The New Market in Corporate Tax Shelters

Posted: 1 Jul 1998

Date Written: June 1998


The term ?tax shelter? is commonly used to describe a type of tax favored investment popular in the late 1970's and early 1980's. These investments typically involved assets subject to favorable cost recovery rules owned by a limited partnership; interests in the limited partnership were marketed to individuals with high taxable income, though not necessarily great wealth.

The Tax Reform Act of 1986 effectively put an end to this type of tax shelter. In recent years, however, a new kind of investment, referred to by those in the field as a ?tax shelter,? has emerged. This tax shelter is marketed not to high income individuals but to Fortune 500 companies and, less commonly, privately held companies controlled by individuals of substantial wealth. The new corporate tax shelter is much more sophisticated and complex than its 1980's predecessor. It may involve tangible assets, such as equipment subject to long-term lease, but is more likely to involve financial instruments. It is also much more aggressive in its interpretation of the tax law. The new corporate tax shelter is apt to be subject to legal challenge if discovered on audit; and at least one of the new shelters has been struck down in an ensuing trail. Once the odds of audit are factored in, however, the cost benefit analysis leans decidedly in favor of the new corporate tax shelter.

Part I of this paper describes the common features of the new corporate tax shelter, and provides some examples of recent tax shelters. Part II provides a qualitative description of the tax shelter industry. Particular attention is given to the role of tax lawyers, and, to a lesser extent, corporate executives. In the past, these agents have been subject to an incentive structure and subscribed to a set of norms that limited tax shelter investments. The incentive structure and norms are rapidly changing, however, in the fact of the attractive economics of tax shelter investments.

Part III discusses how the government has responded, and might respond, to the new market for corporate tax shelters. Fundamental tax reform would, depending on the form it takes, reduce or eliminate the market for tax shelters. Short of that, at least seven approaches to tax shelters have been suggested and/or seem facially plausible: (1) strengthening the Service?s position through greater incentives and funding; (2) giving the Treasury increased rule-making powers; (3) providing for effective disclosure of shelter items; (4) revival of purposive statutory interpretation and/or common law doctrines such as business purpose; (5) increased penalties; (6) changes in standards governing opinion letter and/or the use of such letters to abate penalties; and (7) greater focus on certain financial intermediaries (such as accounting firms and investment banks) that market the shelters. Unfortunately, many of these approaches are likely to be ineffective. Most of these approaches will impose costs on parties not engaged in shelter activity; in some cases, costs may outweigh benefits. Finally, many if not all of these approaches are politically unfeasible. In the short term, the shelter industry is certain to continue its exponential growth. Eventually, this growth may so limit revenues from capital as to bring about some combination of the changes described above.

Suggested Citation

Bankman, Joseph, The New Market in Corporate Tax Shelters (June 1998). Available at SSRN:

Joseph Bankman (Contact Author)

Stanford Law School ( email )

559 Nathan Abbott Way
Stanford, CA 94305-8610
United States
650-725-3825 (Phone)
650-725-7663 (Fax)

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