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Note: The following is an excerpt from the introduction to the
article as published in The State and Local Tax Lawyer, 2006 Symposium Edition. Author citations have been
omitted for brevity.
The Flexible and Uncertain Line Between Legal Tax Planning and Illegal Tax Shelters
Joe Huddleston and Frank Katz*
I. Why States are Concerned
The reason states are concerned by corporate tax sheltering activity can be readily gleaned from this executive summary of a Multistate Tax Commission report issued in July 2003 entitled, Corporate Tax Sheltering and the Impact on State Corporate Income Tax Revenue Collections.
Corporate tax sheltering reduced state corporate income tax revenues by more than a third of actual collections in 2001. These findings indicate that state corporate income tax revenue, which totaled $35.4 billion in 2001, would have been as much as $12.38 billion (or 35[%]) higher had such widespread tax sheltering of income not taken place.
The lost revenue attributable to domestic and international income tax sheltering is adding to the size of state budget deficits while undermining the equity and integrity of state tax systems. It is not enough to say that state corporate tax revenues are declining just because of federal tax law changes or state tax-cutting during the 1990[]s. It is apparent that some corporations are increasingly taking advantage of structural weaknesses and loopholes in the state corporate tax systems.
Declining revenues and eroding integrity and equity of the tax systems are obvious major concerns. But there is another concern: the economic inefficiency—the damage to the economy in general—that results from spending hundreds of thousands of dollars for tax planning fees and costs that do not result in any substantial economic gain. Generally, the result of tax sheltering is simply to avoid paying taxes on income earned from sources within a state that the state legislatures thought would be forthcoming. However much tax professionals may profit from these expenditures, it is hard to say that the economy as a whole profits at all.
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*Joe Huddleston: Executive Director, Multistate Tax Commission.
Frank Katz: General Counsel, Multistate Tax Commission.
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