Trojan Horses.

When the U.S. Treasury announced a new assault on corporate "tax shelters" this spring, executives and tax attorneys were quick to cry foul. The measures proposed in President Clinton's fiscal 2000 budget sought to give the IRS new, broad authority to label nearly any tax-beneficial transaction as abusive, and dramatically penalize companies for entering into them.

"Bright-line/safe-harbor tests encourage companies to take aggressive positions and play the examination lottery," Don Lubick, deputy assistant secretary of the Treasury for tax policy, said at the time. "Some uncertainty may be useful in discouraging taxpayers from venturing too close to the edge, and thereby going over the edge, of established principles."

But the Treasury has since backed away from the edge, killing several of the most objectionable propositions. In the long-anticipated white paper on the anti-shelter proposals, released July 1, tax policy makers took cues from leading tax practitioner groups and corporate lobbyists to make the initiative more palatable to both the private sector and Congress.

Specifically, the proposal to broaden IRS auditing powers, the so-called Super-269 rule, was scrapped in favor of a more refined approach. The new proposal would narrow the definition of "corporate tax shelter" and codify the judicially based "economic substance" test, allowing transactions to be evaluated against more objective measures than the interpretive whims of IRS auditors. Further, several proposed penalties were dropped altogether, including the 25 percent excise tax on insured contingency amounts and the nondeductibility of accountant or attorney fees for such work.

But what was added should be of great interest to CEOs. Treasury has proposed a requirement that companies disclose their tax-advantaged positions to the IRS immediately upon entering into them, as a sort of "early warning system" to protect the corporate tax base. Additional disclosure on the company's tax returns would also be required. Most important, the new rule would require an officer of the company to sign the disclosure form, certifying that all the facts and due diligence are known to him or her, under penalty of perjury and possibly civil fraud.

"Once executive officers are on the line, they will insist that the real due diligence on these transactions get done, with the result that most will never be entered into," explains Stef Tucker, a partner of Tucker, Flyer, LLP, in Washington, D.C., and chair of the ABA's tax section.

A big weakness in the current system, say tax attorneys and others familiar with the shelter industry, is that many transactions rely on minimal due diligence by tax attorneys to show that a particular transaction works theoretically on assumed rather than actual facts. Worse, the attorneys giving the opinions are usually being paid huge fees by the promoters of the shelter idea - a major accounting firm or investment bank - sometimes even on a percentage of tax savings basis. Such opinions currently give taxpayers a card to play against IRS penalties, as they can claim "reasonable cause" for believing the transaction was kosher.

In addition, the proposals would now impose two penalties on companies: a 40 percent penalty on abusive transactions not disclosed by an early warning form, and a 20 percent penalty on items disclosed but found to be abusive and without "reasonable cause."

All of this will place a significant new burden on corporate executives not well-versed in the arcana of taxes. Such language will likely not come before a vote until late fall, but CEOs should be asking more questions about potential "shelter" transactions now, as new penalties could be made retroactive to March, when the initial budget was proposed.

The following are questions every CEO should consider when faced with a decision on a tax savings plan presented by his or her primary tax advisor:

1) What do you believe would happen to the employee, community, and customer image of the company and its brand if the company were named as part of a tax avoidance scheme? What about your reputation as CEO? "The first standard we use in considering any tax saving plan or transaction is, would we embarrass Andy Grove by doing this? Is this at all questionable?" says Robert Perlman, VP of tax for Intel Corp.

2) What kind of due diligence does the company do on any moneymaking business initiative? Is the level of due diligence the same for cash-saving tax initiatives? Ideally, they should be viewed the same, says Tucker.

3) Finally, if the company decided to challenge the IRS in court and lost, how would you, the CEO, explain it to the board and to shareholders? Tax reserves would most likely cover the impact on earnings per share, but they might not under the new penalty rules.

Ultimately, whether Congress passes into law the Treasury's new proposals or not, CEOs should give strong consideration to the company's tax positions and policies before they cause unintended damage.

Ian Springsteel is a Weston, MA-based freelance business writer who writes about corporate finance.