DETERRENCE OF THIRD PARTY MISUSE OF TAX-EXEMPT AND GOVERNMENT ENTITIES
I am turning now from abuses involving failures of governance of certain tax-exempt entities to abuses of tax-exempt entities by third parties. Unquestionably, there is overlap. There is often complicity between the exempt entity and the third party abuser, and thus governance issues arise in these cases as well. What distinguishes this category of abuses is that the third party is seeking to exploit the entity’s tax-exempt status.
Abuse Involving Tax-exempt Accommodation Parties
I cannot overstate the seriousness of the involvement tax-exempt and government entities as accommodation parties to abusive transactions. We use the term “accommodation party” to describe the tax-exempt entity’s involvement in a transaction that does not necessarily affect the entity’s primary function, but is designed to provide tax benefits to a third party that is a taxable entity. This role served by tax-exempt entities has become increasingly significant as abusive transactions have evolved. Many of the earliest abusive transactions hinged on the use of partnerships and subchapter S corporations to facilitate transactions and thwart detection through the use of multiple entities and complex structures. As the IRS has responded and placed increased emphasis on the examination of those types of entities, we have seen an increased use of various tax-exempt entities--including charities private and government pension plans, Indian tribal governments, and municipal governments--to achieve equally abusive results.
Almost half of the transactions we have identified to date as "listed transactions" (i.e., tax avoidance transactions) under the return disclosure regulations may rely to some degree on the use of a tax-exempt party. In fact, five of the eight transactions we have listed in FY 2004 use a tax-exempt party. Although in many of the transactions the entity involved could be a foreign entity not subject to U.S. tax, in other cases the entity could be a tax-exempt organization. The S corporation transaction described below is an example of an abusive transaction that may involve a domestic tax-exempt organization.
We believe this is an area of major concern for your Committee. When taxpayers use artificial means to avoid their share of the tax burden, they not only shift the burden to all taxpayers, but also undermine the public’s confidence in the integrity of our system. Further, for many tax-exempt entities, most notably charities, tax-exemption, the charitable contribution deduction, and other tax benefits constitute an indirect subsidy of activities Congress has determined are beneficial to society. However, when those entities engage in transactions that offer tax benefits not intended by Congress to third parties, there is a cost to society without a corresponding increase in social benefits.
The schemes are many. Here I will detail two examples of recently listed transactions that illustrate the abuse of the tax system and the challenges we face in dealing with the transactions. The first example is a transaction in which taxpayers donate offsetting foreign currency option contracts to a charitable organization to trigger a loss deduction while avoiding taxation on corresponding gain. The second example involves the purported transfer of S corporation nonvoting stock by a taxpayer to a tax-exempt entity in an attempt to shield income from taxation while allowing the taxpayer to retain the economic benefits of ownership.