Drop in corporate tax payments raises concerns over sham shelters

As their profits grow, more companies turn to elaborate dodges


With incomes rising, particularly among the wealthy, Americans are paying a lot more in federal taxes than they did before the economic expansion of the last decade. Not so, American corporations. Their profits are growing even faster than personal incomes, but the taxes they pay have peaked and have begun to fall.

The changes have been striking. Almost 15 cents of every dollar of income earned by Americans in 1997, the latest year for which figures are available, went to the Internal Revenue Service, up from 13 cents in 1990. By contrast, taxes paid by companies on profits reported to the IRS fell to 20 cents on the dollar in 1997, from 26 cents on the dollar in 1990.

A number of factors explain why the corporate tax burden has fallen, from the legitimate use of various tax credits to the deduction of the cost of stock options exercised by employees. But the most troubling factor is the rapid spread of tax shelters, especially among large corporations.

Some of these tactics have been found in the courts to be illegal tax dodges. Others, many of them novel arrangements, have not been tested in the courts but are raising concern.

"Corporate tax shelters are our No. 1 problem" in enforcing the tax laws, Treasury Secretary Lawrence Summers said, "not just because they cost money but because they breed disrespect for the tax system."

What particularly alarms IRS and Treasury officials is what they call a growing willingness by prominent companies that are known for guarding their public image to engage in the kind of tax avoidance tactics more characteristic of the most disreputable companies.

Among the companies that have been found to have engaged in what the courts called shams are Colgate-Palmolive, Compaq Computer and United Parcel Service. For example, the tax court found last year that UPS engaged in a long-running "sham" to evade more than $1 billion in taxes.

"There is a race for the bottom," said Jonathan Talisman, acting deputy Treasury secretary for tax policy.

Compaq did not return calls seeking comment; Colgate-Palmolive declined to comment, and United Parcel Service, in a statement, said it was "deeply offended" that government officials "would even begin to equate" its tax case with evasion or impropriety.

The tactics have become widespread enough that even corporate tax lawyers are quietly alerting the IRS about tax shelters they think cross the line from legitimate tax planning into illegal schemes.

Such tax shelters differ from legitimate ones because they use accounting gimmicks intended solely to lower tax liabilities and have no legitimate business purpose. In one typical example, a company that owes taxes forms a partnership with a business, often one abroad, that for various reasons does not owe any taxes. The company then shifts its profits to the other business' books, reducing its own profits, and later takes back the money in ways that do not count as profits. Many big accounting firms and Wall Street investment houses help arrange such deals for a fee.

In one case involving AlliedSignal, the big automotive and aerospace company that was acquired last year by Honeywell, a substantial tax bill was wiped out. In that deal, AlliedSignal sold its investment in a Texas petroleum company at a profit of more than $400 million. The company would have owed more than $140 million in taxes on the profit. But, following a plan devised by Merrill Lynch, the company shifted the profit to a partnership created with a Dutch bank. AlliedSignal later took back the profit from the partnership, untaxed, and even reported a $4 million profit from the investment in the partnership.

The Tax Court disallowed the deal as having no purpose other than avoiding taxes, and an appeals court upheld that decision this month. Honeywell said in a statement that its policy was to comply with all applicable tax laws and pay all taxes properly due.

Deals like this one, which are revealed by IRS audits, have repeatedly been labeled illegitimate by the courts. But the IRS may find fewer than one such deal in 10, and its auditing resources have been shrinking.

That apparently is emboldening some companies to play "audit roulette," said Larry Langdon, commissioner of the IRS large and midsize business division and former tax director at Hewlett-Packard.

Pub Date: 2/20/00

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