Helter Shelter

...The "smart" shelters are highly leveraged...

...For technical tax language, that's reasonably clear...

...In a successful shelter, the loan is eventually paid back, and the money used to pay it back is taxable to the partners...

...At that point, the investors (a) lose their original investment, (b) must repay the bank for the amount they borrowed, and (c) must report as income many of the tax losses they have claimed in earlier years...

...a high leverage tax shelter is one where the combination of interest deductions and depreciation deductions (in the early years) gives large tax losses to the investors...

...Depreciation is based on a prediction of the declining economic usefulness of an asset...

...Typically, the partnership borrows much of the money it invests...

...To understand the problem, you have to understand the mechanics of shelters...

...Dan Levenson is an attorney practicing in Boston who has had significant experience in the field of taxation...

...A shelter can, in theory (and in practice many do), provide cash profits which are entirely exempt from taxes because of the combination of paper losses (depreciation) and interest payments...

...And its inequity ought to be of concern to us, because it makes little sense for Jews to limit themselves to the question of how government takes care of the disadvantaged while ignoring the question of how government deals with its most affluent citizens—especially those affluent citizens whose objective is to reduce their taxes...

...Reforms are badly needed not only to achieve equity, but to sustain credibility, in a system which affects our lives more pervasively than any other code of laws, including, unfortunately, halacha...

...Some shelter investments are socially valuable...

...And if the shelter is not successful, and does not earn enough to pay its debts, the bank will foreclose on its loan...

...Call it free enterprise, call it capitalism—but don't call it fair...

...And while the amount of depreciation may offset the actual income credited to you and used to repay the loan, normally that income will increase while the depreciation decreases...

...Much of that rhetoric is a code for attacking programs that benefit the less advantaged in our society...

...The packaging and selling of investments in shelters (known as "syndicating") which allow the investor to save taxes (known as "sheltering") raise serious problems for public policy...

...Aside from those with ideological cataracts, most people recognize that government actions not only do but should have an impact on national economic life...

...The point is that the government, under the present circumstances, has no control over the investment...

...For the plain fact is that every dollar of tax saved through the depreciation deduction is a tax subsidy, as real an expenditure of government funds as the dollars put into Medicare or the MX Missile...

...others are not...

...it's merely a prediction of obsolescence, and that paper prediction causes a savings on real, cash income...

...If what you own this year is less valuable next year, then you've "suffered" a loss, and that loss is deductible from your taxes...

...Little attention is given to reforming a policy which subsidizes many investments of very dubious economic value and ends up costing more than a direct government subsidy would...

...it's the tax benefits themselves that are the incentive...

...The paper losses have become paper gains, and they are taxable to the investors...

...How can one claim such losses...

...What that means, these days, is talk about tax shelters, America's true growth industry...

...But the tax rules permit the partners to claim losses which are not "actual," which, though they exist only on paper, provide direct cash benefits to the investor...

...Such a policy is bad for everyone—for the country, for those whose incomes are not high enough to take advantage of it, and even for those who are wealthy enough to buy tax shelters...

...An investor seeking shelter usually invests in a limited partnership, a legal entity in which no partner can be liable to creditors for more than the amount he has invested—thus insuring that one's actual losses cannot exceed one's investment...

...Tax shelters offer the affluent tax payer a way to avoid— for the time being—the payment of Federal income taxes...

...What it means is that a shelter is not something one invests in primarily for the cash return on investment...

...It's not entirely a free ride...

...That's called "leverage...

...Sensible tax reform might, for example, provide that depreciation be limited to the amount of cash profit returned to investors, thereby eliminating the incentive to invest in one enterprise in order to reduce taxes on totally unrelated income...

...Or are we not aware that such a reduction can be realized only by shifting the tax burden to those not sufficiently affluent to be sheltered...

...It gets more complicated...

...Hence the government has no opportunity to assess the merits of the enterprise from the standpoint of general public policy...

...It acts as a sugar-daddy for the affluent rather than as a promoter of the public good...

...We just cannot seem to get away from building pyramids...

...Interest, too, is deductible from income...

...The more it borrows, the less the partners must part with their own cash, and the higher the interest they must pay...

...Indeed, some shelters can free the investor of taxes on income he receives from other sources...

...You deduct the loss from your income, and you end up paying taxes on less money—hence less taxes...

...The key to most shelter investments is the deduction for depreciation...

...Thus, the more money that is borrowed, the higher the losses, the lower the taxes, the higher therefore the rate of return on actual dollars invested...

...Capital for serious entrepreneurs dries up, and government loses control of the uses of its tax subsidy...

...The problem here is that the depreciation does not reflect any cash expenditure on your part...

...For surely it is a serious problem that we have a system which, on the one hand, prides itself for trying to tax each person according to his income and, on the other hand, allows those at the upper income level to have the government subsidize their wealth...

...When human greed leads a significant segment of our society, those with capital to invest, away from economically risky and potentially rewarding investment, and towards investments whose attraction is the predictability of their shelter benefits, we all suffer...

...How does it work...

...Yet it is impossible for government to engage in rational economic behavior if its tax policies create huge subsidies for those who need them least and, at the same time, allow those subsidies to be spent in enterprises of dubious national importance...

...The Treasury defines a tax shelter as a "sale, offering, syndication, promotion, investment or other transaction in which the claimed tax benefits are likely to be perceived by the taxpayer as the principal reason for his or her participation...

...its subsidy is to the investor...

...We have just finished listening to politicians of every party lash out at budget deficits, at waste and at welfare fraud...

...Most discouraging—and threatening—of all, as more people come—correctly—to believe that the tax laws are fundamentally inequitable, pointing especially to the disproportionately light tax burdens on the affluent, the whole system begins to corrode...

...In either of these circumstances, chances are there will be a smart money man ready to sell you another shelter investment to shelter the taxable income you now have to report from the first shelter—taxable income which you've not actually seen, because it is either money being paid to the bank or paper income representing the recapture of previous tax benefits...