Tax Update Blog: Tax Shelter News Archives
Buy.com founder learns the truth about the Tax Fairy
January 19, 2012
There is no tax fairy, despite of the best efforts of big law and accounting firms a decade ago. The founder of Buy.com learned the sad truth the hard way this week when the Tax Court ruled against his "OPIS" tax shelter, marketed by KPMG. The court ruled that the shelter failed to protect Scott Blum from $25.7 million in federal taxes for 1998, 1999 and 2002. It also upheld a $10.2 million penalty assessment. The TaxProf has more.
Cite: Blum, T.C. Memo. 2012-16
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For want of a QSUB, the shelter was lost
October 11, 2011
Presidio Advisors, LLC, a boutique firm at the center of the tax shelter industry of the late 1990s, got another spot on its record last week in the Court of Federal Claims. This time, the losers weren't outside tax shelter investors, but Presidio's founders.
Presidio put together a basis-shifting shelter that involved transferring assets to "qualified subchapter S subsidiary," or QSUB. If an S corporation owns 100% of the stock of another corporation, the subsidiary's activities are included on the S corporation return if the subsidiary makes a "QSUB" election.
Presidio set up a shelter deal where it set up a corporation, PCC, to buy equiment from a foreign corporation for consideration for $11.7 million, including an obligation to close a $12 million short sale on treasury securities. The equipment had a built-in loss of around $11.4 million, based on this value. The organizers contributed the PCC stock to an S corporation called Prevad, owned largely by lead figures in Presidio. PCC was intended to be a QSUB of Prevad.
PCC then contributed the property to Presido Advisors, LLC, which then sold the property for a big loss, which passed through the LLC K-1 to the QSUB and thence to the Prevad S corporation return.
Except for one little problem. The court explains:
In this case, petitioners contend that PCC was a QSub of Prevad, entitling Prevad to treat PCC's assets as its own, as of the effective date of the election. They further assert that Prevad assumed PCC's $11,881,813 basis in the latter's equipment before that equipment was contributed to Presidio on November 8, 1998. The latter must be true if Presidio has any hope to deduct the $10,644,471 loss it claims on Presidio's subsequent sale of the equipment. In its motion for partial summary judgment, however, respondent argues that Prevad's election to treat PCC as a QSub was not effective as of November 8, 1998, such that PCC's allegedly stepped-up basis in its equipment did not carry over to Presidio. It would appear that respondent is right.
Did somebody fail to file a QSUB election? No; it looks more like the shelter organizers were careless in throwing their entities around:
Rather, petitioners admit that Prevad did not become the sole shareholder of PCC until November 6, 1998. Petitioners, moreover, further admit that Prevad did not retain its ownership of PCC, but rather, on the same day, transferred its shares in PCC to Presidio. Accordingly, PCC was not held by a Subchapter S corporation for the entire retroactive period in question and thus failed to qualify as a QSub.
It's not clear the shelter would have worked if the equipment had been a QSUB on November 8, but it clearly fails once the court decides that it wasn't. Without an effective QSUB election, the loss is locked in a C corporation with no income of its own.
The Moral? Paperwork matters. If you are basing a big transaction on effective dates of incorporations and tax elections, and you are cutting it close, make very sure that your paperwork has all of the right dates.
Cite: Presidio Advisors LLC, Ct of Federal Claims No. 05-411.
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Failed tax shelter wrecks S corporation election
September 27, 2011
One of the products marketed by a national accounting firm in the turn-of-the-century tax shelter frenzy turns out to have cost a taxpayer a lot more than back taxes. The shelter turns out to have blown the taxpayer's S corporation election.
KPMG marketed the "SC2" tax shelter to enable S corporation owners to have their cake and eat it too. The shelter had S corporation shareholders donate shares to a tax-exempt entity. Where the income was interest and dividends, it didn't subject to "unrelated business income tax" and was therefore tax free. A federal judge explains what happens next:
During this period, the S corporation's income accumulates in the corporation; distributions are minimized or avoided. After the pre-determined period of time has elapsed, the charity sells the "donated" shares back to the original shareholders. Tax has been avoided for the period of time that the shares were "parked" in the charity, and the accumulated income of the S corporation may be distributed to the original shareholders either tax-free or at the favorable long-term capital gains rate.
But what if the charity doesn't want to sell?
The original shareholders retain control over the S corporation by donating only non-voting stock while retaining all shares of voting stock. Moreover, to protect against the possibility that the donee charity might refuse to sell its majority stock back to the original shareholders after the agreed-upon length of time, warrants are issued to the original shareholders prior to the "donation." The warrants enable the original shareholders to purchase a large number of new shares in the corporation; if exercised, the warrants would dilute the stock held by the charity to such an extent that the original shareholders would end up owning approximately ninety percent of the outstanding shares. Thus the warrants allow the original shareholders to retain their equity interest in the corporation even though the charity nominally is the majority shareholder.
So if the charity doesn't want to sell, the taxpayer can dilute them to insignificance.
The problem?
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Dumb squared?
September 07, 2011
My new post at Going Concern on the "Distressed Asset/Debt" tax shelter, and why the Tax Court doesn't much care for it.
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Kansas City tax advisor runs out of tax miracles at appeals court
August 17, 2011
There are no tax miracles.
Sure, lots of folks say there are, if you just hire them, or buy their book. There are always clients for those who promise a painless end to tax woes, and there's always an audience that wants to hear that their old tax pros are just incompetents or wimps who are afraid to take on The Man.
A case decided by the Eighth Circuit Court of Appeals holds a lesson for these folks. The Eighth Circuit upheld an injunction against a host of tax plans promoted by former Coopers & Lybrand and Grant Thornton attorney A. Blair Stover. These included:
- A setup using a "parallel" C corporation with a November year end to suck all of the income out of an S corporation as "management fees" in December, providing an 11-month deferral of the tax on the income.
- A similar deal where the substance-free management company was owned by an ESOP, thus sheltering the income until it was withdrawn by the owner.
