GT Alert

New York and Connecticut Announce Tax Shelter Compliance Initiatives, Effective October 1, 2005

October 2005

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In keeping with the continued nationwide effort to combat illegal tax shelters, New York and Connecticut have announced the states’ respective voluntary compliance initiatives, beginning October 1, 2005. The New York State Department of Taxation and Finance announced its “Tax Shelter Voluntary Compliance Initiative,” which is open to all eligible taxpayers and tax shelter promoters from October 1, 2005 through March 1, 2006. Connecticut’s Department of Revenue Services is offering the “Connecticut Abusive Tax Shelter Compliance Initiative” from October 1, 2005 through December 31, 2005.

Both New York and Connecticut’s abusive tax shelter compliance initiative programs target participants in, and promoters of, tax avoidance transactions. All New York and Connecticut taxpayers involved in an IRS “listed transaction,” whether still in audit status, having previously settled other issues for the same tax year, or still undetected, can participate in each state’s tax shelter compliance initiative. A tax avoidance transaction is a plan or arrangement devised for the principal purpose of avoiding tax. These transactions include, but are not limited to, listed transactions that are the same as or similar to those identified by the Internal Revenue Service. For an updated list of the IRS’s Listed Transactions, visit the IRS’s website.

The requirements of New York and Connecticut’s tax shelter compliance initiative programs are somewhat different, but both taxing agencies have resolved to discourage tax shelter schemes within the state. Promoters and taxpayers who fail to participate in the abusive tax shelter initiatives in either state will be “vigorously pursued” and New York and Connecticut’s taxing agencies have absolute authority to impose stringent penalties, excessive interest, and pursue criminal prosecution when warranted. Both New York and Connecticut have passed legislation which raises the statute of limitations to 6 years for auditing participants in, and promoters of, abusive tax shelter arrangements. The statute runs from the date of filing the relevant tax returns. In the wake of IRS’ recent imposition of criminal indictments of promoters of tax shelters, New York and Connecticut have decided to send a clear message to the public that “tax fraud and abuse do not pay.”

New York’s Tax Shelter Voluntary Compliance Initiative (New York VCI)

During New York’s 5-month period to participate in the New York VCI (between October 1, 2005 and March 1, 2006), corporate and individual taxpayers are encouraged to voluntarily disclose their participation in abusive tax shelters for the tax years prior to January 1, 2005, and pay the unreported tax liabilities and interest attributable to tax avoidance transactions in order to avoid the punitive penalties New York recently enacted to target tax shelter participants.

Eligible New York taxpayers who wish to participate in the New York VCI must notify the New York State Department of Taxation and Finance of their election on or before March 1, 2006 by sending a completed Form DTF-671, Election to Participate in the Tax Shelter Voluntary Compliance Initiative. A Form DTF-671 must be completed for each year in which the tax avoidance transaction was used and the taxpayer must file an original or amended tax return and remit full payment of tax and interest for each year attributable to the tax avoidance transaction. A New York taxpayer or promoter, non-resident taxpayer or promoter with New York source income, or a corporation doing business in New York that knowingly or unknowingly participated in or promoted a tax shelter is eligible to apply. Taxpayers and tax shelter promoters who are under criminal investigation involving underreported or underpaid taxes, taxpayers convicted of a crime involving a tax shelter that would be the basis for participation in the initiative, and taxpayers who are a party to pending litigation involving the tax shelter that would be the basis for participation in the initiative are not eligible for the New York VCI. Lastly, taxpayers who participated in New York’s 2003 VCI are not eligible to participate in the new program for the same tax shelters.

Participants in the New York VCI have two options to consider when filing the DTF-671 — one with appeal rights, and one without. Under the voluntary compliance option without appeal rights, taxpayers must waive their appeal rights but all penalties attributable to their use of the tax shelter will be waived. Taxpayers who waive their appeal rights may not file a claim for refund with respect to the use of the tax shelter for that year. For taxpayers who do not wish to waive their appeal rights, all penalties attributable to the use of the tax shelter will be waived, except the negligence and substantial understatement penalties, which can be high (5% of the tax plus 50% of the interest for negligence and 10% for substantial understatements, respectively). However, taxpayers who did not waive their appeal rights will retain the right to file a claim for refund and contest the tax and the imposition of negligence or substantial understatement penalties. Under either option, the New York Commissioner of Taxation and Finance will not seek civil, administrative or criminal action against the taxpayer for each year the taxpayer participated in the New York VCI.

