Tax Update Blog: Tax Shelter News Archives
Tax shelters and the big lie
June 18, 2009
Federal Tax Crimes blog says The Big Lie is at the heart of the Daugerdas tax shelter indictment:
I have blogged before that tax shelter prosecutions are about the lie. Often, the claim is that the tax shelters lack economic substance, but in these prosecutions the real complaint is the lie that is designed to give an appearance of economic substance. The jury will not understand the complex, convoluted tax structure and byzantine legal analysis, but the jury will understand the lie.
Federal Tax Crimes Blog is all over this case.
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Greetings, Federal Tax Crimes Blog
June 15, 2009
While I just noticed it last week, the Federal Tax Crimes blog has been rolling since February. Its proprietor is Jack Townsend, a Houston attorney who was a defendant attorney in the KPMG case. He has posted a good explanation of the recent indictment of Paul Daugerdas and six others in connection with Jenkens & Gilchrist tax shelters.
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Is backdating the fatal flaw for Daugerdas?
June 10, 2009
Looking over yesterday's tax shelter indictment of Paul Daugerdas and others, you can see opportunities for the defendants to argue that the IRS is trying to make them criminals for being aggressive advocates for clients in their tax practice -- merely for doing their jobs. That's debatable, but sometimes debatable is enough to avoid prison.
That's why this part of the government's case could be the most dangerous for the defendants:
In several instances in 2000 and 2001, J&G caused clients' tax shelter transactions to be incorrectly implemented at Bank A, which resulted in the wrong amount and/or type of tax loss to be generated for the clients. After the close of the tax year but before the respective tax return was to be filed, defendants PAUL DAUGERDAS and DONNA GUERIN, and Lawyer A, a co-conspirator not named as a defendant herein, discovered or were made ware of the errors and caused new transactions to be effectuated by Bank A through defendant DAVID PARSE and caused them to be backdated to the prior year.
If the government can prove backdating, it might be much easier for a juror to vote for conviction. Tax is hard, and a good defense lawyer has a lot of opportunities to give jurors a reasonable doubt in a case involving short sales, derivatives and currency options. But anybody can understand backdating. If the government convinces the jurors that backdating happened, it should be easier to sell the rest of the government's case.
Related: Tax shelter maven Daugerdas indicted
The Tax Grrrl has more.
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Tax shelter maven Daugerdas indicted
June 09, 2009
Paul Daugerdas, who reportedly was paid $93 million from 1999 through 2003 as head of the tax shelter practice of law firm Jenkens & Gilchrist, was indicted today on federal tax charges. Six others were also indicted, including two former J&G partners and the former Chairman and CEO of national accounting firm BDO Seidman, according to the Department of Justice press release.
The indictment follows a series of guilty pleas by other figures in tax shelters associated with Mr. Daugerdas. Bloomberg.com reports:
The indictment stems from a wider U.S. probe of illegal tax shelters. On May 8, four current and former executives of Ernst & Young LLP were found guilty by a federal jury in New York of selling illegal shelters to wealthy clients. On June 3, former BDO Seidman LLP Vice Chairman Charles Bee pleaded guilty to federal charges that he helped clients evade more than $200 million in taxes through illegal shelters....
Bee’s plea in Manhattan federal court follows that of two other BDO Seidman officials, former Vice Chairman Adrian Dicker and ex-principal Michael Kerekes.
Bloomberg.com says the tax involved in the Daugerdas shelters is alleged to exceed $1 billion. The sentencing guidelines for a conviction with that sort of tax loss would start at 121-151 months.
UPDATE: TaxProf Blog roundup
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Celebrity financial consultant indicted on tax charges
June 05, 2009
The former CEO of an investment firm with A-list clients including Bill and Hillary Clinton was indicted yesterday on tax charges. The New York Times reports:
The executive, Jeffrey I. Greenstein, is a former chief executive and a co-founder of the Quellos Group, whose core business was bought by BlackRock for $1.7 billion in 2007. He faces 18 counts of conspiracy, fraud and tax evasion.Quellos, which was based in Seattle and catered to wealthy investors, had star clients, including former President Bill Clinton and his wife, Hillary Rodham Clinton; Robert Wood Johnson IV, the owner of the New York Jets football team; and the Hollywood mogul Haim Saban, the producer of the “Mighty Morphin Power Rangers” children’s show, according to public records.
The charges arise from basis-shifting tax shelters like those involved in the recent BDO guilty pleas Look for lots of finger-pointing and a blame-the-accountants-and-lawyers defense.
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The BOSS's son is a ne'er do well
May 19, 2009
The "Son of Boss" tax shelter has had a rough time of it in court in the last few days.
On Friday the Fifth Circuit Court of Appeals joined other appeals courts in ruling that the widely-marketed tax shelter lacks economic substance. The shelter used offsetting option positions and a partnership to create artificial losses. The Treasury describes the shelter:
In one variant of this transaction, a taxpayer purchases a call option and simultaneously writes a similar offsetting call option. The offsetting option positions are then transferred to a partnership. Under the position advanced by the promoters of this arrangement, the taxpayer purports to have a positive basis in the partnership interest equal to the cost of the purchased call options, even though the taxpayer's net economic outlay to acquire the partnership interest and the value of the partnership interest are nominal or zero. This is because they claim that the taxpayer's basis in the partnership interest is not reduced for the partnership's assumption of the taxpayer's obligation with respect to the written call options. This artificially high tax basis in the partnership is then used to claim deductible losses (that can be used to shelter other income) by immediately selling the taxpayer's partnership interest, even though the taxpayer has incurred no corresponding economic loss.
It has fared poorly in the courts, including yesterday in the Tax Court. There a gentleman who used a Son-of-BOSS transaction to try to wipe out a $60 million capital gain came to grief. When the IRS disallowed the losses, he tried to get off on a technicality: that the Final Partnership Administrative Adjustment disallowing the loss wasn't adequate notice from the IRS. The Tax Court wasn't buying:
Petitioner waited until the partner-level proceeding, instead, to argue that the FPAA did not provide him adequate notice. He makes this argument despite the multiple determinations in the FPAA that disallow all tax benefits of the tax shelter. Petitioner's participation in a complicated basis-inflating tax shelter belies his naivete. Petitioner purchased a packaged tax shelter involving several sophisticated transactions to avoid paying taxes on a $60 million gain. He received the advice of multiple professionals, including counsel, regarding this purchase.
