Straddle Transactions – These transactions involve the use of a common trust fund that invests in economically offsetting gain and loss positions in foreign currencies and allocates the gain to one or more tax-indifferent parties and the losses to the taxpayer.  The Treasury Department and the IRS issued Notice 2003-54 to shut down these transactions.

· Abusive 401(k) Accelerated Deductions – These transactions involve claims by employers of accelerated deductions for contributions to retirement plans on compensation expected to be earned by participants in future years.  The Treasury Department and the IRS issued Rev. Rul. 2002-46 to expand earlier guidance identifying these listed transactions.

· Abusive Notional Principal Contracts or Contingent Swaps – These transactions involve the use of a notional principal contract to claim current deductions for periodic payments made by a taxpayer while disregarding the accrual of a right to receive offsetting payments in the future.  The Treasury Department and the IRS issued Notice 2002-35 to stop these abuses.

· Abusive Inflated Basis ("CARDS") Transactions – These transactions involve the use of a loan assumption agreement to claim an inflated basis in assets.  The assets are sold for fair market value and the taxpayer claims a significant loss, arguing that the entire principal amount of the loan is included in taxpayer’s basis.  The Treasury Department and the IRS issued Notice 2002‑21 to shut down these transactions.

· Abusive Section 302/318 “Basis Shift” Transactions – These transactions involve an abuse of the attribution rules to increase the basis of the stock held by the taxpayer through a redemption of stock held by a tax-indifferent party (typically, a foreign entity).  The taxpayer claims a loss on the sale of its stock based on its position that the basis of the redeemed stock is added to the basis of stock the taxpayer sold.  The Treasury Department and the IRS issued Notice 2001-45 to shut down these transactions.

Promoters of tax shelters often attempt to take advantage of highly technical tax rules to obtain tax benefits not intended by Congress.  The Administration is using its regulatory authority whenever appropriate to stop abusive transactions and eliminate potential opportunities for abuse.  Administrative actions taken over the past three years include:

·  Issued Final Regulations to Stop Abusive Split-Dollar Life Insurance Arrangements – “Split-dollar life insurance arrangements” have been used to provide some corporate executives with tax-free compensation and to make tax-free gifts among family members.  In September 2003, the Treasury Department and the IRS issued final regulations that shut down the use of these arrangements.

· Issued Notice to Stop Abusive “Reverse Split-Dollar Life Insurance Arrangements” – “Reverse split-dollar life insurance arrangements” were being marketed as a means to avoid gift and estate taxes on wealth transfers to family members.  The Treasury Department and the IRS issued Notice 2002-59 to shut down these arrangements.

· Issued Final Regulations to Stop Abusive Hedged Deferred Compensation Liability Arrangements – These transactions were being used to claim favorable hedging income tax treatment with regard to certain deferred compensation arrangements.  In March 2002, the Treasury Department and the IRS issued final regulations to prevent these claimed tax benefits.

· Issued Revenue Rulings to Stop “Double-dip” Health Benefit Deduction Schemes – Promoters had been marketing schemes that purport to exclude health insurance premiums from an employee's income twice – i.e., once when paid by a reduction in salary and a second time when the amount of the salary reduction was reimbursed.   The Treasury Department and the IRS issued Rev. Rul. 2002-3 and Rev. Rul. 2002-80 to shut down these arrangements, which often were not disclosed to the employees.

· Issued Final Regulations to Stop Abusive Deferred Compensation Schemes for Nonprofit Executives – Some nonprofit organizations offered steeply discounted “options” to executives to purchase mutual funds.  These arrangements effectively gave the executives cash compensation that could be claimed at any time, even though the compensation was purported to be not taxable until claimed.  In July 2003, the Treasury and IRS issued final regulations that made these options and similar arrangements currently taxable.

· Issued Revenue Ruling to Stop Potential Abuses Involving Donations of Patents – Some taxpayers had claimed deductions for contributions of patents that far exceed the actual value of the patent to the recipient public charity.  The Treasury Department and the IRS issued Rev. Rul. 2003-28 to clarify that certain transfers of rights in a patent do not give rise to a charitable contribution deduction.  The Administration’s FY 2005 Budget also proposes to limit further a taxpayer’s ability to claim a deduction for the contribution of a patent or other intellectual property.

