Nevada Law Professor Offers Ideas for Tax Shelter Bill

[1] Thank you for your invitation at last weekend's ABA Tax Section meeting that we suggest ideas for tax shelter legislation. Please consider the following. It is similar in some ways, dissimilar in others to one of the suggestions that Professor Calvin Johnson has sent or will send you.

I. Core Idea

[2] Congress should enact a statute authorizing the issuance of legislative regulations wherein Treasury would identify specific plans and arrangements and declare unallowable the tax benefits claimed through those arrangements. The authority would extend to plans or arrangements having two characteristics: 1-they are tax shelters (either under the current sec. 6111 meaning or under a new definition specifically for this purpose) and 2-they entail tax treatment or results not within those intended by Congress. I would anticipate that the first regs issued under such authority would reflect the abusive transactions covered by the various IRS notices to date. Thereafter, Treasury could exercise this authority as often as needed to deal with new tax schemes. The statute should specifically provide for "fast track" procedures so that Treasury could promulgate the antidote reg. rapidly after discovering a new scheme.

II. Additional Provisions

[3] There are two related items I would include in the new legislation. Both would be useful but not essential. First, the legislation should provide that Treasury may make retroactive any new reg promulgated pursuant to the new statute. For reasons explained later, I would limit the period of retroactivity to one year from the date of the reg's issuance. Sec. 7805(b)(3) may already permit such retroactivity, but it wouldn't hurt to say it specifically in the new legislation.

[4] Second, the legislation should provide that the sec. 6501 statute of limitations on assessment be extended by the length of time the applicable new reg is made retroactive. (So, one year of retroactivity would mean one extra year on the assessment SOL.) The extension would not apply to the entirety of a taxpayer's return -- only to those items on her return that relate to the plan or arrangement disallowed by the new reg(s).

III. Rationale

[5] The most challenging of current tax shelters are those that may be technically valid in their steps but which, taking the steps together, produce tax benefits that Congress did not intend. These shelters are crafted by skilled tax specialists who combine Code provisions in unexpected ways. In a Code as complex as ours, such possibilities for unexpected combination are always possible. Thus, our system cannot rely on perfect foresight in crafting rules. Nor can it rely wholly on audit and litigation that are bounded by the general ex ante rules.

[6] Congress cannot respond to each new shelter via corrective legislation. Shelter promoters are always faster than the legislative process. The IRS can identify and warn about abusive arrangements, but IRS Notices are not law. We need a corrective regime as fast and as shelter-specific as Notices but with "force of law" status. Thus the need for fast-track regs.

IV. Objections Considered

[7] One possible objection is that Treasury might use the power to disallow valid arrangements (that Treasury may read congressional purposes too narrowly, thus disallow too widely). But there are ways to prevent or remedy that. First, taxpayers could challenge an issued reg in court. Legislative tax regs are hard, but not impossible, to challenge. If the courts believed Treasury misconstrued Congress' purposes in a particular case, they could strike the reg down. Second, Congress would retain the ability to overthrow an overreaching reg via subsequent legislation. Third, if it is felt that more protections need to be added, they could be added fairly easily. For example, legislative or executive consultation might be required before a new reg be issued. That would make the track less fast but would ease concerns about overreaching.

[8] Another objection might be to retroactivity, but that concern is eased by principles in United States v. Carlton, 51 2 U.S. 26 (1994), the key authority as to the constitutionality of retroactive tax statutes. In Carlton, despite the taxpayer's reliance on the original statute as written, the Court unanimously upheld a retroactive change to former sec. 2057 that left the taxpayer saddled with additional tax liability exceeding $2.5 million. It did so because 1-the retroactive measure was curative in nature; 2-the device used by the taxpayer met the letter of the original statute but was beyond what Congress intended or contemplated in enacting the original measure; 3-the corrective purpose was neither illegitimate nor arbitrary; 4-the correction was made promptly; and 5-the period of retroactivity was only modest. The actual period of retroactivity only slightly exceeded one year. See also Justice O'Connor's concurrence, 512 U.S. at 38 ("A period of retroactivity longer than the year preceding the legislative session in which the law was enacted would raise, in my view, serious constitutional questions.").

[9] The factors that eased the constitutional concern in Carlton are present in the tax shelter context as well. A statute is different from a regulation, of course, but Congress can make the delegation of power suggested herein. Coordinating changes to sec. 7805 could be made if required.

V. Conclusion

[10] Thank you for your consideration of this proposal. Please contact me if you have any questions. I wish you and all concerned inspiration and good fortune in the important matter of reining in tax shelters.