Tax Report
Wall Street Journal, February 6, 2003
Tom Herman

The blowup at Sprint Corp. over top executives' use of a controversial tax shelter raises a thorny question for many other taxpayers: Just how much protection do you get by having the official blessing of a high-powered accountant or lawyer?

The issue moved into the spotlight when Sprint's two top executives, William Esrey and Ronald LeMay, were forced out as part of a boardroom dispute over their use of a questionable technique under scrutiny by the Internal Revenue Service. Other taxpayers are likely to confront similar issues as the IRS intensifies a recently announced crackdown on tax-motivated transactions by people with high incomes.

Congress also is gearing up to combat tax shelters. Wednesday, the Senate Finance Committee approved legislation that would impose substantial penalties for failing to comply with Treasury regulations requiring disclosure by taxpayers of certain types of tax-motivated transactions. The Senate Finance bill is designed to "flush out tax shelters" and help the IRS "identify them and shut down illegal operations," says Sen. Chuck Grassley, the Iowa Republican who is chairman of the powerful Finance Committee. "Disclosure is the best disinfectant."

Precisely defining a tax shelter is tricky. It's generally viewed as a vehicle designed to shield income or investment gains from taxes. Tax shelters for individuals flourished in the 1970s and early 1980s, much to the dismay of Congress and Treasury officials. The historic 1986 tax act made major changes to curb abuses. But in the 1990s, new types of complex shelters sprang up.

Many people assume that if an accounting firm or lawyer concludes a tax shelter passes muster -- and puts that opinion in writing -- they're in the clear. But the blunt truth is that opinion letters never offered complete cover, and they're viewed with growing suspicion these days.

"Many opinion letters about tax-motivated transactions are basically worthless," says David Hariton, a tax partner at law firm Sullivan & Cromwell in New York. "They hide the ball within a matrix of boiler-plate recitations of complex regulations, but when you cut through all of the cant, what they really say is, 'this will work, unless it doesn't.' "

Clients often whip out opinion letters when the government challenges their tax maneuvers. If the letter proves to be wrong, you still have to pay the tax, plus interest. But the conventional wisdom is that the letter will protect you from penalties. That isn't always true. You may have to pay penalties unless you can prove you were relying on that opinion with reasonable cause and good faith.

The Treasury has already said it will take steps to limit the ability of taxpayers to rely on opinion letters from lawyers and accountants to avoid penalties arising from shelters.

"If it's too good to be true, it probably is," says Leslie B. Samuels, a lawyer at Cleary Gottlieb Steen & Hamilton and a former assistant Treasury secretary for tax policy. Mr. Samuel's advice:

Those facing taxing situations should hire independent advisers, such as an attorney with a different firm that had no part in the design of the tax program. You'll have to pay extra for that advice, but it may save you far bigger dollars in the long run.

Taxpayers shouldn't stop there. They should take time to understand any tax shelters they're considering. Then they should carefully read any opinions to make sure the facts are consistent with the details of the transaction they're about to embrace.

"The Sprint story was quite frightening," says J.J. MacNab, a financial planner in Bethesda, Md. "A legal opinion is good -- maybe -- for avoiding some penalties. But it does not render the taxpayer safe from a lot of very negative consequences."

Taxpayers also should make clear to their advisers what their risk tolerance is for aggressive tax maneuvers. Mr. MacNab says. "A lot of times, clients don't mention the fact that they're quite conservative, and an adviser has no way of knowing unless you tell them."