· Issued Revenue Ruling on Purported Insurance Companies Used to Reduce Tax on Investment Income – Some taxpayers had created purported insurance companies in foreign jurisdictions to shield investment income from U.S. tax.  The Treasury Department and the IRS issued Rev. Rul. 2003-34 to notify taxpayers that the IRS will challenge certain off-shore insurance company arrangements used to reduce tax on investment income.  The Administration’s FY 2005 Budget proposes to curtail the abuse of these insurance company arrangements.

· Issued Temporary Regulations to Stop “Son of BOSS” Transactions – Notice 2000-44 identified the so-called “Son of BOSS” transaction as a listed transaction.  Some promoters continued to market this tax shelter, and some taxpayers were still entering into these transactions.  In June 2003, the Treasury Department and the IRS issued temporary regulations under section 358(h) to stop these “Son of BOSS” transactions.

· Issued Revenue Ruling to Stop Tax Shelters Involving Variable Life Insurance and Annuity Contracts – Some taxpayers had entered into variable life insurance or annuity contract arrangements to avoid current tax on income and gain from the underlying assets even though the taxpayers retained effective ownership over these assets.  The Treasury Department and the IRS issued Rev. Rul. 2003-92 to stop these arrangements.

·  Issued Notice to Stop the Use of Stapled Stock Structures to Artificially Increase Foreign Tax Credits – Congress enacted section 269B in 1984 to address the potential for tax avoidance in certain structured transactions involving stock of two corporations (one foreign and one domestic) that cannot be transferred separately due to contractual restrictions.  Since then, however, taxpayers had sought to use the rules of section 269B to their advantage by creating stapled stock structures to artificially increase their foreign tax credits by manipulating the allocation and apportionment of expenses such as interest.  The Treasury Department and the IRS issued Notice 2003-50 to halt these transactions by announcing an immediately effective, targeted change to the rules of section 269B, and by reminding taxpayers of the potential applicability of existing principles of law, such as the substance-over-form doctrine, to these transactions.

·  Proposed New Information Reporting Requirements on U.S. Persons that Own Certain Foreign Entities – The Treasury Department and the IRS issued Announcement 2004-4 to propose new Form 8858.  This form will require information reporting by U.S. persons that own foreign disregarded entities.  This information reporting requirement will provide a means for the IRS to identify potential compliance issues efficiently in an area in which there currently is inadequate information reporting and will allow the IRS to better focus its audit resources.

· Issued Temporary Regulations to Require Information Reporting to Shareholders on Corporate Inversion Transactions – Corporate inversion transactions generally result in the shareholders of the inverting company recognizing gain on their stock as a result of the transaction.  The Treasury Department and the IRS issued regulations in 2002 that require inverting corporations to provide information reporting on these transactions to ensure that the shareholders accurately report the gain recognized as a result of an inversion.

· Issued Final Regulations to Eliminate Inappropriate Benefits from Domestic Reverse Hybrids – The Treasury Department and the IRS issued final regulations in 2002 to eliminate the benefits of a structure involving a hybrid entity established in the United States that makes payments to a parent company established in a country with whom the U.S. has a tax treaty that was designed to give rise to a deduction in the United States and exemption from tax in both the United States and the treaty country.

· Issued Regulations to Clarify the Treatment of Stock-Based Compensation in Cost Sharing Arrangements – The Treasury Department and the IRS issued regulations in 2003 on the tax treatment of stock-based compensation under the related party transfer pricing rules governing qualified cost sharing arrangements.  These regulations are aimed at ensuring that the rules governing qualified cost sharing arrangements for the joint development of intangible assets cannot be used to facilitate the migration of intangibles outside the United States for less than arm’s length compensation.

