8688 / What is an abusive tax shelter?

While Congress has recognized that the loss of revenue is an acceptable side effect of special tax provisions designed to encourage taxpayers to make certain types of “tax shelter” investments that yield tax benefits, losses from tax shelters often produce little or no benefit to society, or produce tax benefits that are exaggerated beyond those intended. These cases are called “abusive tax shelters,” and are described by the IRS in Publication 550 as follows:

“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. 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.”¹

The IRS has taken steps to combat abusive tax shelters and transactions. A comprehensive strategy is in place to:

Identify and deter promoters of abusive tax transactions through audits, summons enforcement and targeted litigation;

Keep the public advised by publishing guidance on transactions and shelters that are determined to be abusive;

Promote disclosure by those who market and participate in abusive transactions; and

Develop and implement alternative methods for resolving abusive transactions claimed by taxpayers.

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Planning Point: An investment that is considered a tax shelter is subject to restrictions, including the requirement that it be disclosed and registered. The regulations require taxpayers to disclose certain reportable transactions involving abusive tax shelters in which they participate. These transactions include transactions that are the same as, or substantially similar to, a transaction specifically identified by the IRS or state tax agency as a tax avoidance transaction (a so-called “listed transaction”).²

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