Bottom line: $12 million in additional taxes.
Cites:
Klamath Strategic Investment Fund, CA-5, No. 07-40861
Napoliello, T.C. Memo 2009-104
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Four E&Y partners convicted of promoting fraudulent shelters
May 08, 2009
Four partners of national accounting firm Ernst & Young now face federal prison after being convicted yesterday of promoting fraudulent tax shelters. The members of the now-disbanded E&Y "VIPER" group were convicted on an indictment that involved "Contingent Deferred Swap" and "COBRA" transactions. These transactions involved offsetting option or currency positions to provide tax benefits without anything really happening economically, other than fees to accountants and lawyers.
The indictment said the Jenkens & Gilchrist law firm was involved in the COBRA transactions. This can't be reassuring for others involved in the Jenkens deals.
The TaxProf has a roundup.
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A failure of BLISS
April 10, 2009
The Tax Court shot down another Jenkens and Gilchrist/Paul Daugerdas basis-shifting shelter yesterday. The defeat was pretty much total, with the $10 million claimed loss disallowed and a $1,298,284 penalty imposed.
The "Basis Leveraged Investment Swap Spread," or BLISS, shelter, involving offsetting option positions, may have lacked economic substance, but it left behind a great theme song:
Cite: New Phoenix Sunrise Corp, 132 T.C. No. 9
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KPMG defendants sentenced
April 02, 2009
The defendants who were dropped from the KPMG tax shelter prosecution might feel that they dodged a bullet today after seeing the sentences imposed yesterday on the remaining defendants. The New York Times reports:
John Larson, a former senior tax manager, was sentenced to more than 10 years and ordered to pay a fine of $6 million by Judge Lewis A. Kaplan in United States District Court in Manhattan.Robert Pfaff, a former tax partner at KPMG, was sentenced to more than eight years and fined $3 million.
A third person convicted in the case, Raymond J. Ruble, a former partner at the law firm Sidley Austin, was sentenced to six years and six months.
Thirteen defendants were excused from the case because of the efforts of the Justice Department to keep KPMG from paying their legal fees. KPMG itself was not prosecuted, but had to shed chunks of its tax practice as part of its deferred prosecution agreement.
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Leader of BDO 'Wolfpack' brought to bay
March 19, 2009
One of the leaders of the now-defunct "Tax Solutions Group" of national accounting firm BDO Seidman, Adrian Dicker, has pleaded guilty to conspiring to sell fraudulent tax shelters. The group, known as the "WolfPack" within BDO, was involved in a number of prominent tax shelters, including the one in the Jade Trading case. The group worked with law firm Jenkens & Gilchrist and Paul Daugerdas, the law firm's tax shelter maven. From the Justice Department press release:
Dicker and his co-conspirators knew and understood that the clients entering into the tax shelter transactions being marketed and sold with J&G had neither a substantial non-tax business purpose nor a reasonable possibility of earning a profit, given the large amount of fees being charged by the accounting firm and J&G to enter the transaction. Those fees were set by the co-conspirators as a percentage of the tax loss being sought by the tax shelter clients. Dicker also knew that the clients who purchased the tax shelter had no non-tax business reasons for entering into the transactions and their pre-planned steps.
A guilty plea often implies a deal to turn on others. This can't be good news for clients still trying to defend their tax-shelter deals, and it's worse news for others involved in the design and marketing of the shelters.
The TaxProf has a roundup.
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Arthur's dead, but its tax shelters litigate on
February 09, 2009
A U.S. District judge in California last week ruled that another "Son of BOSS" tax shelter - this one marketed by the late Arthur Andersen firm, lacked economic substance. In addition to denying the shelter benefits, the court smacked the participants with the 40% penalty for valuation misstatements.
Court victories for the mass-marketed tax shelters of the 1990s and early 2000s are thin on the ground.
Links:
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The tax law: it's not rocket science. That would be too easy.
December 23, 2008
David Altman surely has a big brain, but even smart people can come to grief with taxes, as he found out yesterday in Tax Court. Mr. Altman is an actual rocket scientist:
After World War II, Dr. Altman worked for 11 years for the Jet Propulsion Laboratory at the California Institute of Technology where he investigated a variety of chemicals, fuels, and oxidizers for use in rocket motors. Following a 3-year stint as head of the propulsion department at Aeronutronic Systems, Inc., a defense and aerospace subsidiary of the Ford Motor Co., he went to United Technologies Corp. There, he eventually became vice president of the Research and Engineering Departments at the Chemical Systems Division, before retiring in June 1981.
Oh, and he has other credentials:
He received a Ph.D. in physical chemistry from the University of California at Berkeley in 1943, where Dr. J. Robert Oppenheimer was one of his thesis advisers.2 Dr. Oppenheimer offered Dr. Altman a position as an associate chemist working for the Manhattan Project, which Dr. Altman accepted.
But none of this prepared him for the jojoba bean tax shelters of the late 1970s and early 1980s. Dr. Altman bought into one, "CAL-NEVA." Like so many of these, it turned into a tax quagmire. The IRS disallowed the claimed tax benefits and assessed negligence penalties.
Dr. Altman made a valiant effort to show that he shouldn't be penalized, but the judge wasn't persuaded:
Dr. Altman's own financial analysis does not support a reasonableness defense because it was based on projected cashflows taken from the private placement memorandum -- projections which were preceded by a conspicuous warning that they were not to be relied upon. This factual situation resembles the factual situation in Kellen v. Commissioner, supra, in which the taxpayer, a "well- educated and successful attorney and a sophisticated investor", prepared an analysis based on projections set forth in an offering memorandum that were coupled with a warning that they had been prepared for the general partner, were unaudited, and were not to be relied upon. We held that "Any reliance on those projections was unreasonable." Moreover, Dr. Altman testified that he invested in CAL-NEVA knowing that the investment would provide a tax benefit -- indeed, the anticipated tax benefit was part of his financial analysis.
The moral? No matter how smart you are, a flaky tax shelter is a flaky tax shelter.
