November 15, 2004 - Phil Hodgen

S corporation tax shelter — off limits

The IRS has put the universe on notice that another tax shelter is off limits. Sane people would have held their noses and walked away even without the warning from the IRS.

The scheme involves an S corporation and a friendly tax-exempt organization. Through a manipulative set of transactions, 90% of the S corporation’s stock is transferred to a tax-exempt organization. Hmm. Charitable deduction for donor. Because the tax-exempt organization owns 90% of the stock, 90% of the income is attributed to the tax-exempt organization. It pays no tax on this income. However, the S corporation doesn’t distribute cash to its shareholders, so the tax-exempt organization doesn’t get any cash.

Later, the transaction is unwound, so that you (the clever tax shelter purchaser and real owner of the S corporation) buy back the stock from the tax-exempt organization at a pittance.

Here’s how I look at these deals when they float by me. First, I look at who’s getting paid what. If there’s someone in the transaction who appears to be there solely to collect a big check, it looks stinky. (That person is the promoter). Watch the money.

Second, I just check my gut. If my little heart starts to go pitter-pat with excitement, and I think, “Ooooh, so clever!” with envy at the intellectual prowess of the person who thought up this plan, I pause. (You know the old advice, “. . . we pause when agitated or doubtful . . . .”) The excitement and envy of intellect tell me that this transaction might have been manufactured in the abstract universe of the Internal Revenue Code, not the real world of business transactions.

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