RAY SUAREZ: Now, legal tax shelters and the backlash against them. Our business correspondent Paul Solman of WGBH-Boston reports.
PAUL SOLMAN: You may remember this scene form a 1997 Senate hearing: IRS employees testifying on agency abuses shielded from the public as if they were in a federal witness protection program. It ran on all the evening newscasts, including our own. But much less publicized, although perhaps more significant, was this testimony by Texas oil man William Moncrief, of which we managed to find a VHS tape.
WILLIAM MONCRIEF: I am one of the few taxpayers blessed with the resources to fight back against IRS Abuse and Gestapo-like tactics.
PAUL SOLMAN: Six years ago, Mr. Moncrief elicited great sympathy by claiming before a Senate committee and the world that armed IRS agents raided his office, trampled his civil rights.
WILLIAM MONCRIEF: The damage to our family business and reputation was enormous. The emotional damage was even greater.
PAUL SOLMAN: But the real damage was to aggressive tax collection, says David Cay Johnston, author the recent bestseller on taxes and tax avoidance, "Perfectly Legal." Moncrief made the IRS the bad guy by telling only part of the story.
DAVID CAY JOHNSTON: What wasn't presented at the hearings was that Mr. Moncrief was under criminal investigation for cheating the government out of $300 million, that the source of the cheating allegations was the chief financial officer of his company, who had given the IRS business records over a long period of years indicating improprieties.
PAUL SOLMAN: To Johnston this was not a case of IRS's Gestapo so much as a tax shelter abuser's counterattack. By law, the IRS couldn't defend itself, but newspapers and Congress' General Accounting Office later investigated and found gross exaggeration.
DAVID CAY JOHNSTON: These hearings were absolute nonsense that were done simply to stir up people and bring in votes and campaign contributions. It was one of the most cynical displays I've ever seen in Washington.
PAUL SOLMAN: But the results were dramatic. Congress passed a law restructuring the IRS And changing the agency's mission from collecting taxes to providing "top-quality service." And as a result perhaps dubious shelters the IRS now estimates have cost the U.S. nearly $100 billion in recent years. A new government report adds that 60 percent of U.S. firms paid no taxes at all between 1996 and 2000. But how exactly have high-income individuals and corporations been sheltering their earnings from the once prying eyes of the IRS to lower their taxes. Well, we're going to focus on the technique behind some of the most controversial yet popular tax shelters of recent years, including this one featured on PBS' Frontline, reported by Hedrick Smith.
HEDRICK SMITH: We are standing in the Bochum sewer system which is about 1,200 kilometers long and close to downtown Bochum.
PAUL SOLMAN: Now before we delve any deeper into the bowels of Bochum, Germany, we're going to try to explain the core concept of so many dubious shelters: depreciation. From a sewer to a building to a car, any property that wears out depreciates; that is, loses value.
Say I bought this 1989 Mercedes here for $10,000. To the IRS, it loses its entire value; that is, fully depreciates in five years. Okay, say I'm a traveling salesman and I use the care solely for work. Keeping it simple, I can write off $2,000 a year in depreciation because that's how much the car loses in value every 12 months, and thus I can reduce my taxes.
But say I'm not a traveling salesman; I run my own not-for-profit business. I'm in the business of, let's say, helping clean up the neighborhood by getting rid of some of the local litter. But the problem is if I'm in that business, my business has no profits, and therefore I can't deduct the depreciation for the car.
So suppose I transfer the ownership of the car to a profit-making institution, like this bank here. The bank owns the car, then rents it back to me. I get to keep the car, and the bank gets the $2,000 depreciation. In essence, that's what happened in Bochum, Germany. The Wachovia Bank, based in North Carolina, claimed to buy Bochum's sewer system and rent it back to the city, eventually sell it back. The bank took no responsibility for the sewers. But if it owned them, it could claim the depreciation on them, to lower its taxes and kick back a few bucks to the city as well.
DAVID CAY JOHNSTON: So in return for being able to depreciate this sewer system, they make a small payment to the local government which is eager to get the money, a few million dollars. And they get a tax deduction that's worth many times that. Typically nine or ten times as much as the local government gets.
PAUL SOLMAN: In recent years, such deals have proliferated, both abroad and here at home. For example, depreciating subway cars in New York and commuter systems in Atlanta helped Wachovia Bank wipe out its entire tax bill in 2002, despite a $3.6 billion profit. Altria, the renamed Phillip Morris Tobacco Company, owns hundreds of New York subway cars, buses in New Jersey and Los Angeles, according to a report in Bloomberg News.
DAVID CAY JOHNSTON: And what's astonishing about this is, in the case of, let's say, the buses that are being leased all over America, is you and I as taxpayers bought those through the federal government and gave them to the local cities. Now somebody's getting a tax deduction off of them. That's just an astonishing system.