- Still another deal where the "management" C corporation was owned by a Roth IRA.
While these may have seemed attractive at the time, they worked out badly for the clients. From the Appeals Court opinion:
The IRS conducted a lengthy and costly investigation into Stover's schemes. The district court found that agent Rhonda Kimball spent over three thousand hours (more than one year's normal work) unraveling transactions for just two of Stover's clients. It also found that even the most conservative estimate of the tax loss to the government caused by Stover's schemes was $100 million, and potentially as high as $800 million. Agent Janice Mallon testified that a "reasonable estimation" of the government's tax loss was $300 million. Apart from those costs, most of Stover's clients had to pay other professionals to "undo" the structures Stover promoted, organized, and sold. Many had to pay penalties to the government.
Until things blew up, these taxpayers probably sneered at their wimpy old tax advisors, who weren't willing to be really creative like Mr. Stover. In the end they had to pay extra to the IRS and to those milquetoast tax people who color inside the lines. One of these cases showed up in the Tax Court just last month. It's something to keep in mind when you see one of those "pennies on the dollar" TV ads.
Cite: Stover, Case No. 08-6018-CV-SJ-ODS, CA-8, 8/16/2011
Related:
Kansas City attorney gets unwanted review of his tax work
FOOL'S GOLD AND CHICKEN SHELTER
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You can't squeeze $1.3 million into a $2,000 Roth IRA contribution. Not even in Kansas City.
July 07, 2011
A tax plan hatched by a Kansas City-area tax advisor met disaster in Tax Court this week. The plan was the braincraft of A. Blair Stover, a former Grant Thornton tax practitioner. Mr. Stover has since come under unpleasant government scrutiny for overly-imaginative tax planning.
If everything worked out, it would have moved about $1.3 million from a traditional IRA, where it would have been taxable when withdrawn, to a permanently tax-free Roth IRA.
The plan was simple, yet absurd. When the smoke cleared, it worked like this: the taxpayer set up a new Roth IRA with a $2,000 contribution. He then had the Roth IRA and his existing traditional IRA set up new corporations. The Roth IRA-owned corporation got the $2,000 Roth contribution, while the Traditional IRA corporation got the $1.3 million in Traditional IRA assets. The Traditional IRA corporation then merged into the Roth IRA corporation. Suddenly the Roth IRA magically owned $1.3 million in assets, rather than $2,000. What could go wrong?
Mr. Paschall, the taxpayer, paid accounting firm Grant Thornton $120,000 to set up this transaction. GT's Mr. Stover took care of the paperwork details. The taxpayer probably took comfort in this from the GT engagement letter:
The engagement letter contemplated a fee of $120,000 and contained a clause providing that Grant Thornton would represent and defend Mr. Paschall or any related entity at no additional cost in case of audit by the Internal Revenue Service (IRS). The engagement letter also contained an indemnity clause providing that Grant Thornton would reimburse and indemnify the Paschalls and any related entity for any civil negligence or fraud penalty assessed against them by Federal or State authorities.
Unfortunately for the taxpayer, Mr. Stover's tax planning came under IRS scrutiny. The Tax Court explains:
In either 2003 or 2004 Mr. Paschall received a letter stating that Grant Thornton was turning over the names of people who had engaged in Roth restructures to the IRS. Mr. Stover at this time advised Mr. Paschall that the Roth restructure was legal but that he "might want to disclose on [his] income tax returns the structure". Mr. Paschall thereafter attached to Telesis' and his personal tax returns Forms 8886, Reportable Transaction Disclosure Statement.
When the taxpayer set up his Roth IRA, the annual limit for contribuitons was $2,000. The tax law applies a 6% annual penalty for excess contributions until the excess contribution and earnings are eliminated. The IRS said the $1.3 million moved into the Roth IRA was an excess contribution; over five years, that added up to $425,513 in taxes, plus another $105,000 or so in penalties.
The taxpayer naturally objected. The taxpayer first argued that the statute of limitations had expired on the tax, because he had filed timely 1040s more than three years before the assessment. The court ruled that the three-year statute never started running because he had never filed Form 5329, the form for reporting excess IRA contributions.
As for the substance of the transaction, the Tax Court said:
The substance of what happened in the instant case is that approximately $1.3 million began the year in Mr. Paschall's traditional IRA and was transferred to his Roth IRA by the end of the year with no taxes being paid. Mr. Paschall did not attempt to provide a nontax business, financial, or investment purpose for what he did, and this Court cannot ascertain one. Instead, Mr. Paschall, incited by and at the urging of Mr. Stover, used corporate formations, transfers, and mergers in an attempt to avoid taxes and disguise excess contributions to his Roth IRA.
In upholding penalties against the taxpayer, Judge Wherry said the taxpayer should have known better:
Mr. Paschall should have realized that the deal was too good to be true. See LaVerne v. Commissioner, supra at 652-653. Mr. Paschall is a highly educated and successful businessman. He explained to this Court that because he grew up in the Depression, he was conservative with his investments and worried "about having enough money" to last through retirement. Yet he paid $120,000 for a transaction that he "did not fully understand".Mr. Paschall had doubts, repeatedly asking whether the Roth restructure was legal. Despite these doubts, he never asked for an opinion letter or sought the advice of an independent adviser, including Mr. Jaeger, who was preparing his tax returns at the time he met Mr. Stover. This was even after he received a letter warning him that there might be problems with the Roth restructure and that his name was being turned over to the IRS.
The cost of this do-it-yourself Roth IRA conversion was a lot more than it would have been to wait until 2010 to do a legal taxable conversion of his traditional IRA. It would be interesting to know how Grant Thrornton's indemnification will hold up.
The Moral? Just the obvious:
- If it sounds too good to be true, it probably is.
- If somebody wants to sell you a tax plan, run it by a tax advisor who isn't getting a cut of the deal.
Cite: Paschall, 137 T.C. No 2.
