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HARRIET MIERS' LAW FIRM: TAX SHELTER PROMOTER?

October 07, 2005

The new Supreme Court nominee's law firm wrote opinions backing a tax shelter that the IRS later ruled a "listed transaction." Tax Analysts goes back to documents a report from Congressional tax shelter hearings for the details:

A February 2005 report from the Senate Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations (Doc 2005-2795, 2005 TNT 28-28) details the role of Miers’s firm, Dallas-based Locke, Liddell & Sapp, in transactions involving a tax shelter known as contingent deferred swap (CDS). The report says Locke, working in concert with accounting firm Ernst & Young, provided clients with a legal opinion assuring them that the transaction "should" be upheld in court if challenged by the IRS.

The report, however, describes widely diverging opinions from Locke’s opinion on the transaction, including some from lawyers within E&Y. In an e-mail to E&Y, one client’s lawyer denounced CDS as "a classic ‘sham’ tax shelter."

Ms. Miers was co-managing partner of the Locke, Liddell & Sapp law firm when the opinions were written. Not being a tax lawyer (a pity), she was not directly involved in the opinions, which "typically" returned a $50,000 fee. Reportedly 70 of the CDS shelters were sold.

THE CDS STRUCTURE

The CDS transactions used "swaps" to convert ordinary income to capital gain. In general terms, they worked like this:

- a taxpayer would set up a partnership to own swaps.

- the partnership open a "swap", under which would promise to pay an investment bank the interest on a given sum over a period that would run past its year-end. At the end of the period, the taxpayer would receive a lump sum payment computed on a similar basis. In other words, it would pay an interest amount and deduct it in year one, and it would receive about the same amount back in year two.

- the partnership would engage in short-term securities trading to try to qualify as being in the "trade or business" of securities dealing.

- The partnership would accrue and deduct the payments it was required to make during year 1 as ordinary expenses (giving a 39.6% benefit in those years). It would then pick up the offsetting amount it received the next year as capital gain, taxable at 20%.

The IRS made this a listed transaction via Notice 2002-35. It is apparently no longer marketed. It looks pretty doubtful on its face.

This issue might add some interest to Ms. Miers' confirmation hearings. While she wasn't directly involved in the shelters, as co-managing partner she had to be aware of such a lucrative part of the firm's practice. If the $50,000 fee is correct, the 70 transactions would have generated $3.5 million for the firm, without much more effort than mastering the "find and replace" function on the word processor.

UPDATE: The TaxProf Blog has more.

Links:

Congressional Report describing the CDS transaction (pdf format; CDS is described starting at page 83)

Tax Analysts Story (free version)
Tax Analysts Story (suscriber-only version)

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