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New audit unit to check into abusive tax shelter promoters

Promoters and organizers of abusive tax shelters should take heed - FTB has established a new audit unit with them in mind. Its primary responsibility is examining abusive tax shelter promoters and organizers, and determining whether the promoter penalty (California Revenue & Taxation Code Section 19177) applies.

A tax shelter is defined as a partnership or other entity, investment plan or arrangement, or any other plan or arrangement, for which a significant purpose is the avoidance or evasion of federal or state income tax.

While not all promoted transactions are abusive, many that have been marketed and sold since the mid-1990s are abusive. The Internal Revenue Service provides public guidance on transactions deemed abusive, i.e., known as "listed transactions.” The number of listed transactions climbed from five to more than 25 between 1998 and 2004.

Promoters of current generation tax shelters use complex technical transactions, often involving multiple layers of entities, to escape detection on the tax return. The transactions are usually marketed by accounting, banking, and consulting firms, to taxpayers with high net worth. These transactions generate millions of dollars in fees to the promoter. 

The promoter penalty applies to any person who:

  • Organizes an abusive tax shelter.
  • Assists in organizing an abusive tax shelter.
  • Participates (directly or indirectly) in selling any interest in an abusive tax shelter.
  • Expresses a qualifying false or fraudulent statement about the ability to:
  • Allow any deduction or credit.
  • Exclude any income.
  • Secure any other tax benefit, which the person knows is materially false or fraudulent.
  • Overstates gross value.

The amount of the penalty is $1,000 or 100 percent of the gross income from promoting or organizing an abusive tax shelter, whichever is less. The abusive tax shelter promoter or organizer must prove that 100 percent of gross income from the transaction was less than $1,000.

The penalty is increased to 50 percent of gross income derived from promoting or organizing an abusive tax shelter if:

  • The person's activities involve a statement about the tax benefits of participating in a plan or arrangement.
  • The person knows that the statement is materially false or fraudulent.

The penalty can also be separately applied to more than one employee of a tax shelter promoter on a single sale. Each employee that knowingly made false statements about the sale’s purported tax benefits is subject to the penalty.