Same result: Swanson, T.C. Memo 2011-156
Related:
Kansas City attorney gets unwanted review of his tax work
Fool's gold and chicken shelter
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Tax shelter maven Daugerdas found guilty
May 25, 2011
The government has bagged perhaps its biggest conviction so far of a tax shelter figure with the guilty verdict yesterday of Paul Daugerdas and three others. Bloomberg.com reports:
Daugerdas, the former head of Jenkins & Gilchrist’s Chicago office, was convicted on more than 20 counts, including conspiracy, multiple counts of tax evasion and attempting to impede the Internal Revenue Service. U.S. District Judge William Pauley allowed the defendants to remain free pending their sentencing on Oct. 14.
Daugerdas was said to have earned $90 million in fees for his efforts in inventing and marketing tax shelters like the "HOMER" shelter and similar basis-shifting devices.
Jack Townsend, an attorney who does tax criminal defense work, has some thoughts on the jury instructions. The TaxProf has a roundup.
Related: Is backdating the fatal flaw for Daugerdas?
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Biggest shelter fish trial near finish
May 11, 2011
The Wall Street Journal Law Blog has an update on the criminal trial of Paul Daugerdas. Mr. Daugerdas is probably the most prominent figure targeted by federal prosecutors in the aftermath of the mass-marketing of tax shelters in the late 1990s and early part of this century. He is said to have made $95 million in fees as the brains behind now-discredited basis-shifting shelters with names like CARDS and Son of Boss.
Jack Townsend has a technical analysis of the case up today.
I have just today read the transcript for the instruction conference on 5/5/11 in the Daugerdas criminal case. Daugerdas involved the same basic pattern as the Larson and Coplan cases (previously discussed here and here). That pattern is the prosecution of the enablers but not the taxpayers (or taxpayer advisors), with even a concession that for purposes of the submission to the jury the taxpayers are not guilty of the crime of evasion. In these cases, the prosecutors trot out several redundant or just not applicable theories of liability as if they were different than criminal liability for the underlying criminal offense of tax evasion. They are not.
The TaxProf has more.
Prior Tax Update Coverage:
Tax shelter maven Daugerdas indicted
Is backdating the fatal flaw for Daugerdas?
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Tax Shelter figures get 50-month sentence
January 31, 2011
Two prominent figures in the high-end marketed tax shelters of the 1990s and early part of the last decade were sentenced for tax crimes last week. From the Department of Justice Press Release:
Quellos founder and former CEO JEFFREY I. GREENSTEIN, 48, of Mercer Island, Washington, and former Quellos tax attorney CHARLES H. WILK, 52, of Seattle, pleaded guilty in September 2010. Today both men paid the IRS $7 Million in penalties related to their personal gain realized from the design, promotion and implementation of the fraudulent tax shelter, which they called POINT. The estimated tax loss from the scheme is $240 million. Those losses have since been repaid by the taxpayers.
Most of the big tax shelters at least involved real transactions, even if they were rigged to create tax losses without economic substance. Not so here, according to the press release:
Greenstein and Wilk did not tell clients, or the attorneys who evaluated the proposals, that the POINT transaction was predicated on a sham. They knew but did not disclose that there was no offshore investment fund, and that no shares of stock were actually purchased and possessed by any offshore investment fund. They knew that the purported offshore investment fund was merely a shell entity with nominee administrators and no assets or employees.
Other than that, it was a great shelter. Jack Townsend has more, including observations of the way tax shelter promoter sentences seem to vary inexplicably.
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Tax Court: the salesman's pitch isn't going to get you out of tax shelter penalties
January 11, 2011
The Tax Court yesterday ruled that a taxpayer who invested in a bad tax shelter couldn't rely on the opinion of his lawyer -- who got a fee for selling the deal -- to avoid penalties. Judge Holmes explains how the advice of attorney Garza and accountants Turner and Stone fell short (my emphasis):
We find that both these advisers not only participated in structuring the transaction, but arranged the entire deal. Garza set up the LLCs, provided a copy of the opinion letter, and coordinated the deal from start to finish. And both Garza and Turner & Stone profited from selling the transaction to numerous clients. Garza charged a flat fee for implementing it and wouldn't have been compensated at all if Palmlund decided not to go through with it. He wasn't being paid to evaluate the deal or tweak a real business deal to increase its tax advantages; he was being paid to make it happen. And Turner & Stone charged $8,000 for preparing Palmlund's tax returns -- $6,500 more than usual. The extra fees were not attributable to an extraordinarily complex return -- Palmlund's returns were always complex due to his various business interests -- but, we find, were the firm's cut for helping to make the deal happen. Because Palmlund's advisers structured the transaction and profited from its implementation, they are promoters. Palmlund therefore could not rely on their advice in good faith.
The moral? If the drug dealer tells you it's legal, you'll still get in trouble for smoking dope, and if the promoter tells you the tax shelter is legit, that doesn't help if the judge finds otherwise.
Cite: 106 Ltd., 136 T.C. No. 3
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The Deutsche Bank Deal
December 23, 2010
Deutche Bank has settled potential charges arising out of its role in the mass marketed tax shelters of the late 1990s and early part of the last decade. The German Bank enabled many of the shelters that brought national accounting and law firms to grief. Jack Townsend explains the deal:
1. DB admits criminal wrongdoing.]2. A payment of $553,633,153, representing DB's total fees from its participation in tax shelter activity, the tax and interest the IRS was unable to collect from the taxpayers entering those shelters, and a civil penalty of over $149 million.
3. DB provided a detailed Statement of facts admitting its tax shelter shenanigans.
4. DB must implement and maintain an effective compliance and ethics program. Incident to this commitment, DB must install a government-appointed independent expert to oversee the program. The independent expert is Bart Schwartz of Guidepost Solutions.