Cite: Altman, T.C. Memo. 2008-290
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Three KPMG convictions; one acquittal
December 17, 2008
Guilty on tax evasion counts, reports the Wall Street Journal:
Robert Pfaff, John Larson (former KPMG); Raymond Ruble (former Brown & Wood lawyer)
Not guilty on all counts: David Greenberg (former KPMG).
Thus ends the big KPMG tax shelter case that resulted in the forced divestiture of much of KPMG's business, the embarassment to the Government of the dismissal of charges against 13 defendants, and changes in the way white-collar prosecutions are to be handled.
Full Tax Update coverage here.
UPDATE, 12/18: The TaxProf has a roundup.
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Aiding another worthy industry
December 10, 2008
It appears that Congress might move to bail out another struggling industry: America's beleaguered tax-shelter enablers.
Many local transit agencies "sold" their assets in "LILO" or "SILO" deals to enable taxpayers to generate depreciation and interest deductions to shelter their income. When the IRS blocked the tax benefits, the "buyers" wanted out. Many of the deals were guaranteed by AIG; when its finances collapsed, it threw the agencies into default, entitling the shelter participants to penalties under the agreements.
Now Congress may step in to guarantee the agencies' liabilities under these deals. That will teach them not to participate in future tax shelters, for sure.
UPDATE: The TaxProf has more.
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Dismissed KPMG defendants officially off the hook
December 03, 2008
The case against the 13 KPMG defendants whose cases were thrown out by the trial judge quietly has come to the end when the government declined to ask for Supreme Court review. The Tax Prof has a roundup. The judge dismissed the charges as a result of efforts by the prosecution to keep KPMG from paying the defendants legal costs.
The case against the remaining four defendants continues.
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Doh! HOMER comes to grief
November 18, 2008
Perhaps naming a tax shelter for Homer Simpson was a mistake.
Certainly John B. Ohle III is wishing he never heard of the "HOMER" tax shelter, a tortured acronym for "Hedge Option Monetization of Economic Remainder" Mr. Ohle, a former supervisor at Banc One's "Innovative Strategies Group," has been indicted for promoting "fraudulent tax shelters" -- namely HOMER.
The indictment is interesting in that it says that HOMER, a knockoff of the "COBRA" tax shelter, was never just an agressive tax planning tool, but was just slickly-packaged fraud. From the Department of Justice press release:
The indictment alleges that Ohle and his co-conspirators marketed HOMER as a legitimate tax elimination strategy, despite the fact that HOMER was actually designed as a carefully planned series of steps to fraudulently produce the tax loss amounts desired by the clients. Jenkens allegedly issued a false and fraudulent opinion letter that found that it was "more likely than not" that the transaction would withstand IRS challenge. Ohle and two Jenkens lawyers are alleged to have known that the opinion letter contained false representations, including that the clients had a substantial non-tax business purpose in engaging in the HOMER transaction; that the clients created the HOMER trust for estate planning purposes; and that the clients exchanged the options for third-party notes for sound economic reasons.
Mr. Ohle appears to like home cooking; he is also accused of using HOMER to fraudulently reduce his own taxes.
Regardless of whether the Government proves its case - and Mr. Ohle is presumed innocent until and unless it does - this indictment will make advisors think twice before doing tax deals based on a wink-and-a-nudge business purpose.
Other coverage:
The TaxProf
Linda Beale
TaxGrrl
Related: WOULD THEY HAVE BOUGHT A TAX SHELTER CALLED "DORC"?
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KPMG Trial under way
October 16, 2008
The trial of the four remaining KPMG tax shelter defendants got going yesterday. The defendants will call it tax planning; the government will call it fraud. If the government shows that the shelters were built on transactions that never happened, that will be bad news for the defense. If the shelter transactions actually happened and the paperwork wasn't faked, the defendants should have a good shot at acquittal.
The TaxProf has a roundup.
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Can you welsh on a bad tax shelter deal?
October 02, 2008
Some tax shelters require the help of a tax-exempt third party. If the IRS explodes the shelter, can the taxpayer weasel out of his promises made to the tax-exempt entity in the tax shelter documents? A Mississippi case this week implies "no."
One of the heavily-marketed tax shelters of the late 1990s was "SC2." In a typical fact pattern a taxpayer with lots of interest and dividend-producing assets would contribute them to an S corporation and then contribute non-voting shares of the corporation to a charity for maybe 90% of the company. The charity would have the right to redeem the shares in, say, two years. In the meantime, the interest and dividend income would be allocated on K-1s to the tax-exempt charity, sheltering it from tax.
William Brown, an owner of Brown Bottling Group, Inc. in Mississippi, bought this shelter from national accounting firm KPMG in 2000, with the Austin Firefighters Relief and Retirement Fund acting as the enabling charity for the deal. Things went sour when the IRS declared such arrangements abusive (IRS Notice 2004-30). When the charity went to redeem its shares, the owners declined on the grounds that the shelter had failed. The charity sued.
The court ruled on summary judgement motions this week. Mr.Brown's defenses were shot down. While the case is not done, it looks likely that the charity will eventually get its cash.
One of Mr. Brown's arguments was that the charity had "unclean hands" and should not benefit from its participation in the shelter. The court disagreed:
Again, defendants do not contend that AFF entered into the transaction initially with unclean hands; rather, they argue that after the IRS concluded the SC2 transaction was an abusive tax avoidance transaction and declared that tax-exempt parties in these transactions, including AFF, would be treated as participants in the transactions, AFF, notwithstanding that it had been found to be a participant in the transaction, sued defendants to enforce the Redemption Agreement. Defendants posit that such acts by AFF "constitute wilful inequity toward Defendants which makes the unclean hands doctrine applicable to AFF's claims to enforce key elements of the now known to be illegal SC2 transaction." The court rejects this argument. Even if the court assumes that AFF's claims in this action have no merit, AFF still cannot reasonably be found to have acted with wilful inequity toward defendants merely by virtue of filing this lawsuit to enforce the Redemption Agreement or to otherwise enforce the terms of the SC2 transaction.
In other words, it's not bad faith to sue to enforce a contract.
The moral? Even if the tax shelter fails, promises to third parties made to avoid taxes may survive.
