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WALL STREET JOURNAL ATTACKS KPMG INDICTMENTS

October 06, 2005

An editorial in the Wall Street Journal today criticizes the indictments of former KPMG partners in connection with tax shelter sales:

The KPMG case attempts to short-circuit the messy business of proving that a tax shelter is illegal by using the power of prosecution to target the tax advisers directly. And by cutting them off from the support of their firm through the threat of a death-sentence indictment of KPMG itself, the government seems intent on compelling the accused to cop a plea or settle the case, and so deny them their day in court.

The editorial says criminal charges are at best premature:

Whether a shelter qualifies as a tax deduction is, like any other point of law, adjudicated in court. But BLIPS, FLIP, OPIS and the other tax shelters in this case have never been brought before a judge, so their legality and legitimacy has never been settled as a point of law.

Never. The way tax law has usually developed in this country is that the IRS issues its point of view on a shelter, putting taxpayers who use it on notice. If the IRS then takes the taxpayer to court over the shelter, he has the chance to respond before a judge, who makes a ruling and precedents are thus established. In this case, the IRS has called in the prosecutors first.

By indicting the former partners, the Justice Department assumes a heavy burden of proving true criminal behavior, rather than overly-aggressive tax planning. It will be a disaster for tax enforcement if the IRS can't back up the charges, especially considering the horrendous strain and legal costs to the defendants.

Where The Journal goes overboard is when it implies that, as a general rule, criminal charges shouldn't be made until a shelter is ruled invalid by the courts. While it shouldn't be easy to bring criminal charges, such a test would allow flaky shelters to run riot for years before they work their way through the courts. At what point would the Wall Street Journal allow injunctions against criminal behavior? After the taxpayers lose a Tax Court decision? After two Circuit Courts of Appeal rule against the shelter? Or only after the Supreme Court speaks?

While the Journal feels that the legitimacy of the shelters is still an open question, it's worth noting that the law and accounting firms behind them seem to feel otherwise. Rather than defending the shelters, they are settling with their clients to the tune of hundreds of millions of dollars. That doesn't mean the indictments are justified, but it does imply that the shelters themselves aren't exactly ironclad.

XELAN: A BAD EXAMPLE?

The editorial cites the Xelan case as an example of prosecutorial overreach:

Last November, Justice froze $500 million in assets at Xelan, a charitable trust set up for doctors in California, alleging that the trust was a vehicle for tax fraud. Six weeks later, the Federal Court for the Southern District of California threw out the case, noting, among other shortcomings, that the prosecutors could not show that any court had ever ruled that Xelan's activities were illegal under the tax code.

The case that was thrown out was the attempt to freeze assets held in the shelters under attack. This week Xelan agreed to shut down and distribute its "sheltered" amounts to its clients. Xelan will aslo pay an additional $2.3 million to IRS, but without admitting wrongdoing. While it is a favorable settlement of the shelter investors -- they only have their deductions recaptured now, rather than in prior years -- it is also an indication that the shelter was vulnerable. (Quatloos.com has very thorough coverage) Given that the IRS ultimately shut the shelter down, it probably isn't the best example of prosecutorial abuse for the Journal to use.

WHAT ABOUT THE WILY AGITATORS?

It would be wrong for the Justice Department to bring indictments indiscrimately, and it will be a disgrace if that's what turns out to have happened in the KPMG case.

Still, the Journal is wrong to imply that the IRS should not go after promotors:

As in the Xelan case, Justice has chosen in KPMG to go not after taxpayers, who under settled law are legally responsible for their own tax returns, but has instead targeted those offering shelters.

Abraham Lincoln said in another context, "Must I shoot a simple-minded soldier boy who deserts, while I must not touch a hair of a wily agitator who induces him to desert?" Just as the poor soldier boys did get shot, the IRS is going after shelter investors as well as promotors. To allow an abusive shelter-promoter to continue to get taxpayers in trouble while the cases crawl through the court system just gets more taxpayers in trouble. Whether the charges in the KPMG indictments were justified is debatable; but to imply that shelter promoters in general should be left undisturbed makes no sense.

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