The Administration’s Legislative Proposals Will Shut Down Specific Abusive Tax Shelters

The Administration’s FY 2005 Budget builds on earlier Administration legislative proposals to strengthen the disclosure rules and on the information gathered through IRS compliance programs.  The new legislative proposals close loopholes and target identified tax shelters and abusive practices.  As other abusive transactions are identified, the IRS will challenge the transactions in audits, and the Treasury Department and the IRS will work with Congress to enact any legislation necessary to address the transactions.

·  Proposed Legislation to Stop Abusive Leasing Transactions with Tax-Indifferent Parties – Taxpayers increasingly have used purported leasing transactions, often referred to as SILO transactions, to “acquire” significant tax benefits from a tax-indifferent party, such as a municipal transit authority or foreign government, in exchange for a modest fee.  These transactions do not involve any useful economic activity, such as the acquisition or financing of business assets.  The Administration’s FY 2005 Budget proposes to sharply limit the tax benefits that a taxpayer can claim in these transactions.

· Proposed Legislation to Eliminate Abusive Transactions Involving Foreign Tax Credits – Current law provides taxpayers with a credit for certain foreign taxes in order to eliminate the double taxation of foreign income (i.e., taxation by both the United States and the country where the income is earned).  Taxpayers have structured transactions in an attempt to use foreign tax credits not to eliminate double taxation, but inappropriately to reduce their U.S. tax liability on unrelated foreign income.  The Administration’s FY 2005 Budget proposes to deny foreign tax credits for foreign withholding taxes imposed on income if the underlying property generating the income was not held for a specified minimum period of time.  In addition, the Administration’s proposals would provide the Treasury Department with regulatory authority to prevent transactions that inappropriately separate foreign taxes from the related foreign income to take advantage of the foreign tax credit rules where there is no real risk of double taxation.

·  Proposed Legislation to Stop Abusive Income-Separation Transactions – Some taxpayers continue to engage in transactions that separate the periodic income steam from an underlying income-producing asset in order to generate an immediate tax loss for one taxpayer and the conversion of current taxable income into deferred capital gain for another.  Although the Tax Code prohibits these transactions for bonds and preferred stock, taxpayers have been engaging in essentially identical transactions using similar assets, such as shares in a money-market mutual fund.  The Administration’s FY 2005 Budget again proposes to treat an income-separation transaction as a secured borrowing, not a separation of ownership.  Debt characterization will ensure that the tax treatment of the transaction clearly reflects income.

·  Proposed Legislation to Prevent the Misuse of Tax-Exempt Casualty Insurance Companies – Certain small casualty insurance companies are not subject to federal income tax.  Some taxpayers are abusing this rule by creating insurance companies, claiming tax-exempt status, and improperly accumulating investment income tax-free.  The Administration’s FY 2005 Budget proposes to prevent taxpayers from using this targeted exemption to inappropriately avoid tax on investment income. 

· Proposed Legislation to Tighten the Deduction Limitation for Interest Paid to Related Parties – Current law denies a deduction for certain interest paid by a corporation to a related party to the extent the corporation’s net interest expenses exceed 50 percent of its taxable income (computed with certain adjustments).  This limitation only applies if the corporation's debt-equity ratio exceeds 1.5 to 1.0.  In order to address the opportunities available under current law to inappropriately reduce taxes on U.S. operations through the use of foreign related party debt, the Administration’s FY 2005 Budget proposes to tighten the limitation for related party interest expense.

· Proposed Legislation to Prevent Avoidance of U.S. Tax on Foreign Earnings Invested in U.S. Property – Under current law, U.S. shareholders of a controlled foreign corporation must include in income their pro rata share of earnings of the corporation that are invested in certain U.S. property.  Deposits with banks are excluded from the definition of U.S. property subject to this rule, however, so that taxpayers operating through foreign subsidiaries are not discouraged from using the U.S. banking system.  This exception has been interpreted in a manner inconsistent with the underlying policy.  For example, certificates of deposit have been issued by a U.S. affiliate in a transaction structured to take advantage of the bank exception.  Under the proposal contained in the Administration’s FY 2005 Budget, the exception for deposits with persons carrying on the banking business would be modified to eliminate this potential for abuse. 