Cite: Austin Fire Fighters Relief and Retirement Fund v. Brown, DC-SD Mississippi, No. 3:07-cv-0028
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TOO GOOD TO BE TRUE?
September 11, 2008
The New York Times has a new piece on avoiding flaky tax shelters. It quotes this tax expert:
“Here are three warning signs that a tax deal should be avoided,” said Tanina Rostain, a legal ethics scholar at New York Law School: “When the tax savings promised are many times the amount of the initial investment, when you are told that there is no financial risk involved and when you are urged not to show it” to anyone else.
The piece includes much good advice, most notably to consult a tax advisor who's not trying to sell you the deal. But the piece only scratches the surface. Here are some tips to help you point out a really bad tax shelter.
- It's sold on the Midway at the State Fair.
- You ask the promoter if you will go to jail for it, and he says "oh, it's about you now?"
- The promoter offers to throw in a Pocket Fisherman.
- You have to buy the shelter using small unmarked bills.
- The advisor says "hey, it worked for Wesley Snipes!"
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APPEALS COURT AFFIRMS DISMISSAL OF KPMG CASE CHARGES
August 28, 2008
The judge in the criminal case involving tax shelters marketed by KPMG dropped 13 defendants from the case last summer. Five defendants remained under indictment.
The Second Circuit court of Appeals in New York upheld the trial judge's decision today. The courts held that the defendants were denied their right to counsel when the Department of Justice pressured KPMG to not pay employee and partner legal fees.
Cite: United States v. Stein, et.al., CA-2, No. 07-3042-cr.
Media Roundup:
Bloomberg
NY Law Journal
NY Times
And the TaxProf has more.
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TAX EVASION CHARGES TO BE TRIED SEPARATELY IN KPMG CASE
August 05, 2008
Tax evasion charges against one of the defendants in the KPMG tax shelter trial will be tried separately from the rest of the case, WebCPA reports. The trial is set to begin next month.
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ANOTHER JENKENS SHELTER DEFEATED IN COURT
August 01, 2008
The Court of Federal Claims yesterday gave the IRS another victory in a case involving a Jenkens & Gilchrist tax shelter based on artificial losses created by offsetting foreign currency positions in a partnership. The opinion is thorough and somewhat tedious, but I like how it recalls this episode where a skeptical attorney commented on a memo defending the shelter (my emphasis):
Mr. Waterman was not impressed with some aspects of the his colleagues' analysis. In a comment box addressing whether the "Evaluated Transaction" (the J&G strategy) lacked economic substance, the memorandum expressed that "the Evaluated Transaction consisted of an investment strategy intended to generate a pre-tax profit that far exceeds any 'expected' tax savings." Mr. Waterman's handwritten annotation reads "B.S."...
Another paragraph titled "Tax-Structured Transaction" stated that "[o]ne may infer that the Evaluated Transaction qualifies for [an exception from a registration requirement] because (i) the trade constitutes a standard trade for the vehicle used and (ii) the tax consequences of the trade are fairly well established." PX 259 at 14. Mr. Waterman added another handwritten "B.S." below that paragraph.
The court dryly notes:
a document can bear the indices of credibility, the "B.S. memo" certainly reflects a lawyerly reaction to the SLK tax attorneys' expression of comfort.
I assume "B.S." is shorthand for some Latin term, but I can't figure out what. Can any of you lawyers out there help?
Cite: Stobie Creek Investments LLC et al. v. United States; Nos. 05-748T, 07-520T
PS: The TaxProf noted a ruling in this case back in April, when the court refused to allow expert testimony from Tax Professor Ira B. Shephard.
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TOUR DE FORBES
May 20, 2008
Janet Novack has two pieces in the new issue of Forbes that deserve careful reading.
Read My Lips discusses the Presdiential candidate tax positions:
As president, Senator John McCain (R–Ariz.) aims to balance the budget while extending the Bush-era income tax cuts, doubling the personal exemption and eliminating the alternative minimum tax. The Democratic candidates say they’ll raise taxes only on the well-off—those making over $200,000 for Senator Barack Obama (D–Ill.) and $250,000 for Senator Hillary Clinton (D–N.Y.)—while showering tax breaks and health insurance on working families. (At press time Clinton is still hanging in.)Anyone who believes any of this likely already owns Florida swampland.
The article also has thoughts on how to plan your investments around likely tax policy changes in the next administration.
Tax Shelters 2.0 tells how the IRS tax shelter crackdown has gotten the national accounting firms out of the retail tax shelter market, opening the door to smaller operaters, often using twists on the same old discredited schemes. Buyer beware.
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WEB SITES FOR SALE: THE MORE YOU PAY, THE MORE YOU DEDUCT?
May 15, 2008
The retail cattle feeding tax shelters of the 1970s used a simple scheme to generate deductions: Sell a cow worth $500 for $5,000 (heck, $10,000 - who cares?) to the tax shelter - but accept a non-recourse note from the shelter as payment. The shelter would then depreciate the $10,000 "cost" of the the cow, but with no intention of ever paying off the note.
Now comes word from Virginia of a new economy twist on this old scheme involving Virginia CPA John T. Hoang:
The complaint alleged that Hoang, through his company Tax Smart Technology Services, sold customers Web sites worth almost nothing. But the sales contracts between Tax Smart and customers falsely stated that the Web sites were worth tens of thousands, hundreds of thousands or even millions of dollars. Hoang then allegedly prepared customers’ federal income tax returns, improperly using the false values to claim large depreciation deductions. The lawsuit asserts that Hoang used offsetting sham promissory notes to create the appearance of sales of valuable assets, while in reality customers paid Hoang a small sum and Hoang then provided customers a worthless Web site and a large tax deduction. The government complaint estimates that the harm from Hoang’s misconduct exceeds $6.1 million.
Mr. Hoang has now consented to a permanent injunction barring him from preparing returns or promoting this scheme.