5. The shelters involved, with the ubiquitous, sometimes tongue in cheek, acronyms included:
a. BLIPS (involving KPMG)
b. FLIP/OPIS (involving KPMG)
c. Short Option Strategies (SOS) (involving Jenkens & Gilchrist (Daugerdas et al), KPMG,. E&Y and others.
d. PICO and POPS (involving "various accounting firms and other entities)
In hindsight, it's amazing that people thought this stuff would work, but it was hard for those of us who weren't selling "product" to convince clients that the big boys were selling snake oil.
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Convictions of two KPMG defendants affirmed
August 30, 2010
A federal appeals court upheld convictions of two of the defendants convicted in the KPMG tax shelter trial after charges against most of the defendants were thrown out. Jack Townsend, a defense attorney in criminal tax cases, thinks the circuit court shouldn't have been so glib.
More from the TaxProf.
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Murphy Farms hit with 40% penalty for tax shelter on their sale to Smithfield
August 18, 2010
When big hog farm operator Murphy Farms was acquired by even-bigger Smithfield Foods in 1999, the Murphy family faced a big capital gain tax. Like many taxpayers at the time, the family tried to avoid the tax through a generic tax shelter offered by one of the national accounting firms. They ended up using a "COBRA" transaction sold by Ernst & Young -- a version of the "Son-of-Boss" shelter. The Court of Federal Claims explains (footnotes omitted):
COBRA involved foreign currency options. The strategy called for at least two individuals to each simultaneously sell a short option and purchase a long option at a different strike price. The individuals then transfer the option contracts along with cash to a newly formed general partnership, receiving in return an interest in the partnership. So long as the options expired out of the money, the partnership recognizes a loss. The individuals then transfer the entire partnership interest to a newly formed S corporation, which causes the partnership to be terminated. The partnership liquidates and distributes its investments to the S corporation. The S corporation sells its assets to an unrelated third party, generating a loss for tax purposes.
Because there are offsetting long and short positions, the taxpayer is protected against a real economic loss. The IRS issued a notice attacking these basis-shifting tax shelters, and E&Y stopped marketing the shelters. The family chose to go ahead with the shelter anyway, and the accountants agreed to set it up after the Murphys singed an agreement to hold them harmless from any penalties. According to the court, E&Y earned $2.5 million for their efforts to shelter a $100 million gain.
Flickr image courtesy Laertes under Creative Commons license.
The IRS disallowed the Murphy losses, and, perhaps as a result of universal failure of taxpayers to prevail on these deals in court, the Murphy family conceded to the IRS adjustments. They weren't too crazy about the 40% gross valuation misstatement penalty. They appealed it to the Federal Claims Court, citing reliance on their internal tax guru and Ernst and Young.
Not surprisingly, the court didn't allow the family to rely on their in-house advisor for "independent" advice. As to Ernst and Young:
In the circumstances presented here, reliance on E&Y's advice was not reasonable. As the Federal Circuit stated in Stobie Creek: "Reliance is not reasonable, for example, if the adviser has an inherent conflict of interest about which the taxpayer knew or should have known." 608 F.3d at 1381. The Murphys could not reasonably have expected to receive independent advice from the same firm that was selling them COBRA. Because E&Y had a financial interest in having the Murphys participate in COBRA, the firm had an inherent conflict of interest in advising on the legitimacy of that transaction.That conflict of interest was exacerbated by the fee structure. The Murphys have conceded that from the beginning they understood that E&Y's fee would be a percentage of their desired tax loss.
Assuming the $100 million Murphy capital gain was taxed at 20%, the penalty is $8 million, on top of the $20 million in tax and the $2.5 million shelter fee.
The Moral? If you want to rely on ouside advice to avoid potential penalties, make sure the advisor isn't on your payroll and doesn't get paid based on the amount of your tax savings.
Cite: Murfam Farms LLC, Ct. Claims Nos. 06-245T, 06-246T, 06-247T
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Son-of-Boss taxpayers: no straws left to grasp?
July 28, 2010
The only court decision upholding a "Son-of-Boss" tax shelter has been reversed on appeal. Things look bleak for the basis-shifting shelters of the 1990s tax shelter frenzy. Linda Beale has more.
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You can't avoid penalties by relying on weasels
May 21, 2010
Many investors in exploded tax shelters of the late 1990s and early 2000s have found themselves subject not only to back taxes, but also to stiff penalties for taking unreasonable tax return positions. Jack Townsend, a criminal defense tax attorney, gives some insight as to why by reporting on a judge's opinion that rips two big law firms:
There were two principal law firms involved in issuing the Egan opinions that would, the parties hoped, give the taxpayers risk-free access to the audit lottery for which they charged large premium fees (sort of like the driver of the get away car for a bank robbery charging a lot more than a tax driver would charge).
The judge on the opinion letters:
The authors of the opinion letters knew that it was not likely that the Fidelity High Tech or Fidelity International transaction would survive a legal challenge in which all the underlying facts were made known...The purpose of the opinion letters was not to provide legal guidance, but to provide a potential defense against the imposition of penalties, and thus to induce the taxpayer/Investor to enter into the transaction.
It's long, but worth reading in full.
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Tell us how you really feel
May 20, 2010
Jack Townsend, a criminal defense tax attorney, seems to think the taxpayer fared poorly in a recent Son-of-Boss tax shelter case:
Judge Finds Ambassador's Tax Shelter Transactions Bull**** (Actually Worse Than That)
He summarized this nicely:
The taxpayers involved (when the drill down on the partnerships is made) were Richard and Maureen Egan. Richard Egan was former Ambassador to Ireland. He and his wife made too much money. He and his wife did not like to pay tax. They entered phony transactions to shelter large gains. They did not pay the tax. They tried to hide their activity from the IRS. They were caught. His estate and his wife will have to pay the tax, interest on the tax, apparently the accuracy related penalties, and interest on the accuracy related penalties.
But the litigation goes on in hopes that sooner or later one of the appeals courts will accept these deals.
