Drilling a hole in IRS' tax shelter offensive

October 31, 2004|By JAY HANCOCK

SCORE ONE for the "taxpayers," as the Internal Revenue Service euphemistically refers to its tax-averse legal opponents.

Black & Decker Corp.'s $180 million court victory over the IRS a week ago is a setback in the drive to crack down on what the government calls abusive tax shelters.

One of the larger civil tax rulings, it blunts the momentum of an IRS win two months ago in a tax shelter case against Long Term Capital Management, the notorious, Nobel laureate-led hedge fund that collapsed in 1998.

The clashing opinions have advocates on both sides confusedly searching for clarity.

"I can't recall when two District Court decisions have been as widely heralded by both the taxpayer and the IRS as these two decisions," says Larry R. Langdon, who stepped down last year as the IRS commissioner for large and mid-size businesses. "We're dealing with major issues here with regard to what should be the future of the tax shelter" industry.

This must be Towson-based Black & Decker's year.

The toolmaker's profit through September rose 66 percent from the year-earlier period to $320.7 million, on top of a record performance last year. Its stock hit an all-time high of $80.34 last week.

And thanks to a ruling by U.S. District Judge William D. Quarles Jr. in Baltimore, Black & Decker's $140 million bill from the IRS may disappear, and it may in fact get tens of millions in refunds and interest.

Black & Decker's tax shelter, which the IRS claimed was abusive, involved transferring $562 million in cash and a similar amount of employee medical liabilities to a subsidiary in exchange for stock. Then it borrowed back most of the cash and sold the stock to Black & Decker retiree Raymond DeVita for $1 million.

Ta da! A $561 million, tax-deductible loss on the stock -- even though Black & Decker still had most of its cash and still controlled the subsidiary through other classes of stock.

As far as I can tell, Black & Decker's money basically made a round trip, doing a drive-by mugging of the IRS on the way.

But Quarles, in finding for Black & Decker without holding a trial, ruled that the subsidiary's creation "had very real economic implications" and that "the court may not ignore a transaction that has economic substance, even if the motive for the transaction is to avoid taxes."

Black & Decker will probably have to defend its tax shelter again, "but I would certainly not want to bet against them winning in the Court of Appeals," Langdon says.

The Justice Department, which is handling the case for the IRS, has not said whether it will appeal.

The general of the war on shelters is Mark W. Everson, who took over as IRS commissioner in early 2003 with a pledge to enforce tax law "with particular vigor in the corporate arena and for high-income individuals who enter into abusive shelters to game the system."

He was responding to an explosion of cash-and-carry tax-shielding vehicles dreamed up in the 1990s by accounting and law firms to sell to big-money clients. There were dozens of varieties, but many involved shifting assets and liabilities among affiliate companies to create "losses" that could be deducted from taxable income.

In the Long Term Capital Management case, the hedge fund claimed a tax loss of more than $100 million on stock that it "sold" to an offshore entity that "borrowed" millions from Long Term and then "reinvested" a nearly identical amount back into the hedge fund.

In upholding a tax bill of $40 million plus penalties against Long Term, Judge Janet Bond Arterton of U.S. District Court in New Haven, Conn., criticized the firm for "misleading titles and labels" on its returns and the "disingenuous choices" of its tax advisers.

The Black & Decker setback notwithstanding, some tax pros believe the IRS' assertiveness is diminishing the use of dubious shelters. The agency is sharing leads on shelters with state authorities, issuing summonses to firms selling shelters to learn client identities and reportedly working with the Justice Department on several criminal investigations.

"A single case doesn't make victory for the IRS or defeat for the IRS," says Timothy J. McCormally, executive director of the Tax Executives Institute in Washington. "Clearly, the government's aggressive stance in litigation and otherwise is a signal to taxpayers that you better be awfully darn sure about what you put on your return."

Or have an awfully darn good lawyer.

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