Tax Shelter Defense

Very generally, a tax shelter is a description of a manner or method of storing assets that minimizes current or future tax liabilities.

Simply because a tax minimization strategy is labeled a “tax shelter,” however, does not mean that it illegal or abusive.  However, the Internal Revenue Service regulates certain types of tax shelters on the basis that they are abusive strategies designed solely to avoid being taxed.

• Listed Transactions: The IRS periodically identifies certain types of transactions by the creation of a list (thus, a “listed transaction”).  A transaction that is the same as or substantially similar to one of the types of transactions that the Internal Revenue Service (IRS) has determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance is deemed to be listed transaction, which must be reported.
• Confidential Transactions: Certain transactions that are offered to a taxpayer under conditions of confidentiality and the taxpayer has paid a minimum advisor fee are considered reportable transactions.
• Transactions offering contractual protection: Certain transactions that are offered with the right to full or partial refund of fees if the IRS does not allow the tax benefit of the transaction are considered reportable transactions.
• Loss Transactions: If a taxpayer claims a loss under § 165 of at least one of the following amounts on a tax return, then the taxpayer has participated in a loss transaction and must file Form 8886. If an advisor provides material aid, assistance, or advice on a transaction that results in a taxpayer claiming a § 165 loss of at least one of the following amounts and meets other filing requirements; then the advisor is a material advisor and must file Form 8918.
  1. For individuals, at least $2 million in a single tax year or $4 million in any combination of tax years;
  2. For corporations (excluding S corporations), at least $10 million in any single tax year or $20 million in any combination of tax years.
  3. For partnerships with only corporations (excluding S corporations) as partners (looking through any partners that are also partnerships), at least $10 million in any single tax year or $20 million in any combination of tax years, whether or not any losses flow through to one or more partners.
  4. For all other partnerships and S corporations, at least $2 million in any single tax year or $4 million in any combination of tax years, whether or not any losses flow through to one or more partners or shareholders.
  5. For trusts, at least $2 million in any single tax year or $4 million in any combination of tax years, whether of not any losses flow through to one or more beneficiaries.
  6. A loss from a foreign currency transaction under Internal Revenue Code section 988 is a loss transaction if the gross amount of the loss is at least $50,000 in a single tax year for individuals or trusts, whether or not the loss flows through from an S corporation or partnership.

• Other Transactions of Interest.  “Transactions of Interest” are certain transactions that the IRS and the Treasury Department believe to have the potential for tax avoidance or evasion, but lack sufficient information to determine whether the transaction should be identified specifically as a tax avoidance transaction.  Transactions of interest will typically be identified by way of official Notices issued by the IRS

Syndicated Conservation Easement Transactions:

Syndicated conservation easement transactions are transactions in which a promoter purports to give investors the opportunity to obtain charitable contribution deductions in amounts that significantly exceed the amount invested.

The promoters identify a pass-through entity that owns real property, or form a pass-through entity to acquire real property.  Additional tiers of pass-through entities may be formed. The promoters then syndicate ownership interests in the pass-through entity or tiered entities that owns the real property, suggesting to prospective investors that they may be entitled to a share of a charitable contribution deduction that equals or exceeds two and one-half times the amount of the investor’s investment.

The entity then donates a conservation easement encumbering the property to a tax-exempt entity.  Investors then claim a charitable contribution relying upon the pass-through entity’s holding period.

Micro-Captive Transactions

Micro-captive transactions are transactions in which a taxpayer attempts to reduce the aggregate taxable income of the taxpayer, related persons, or both, using contracts that the parties treat as insurance contracts and a related company that the parties treat as a captive insurance company.

Each entity that the parties treat as an insured entity under the contracts claims deductions for premiums for insurance coverage. The related company that the parties treat as a captive insurance company elects under § 831(b) of the Internal Revenue Code to be taxed only on investment income and therefore excludes the payments directly or indirectly received under the contracts from its taxable income.

Basket Contracts:

Basket Contracts are transactions denominated as an option, notional principal contract, forward contract, or other derivative contract to receive a return based on the performance of a basket of referenced assets (the “reference basket”).

The assets that comprise the reference basket may include (1) interests in entities that trade securities, commodities, foreign currency, or similar property (“hedge fund interests”), (2) securities, (3) commodities, (4) foreign currency, or (5) similar property (or positions in such property).

The Basket Contracts attempt to defer income recognition and may attempt to convert short-term capital gain and ordinary income to long-term capital gain.

Charitable Remainder Trusts

The IRS has identified as a transaction of interest sales of charitable remainder trust interests.

Such a transaction involves a sale or other disposition of all interests in a charitable remainder trust (subsequent to the contribution of appreciated assets to and their reinvestment by the trust).

The transaction results in the grantor or other noncharitable recipient receiving the value of that person’s trust interest while recognizing little or no taxable gain.

Transactions Involving Grantor Trusts

Certain transactions use a grantor trust, and the purported termination and subsequent re-creation of the trust’s grantor trust status, for the purpose of allowing the grantor to claim a tax loss greater than any actual economic loss sustained by the taxpayer or to avoid inappropriately the recognition of gain.

Each taxpayer that has participated in a reportable transaction and that is required to file a tax return must disclose information for each reportable transaction in which the taxpayer participates. Use Form 8886 to disclose information for each reportable transaction in which participation has occurred.

Generally, Form 8886 must be attached to the tax return for each tax year in which participation in a reportable transaction has occurred. If a transaction is identified as a listed transaction or transaction of interest after the filing of a tax return (including amended returns), the transaction must be disclosed either within 90 days of the transaction being identified as a listed transaction or a transaction of interest or with the next filed return, depending on which version of the regulations is applicable. See the regulations under section 1.6011-4 for more information.

Material advisors with respect to any reportable transaction must also disclose information about the transaction on Form 8918. This requirement applies to material advisors who provide material aid, assistance, or advice on any reportable transaction after October 22, 2004.

A Material Advisor is defined as:

Anyone who provides material aid, assistance, or advice with respect to organizing, promoting, selling, implementing, insuring, or carrying out any reportable transaction, and

Directly or indirectly derives gross income in excess of a threshold amount (or such other amount as may be prescribed by the IRS) for such aid, assistance, or advice.

Threshold amounts:

1. Listed Transactions: $10,000 for a natural person and $25,000 for all other entities.
2. Non-Listed Transactions: $50,000 for a natural person and $250,000 for all other entities.

If you’re a Material Advisor, you may be required to file the Form 8918, Material Advisor Disclosure Statement.

Generally, a Material Advisor must maintain a list identifying each entity or individual with respect to whom the advisor acted as a Material Advisor with respect to a reportable transaction.

A separate list must be prepared and maintained for each transaction or group of substantially similar transactions. This list must be maintained for 7 years following the earlier of the date on which the Material Advisor last made a tax statement relating to the transaction, or the date the transaction was last entered into.