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Jade still broken
March 24, 2010
The first big IRS "Son of Boss" tax shelter victory was upheld yesterday by the Federal Circuit Court of Appeals, reports the TaxProf. The Court abated the penalties on procedural grounds, but upheld the Court of Federal Claims decision that the shelter lacked economic substance.
We wrote of the initial decision:
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.
This shelter was sold by the BDO "Wolf Pack," a tax-shelter marketing arm that has since come to grief.
Cite: Jade Trading, LLC, CA-FC 2008-5045
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Wells-Fargo SILO shelters 'worse than KPMG?'
January 12, 2010
Jack Townsend on the Wells Fargo SILO deals shot down in the Court of Federal Claims last week:
I don't think that these transactions are materially different than the transactions involved in the KPMG prosecutions; indeed at some level they may be worse. As I have said, criminal tax cases are all about the lie. And, there appears to have been lies in these transactions.
And that's the nicest thing he has to say about the deals.
Prior Tax Update Coverage: Bureaucrat vs. Bureaucrat
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Bureaucrat vs. Bureaucrat
January 09, 2010
One federal agency encourages local agencies to participate in flaky tax shelters, to the chagrin of the federal tax agency:
The SILO transactions here are offensive to the Court on many levels. A cadre of company executives, in concert with teams of well known legal and accounting firms and other consultants, regularly constructed and participated in these tax schemes for Wells Fargo, apparently blind to professional standards of care. Representatives from the Federal Transit Administration (“FTA”) encouraged transit agencies to participate in SILO transactions as a way to raise additional funds, without seriously considering the probable adverse tax treatment of the transactions.
It works out badly for Wells-Fargo; the Claims Court ruled against 26 of their SILO tax shelters. Via the TaxProf.
Cite: Wells Fargo & Co., Fed. Cl. No. 06-628T.
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Tax Court finds Thighmaster's tax shelter flabby
December 16, 2009
Suzanne Somers parleyed a long sitcom run into an infomercial empire with the Thighmaster. But firm thighs only get you so far in Tax Court.
Ms. Somers and her husband got involved in a Son-of-Boss basis-shifting tax shelter to reduce taxes on their Thighmaster earnings. The shelter involved offsetting currency positions and a partnership, generating a tax loss of over $5 million (see the "read more" part of this entry for an IRS description of the mechanics of these shelters). The Tax Court said that the shelter didn't work:
Petitioner has not introduced credible evidence to establish that Palm Canyon had a legitimate nontax business purpose for entering into the MLD transaction, and the transaction did not have a reasonable prospect of achieving a pretax profit. A review of the MLD transaction reveals a prearranged set of transactions that were not imbued with any meaningful economic substance independent of tax benefits.
Not only did Ms. Somers lose the case, she and her husband also were hit with 40-percent valuation misstatement and 20-percent negligence penalties.
The Moral: don't trust shortcuts to either fitness or tax savings.
Cite: Palm Canyon X Investments LLC, T.C. Memo. 2009-288
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Was the "Midco" shelter a tax crime?
November 16, 2009
Last week an appeals court struck down a "midco" tax shelter for lacking economic substance. Tax criminal defense lawyer Jack Townsend asks whether it might have been not just a blunder, but a crime.
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Midco a no-go
November 12, 2009
When a C corporation is up for sale, the tax law pits the interests of the buyer against the seller. The buyer wants to buy assets to get a fresh new basis for depreciation, maximizing future deductions. The seller doesn't like that so much because much of the income from asset sales is often ordinary, and because the seller pays tax both on the asset sale and on the subsequent distribution of the proceeds from the corporation.
During the tax shelter frenzy of the late 90's, big-firm tax scientists tried to square the circle on stock sales with the "Midco" shelter. It was a simple structure as these things go. A tax-indifferent entity -- maybe an offshore shell company -- would buy the target company stock, and then turn around and sell the assets to the real buyer. If it works, the seller gets the benefits of a stock sale and the buyer gets the benefits of an asset sale.
A District Court last year said it doesn't work. Now the Fifth Circuit agrees with the Tax Court, reports the TaxProf.
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 appeals court said the IRS could ignore K-Pipe:
Accordingly, the uncontroverted facts support the district court’s determination that the IRS was entitled to disregard the form of the transaction and treat it as a direct sale of stock. Given that the transaction was designed solely for the purpose of avoiding taxes, and Midcoast has offered no adequate non-tax reasons for using a conduit entity, the district court did not err in finding the IRS appropriately disregarded the form of the transaction.
So far there doesn't seem to be a single mass-marketed big firm shelter that actually worked reliably when challenged.
Cite: Enbridge Energy Co. v. United States, No. 08-20261 (5th Cir. Nov. 10, 2009).
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Will Enron CFO Supreme Court case affect tax crime law?
October 14, 2009
Tax fraud isn't supposed to happen accidently, explains attorney Jack Townsend:
Since the tax law requires willfulness, defined as the intentional violation of a known legal duty, then the legal standard must be knowable so that the defendant -- any defendant, even the hypothetical reasonable defendant -- charged with the crime must be able to ascertain the legal standard in order to intend to violate the standard.
Is it fair to apply this sort of standard to fuzzy concepts like economic substance? When the tax law is obscure and uncertain, where do you draw the line between "non-deductible" and "illegal" in a tax shelter?
These questions might get addressed when the Supreme Court takes up the criminal conviction of Enron executive Jeff Skilling for failure to provide "honest service" at Enron, as Mr. Townsend discussed in his Federal Tax Crimes blog.
Update, 10/15/2009: More here.
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It's not the law, it's the lie.
September 10, 2009
This is a great short summary of the problems with the big-firm marketed tax shelters of the late '90s and early years of this decade:
The problem with these shelters, as I have noted earlier, is the lie. They, like many of the earlier shelters, had plausible – noncriminal – legal constructs; the problem was that the facts – often the economics – simply did not support the legal constructs.