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4TH CIRCUIT REJECTS LILO APPEAL
April 30, 2008
After a defeat in a "Son of Boss" tax shelter case last week in a federal district court, the IRS bounced back yesterday with an appeals court victory. The Fourth Circuit upheld a 2007 decision defeating a "Lease-in Lease-out" shelter. From the opinion:
In closing, we are reminded of "Abe Lincoln’s riddle . . . 'How many legs does a dog have if you call a tail a leg?'" Rogers v. United States, 281 F.3d 1108, 1118 (10th Cir. 2002). "The answer is ‘four,’ because ‘calling a tail a leg does not make it one.’" Id. Here, BB&T styled the LILO as a lease financed by a loan, but did not in substance acquire a genuine leasehold interest or incur genuine indebtedness. Accordingly, although we decline to resolve whether the transaction as a whole lacks economic substance — that is, whether it has "reached the point where the tax tail began to wag the dog," Hines, 912 F.2d at 741, we conclude that the Government was entitled to recognize that tail for what it was, not what BB&T professed it to be.
The IRS has occasionally lost cases against the mass-marketed tax shelters of the late 1990s at the district court level, but I think they have won all of their cases at the more important appellate level.
Links:
TaxProf Blog
Prior Tax Update BB&T coverage
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A BAD DAY FOR LILO
April 22, 2008
A Cincinnati jury didn't buy the LILO tax shelter. The jury ruled Friday that Fifth Third Bancorporation wasn't entitled to deductions arising from a sale-leaseback of rail cars in the foreign countries of France, Germany and Massachusetts.* A Justice department press release said that this was "the first large, complex corporate tax shelter case tried by a jury."
More from the press release:
"The success in this case is due to the great teamwork by lawyers from both the Justice Department's Tax Division and our IRS Office of Chief Counsel," said IRS Chief Counsel Don Korb. "This is just the beginning of the enhanced collaboration between the Tax Division and the Office of Chief Counsel in litigating cases. This enhanced collaboration will be more and more evident in the coming months, and will, I believe, significantly increase the government's effectiveness in combating tax sheltering activity like the LILOs at issue in this case."
Given that the verdict disallowed $5.6 million in tax refunds, an appeal by Fifth Third wouldn't be surprising.
The TaxProf has more.
*Yes, technically speaking, Massachusetts isn't a foreign country, even though it is much too hard to spell.
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IRS DEFEATS 'MIDCO' TAX SHELTER
April 02, 2008
When a C corporation sells its business, there is typically a little tug of war between the buyer and seller.
The seller wants to sell his stock because he will be taxed twice if he sells the assets -- first on the gain on the assets themselves, and again when he liquidates the corporation.
The buyer, in contrast, wants to buy assets. The buyer doesn't want to take on any unknown liabilities of the old corporation, but he also wants to recover his purchase price through depreciation and amortization. The cost of stock isn't recoverable until it is sold.
A tax shelter launched in the 1990s tax shelter frenzy sought to give both sides what they want. The "Midco" shelters would set up a tax-indifferent middleman to buy the stock -- giving the seller his sought-after stock sale -- and then sell the assets to the buyer. The IRS won a court battle against this shelter in a U.S. District Court in Houston yesterday; the court upheld the IRS position on summary judgement.
Accounting firm PriceWaterhouse Coopers (PWC) arranged for a tax-indifferent "Midco" named "K-Pipe" to buy the stock of Bishop Group Ltd. and sell the assets to Midcoast Energy Resources. The judge disregarded the midco and said the transaction was a stock sale:
Moreover, there is no objective evidence in the record that K-Pipe negotiated the stock sale at all. All of the communications involved Midcoast, and it was at the insistence of Midcoast's tax advisors that certain actions be undertaken, such as the agreement not to liquidate Bishop for two years and the formation of the Butcher Interest Partnership to add "good facts" to the transaction. Additionally, K-Pipe's obligations were almost entirely indemnified by Midcoast through various side agreements and under the Stock and Asset Purchase Agreements. It was Midcoast's loan that acted as security for the $195 million, which K-Pipe borrowed. K-Pipe, having been created for the purposes of this transaction, could not have provided any assets as security. After the transaction, K-Pipe engaged in virtually no business activity and was, in substance, a mere shell. Finally, K-Pipe's sole purpose in participating in the transaction was to allow Midcoast to step up the basis of the Bishop Assets. Under the facts of this case, the court finds that K-Pipe's role in the transaction should be disregarded.
Another blow to the big-firm tax shelter industry.
Cite: Engbridge Energy Company, Inc. v. U.S., No. 4:06-cv-00657 (DC-SD Texas)
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EX-KPMG PARTNER FACES NEW TAX SHELTER CHARGES
March 20, 2008
One of the defendants still facing criminal charges relating to KPMG's tax shelter business was hit with a new round of criminal charges yesterday. Robert Pfaff faces new charges of setting up fraudulent shelters in the Northern Marianas islands. The charges also allege that he hid his fees for the transactions from both the IRS and his own accounting firm, KPMG.
The TaxProf has a roundup.
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FOOL'S GOLD AND CHICKEN SHELTER
February 22, 2008
The tax authorities may move slowly to shut down tax scams, but when they do move, it can be impressive. The Justice Department moved to shut down two tax-shelter organizers yesterday for what appear to be pretty brazen abusive tax shelters.
There's gold in them there football players
The New York Times reports on one of these schemes, a bogus gold-mine tax shelter:
The Justice Department filed two lawsuits on Thursday in a move against what it said was a fraudulent gold-mining scheme sold to dozens of wealthy investors, including seven current or former National Football League players.Prosecutors say the promoters of the investment, known as Midas, for mining interest development action strategy, promised investors a return of at least 34 percent if they invested refunds they got after filing amended tax returns that claimed bogus deductions related to supposed gold-mining expenses in Colorado, Arizona and elsewhere.
Sure, just about every NFL player has been to college, but not many of them were finance or accounting majors.
Liquid Eggs
The other tax-shelter action yesterday went after two former Grant Thornton partners who apparently were run out of that national accounting firm and went into the tax-shelter business on their own in the Kansas City area. One of them became known by the not-very-manly nickname "Dr. Poof" for his alleged ability to make taxes "go poof." The Kansas City Star reports:
Two area tax advisers used sham companies and nonexistent chicken farms to shelter their clients’ income from hundreds of millions in taxes, government lawyers alleged Thursday.In separate but related civil suits filed in federal court, the IRS said that Allen R. Davison of Overland Park and A. Blair Stover Jr. of Platte City and Beverly Hills, Calif., sold numerous fraudulent tax-avoidance schemes to wealthy investors. The agency’s lawyers asked a federal judge in Kansas City to permanently bar the men from giving tax advice or representing clients before the IRS.
The federal complaint alleges that the promoters used a menu of scams, including:
-Claiming disabled-access tax credits without actually incurring any expenses for improving disabled access.
- Deducting bogus "management fees" to Roth IRA-owned corporations.
- Inflating depreciation deductions through bogus asset basis.
The most picturesque item in their alleged toolkit is phoney chicken farms. The complaint says that non-farmers - say, insurance brokers - would write a big check at year-end to allegedly buy a flock of layers, and a tax deduction Cash-basis "dirty boots" farmers can do this, but an insurance broker in Mission Hills probably isn't spending much time on the chicken farm. The insurance broker-farmer would get the check back the following year, including it in income, and then write a bigger check the subsequent December to keep the deduction going.
The Kansas City Star report quotes one participant:
“I just think somebody doesn’t have their facts here,” she said. “Because I know that some of the investments that Al is in, and has involved other people in, are in chicken farming and they have literal chicken farms that produce liquid eggs for McDonald’s. I know about the business and it’s extremely legitimate.”
Liquid eggs? I bet they don't hard-boil very well.
Links to Justice Department Press Releases:
TAX PREPARERS FROM WASHINGTON, D.C. & TEXAS SUED FOR ALLEGEDLY PROMOTING GOLD MINING TAX SCAM
The linked items also have links to the actual complaints filed in federal court.
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SEVENTH CIRCUIT UPHOLDS RETROACTIVE 'SON OF BOSS' REGS
February 07, 2008
The Seventh Circuit Court of Appeals has upheld a ruling striking down a variant of the "Son of Boss" tax shelter. The TaxProf reports:
The opening of Judge Easterbrook's unanimous opinion foreshadowed the result:Paul M. Daugerdas, a tax lawyer whose opinion letters while at Jenkins & Gilchrist led to the firm’s demise (it had to pay more than $75 million in penalties on account of his work), designed a tax shelter for himself, with one client owning a 37% share.The Seventh Circuit described the tax shelter this way:
A transaction with an out-of-pocket cost of $6,000 and no risk beyond that expense, while generating a tax loss of $3.6 million, is the sort of thing that the IRS frowns on. The deal as a whole seems to lack economic substance; if it has any substance (a few thousand dollars paid to purchase a slight chance of a big payoff) then the $3.6 million “gain” on one premium should be paired with the $3.6 million “loss” on the other; and at all events the deal’s nature ($36,000 paid for a slim chance to receive $7.2 million) is not accurately reflected by treating Euro 56,000 as having a basis of $3.6 million.
We blogged the district court decision here.
Mr. Daugerdas hobnobs with Howie Mandel in happier times:
Cite: Cemco Investsors, LLC v. Forest Chartered Holdings, Ltd, No. 07-2220 (7th Cir. 2/7/08).
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BROKEN JADE
December 27, 2007
The IRS has won an across-the-board victory in the U.S. Court of Claims over the "Son of Boss" tax shelter.
The case involved three Texans who together had $40 million in capital gains on which they didn't care to pay taxes. They each bought bought a Euro option for $15,000,020 and sold an offsetting option for $14,850,018 - a spread of $150,002. Any increase in the value of one option was almost perfectly offset by a decline in the value of the other option, so there was only $150,002 really at stake, and that was all the each of the Three Texans were out-of-pocket. Well, that and $900,000 in fees to the promoters and facilitators of the shelter.
The partners contributed the offsetting positions to Jade Trading LLC, which was treated as a partnership under federal tax rules. They claimed a basis of $15,000,020 basis in each partnership interest, relying on a technical reading of the tax law that ignored their "contingent" liability for the $14,850,018 option they wrote. They then sold their partnership interests for their $150,000 fair market value, claiming the $14,850,000 difference as a capital loss.
The Court of Federal Claims struck down the transaction under what you might call the "too good to be true doctrine." The court said there was no "economic substance" to the deal, so the tax law does not have to respect its formalities:
A final indicium of the lack of economic substance here, while not dispositive in and of itself, is the highly disproportionate tax advantage to the underlying monetary outlay -- the tax loss per brother, $14.9 million, was roughly 65 times greater than each LLC's $225,002 financial commitment to Jade, almost 100 times each LLC's $150,002 investment in the spread transaction which generated the loss, and approximately 100 times the $140,000 potential net profit each LLC could have earned.In sum, this transaction's fictional loss, inability to realize a profit, lack of investment character, meaningless inclusion in a partnership, and disproportionate tax advantage as compared to the amount invested and potential return, compel a conclusion that the spread transaction objectively lacked economic substance.
The court disallowed the deduction and upheld a 40% "gross valuation misstatement penalty," making the transaction a bad deal all around for the participants.
The shelter at issue in Jade Trading was the brainchild of accounting firm BDO Seidman's "TAX $ELLS!" division, "known internally as the 'Wolf Pack.'" Other national firms sold similar shelters, including those that triggered the KPMG criminal prosecutions. Defenders of the promoters used to say that "these shelters haven't been ruled illegal." Not any more.
The TaxProf has more, including a link to the opinion.
Other coverage:
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NEW E&Y TAX SHELTER CHARGES?
September 12, 2007
Fresh from winning a guilty plea in their tax shelter case involving former KPMG partners, the Justice Department is revving up a case involving another national accounting firm, reports the New York Times:
Federal prosecutors are planning a fresh indictment in a case that involves tax shelters sold by the accounting firm Ernst & Young, according to defense lawyers in the case.
Four current and former partners of Ernst & Young were indicted last May in connection with their tax shelter work from 1998 through 2004. The firm itself, which has not been charged, has been under investigation since 2004 by federal prosecutors in Manhattan, who have been looking into its creation and sale of aggressive shelters.
Nobody expects charges against E&Y, but that can't be much comfort to those involved in tax shelter frenzy that ran from the late 1990s until around 2003. The Times provides some background:
The case against the four Ernst & Young defendants focuses on four aggressive shelters known as Cobra, Pico, CDS and CDS Add-on. Several firms other than Ernst & Young, including Deutsche Bank and the law firm of Jenkens & Gilchrist, which is now defunct, also worked on Cobra. Deutsche Bank, which is part of the broad criminal investigation, helped make and sell Cobra to more than 1,100 wealthy investors in 1999 and 2000, according to court papers in related cases.
While the tax shelter party was incredibly lucrative for the big firms at the time, the hangover is nasty.
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GUILTY PLEA BOOSTS KPMG CASE PROSECUTION
September 11, 2007
A few weeks ago, the high-profile tax shelter prosecution of former KPMG seemed on the verge of collapse. A guilty plea may give it new life. From today's New York Times:
The governments criminal case against promoters of questionable tax shelters took a step forward yesterday when an investment adviser at the center of the inquiry pleaded guilty and provided new details on those involved.
The plea by David Amir Makov, 41, in Federal District Court in Manhattan is expected to bolster the governments investigation of Deutsche Bank over its work with questionable shelters, including one known as Blips, whose workings Mr. Makov described in detail yesterday.
The work must have been profitable; Mr. Makov agreed to pay a $10 million fine. His plea may help prosecutors argue that the shelters were not agressive tax planning, but mere shams. He explained the "BLIPS" tax shelter, versions of which were marketed by KPMG and others. The shelter is reported to have generated over $5 billion in false tax losses. From the Times report:
Although Blips were created on paper to look like seven-year investments, it had neither real loans nor a real investment component, Mr. Makov explained yesterday. "There was no economic substance," he said. "Instead, we created the appearance of economic substance, rather than the reality." Mr. Makov added that he was "clearly told by Bank A, KPMG and others that the loan was not at risk."
While he initially thought that Blips were legitimate, he said that "as part of the deception" he was eventually "asked by representatives of Bank A," among others, "to come up with an investment rationale."
How's this for a rationale: "to generate $10 million to pay my criminal fines."
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JUDGE DROPS CHARGES AGAINST 13 KPMG DEFENDANTS
July 16, 2007
When you're thrown off the sled, usually the wolves get you. Thirteen former KPMG partners and employees cheated the wolves today.
The trial judge in the KPMG tax shelter criminal case dismissed the charges agains the 13 defendants who were affected when KPMG agreed not to pay for their legal defense to keep the firm itself from being indicted.
The case agains three other ex-KPMG employees and two non-KPMG defendants in the case will proceed to trial.
The TaxProf has a full roundup.
Link: Complete Tax Update coverage.
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INSIDE THE KPMG NEGOTIATIONS
July 06, 2007
The New York Times today describes notes taken by a defense attorney during the tense negotions between international accounting firm KPMG and the Justice Department when the firm was on the verge of being indicted:
Now Mr. Barloons notes of meetings from March through June 2005, which were made public in June in connection with the related criminal trial of 16 former KPMG tax employees, provide a rare and detailed look inside the closed-door process of those dealings.
We almost never get a front-row seat to a negotiation between a major multinational company and the United States government, said Stephanie Martz, director of the White Collar Crime Project.
An indictment would probably have brought down KPMG. The notes seem to show that the government made KPMG throw some of its partners off the sled to hold off the wolves:
Rod Rosenstein, the deputy assistant attorney general, who was at the meeting, asked whether the Justice Department was setting a precedent that we cant prosecute somebody if they come and clean everything up.
But earlier in the meeting, [defense attorney] Mr. Bennett said that what was really precedent-setting about the case was the conditioning of the payment of [partner and employee] legal fees on cooperation. We said wed pressure although we didnt use that word our employees to cooperate.
This denial of legal fees for employees is at the heart of efforts to have the criminal charges against former KPMG partners and employees dismissed. The trial judge is considering the issue.
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KPMG CHARGES TO BE THROWN OUT?
June 01, 2007
The judge hearing the criminal case involving ex-KPMG employees will hold a hearing on whether to throw out the charges. The judge is considering dismissal on the grounds of prosecutorial misconduct. The White Collar Crime Prof Blog discusses the details. The TaxProf and the Tax Girl have more.
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NYT: INDICTMENTS LOOM FOR E&Y TAX SHELTER FIGURES
May 30, 2007
The New York Times reports:
Federal prosecutors have decided not to bring criminal charges against the accounting firm of Ernst & Young over its work with questionable tax shelters, but will instead bring criminal charges against four employees today, people close to the case said.
The Ernst & Young employees to be charged by federal prosecutors for the Southern District of New York are Robert Coplan, Richard Shapiro, Martin Nussbaum and Brian Vaughn, according to these people.
The prosecutors seem to be taking a more low-key approach here than they did with their indictment of 17 people, mostly former partners and employees of KPMG, coupled with a "deferred prosecution agreement" that made major changes to the KPMG tax practice. The KPMG case has run into trouble, with the presiding judge unhappy with prosecution tactics. Perhaps the Justice Department's more subdued approach to the E&Y case is a result of their problems in the KPMG matter.
UPDATE: Indictments announced.
UPDATE II: The TaxProf has a link roundup.
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THIS DEAL NEEDED MORE KETCHUP
May 29, 2007
Last week the H.J. Heinz Company lost a big "basis shifting" tax shelter case.
The shelter was supposed to work like this:
1. A Heinz subsidiary, Heinz Credit Corporation, bought 3.5 million shares of Heinz stock on the public markets for about $129 million.
2. Heinz redeemed all but 175,000 of the shares in a transaction that (on purpose) did not qualify as a redemption under Sec. 302. That means the transaction is a dividend, and the $120+ million basis in the 3,325,000 shares shifts to the remaining 175,000 shares.
3. The subsidiary sells the remaining 175,000 shares on the public market, generating a $124 million capital loss and more than $40 million in tax refunds.
These basis-shifting transactions were designed to take advantage of an old tax law provision meant to keep people from disguising corporate dividends as stock sale proceeds. This was more important before dividends and capital gains were taxed at the same rate, but it still matters; a dividend is 100% taxable, while a stock sale is taxable only to the extent the proceeds exceed your stock cost ("basis").
