Table of Contents
Investments that yield tax benefits are sometimes called “tax shelters.” In some cases, Congress has concluded that the loss of revenue is an acceptable side effect of special tax provisions designed to encourage taxpayers to make certain types of investments. In many cases, however, losses from tax shelters produce little or no benefit to society, or the tax benefits are exaggerated beyond those intended. Those cases are called “abusive tax shelters.” An investment that is considered a tax shelter is subject to restrictions, including the requirement that it be disclosed, as discussed later.
Publication
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538 Accounting Periods and Methods
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556 Examination of Returns, Appeal Rights, and Claims for Refund
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561 Determining the Value of Donated Property
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925 Passive Activity and At-Risk Rules
Form (and Instructions)
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8275 Disclosure Statement
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8275-R Regulation Disclosure Statement
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8283 Noncash Charitable Contributions
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8886 Reportable Transaction Disclosure Statement
See chapter 5 for information about getting these publications and forms.
Abusive tax shelters are marketing schemes involving artificial transactions with little or no economic reality. They often make use of unrealistic allocations, inflated appraisals, losses in connection with nonrecourse loans, mismatching of income and deductions, financing techniques that do not conform to standard commercial business practices, or mischaracterization of the substance of the transaction. Despite appearances to the contrary, the taxpayer generally risks little.
Abusive tax shelters commonly involve package deals designed from the start to generate losses, deductions, or credits that will be far more than present or future investment. Or, they may promise investors from the start that future inflated appraisals will enable them, for example, to reap charitable contribution deductions based on those appraisals. (But see the appraisal requirements discussed under Rules To Curb Abusive Tax Shelters , later.) They are commonly marketed in terms of the ratio of tax deductions allegedly available to each dollar invested. This ratio (or “write-off”) is frequently said to be several times greater than one-to-one.
Because there are many abusive tax shelters, it is not possible to list all the factors you should consider in determining whether an offering is an abusive tax shelter. However, you should ask the following questions, which might provide a clue to the abusive nature of the plan.
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Do the tax benefits far outweigh the economic benefits?
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Is this a transaction you would seriously consider, apart from the tax benefits, if you hoped to make a profit?
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Do shelter assets really exist and, if so, are they insured for less than their purchase price?
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Is there a nontax justification for the way profits and losses are allocated to partners?
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Do the facts and supporting documents make economic sense? In that connection, are there sales and resales of the tax shelter property at ever increasing prices?
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Does the investment plan involve a gimmick, device, or sham to hide the economic reality of the transaction?
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Does the promoter offer to backdate documents after the close of the year? Are you instructed to backdate checks covering your investment?
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Is your debt a real debt or are you assured by the promoter that you will never have to pay it?
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Does this transaction involve laundering United States source income through foreign corporations incorporated in a tax haven and owned by United States shareholders?
Congress has enacted a series of income tax laws designed to halt the growth of abusive tax shelters. These provisions include the following.
The IRS has published guidance concluding that the claimed tax benefits of various abusive tax shelters should be disallowed. The guidance is the conclusion of the IRS on how the law is applied to a particular set of facts. Guidance is published in the Internal Revenue Bulletin for taxpayers' information and also for use by IRS officials. So, if your return is examined and an abusive tax shelter is identified and challenged, published guidance dealing with that type of shelter, which disallows certain claimed tax shelter benefits, could serve as the basis for the examining official's challenge of the tax benefits you claimed. In such a case, the examiner will not compromise even if you or your representative believes you have authority for the positions taken on your tax return.
The courts have generally been unsympathetic to taxpayers involved in abusive tax shelter schemes and have ruled in favor of the IRS in the majority of the cases in which these shelters have been challenged.
You may be required to file a reportable transaction disclosure statement.
Use Form 8886 to disclose information for each reportable transaction in which you participated. Generally, you must attach Form 8886 to your return for each tax year in which you participated in the transaction. Under certain circumstances, a transaction must be disclosed within 90 days of the transaction being identified as a listed transaction or a transaction of interest. In addition, for the first year Form 8886 is attached to your return, you must send a copy of the form to:
Internal Revenue Service
OTSA Mail Stop 4915
1973 North Rulon White Blvd.
Ogden, Utah 84404
If you fail to file Form 8886 as required or fail to include any required information on the form, you may have to pay a penalty. See Penalty for failure to disclose a reportable transaction , later under Penalties .
The following discussion briefly describes reportable transactions. For more details, see the Instructions for Form 8886.
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A listed transaction.
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A confidential transaction.
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A transaction with contractual protection.
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A loss transaction.
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A transaction of interest entered into after November 1, 2006.
Note.
Transactions with a brief asset holding period were removed from the definition of reportable transaction for transactions entered into after August 2, 2007.
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“Toggling” grantor trusts as described in Notice 2007-73, 2007-36 I.R.B. 545, available at www.irs.gov/irb/2007-36_IRB/ar20.html.
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Certain transactions involving contributions of a successor member interest in a limited liability company as described in Notice 2007-72, 2007-36 I.R.B. 544, available at www.irs.gov/irb/2007-36_IRB/ar19.html.
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Certain transactions involving the sale or other disposition of all interests in a charitable remainder trust and claiming little or no taxable gain as described in Notice 2008-99, 2008-47 I.R.B. 1194, available at www.irs.gov/irb/2008-47_IRB/ar11.html.
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Certain transactions involving a U.S. taxpayer owning controlled foreign corporations (CFC) that hold stock of a lower-tier CFC through a domestic partnership to avoid reporting income as described in Notice 2009-7, 2009-3 I.R.B. 312, available at www.irs.gov/irb/2009-03_IRB/ar10.html.
Investing in an abusive tax shelter may be an expensive proposition when you consider all the consequences. First, the promoter generally charges a substantial fee. If your return is examined by the IRS and a tax deficiency is determined, you will be faced with payment of more tax, interest on the underpayment, possibly a 20%, 30%, or even 40% accuracy-related penalty, or a 75% civil fraud penalty. You may also be subject to the penalty for failure to pay tax. These penalties are explained in the following paragraphs.
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Negligence or disregard of rules or regulations,
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Substantial understatement of tax,
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Substantial valuation misstatement (increased to 40% for gross valuation misstatement),
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Transaction lacking economic substance (increased to 40% for undisclosed transaction lacking economic substance), or
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Undisclosed foreign financial asset understatement (40% in all cases).
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10% of the tax required to be shown on the return, or
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$5,000.
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The value or adjusted basis of any property claimed on the return is 150% or more of the correct amount.
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You underpaid your tax by more than $5,000 because of the misstatement.
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You cannot establish that you had reasonable cause for the underpayment and that you acted in good faith.
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The transaction changes your economic position in a meaningful way (apart from Federal income tax effects), or
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You have a substantial purpose (apart from Federal income tax effects) for entering into the transaction.
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Any foreign business you control, reportable on Form 5471 or Form 8865.
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Certain transfers of property to a foreign corporation or partnership, reportable on Form 926, or certain distributions to a foreign person, reportable on Form 8865.
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Your ownership interest in certain foreign financial assets, temporarily reportable on Form 8275 or 8275-R.
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Your acquisition, disposition, or substantial change in ownership interest in a foreign partnership, reportable on Form 8865.
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Creation or transfer of money or property to certain foreign trusts, reportable on Form 3520.
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He or she knows, or reasonably should have known, that the appraisal would be used in connection with a return or claim for refund; and
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The claimed value of the property on a return or claim for refund based on that appraisal results in a substantial valuation misstatement or a gross valuation misstatement as discussed earlier.
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