·  Proposed Legislation to Modify Tax Rules for Individuals Who Give Up U.S. Citizenship or Green Card Status – If an individual gives up U.S. citizenship, or terminates long-term U.S. residency, with a principal purpose of avoiding U.S. tax, the individual is subject to an alternative tax regime for 10 years.  The Administration’s FY 2005 Budget proposes changes designed to improve compliance with the expatriation rules.

·  Proposed Legislation to Stop Abuses by Requiring Charitable Deductions to Reflect Accurately the Value of the Donation – Some taxpayers are abusing the laws designed to support charities by claiming deductions for contributions of certain property (e.g., patents, intellectual property, and motor vehicles) that far exceed the value of the property donated.  The Administration’s FY 2005 Budget proposes to impose additional appraisal requirements and, in the case of patents and certain other intellectual property, limit the amount that can be deducted to match the value of the donation.

· Proposed Legislation to Stop Abuses of Section 529 College Savings Plans – Section 529 college savings plans involve a number of issues that are not clearly answered by current law.  As a result, these savings plans could be abused to avoid transfer taxes.  The Administration’s FY 2005 Budget proposes to clarify the rules to prevent abuse and to make the applicable rules more equitable.  The Administration’s proposal would further encourage savings for college expenses through these increasingly popular plans.

The Administration’s Legislative Proposals Will Give the IRS Important Tools and Enhance Its Ability To Combat Abusive Tax Shelters

The Administration’s FY 2005 Budget contains a number of important legislative proposals that will allow the IRS to deal more effectively with abusive tax shelters.  Many of these proposals are designed to end practices used by some taxpayers and promoters to impede or delay examination.  Taxpayers who are willing to enter into abusive transactions and promoters who are willing to recommend abusive transactions should be willing to disclose these transactions and subject them to IRS scrutiny.

·  Proposed Legislation to Permit Injunction Actions against Promoters – Some promoters repeatedly disregard their legal obligations, including the registration and list-maintenance requirements.  The Administration’s FY 2005 Budget again proposes to confirm the Government’s authority to enjoin the most egregious promoters of tax shelters, as it is doing currently with promoters of tax scams directed primarily at individuals and small businesses.

·  Proposed Legislation to Impose a New Penalty for the Failure to Report an Interest in a Foreign Financial Account – Individual taxpayers are required to disclose on their tax returns interests in a foreign financial account, such as a bank account.  The Administration’s FY 2005 Budget again proposes a new civil penalty for the failure to disclose foreign financial accounts, which often are used in tax avoidance transactions.

·  Proposed Legislation to Stop Taxpayers and Promoters from Using the Federal Practitioner Privilege to Delay Disclosing Potential Tax Shelters – Some practitioners and non-corporate taxpayers are claiming the statutory practitioner-client privilege in order to delay the IRS’ efforts to identify and examine potential tax shelters.  The Administration’s FY 2005 Budget again proposes to eliminate the privilege with respect to tax shelters and proposes to confirm that the identity of any person that a promoter is required to identify to the IRS is not privileged.

· Proposed Legislation to Eliminate the Incentive for Taxpayers and Promoters to Delay Disclosing Potential Tax Shelters – Some taxpayers and practitioners are delaying the IRS’ efforts to identify and examine potential tax shelters in order to run out the statute of limitations.  The Administration’s FY 2005 Budget proposes to extend the statute of limitations for potential tax shelters that a taxpayer fails to disclose until the transaction is disclosed to the IRS by either the taxpayer or the promoter.  The IRS, with the assistance of the Department of Justice, is challenging inappropriate claims of privilege in the courts where necessary.

· Proposed Legislation to Increase the Penalties for False or Fraudulent Statements Made to Promote Abusive Tax Avoidance Transactions – Existing penalties are insufficient to deter some promoters from making false or fraudulent statements regarding the claimed benefits of a potential tax shelters.  The Administration’s FY 2005 Budget proposes to increase significantly the penalty for making false or fraudulent statements to up to 50 percent of the fees earned.

