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March 07, 2006

Tax shelter promoters who are facing criminal chargers, and their defenders, like to repeat that none of the shelters have been found illegal in court. The recent New York Times report about Deutsche Bank, which implied that many of the essential transactions in their shelters may have never happened, hinted at why the government decided that the activities of KPMG shelters went beyond aggressive tax planning and became criminal.

The defendants recently moved to dismiss the indictments. In their reply brief to the dimissal request, the prosecutors confirm that their case goes far beyond challenging the tax theories supporting the shelters. They say that many of the transactions that underlie the shelters - transations that even shelter fans would admit are necessary to achieve the desired results -- never took place. Instead, according to the prosecution, phony documents were generated for imaginary transactions, and the shelters relied on less on tax theory than on hiding the ball and hoping the IRS wouldn't notice. The reply brief lays out the basic accusations:

The obvious point of this phony documentation was to convince clients to claim these massive phony tax losses and provide a script and props for misrepresenting the transaction and deceiving the IRS if and when the clients were audited. The defendants used various additional furtive means to conceal or obscure the transactions, such as by: (i) deciding, for business reasons, to refrain from registering the transactions as tax shelters because the penalties for not registering them paled in comparison to the fees they stood to collect from selling unregistered (and therefore unknown to the IRS) tax shelters; (ii) completely omitting income or gain and shelter losses from the clients' individual income tax returns; (iii) splitting up massive phony losses and sprinkling them throughout a schedule to the return in hopes of tricking the IRS into thinking that the losses were created by various different investment transactions; and (iv) using phony attorney-client relationships in order to conceal the facts. If the IRS, despite these fraudulent efforts, nevertheless discovered the shelter in the course of an audit, then the plan, the Indictment alleges, was that the clients would provide the phony documentation to further defraud the IRS and conceal the true facts so that the clients could keep for themselves money the clients should have paid in taxes. If the IRS nevertheless disallowed the phony losses, the plan (it is charged (Indictment 27) was to reveal the false opinion letters to the IRS and claim that no penalties should be assessed on the grounds that the clients relied on the opinion letters.

The government has a long way to go before this is proven in court, of course. Still, these new details about the prosecution of the former KPMG partners are reassuring to tax practitioners, in a perverse way. These assertions aren't about making aggressive tax planning criminal; it's about prosecuting actions that, if they happened, were blatantly fraudulent. Fake transactions and phony documents have always been fraud, and prosecuting tax shelter promoters for fake documentation is no more a threat to ordinary tax practice than the prosecution of Irwin Schiff.


roundup of coverage TaxProf roundup of recent developments in the case.

Prosecution reply brief (large pdf file; if you get an Adobe Acrobat Reader error message, you can view the document by changing your acrobat preferences - Edit, Preferences, Internet, then uncheck "allow fast web view").

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