Hacking Away--at Tax Shelters

Executive dodges have the IRS--and Congress--up in arms

On Apr. 15, Sprint Corp. is going to face some probing questions about taxes--and not just from the Internal Revenue Service. That's the date of the Overland Park (Kan.) telecom giant's annual shareholder meeting. Investors will have plenty to ask, with Sprint's two top execs, Chairman and CEO William T. Esrey and President Ronald T. LeMay, leaving under a shadow of controversy cast by a risky effort to shelter stock option gains from taxes.

Such questions aren't just coming up at Sprint. Former execs of Tyco International Ltd. and defeated California gubernatorial candidate Bill Simon have also been implicated in questionable tax dodges. All were among the many customers of a tax-avoidance industry that mushroomed in the 1990s bull market, fueled by the rise of stock option compensation and an aggressive push by accountants and investment bankers to develop and peddle such strategies. Although it's difficult to quantify the scope of such deals--and their cost to the national coffers--experts say they're huge. "We're talking many, many billions in lost revenues," says former IRS Commissioner Charles O. Rossotti.

With federal budget deficits looming and Corporate America in low regard, tax-shelter abuses could easily turn into the next scandal. They "could produce as great a public outcry as Enron," warns former Securities & Exchange Commission Chairman Arthur Levitt.

In the wake of Sprint's disclosures, Washington is moving quickly to head that off. Concerned that the tax-planning arms of accounting firms have become too close to executives of the companies they audit, lawmakers have already asked the SEC to reconsider a three-week-old decision to let auditors provide tax advice to corporate clients. Charles D. Niemeier, acting chairman of the newly created Public Company Accounting Oversight Board, says his group also intends to look at the issue. And President George W. Bush has promised the IRS, already into the second year of a crackdown on tax shelters, millions more for the effort.

They'll need it. IRS agents are badly outnumbered by the thousands of people at audit firms, investment banks, and law firms who are diligently crafting a seemingly endless stream of new tax shelters. Moreover, few of today's crop of tax-avoidance maneuvers involve owning hard assets such as real estate or race horses, as older shelters did. That means they can readily be sold to far more people. "This is something you just couldn't find 10 or 20 years ago," says Stanford Law School Professor Joseph Bankman.

Taxpayers may not be the only ones footing the bill--at least in the case of schemes like the one Esrey used to defer taxes on gains from options. At Sprint, the benefits of the execs' tax shelter may have cost the company money. According to tax expert Lee A. Sheppard, deferring the sale of their options meant Sprint had to forgo the tax deduction on the compensation it would have gotten otherwise.

Still, for all the outrage the Sprint deal has stirred up, ending lucrative executive tax shelters will be no easy task. Simply finding them is tough: Unlike the reams of information collected by the SEC, the IRS gets scant data in a tax return. The returns offer few clues as to what might be illegitimate. The proliferation of tax rules, which now number more than 50,000, also means that accountants are able to create tax-avoidance devices that are assumed to be legal unless expressly forbidden in the code.

Even when the IRS has a good case, going to court to shut down a shelter is risky. "If the IRS loses, it might set a legal precedent, and that's bad," says David A. Gillespie, a tax partner at Fulbright & Jaworski LLP. "So frequently, the issues are settled out of court." For executives and their highly paid advisers, that trims the risk of using shelters.

For the past two years, the IRS has offered amnesty to taxpayers who reveal their questionable maneuvers. The agency then pushes promoters of those tax shelters to reveal their other clients. The strategy has uncovered hundreds of abusive shelters, says Treasury Assistant Secretary Pamela F. Olson. That's a start. But there are probably thousands more yet to be discovered.

By Nanette Byrnes in New York and Paula Dwyer, with Mike McNamee, in Washington

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE