Abusive Tax Shelters and Other Audit Issues

1. Abusive Tax Shelters and Other Audit Issues Debbie Langsea California Franchise Tax Board September 17, 2004

2. Definition – Abusive Tax Shelter • promoted with the promise of tax benefits • predictable tax losses or consequences • no true or correlating economic loss of income or assets • follows literal reading of the tax statute, but applies the meaning inconsistent with the purpose or intent of the tax statute

3. Characteristics – Abusive Tax Shelters • Separation of income and expenses • Use of pass-through entities • Use of third-party accommodators • Offshore foreign account or accommodator • Double benefit for the same tax loss • Conducted over a short period of time

4. National Abusive Tax Shelter Problem • FEDERAL: up to $85 billion loss over last decade (GAO estimate) • ALL STATES: up to $12 billion corporate loss in 2001 (MTC estimate) • CALIFORNIA: $600 million to $1 billion loss annually (FTB estimate)

5. California Abusive Tax Shelter Compliance Program • Voluntary Compliance • Detection • Enforcement

6. Voluntary Compliance Educational Efforts: • U.S. Senate Hearings, Press Conferences, Press Releases, Newspapers, Symposiums, Tax News, and Presentations • Internet (www.ftb.ca.gov), VCI e-mail address and telephone number • 32,000 Letters: Taxpayers, Preparers, Promoters, and Accounting/Law Firm Employees • 40,000 Brochures, Quick References

7. Voluntary Compliance Initiative California’s 106-Day VCI Program: • $1.4 Billion Additional Tax Revenues • 1,200 Taxpayers • 2,100 Tax Years

8. VCI by Taxpayers

9. VCI by Revenue

10. VCI by States Amounts > $1 Million Amounts > $1 Billion Amounts < $1 Million Amounts = $0

11. Detection – Information Sharing • IRS ATAT Memorandum of Understanding (Sept. 2003) • States ATAT Memorandum of Agreement (Feb. 2004)

12. Detection – Reportable Transactions 6 Reportable Transaction Categories: • Listed Transactions • Confidential Transactions • Transactions with Contractual Protections (contingency fees) • Loss Transactions • Transactions with Significant Book-Tax Differences • Transactions with Brief Asset Holding Period

13. Detection - Taxpayers INVESTORS NEW Registration and Reporting Requirements: • Disclose Reportable Transactions • Disclose Listed Transactions from 2/28/00

14. Detection - Promoters PROMOTERS NEW Registration and Reporting Requirements: • Register Tax Shelters or Listed Transactions (from 2/28/00) • Provide List of Investors for Reportable Transactions or Listed Transactions (from 2/28/00)

15. Enforcement • Conduct investor and promoter audits • Establish Abusive Tax Shelter Unit • Pursue leads, investors lists, registrations, and other informational sources • Issue subpoenas • Focus on promoters, firms, financial intermediaries, and insurance companies • Assess abusive tax shelter penalties • Evaluate for criminal prosecution

16. Enforcement - Taxpayers

17. Enforcement - Promoters

18. Enforcement - Other Other Abusive Tax Shelter Curtailments: • No suspension of interest • Doubles statute of limitations to 8 years • Enhances subpoena provisions • Ability to enjoin promoters • Increases interest on amended returns • Eliminates accountant confidentiality

19. Other Audit Issues • Tax Credits • Individuals - Schedule A • Mortgage interest deduction • Theft loss deduction • Charitable contributions (abusive tax shelters)

20. Other Audit Issues • Individuals - Schedule D • Mark to Market elections • Inflated basis (abusive tax shelters) • Corporations • Cash distributions • Dividend received deduction

21. Other Audit Issues • S corporations • Acceleration of installment sale income • Built in Gains tax on assets • Relocation of intangible assets • Partnerships (abusive tax shelters)

22. Additional information can be found on our website at:www.ftb.ca.gov