A juror doesn't have to understand the Sec. 752 rules for allocating partnership debt to understand a lie. That may be the real danger for the defendants in the Jenkens and Gilchrist tax shelter prosecution.
Related: Is backdating the fatal flaw for Daugerdas?
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That's a big number
August 20, 2009
In the first test of the "Distressed asset/Debt," or "DAD," tax shelter, a U.S. District Court in Texas Tuesday disallowed $1.1 billion in tax losses claimed by #321 in the Forbes 400 list of rich folks. The TaxProf has the scoop.
Related: Notice 2008-34, Distressed ASset Trust (DAT) Transactions
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'Netting' gains and losses is an income 'omission' that extends the tax statute of limitations
August 14, 2009
While the Tax Court earlier this week said a basis understatement doesn't "omit" gross income for purposes of extending the statute of limitations for assessing taxes, "netting" gains and losses does.
The IRS normally has three years to assess underpaid taxes. If a taxpayer omits 25% or more of gross income from a tax return, the IRS gets an extra three years to assess. A tax shelter partnership set up by the now-defunct Jenkens and Gilchrist law firm used offsetting foreign exchange option contracts to create non-economic tax losses. The partnership netted the offsetting gain and loss, presumably to help keep the IRS from noticing the big offsetting transactions. The Tax Court didn't care for this:
In an attempt to disguise the purpose of the partnership and the option transactions, Highwood and the partners reported a net loss on the offsetting options rather than separately computing gain and loss for each section 988 transaction as required by section 988. Highwood and the partners netted the gain and loss from the long and short options to conceal the fact that the partners contributed both long and short options to the partnership and to conceal the fact that Highwood increased the partners' outside bases by the premiums on the long options unreduced by the premiums on the short options. Reporting the offsetting options as a net section 988 loss is misleading and is not adequate disclosure of the nature, amount, or existence of the gain from the short options to apprise respondent of the omitted gross income.
Bottom line: not separately reporting the gain portion of the offsetting positions separately "omitted" gross income, triggering the six-year statute.
Cite: Highwood Partners, 133 T.C. No. 1
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Tax Court: overstating basis doesn't extend three-year tax collection statute of limitations
August 12, 2009
The three-year statute of limitations for assessing taxes is what lets preparers get a good nights sleep, knowing that sins committed before we really understood that one code section early in our careers are forgiven That's why the prospect of an extended statute of limitation gets our attention.
The tax law provides a six-year statute of limitation when "gross income" is understated by 25% or more. An S corporation owner used what appears to be a basis-shifting tax shelter to generate basis to reduce gain on a sale of corporate stock. The Tax Court yesterday ruled that because the taxpayer reported the gross sales price correctly, there was no underreported amount, and the taxpayer is protected by the three-year statute of limitations.
This could be a big deal for taxpayers who used Son-of-Boss type basis-shifting shelters for which the three-year statute has run.
There is no statute of limitation for assessing tax when fraud is involved.
Russ Fox has more.
Cite: Beard, T.C. Memo. 2009-184
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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 outlining planned events that in real life were never meant to happen.
Interestingly, the U.S. District Court declined to assess penalties on the taxpayers, saying they reasonably relied on their tax advisors and the shelter opinions.
Link:
Cite: Klamath Strategic Investment Fund, LLC No 5:04-CV-278
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LILO FAILS
January 05, 2007
The IRS won another courtroom victory in the tax shelter wars yesterday. A federal judge in North Carolina ruled on summary judgement that a LILO (lease-in lease-out) tax shelter had no substance and could be disregarded.
BB&T Corporation set up a "lease" with Sodra, a Swedish paper manufacturer, where it leased Sodra's manufacturing equipment on a 36-year lease. It "borrowed" $68 million from a subsidiary of Dutch Bank ABN-AMBRO and paid $18 million of its own money. All of this money went into BB&T's ABN bank account.
$68 million then went from the ABN account to "lease" the equipment from Sodra, who then leased it right back from BB&T. Sondra had to pay the $68 million right back to ABN as part of the deal. Over the term of the "lease," Sodra's rent payments to BB&T equalled BB&T's debt payments to ABN, and the debt was non-recourse to BB&T.
The tax angle was the interest deduction purportedly generated by the $68 million "loan." The court said it didn't work:
When the intermediate payment steps are disregarded, which must be done in order to consider the substance of the loan transaction and not the form selected by the parties, it becomes clear that the loan transaction is only a circular transfer of funds in which the HBU loan is paid from the proceeds of the loan itself. There was no money lent to BB&T in a substantive sense, and the HBU loan does not reflect genuine indebtedness
No debt, no interest; no interest, no deduction.
Cite: BB&T Corp. v. United States, No. 1:04CV00941 (M.D. NC 1/4/06)
Links: TaxProf coverage
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SHEPPARD: PROSECUTION OVERREACHED ON KPMG PARTNER INDICTMENTS
August 01, 2006
Lee Sheppard has an important piece in Tax Analysts today ($link) where she finds the prosecution case in the KPMG partner indictments wanting. She concludes:
What we may have here is another Martha Stewart case if the government loses a civil case on the underlying shelter. That is, we could have charges of conspiracy to defraud the United States by means of obstruction and false statements sustained against the Stein defendants even though there was no underlying crime. Judge Kaplan should dismiss the tax evasion charges in the superseding indictment, if not the whole thing.
Ms. Sheppard isn't known for sympathy with shelter promoters. It's a bad sign for the prosecution if they have lost her. If you have a subscription to Tax Analysts, the piece is worth the read.
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JUDGE: KPMG PROSECUTORS ACTED UNCONSTITUTIONALLY, BUT CHARGES AREN'T DROPPED
June 27, 2006
A U.S. Judge helped out the finances of the indicted former KPMG partners by opening the door for the international accounting firm to pay the parters' legal fees -- and then vigorously motioning the firm through that door. The judge declined to drop the charges, however. The Wall Street Journal reports ($link):
A federal judge in Manhattan found that government prosecutors violated the constitutional rights of 16 former KPMG LLP executives facing criminal charges for allegedly marketing fraudulent tax shelters by pressuring the firm to cut off their legal fees.
