IRS Gets Upper Hand in Fight Against Tax Shelters

Many companies have used tax shelters known as Lease In Lease Out (LILO) and Sale In Lease Out (SILO) to claim deductions. A string of recent court decisions are being seen as a major victory for the Internal Revenue Service in its fight to outlaw the use of such tax shelter. The IRS designated LILOs as “listed transactions” back in 2000 and SILOs in 2005.

In BB&T vs. United States of America, the Court held that to have a tax deduction for lease or interest expense, you must actually incur them. And to incur them, you must have a genuine lease and genuine indebtedness.

In AWG Leasing Trust vs. United States of America , a federal district court denied tax benefits to a U.S. partnership related to its alleged purchase of a German waste-to-energy facility as an abusive SILO transaction.

In Fifth Third Bancorp of W. Ohio vs. United States of America, a federal district court jury, applying the economic substance doctrine, denied tax benefits related to a bank’s leasing arrangement for passenger rail cars as an abusive LILO transaction.

LILO involved corporate leasing of infrastructure on paper only while SILO involved corporate sale on paper only. In both tax shelters, the infrastructure is leased back to the owners. LILO and SILO as tax shelters have been under scrutiny from lawmakers. In 2003, the Treasury and Senate Finance Committee held an investigation on these tax shelters.

The IRS has over the years been using various incentives to entice users of tax shelters to come forward. With the tax shelters becoming more sophisticated, the IRS had to spend time to figure out who is buying what and leasing what.

According to the IRS many companies including large banks had bought more than thousands of tax shelter to improperly defer taxes and bolster their balance sheets. Bolstered by this recent ruling, the IRS is now offering a chance to such companies a chance to settle. The settlement has five main features:

  • The taxpayer must agree to concede 80 percent of any claimed interest expense deduction, amortized transaction costs, and head lease rent expense for each tax year through 2007
  • The IRS agrees to disregard 80 percent of any reported taxable rental income with respect to SILO or LILO transactions for each tax year through 2007
  • The taxpayer must agree to report in 2008, 80 percent of the original issue discount (OID) connected with the SILO or LILO transactions for each tax year through 2007
  • The taxpayer must exercise best efforts to terminate its SILO or LILO transactions on or before December 31, 2008
  • The taxpayer must agree to recognize as ordinary income any termination gain, whether realized under an actual or deemed termination.

Companies that do not accept this offer could end up fighting a loosing battle. With three court decisions in its favor, the IRS is having a strong hand.

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