PAUL SOLMAN: Moreover, this type of shelter alone could theoretically wipe out all corporate taxes in America, because there's so much tax-exempt property. Don Alexander, president Nixon's IRS commissioner who practices tax law in Washington, D.C., has his own fanciful, if sarcastic, example.
DONALD ALEXANDER: If the District of Columbia owned the Washington Monument -- which it does not do -- I guess you could do it with the Washington Monument.
PAUL SOLMAN: You mean you could lease the Washington Monument to a taxable entity?
DONALD ALEXANDER: Yeah, why, why not? It may be an interesting situation. It's too bad we don't sell. Maybe we should sell the Washington Monument to the District of Columbia and go through one of these exercises. There might be an uproar in Congress.
PAUL SOLMAN: Actually, Congress is now considering ways to close the depreciation loophole. But Alexander thinks it's an uphill battle because the stakes are so huge. If shelters cost the IRS billions, then they must be worth billions to those who promote and use them. Lobbyist Ken Kies, among others, is well-paid to make the case: That such shelters are legal because the investors really do own the properties. That is, they're really taking a business risk, without which the shelters are clearly illegal.
PAUL SOLMAN: I mean, that's what critics charge, is that there's no risk.
KEN KIES: Well, nobody who actually understands these transactions would... no intelligent person would say that.
PAUL SOLMAN: I don't think you want to quite color the critics with that brush.
KEN KIES: Well, no ... no, I would happily tar it, because they haven't read the transactions, if they say that. That's just foolish.
PAUL SOLMAN: Kies told us it's "foolish" because the intricate details of these deals make it clear they entail risk.
KEN KIES: It is black letter law if these deals have as their sole purpose tax avoidance, they don't work. That is not the case with these transactions.
PAUL SOLMAN: But then why is President Bush's IRS Commissioner, Mark Everson, a skeptic?
MARK EVERSON: It's very difficult for an intelligent person to figure out what these deals are is the first point I'd make, because they're... they're structured to be very complex and oftentimes just through their complexity to elude detection by us or by other taxing authorities.
PAUL SOLMAN: Stanford tax law Professor Joe Bankman gets quite worked up at the claim that these are genuine business deals, and not purely motivated by tax avoidance.
JOSEPH BANKMAN: If it's not tax motivated, why would a bank want to start investing in a sewer system? You can't sell a bank on a sewer investment. The only way you get your foot in the door is to reassure them that it's just for taxes.
PAUL SOLMAN: But even if some of these deals were legally dubious, lobbyist Kies would still object to banning them all. Desirable tax shelters would be lost in the process, he insists. Moreover, cities already strapped for cash would lose money they've come to rely on if Congress were to outlaw such shelters.
KEN KIES: The impact on municipal transactions and mass transit's very real. The Joint Committee on Taxation concluded that over the ten years, cities will not get 5.4 billion of assets that they will have available. And let me tell you, the cities know no one's going to make up that $5.4 billion to them.
MARK EVERSON: Look, I think these ... these deals are reprehensible, and to try and justify them as anything other than ... than just a way to reduce taxes for sophisticated corporations and other players is just a sham.
PAUL SOLMAN: Do you take offense at the idea that any intelligent person...
MARK EVERSON: Look, nobody's fooled by that kind of muddled explanation. The Congress is onto this. We're working aggressively to shut down these transactions. The administration's made legislative proposals. Those deals are going to go away.
PAUL SOLMAN: And indeed the IRS has been moving to eliminate such transactions. It says it has more than 1,000 promoters of abusive tax shelters and tax schemes under investigation, and has recently turned over 25,000 names of tax evaders and avoiders to local authorities, with whom it will share the money collected.
But for all Commissioner Everson's resolve, he's probably doomed to play catch-up. There are plenty of other tax shelters -- tax-exempt insurance companies, offshore tax havens, transferred losses through partnerships. We could regale you with such maneuverings until your refund comes home. But the point is that taken as a whole, such tactics support the bottom-line belief of ex-IRS Commissioner Don Alexander that as the tax code has become more complex, the IRS has fallen further behind.
DONALD ALEXANDER: Because you're continually a few steps behind the people who are putting schemes together to try to misinterpret the latest provisions of the internal revenue code, and we have the IRS Behind the curve, but running like mad to keep from falling further behind the curve.
PAUL SOLMAN: Since the hearings of the late-'90s, that's been especially difficult.
SPOKESMAN: We reduced the number of revenue agents and criminal investigators by over a quarter, and that had the result and effect of fewer audits, fewer criminal investigations, and less dollars collected.
PAUL SOLMAN: And that, in the end, means that when it comes to the subways of New York, the sewers of Bochum, and goodness knows what else, you and I as taxpayers may continue to pay more because others have figured out how to pay less.