While the redemption rules can be complicated, a simple example gives an idea how it works:
If you own all 100 shares of a corporation, a sale of 99 shares back to the corporation still leaves you with 100% ownership, so the tax law ignores the "sale" and treats the transaction as a dividend. The basis of the 99 shares "sold" is reallocated to the remaining 1 share in such a "failed" stock redemption.
The basis-shifting shelters sought to create losses by using "failed" redemptions to inflate the basis of shares and then selling them to outside parties at a loss.
The Court of Federal Claims said that the Heinz basis-shift was a "sham":
This court will not don blinders to the realities of the transaction before it. Stripped of its veneer, the acquisition by HCC of the Heinz stock had one purpose, and one purpose alone -- producing capital losses that could be carried back to wipe out prior capital gains. There was no other genuine business purpose. As such, under the prevailing standard, the transaction in question must be viewed as a sham -- a transaction imbued with no significant tax-independent considerations, but rather characterized, at least in terms of HCC's participation, solely by tax-avoidance features. The tax advantage sought by Heinz via this sham must be denied.
The moral? If you do a deal solely to generate tax losses, the courts might not buy it, no matter how much ketchup you pour on it.
Cite: H.J. Heinz vs. United States, Ct. Fed. Cl. No. 03-2847T
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SIDLEY SETTLES; KPMG AVOIDS TRIAL ON FEES
May 24, 2007
Yesterday saw two developments in the ongoing tax shelter court battles. Legal giant Sidley & Austin settled charges of promoting bad tax shelters by agreeing to pay a $39.4 million penalty; in return, the government agreed to not pursue criminal charges. The case arose from tax shelter opinions written by Richard Ruble, one of the defendants in the case of the former KPMG partners. Mr. Ruble joined Sidley & Austin when it bought the Brown & Wood law firm.
Meanwhile, KPMG avoided a separate trial on whether it would have to pay the legal fees of its indicted former partners. The Second Circuit Court of Appeals ruled that the trial court judge was out of bounds when it ordered the trial on fees. The fee issue will now be settled in arbitration.
The TaxProf Blog rounds up both stories:
TaxProf Sidley coverage
Tax Prof KPMG coverage
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JENKENS AND GILCHRIST FUN FACTS
March 31, 2007
Amount paid by the fatally-wounded Jenkens and Gilchrist law firm as a penalty to the government for its tax shelter activities: $76 million.
Compensation reportedly ($link) paid from 1999 to 2003 to Paul Daugerdas, head of the Jenkens and Gilchrist tax shelter practice: $93 million.
More on the fall of Jenkens here.
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TAX SHELTER PENALTIES BRING DOWN JENKENS AND GILCHRIST
March 29, 2007
Jenkens and Gilchrist rode the 1990s tax shelter boom to great wealth. Today they rode it back to earth.
The firm today agreed to pay $76 million in penalties to the IRS for its tax shelter activities - penalties that doom the firm. From a Department of Justice press release:
The firm has acknowledged not only that its tax shelter practice was fraudulent and caused serious harm to the United States Treasury, but also that the practice caused such harm to the firms reputation and revenues that it cannot survive as a going concern. The demise of Jenkens & Gilchrist demonstrates that a lucrative but fraudulent tax shelter practice may provide short-term financial rewards, but at a great long-term cost."
Wow. What a way to go out. While this will put a lot of Jenkens and Gilchrist attorneys on the street, the recriminations promise employment to other lawyers for years to come.
Paul Daugerdas, pictured above, was one of the Jenkens attorneys in the tax shelter practice; we blogged about one of his shelters earlier today. He probably isn't the most popular guy around the office right now.
The TaxProf has coverage and a full set of links.
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IRS WINS CASE IN HEAVILY-MARKETED TAX SHELTER
March 29, 2007
The IRS won a "summary judgment" ruling on a version of the "BLIPS" tax shelter in a Chicago Federal courtroom yesterday. A district court judge ruled that the shelter, which involved inflating the basis of a partnership through a purchase of offsetting foreign currency contracts, didn't work. The judge discussed the procedural defense of the shelter ("Cemco") with a statement that could apply to many of the big-firm tax shelters of the late '90s:
As detailed below, Cemcos theory consists of several nuanced procedural steps. Ultimately, however, the argument amounts to little more than a house of cards, for if any of the steps fail (and several do), Cemcos entire position collapses.
The case has additional resonance because a version of this shelter is involved in the KPMG criminal litigation. This complete defeat for the shelter (including valuation penalties) may help support the prosecution's view of the shelters. This particular shelter, though, was the progeny of Paul Daugerdas, a Jenkens and Gilchrist tax attorney pictured here in happier times with Howie Mandel:
Jenkins and Gilchrist attorney with Howie Mandel at a charity ball. No deal, says the judge.
.
Cite: Cemco Investors, LLC v. United States, DC-Ill Case No. C 8211 (link courtesy of the TaxProf).
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KPMG CRISIS RECALLED IN WALL STREET JOURNAL
February 15, 2007
The Wall Street Journal has a page-1 piece today on accounting giant KPMG's near-death experience. It tells how Timothy Flynn took the reins of the firm when the former chairman stepped down after being diagnosed with a fatal brain tumor. Only three days later, Mr. Flynn was in conference with the Justice Department trying to keep the firm from being indicted for its tax-shelter dealings.
It's an interesting account of how KPMG narrowly avoided being put out of business by its tax shelter products. It certainly is a different firm than it was in 2005.
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ANOTHER SHELTER LOSES IN COURT
February 02, 2007
A marketed tax shelter failed a court test in Texas this week. The New York Times reports:
The shelter, known as Blips, plays a central role in the criminal inquiry of Deutsche Bank over questionable tax shelters and in the pending criminal trial in federal court in Manhattan of 16 former employees of the accounting firm KPMG and two outsiders.
The civil ruling on Tuesday by Judge T. John Ward of Federal District Court for the Eastern District of Texas will probably add ammunition to Manhattan prosecutors arguments that Deutsche Bank acted improperly by providing fake loans for Blips and similar shelters. Judge Wares is the first major civil ruling on the legitimacy of Blips, or bond-linked issue premium structure.
The opinion says that much of the transaction documentation was a facade, meant to legitimize the shelter by out