But U.S. District Judge Lewis A. Kaplan declined to dismiss the indictment against the former KPMG employees, saying they could file civil claims against the accounting firm to have the fees paid. He also suggested that KPMG could agree to advance the fees, and said the government could use its "leverage" to get the firm to pay the legal fees beyond its $400,000 cap.
In case somebody didn't get the hint:
Judge Kaplan left open the possibility the court could take further action if the fee issue isn't resolved. "The court declines to consider additional relief at this time, although it may do so in the future if KPMG does not, for one reason or another, advance defense costs," he wrote
The fees for the defense have to be enormous, so this must be a great relief to the defendants and their families. Given that long prison sentences are still a possiblity if the charges ultimately stick, the defendants can be excused if they aren't too happy just yet. Of course, being able to pay your lawyers can't hurt them on that score.
The TaxProf has a roundup.
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IRS WINS 'SON OF BOSS' TAX COURT SUMMARY JUDGMENT
April 22, 2006
Defenders of the tax-shelter practices of the 1990s like to say that "the courts haven't found them illegal." That's a bit less true now, according to the weekened Wall Street Journal today ($ link). The paper reports that the tax court this week ruled a Son of Boss partnership out of Omaha didn't work:
Tax Court Judge David Laro, in Washington, D.C., in an opinion not yet released, granted the IRS summary judgment earlier this week in its case against now-defunct RJT Investments X LLC, which was based in Omaha, Neb. The IRS argued that RJT used scam accounting to create large losses in order to slash its federal taxes.
In 2004, the IRS settled out of court with about 1,200 businesses and collected $3.8 billion in taxes due, interest and penalties that were less than the maximum allowed by the law. At the time, the IRS warned 600 other taxpayers that had taken advantage of the shelter that if they didn't come forward and settle, the IRS would disallow all the tax benefits and assess the full 40% penalty that the law allows.
"The RJT Investments case is the first concrete manifestation of the fruits of that commitment," said IRS Commissioner Mark Everson in a statement. ""We will continue to fight these cases as long as we have to."
The "not ruled illegal" argument has always been disingenous, given that it takes years for tax shelter cases to come to trial.
As the decision hasn't yet been released, it's hard to tell how much impact the RJT case will have. According to the journal, "In the RJT case, RJT didn't challenge the IRS on the merits of the case. Instead RJT defended the case on a jurisdictional issue, which the judge rejected."
The Omaha locatiion of this shelter may mean that our Eighth Circuit will be a key player in the tax shelter wars on appeal. The WSJ cites an RJT attorney as saying an appeal is in the works.
Tax Analysts has more on its free site here.
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INDICTED EX-PARTER FLIPS IN TAX SHELTER CASE
March 27, 2006
David Rivkin, one of the 19 individuals indicted in the KPMG tax shelter case, entered a guilty plea today and agreed to cooperate with prosecutors:
Rivkin admitted that he conspired with others between January 1999 and May 2004 to prepare and execute false documents so that clients could file false tax returns.He also admitted that he took steps to conceal the existence of fraudulent tax shelters from the Internal Revenue Service and avoided registering the shelters with the IRS by claiming attorney-client privileges.
In pleading guilty to conspiracy and tax evasion, Rivkin signed an agreement to cooperate with prosecutors, who could then ask the judge to consider giving Rivkin a more lenient sentence rather than the years he might face in prison. Sentencing was set for Feb. 9, 2007.
This is the first crack in the solid front of resistance of those indicted in the case. Expect the remaining defendants to say that the guilty plea was the result of irrisistable pressure by the prosecution.
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TAX SHELTER CASE NOT JUST ABOUT TAX PLANNING
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.
Links:
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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DEUTSCHE BANK: PRETENDING TO PRETEND?
February 24, 2006
Many tax shelter transactions in the 1990s depended on a certain suspension of disbelief. Taxpayers would weave an elaborate web of deals and entities to, say, move income offshore or generate artificial losses, and then try to say with a straight face that this stuff happens all the time, and they just needed an offshore partner in the Netherlands and the Caymans to borrow money just the right way. The paper trail was carefully marked with a pretend business purpose for the real transactions. With all of the transactions actually taking place, there was at least something to argue about.
But what if the real transactions with a pretend non-tax purpose were themselves imaginary? That's the intriguing implication of a story in this morning's New York Times. The story says Deutsche Bank, which played a prominent role in the shelters that are the subject of the KPMG indictments, is negotiating a settlement of criminal charges related to the Justice Department:
For Deutsche Bank, the path toward a settlement may be rockier, in part because it had a much larger role in the creation of some questionable tax shelters and the transactions underpinning them, investigators have said. A potentially larger obstacle, say the people briefed on the case, is that Deutsche Bank appears unable to account for a number of those transactions.
In the past, Deutsche Bank has described the transactions it arranged for tax shelters, including ones known as blips and cobra, as regular and ordinary.
But Deutsche Bank has been unable to provide to federal prosecutors in Manhattan paper documents detailing some transactions for these shelters, according to the people briefed on the case.
If the transactions never actually took place, that would make it hard to say that people are just being prosecuted for savvy tax planning.
Previously undisclosed internal documents that were provided by a lawyer involved in civil litigation against the bank raise questions about some Deutsche Bank transactions.
An October 2001 e-mail message written by Andrew Baxter, a trader on Deutsche Bank's derivatives desk, to a Jenkens & Gilchrist lawyer suggests that the bank did not extend actual loans to an investor in a cobra tax shelter. For the shelter, the investor had "borrowed" $20 million from the bank and "bought" options worth $20.125 million. Mr. Baxter, whose e-mail message was titled "cash flows," wrote, "Do you want the monies to actually flow into the account or is it sufficient for the client to net pay" the $125,000. "It makes a big difference to our back office."