The Administration’s Legislative Proposals Will Enhance The IRS’  Effectiveness Without Compromising Taxpayer Protections

The Administration is committed to exploring ways in which the IRS can work more effectively without compromising taxpayer protections.  By working more effectively, the IRS can devote more resources to a range of priorities, including abusive transactions.  Americans must be confident that the IRS is taking all appropriate actions to ensure that all taxpayers are paying their fair share.
 
·  Proposed Legislation to Expand the Use of Electronic Filing – The IRS has taken a number of steps to expand the availability and increase the use of electronic filing, which reduces costs and speeds processing for both taxpayers and the Government.  The Administration’s FY 2005 Budget again proposes to extend the April 15 filing date to April 30 for returns that are filed electronically, provided that any tax due also is paid electronically.  This proposal would encourage more taxpayers to file electronically and allow the IRS to process more returns and payments efficiently. 

· Proposed Legislation to Permit Private Collection Agencies to Support the IRS’ Collection Efforts – The IRS’ resource and collection priorities do not permit the IRS to continually pursue all outstanding tax liabilities.  Many taxpayers are aware of their outstanding tax liabilities but have failed to pay them, and the IRS cannot continuously pursue each taxpayer with an outstanding liability.  The Administration’s FY 2005 Budget again proposes to allow private collection agencies, or PCAs, to support the IRS’ collection efforts in specific, limited ways.  The proposal would enable the government to reach these taxpayers to obtain payment while allowing the IRS to focus its own enforcement resources on more complex cases and issues.  PCAs would not have any enforcement power and would be carefully monitored to ensure that taxpayer rights are carefully protected. 

· Proposed Legislation to Curb Frivolous Returns and Submissions – Some taxpayers are abusing taxpayer protections, such as the collection due process procedures, by making frivolous arguments to in order to delay or impede tax administration.  The Administration’s FY 2005 Budget again proposes to increase the penalty for frivolous returns and allow the penalty to be applied to frivolous submissions that are not withdrawn after IRS request.  The IRS would be permitted to disregard non-return frivolous submissions that are not withdrawn.

· Proposed Legislation to Terminate Installment Agreements if Taxpayers Fail to File Returns or Make Tax Deposits – The IRS cannot terminate an installment agreement even if a taxpayer fails to file required returns or fails to make required federal tax deposits.  The Administration’s FY 2005 Budget again proposes to permit the IRS to terminate an installment agreement in these situations.

· Proposed Legislation to Streamline the Handling of Collection Due Process Cases – The rules regarding the proper court to review a collection due process case are unnecessarily complicated and have been used by some taxpayers to delay tax administration.  The Administration’s FY 2005 Budget again proposes to consolidate jurisdiction over collection due process cases in the Tax Court. 

· Proposed Legislation to Improve Procedures for Taxpayers Seeking to Resolve Their Tax Liabilities – The IRS must be able to work quickly with taxpayers who are seeking to resolve their tax liabilities in good faith.  The Administration’s FY 2005 Budget again proposes to permit the IRS to enter into installment agreements that do not guarantee full payment of a liability over the life of the agreement. This will permit the IRS to work with a broader range of taxpayers who desire to resolve their tax liabilities.  The Administration’s FY 2005 Budget also again proposes to expedite the review process for accepted offers-in-compromise.

The Administration Is Reining In International Tax Abuses

International tax abuses are particularly difficult to address, and the Administration is using all available tools to curtail abusive transactions and practices in this area.

·  Significantly Expanded Network of Bilateral Tax Information Exchange Relationships – In the last two years, the United States has negotiated and concluded important new tax information exchange agreements with nine significant offshore financial centers, including The Bahamas, the British Virgin Islands, and the Cayman Islands.  Each of these agreements reflects the international standards for tax information exchange that the United States has been a leader in establishing, and in each case the agreement is the first such agreement entered into by the offshore financial center with any country.

· Prevented Tax Avoidance on Lump Sum Pension Distributions – The new 2003 income tax treaty with the United Kingdom eliminated an abuse under which a person would establish transitory residence in the United Kingdom prior to receiving from a U.S. pension fund a lump sum distribution that otherwise would be taxable in the United States in order to claim tax exemption on the distribution in both the United States and the United Kingdom.