Though New York’s VCI technically requires participants to pay the full amount of tax and interest by March 1, 2006 for all tax years the taxpayer discloses under the program, participants may request an installment payment agreement by attaching a completed Form DTF-383, Income Tax Installment Payment Agreement Request, to the completed Form DTF- 671, along with all applicable tax returns. If the New York State Tax Department agrees that a participant does not have the ability to pay in full, an installment agreement will be granted. Failure of the participant to comply with the terms of the installment payment agreement will cause New York’s waiver of the penalties to be null and void and the total amount of tax, interest, and all penalties will be due immediately. Participants in the New York VCI who cannot pay the full tax due are ineligible to enter into an Offer in Compromise for any amounts due under the VCI.

Taxpayers who are eligible to participate in the New York VCI, but choose not to, could face serious punitive repercussions, including additional penalties and an “interest penalty,” which now equals 100% of the interest payable on a New York deficiency assessment. Furthermore, New York has enacted recent legislation, which extends the statute of limitations for tax shelter transactions, now up to 6 years from filing the tax return if there was a tax avoidance transaction reported in the return.

Connecticut Abusive Tax Shelter Compliance Initiative (CATSCI)

Connecticut has joined the list of states participating in the ongoing movement to thwart the use of abusive tax shelters. Connecticut has passed legislation which mandates specific disclosure requirements for taxpayers participating in any abusive tax shelter designated by the IRS as a “listed transaction.” For audits of income tax returns or corporate business tax returns beginning on or after January 1, 2006, a penalty of 75% of the amount of the deficiency may be imposed in Connecticut when it appears that any part of the deficiency is due to a failure to disclose a “listed transaction.” Promoters of abusive tax shelters may be subject to a penalty of 50% of the gross income the promoter received from marketing, soliciting, sale, or promotion of illegal tax shelters. The Connecticut state penalties for abusive tax shelters are substantial, and affected taxpayers should seriously consider participation in the CATSCI between October 1, 2005 and December 31, 2005.

Eligible taxpayers who wish to participate in the CATSCI will avoid the 75% penalty for participating in an abusive tax shelter and will only pay a 10% negligence penalty. By participating in the CATSCI, taxpayers who invested in illegal tax shelters will avoid substantial new penalties as well as criminal prosecution by the state of Connecticut. Promoters who elect to participate in the CATSCI, and who provide their complete investor list and fee schedule to the state, will avoid a 50% penalty on the gross income derived from marketing and selling abusive tax schemes.

Taxpayers and promoters who wish to participate in Connecticut’s program must complete the Form CT-ATS, Election to Participate in the 2005 Connecticut Abusive Tax Shelter Compliance Initiative. Additionally, participants in the CATSCI must attach an amended federal and state tax return to the Form CT-ATS, pay the additional tax, interest and 10% negligence penalty by December 31, 2005. Interest on the underpayment of tax attributable to the “listed transaction” will continue to accrue until payment is made in full to the Connecticut Department of Revenue Services. Like New York, Connecticut passed legislation which increases the statute of limitations for audit and assessment of tax returns for up to 6 years after the return was filed where a “listed transaction” was not disclosed.

Tax Shelters Do Not Pay

New York and Connecticut are only two of the many states that have implemented voluntary compliance initiative programs for tax shelter participants and promoters. Both states have information sharing agreements with the Internal Revenue Service and approximately 40 other states in the nation. Hence, the likelihood that a shelter participant will be discovered by the federal or state taxing authorities is becoming increasingly high. New York and Connecticut have publicly stated that they will “aggressively pursue” any taxpayer or promoter who engaged in a “listed transaction” and failed to voluntarily participate in the compliance initiative programs. The consequence for failing to participate in either program can have grave monetary (and possibly criminal) results.

The clock is ticking to participate in the New York VCI (October 1, 2005 through March 1, 2006), or the CATSCI (October 1, 2005 through December 31, 2005).

This Alert was written by G. Michelle Ferreira in the Silicon Valley office and Barbara T. Kaplan in the New York office. If you or your clients are eligible to participate in either program, please contact Ms. Ferreira at 650.289.7855 or Barbara T. Kaplan at 212.801.9250 for assistance.

© 2005 Greenberg Traurig

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