Tax planning and the tax shelter penalty rules.


Companies may have a harder time avoiding the accuracy-related penalties for substantial understatements of income tax that relate to relatively routine corporate tax planning initiatives -- tougher standards may apply to understatements attributed to "tax shelters."

The Taxpayer Relief Act of 1997 broadened the definition of tax shelter to include any entity, investment, plan or arrangement with a "significant" purpose of avoiding (or evading) federal income tax. Prior to the 1997 act, tax shelter rules were triggered only if there was a "principal" purpose of avoiding taxes.

The revised definition was intended to complement a new provision in the law that requires registration of some tax reduction schemes that are marketed on a confidential basis. It exposes companies to increased penalty risk and transaction costs -- even in the absence of confidential corporate tax shelters.

What has changed?

The penalty (20% of the underpayment related to the tax shelter) applies to an understatement of income tax that is substantial because it exceeds 10% of the tax that should have been shown on the return or $5,000 ($10,000 for a C corporation), whichever is greater. Companies can exclude amounts that relate to non-tax-shelter positions for which the taxpayer had "substantial authority" or that were adequately disclosed to the Internal Revenue Service (assuming a reasonable basis for the company's position existed).


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