Skip the Free Lunches; Just Pay Your Taxes

It’s tax season, and I’m offering some free advice to corporations out there getting ready to drop their returns in the mailbox: Think about that foolproof tax shelter and whether it’s worth the risk to your stockholders.

The Treasury Department’s recently announced crackdown on tax shelters has made me feel a little vindicated. For years, I’ve been telling my corporate clients to give many complex, too-good-to-be-true tax shelters a wide berth.

Successful corporations whose primary responsibility is wise stewardship of shareholder interests should not take potentially hazardous long-term risks in exchange for short-term savings. I don’t cleverly save money by not changing the oil in my car, and I don’t save on this year’s tax bill based on the assumption that I might not owe massive penalties three years from now.

Simply put, pushing the envelope on shelters means you are betting against the law of the cycle when it comes to the IRS. Since the late 1970s, a groundswell of tax system resentment has been brewing. Politicians rode this undercurrent and, as the years have passed, the rhetoric has heated up. Today, politicians tell us our income tax system is “a disgrace to the human race” that should be “torn out by its roots” and consigned to the “ash heap of history.” Senate Finance Committee Chairman William V. Roth Jr. (R-Del.) said the IRS is “a troubled agency, one that is losing the confidence of the American people, and one that all too frequently acts as if it were above the law.” President Clinton said he was “outraged” by tales of people “harassed and humiliated by what seemed to be an unaccountable, downright tone-deaf agency.”

Not surprisingly, fewer people today think avoiding taxes is hazardous. Thus has grown an undercurrent of tax avoidance and weak enforcement. Yet there are clear signs on the horizon that this wave is at its crest.

I agree that the IRS is often its own worst enemy. Agents have never shaken the image that they’re quota-driven. And though most agents are reasonable, some are not, and a few are hyper-aggressive.

Yet these underlying problems are, to some extent, the fault of the political system. In the 1970s and 1980s, problems at the IRS were addressed with adequate funding. Now, problems are addressed by cutting funding, and the problems only get worse. Last year, audits dropped by 25%, liens by 85% and levies by almost 70%. Seizures virtually disappeared. And because of political pressure, the IRS no longer has the capability of measuring the extent of noncompliance. And here’s a sobering thought: If overall compliance drops by just 5%, the ballyhooed budget surplus will vanish in just over a year.

But what about the political cycle I mentioned above?

In 2008, the baby boomers will start retiring and, by 2012, Social Security benefits paid out to retirees are expected to exceed by hundreds of billions the employment taxes paid in by workers. For Medicare, the numbers are even worse: The current sources of funding are projected to finance half or less of the promised care.

The only likely answers are smaller benefits, higher taxes or increased federal borrowing. Collecting revenue--now out of fashion--is almost guaranteed to become decidedly in fashion. The IRS boogeyman will become the IRS that the politicians rely on to be part of the solution that keeps them in office.

We’ve been through this cycle before. In the late 1970s, the country started worrying about a growing budget deficit, and the IRS was empowered. In the mid-1990s, the deficit vanished, and the IRS has been clobbered. The tide will turn again. And when it does, corporations that have been cutting deals with harried agents run the risk of having the tax equivalent of SWAT teams descending on their headquarters.

If you don’t see the link when it comes to the recently announced crackdown on tax shelters, consider this: If you read the news coverage, what was notable in its absence was even a single member of Congress crying foul or threatening to derail the move.

And the courts have played a strong role recently by rejecting the mass-market tax shelter sales scheme. We can expect to see more decisions in the same genre. What the judges have been saying is that when they see mass-marketed tax products with similar planning arrangements, transaction documents, opinion letters and glossy brochures, it will be hard to convince them that the transactions were really intended to further your particular company’s business goals rather than to simply reduce the tax bills of those who bought the same products.

So before you drop that return in the mailbox, think about political cycles and where we are on the curve today. Skip the free lunches. And pay your taxes.