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Death, Taxes, and Tax Shelters


Finding creative ways to reduce tax payments has long been a goal at most corporations. But since the mid-1990s, as companies have come under ever more intense pressure to boost earnings, the tax avoidance game has become a major industry. According to the U.S. Treasury, five years ago corporations anted up 12.5% of all taxes paid to the government. Last year, that fell to 8.7%.

Although the economy's decline has played some role, many corporate finance officers could never have pulled off such a feat were it not for the help of a sophisticated and fast-growing army: the lawyers, accountants, and Wall Street advisers who specialize in everything from structuring tax shelters to the art of shifting earnings to low-tax markets overseas. But with the Bush tax proposal suddenly casting new light on companies that pay very low tax bills, does that mean leaner times ahead for the booming tax advice industry?

Don't count on it. While much remains unclear about the Bush plan, one thing is certain: This may be tax reform, but it sure isn't tax simplification. The plan will add more requirements to the tax code, which is already groaning under the weight of thousands of statutes and regulations--1,151 changes since 1997 alone. And new rules generally bring more business to the advice gang, not less. "The world is being turned upside down," says Leslie B. Samuels, a tax specialist with law firm Cleary, Gottlieb, Steen & Hamilton. "From a tax lawyer's point of view, we're in heaven--and we didn't have to die."

Increased complexity has already helped the Big Four accounting firms greatly expand their tax businesses over the last decade. According to Bowman's Accounting Report, the U.S. tax practices of KPMG, Deloitte & Touche, Ernst & Young, and PricewaterhouseCoopers posted revenue of $5.6 billion in 2001. That's more than double their 1995 tax revenue of $2.4 billion. While that includes tax preparation, advisory work is where the big gains have come.

Another wave of growth could soon be on its way. As companies became increasingly global, the tax code, to keep pace, has grown ever more complex. The result has been a rich vein of tax breaks for companies and their advisers to mine. The Bush plan does little to change that. Indeed, a new breed of tax shelters, built around publicly marketed securities rather than hard assets like real estate, are blossoming. With their bigger payoffs and more manageable risks, they make aggressive tax management an even better moneymaker for corporations than it already is.

Companies reaping huge rewards from smart tax strategies will be loath to give them up just to gain tax-free status for their dividends. Financing and manufacturing giant General Electric Co., for example, has saved billions. A 2000 study by the Washington-based Institute on Taxation & Economic Policy found that GE racked up a staggering $6.9 billion in breaks in just three years, trimming its tax bill by 77%. Since 1998, the last year of the study, GE's effective tax rate has declined dramatically, hitting 20.5% in the third quarter of 2002--a far cry from the 32.6% it reported in 1996, or the 35% statutory rate.

Instead, companies that continue to try to minimize their tax bills will likely change how they do it, to capture some of the benefits of the President's plan. Martin A. Sullivan, an economist at Tax Analysts, a nonprofit tax publisher in Arlington, Va., predicts that many will seek to reclassify gains, interest, and other costs as dividends in order to take advantage of their new tax status. Techniques for maximizing foreign tax credits will likewise become even more important since foreign taxes paid will increase the amount of tax-free dividends under Bush's proposal.

Still, some of the more aggressive shelters in use today likely will be toned down. Lehman Brothers Inc. tax analyst Robert Willens argues that there has been a strong public backlash against such tax- avoidance schemes because of scandals at Tyco International Ltd. and Enron Inc. But "normal, smart tax planning? I don't think that will diminish," says Willens. Certainly not if recent history is any guide. By Nanette Byrnes and Louis Lavelle in New York


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