Paul L. Caron

Tuesday, July 20, 2010

Lederman: Basketing and Corporate Tax Shelters

Leandra Lederman (Indiana-Bloomington) has posted A Tisket, A Tasket: Basketing and Corporate Tax Shelters, 88 Wash. U. L. Rev. __ (2011), on SSRN. Here is the abstract:

In an income tax system that comported with the economic, or Haig-Simons, definition of income, deductible expenses would not face source-based limitations. A true Haig-Simons income tax system therefore would not take the schedular approach of sorting different types of expenses and losses into distinct conceptual “baskets” containing corresponding types of income. Practical realities often require departing from the Haig-Simons norm, however. The U.S. federal income tax system does require individuals to basket a number of types of expenses and losses. For example, individuals’ passive activity losses can only be deducted from passive income gains. By contrast, most corporations taxed under Subchapter C of the Internal Revenue Code are not subject to many of these restrictions. Thus, corporations generally can deduct their passive/investment expenses and losses from their active business income. That ability allowed the creation of infamous tax strategies such as Son-of-BOSS and the CINS contingent installment sale shelter.

As a device to prevent the resurgence of abusive tax shelters, the article proposes to extend to the domestic corporate context the passive/active distinction that already exists for individuals. If corporations’ passive-source expenses and losses were required to be basketed with their passive income (such as income from interest; dividends; and rents and royalties, other than those produced by an active business), many abusive tax shelters involving financial products would not work. The article also considers the three principal objections to the proposal - that it is overbroad, underinclusive, and too complex - arguing that the proposal is tailored so as to minimize these costs.

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I wonder if Prof. Lederman is aware that her proposal would kill off leveraged leasing as a form of finance. That business is premised on giving passive lessors the right to deduct depreciation on the leased asset from income earned in a separate active business. I guess that's OK if you want to force businesses to use secured debt rather than leases (which are sometimes cheaper) to finance capital assets, but I'm not sure why you would want to do that.

Posted by: Doug Levene | Jul 20, 2010 12:02:18 PM