Wow. If that stuff is true (and these are assertions from people suing KPMG, so they aren't impartial), then the tax shelter industry doesn't even live up to my already low opinion of it.
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HVB COPS SHELTER PLEA; DEUTSCHE BANK NEXT?
February 15, 2006
Serious activity on the tax shelter front this week:
- HypoVereinsbank (HVB), a German Bank, entered a plea deal yesterday with the Justice Department that includes a $29.6 million fine and a deferred prosecution agreement for its role in implementing tax shelters with the KPMG accounting firm.
- The New York Times reports that Deutsche Bank is also under investigation for its role in the KPMG shelters.
- The IRS released to Tax Analysts a copy of the settlement and cooperation offer ($ link) reported by the New York Times yesterday. The IRS says that it will make this offer to about 100 "accounting firms, law firms, and banks that the IRS contends have been involved in criminal tax shelters," according to an unnamed IRS spokesman.
BAD NEWS FOR KPMG DEFENDANTS?
The admission of criminal wrongdoing by HVB can't be good news for the 19 former KPMG partners and employees under indictment for their role in the shelters. So far none of the indicted individuals has made a plea deal to cooperate against the others; this may increase the pressure on the defendants to strike a deal.
As Deutsche Bank had many more shelters with KPMG than did HVB, they also could have a real problem. Will they also face criminal charges, or will the government try to also turn them against the individual defendants?
As the New York Times points out, "No court has ever ruled blips or the three other tax shelters in question illegal. Still, the I.R.S. has never considered the shelters valid."
BAD NEWS FOR SHELTER BUYERS?
The offer to the other tax shelter promoters could be very bad news for shelter buyers. If they find this an offer they can't refuse, their tax shelter customers will soon get unwelcome certified letters from the IRS; if the shelter promotors cooperate with IRS, it will be very costly for their customers.
Links:
TaxProf Blog Roundup
Tax Analysts Free Coverage
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ROLLING UP THE BIG FRY TO NAIL MR. SMALL
February 14, 2006
Anybody who has watched too much T.V. knows that detectives go after the Big Fish by getting the petty criminals to cooperate. The IRS appears to be taking the opposite approach in its tax shelter investigations, according to a New York Times report:
The Internal Revenue Service is making an unusual offer of leniency to firms that made and sold questionable tax shelters: come forward, pay penalties and turn over information, and you may avoid criminal prosecution.
The offer is being made to accounting firms, law firms, banks and investment firms that have created and sold tax shelters that the I.R.S. considers bogus, as well as to firms that carried out the financial transactions that underpin such shelters. Questionable shelters have been sold to thousands of wealthy investors in recent years. Under the offer, the firms must disclose the names of those investors.
Interesting. If the pushers of flaky tax shelters turn, the IRS can then sweep up the shelter addicts.
There is a logic to this. If word gets out among tax shelter users that their dealers are ratting them out, they and their associates are going to think twice before jumping into the next tax shelter frenzy, which will surely occur sooner or latter.
If IRS doesn't offer a deal to the promoters, they may be able to run out the statute of limitations on some of their customers. With the names, the IRS can audit the returns of the shelter buyers on an assembly-line basis, probably with a high success rate.
Not everyone thinks that the offer is wise:
According to the Senate report, a 1998 memorandum written by Gregg W. Ritchie, a former KPMG partner and one of the 19 indicted, concluded that aggressive shelters were so profitable as to make the fines and penalties worth the risk.
Gary V. Mauney, a lawyer with Lewis & Roberts in Charlotte, N.C., who represents investors suing the firms that sold them tax shelters, said of the I.R.S. offer yesterday: the "I.R.S. is essentially following the logic of the Ritchie memo. Promoters are going to look at this offer and laugh all the way to the bank."
The promoters, though, may need some convincing:
It is unclear how popular the offer will be among promoters. "It is a bad deal," said one lawyer who represents an accounting firm that has been sued by investors who bought its shelters. He said that the I.R.S. wanted too much information under the offer, citing a requirement that marketing materials and other documents must be turned over, leaving a firm potentially exposed to further investigations and prosecutions.
I don't have much sympathy for this anonymous lawyer. If the shelter can't work if the IRS finds out about it, it shouldn't have been sold in the first place. If the promotors won't share details about their customers, transactions, and marketing, they aren't relying on creative interpretation of the tax law; they're merely trying to skate by on deception, smoke and mirrors.
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TAX SHELTER GRAND JURY GOING AFTER LAWYERS?
January 25, 2006
The New York Times reports today that there may be more tax shelter indictments, this time targeting a group of Chicago lawyers:
Federal prosecutors are investigating three lawyers at a prominent Dallas law firm, Jenkens & Gilchrist, in a widening of an investigation into questionable shelters that shielded billions of dollars from taxes, according to people briefed on the inquiry.
The criminal investigation of the lawyers, now being heard by a grand jury in Manhattan, is a clear sign that the government is extending the investigation of tax shelters that it considers abusive beyond the case involving the accounting firm KPMG.
There is no indication that Jenkens & Gilchrist itself is a target of the investigation. Petri Darby, a spokesman for Jenkens & Gilchrist, said yesterday, "We are cooperating fully with the investigation."
Instead, the investigation is focused on three current and former tax lawyers based in the firm's Chicago office, the heart of its tax practice. They are Paul M. Daugerdas (pronounced DOG-er-dus), Erwin Mayer and Donna M. Guerin, according to the people who have been briefed on the investigation.
It's interesting that there was never any thought of going after the law firm, while the KPMG accounting firm was forced to throw a number of its people to the wolves under threat of indictment. Are accountants held to a higher (or less low) standard?
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JUDGE PUTS FREQUENT FLIER MILES ON ICE FOR INDICTED ACCOUNTANT
November 15, 2005
A federal judge denied bail yesterday to one of the indicted ex-KPMG partners. The judge ruled David Greenberg was a flight risk and likely to tamper with witnesses.
Kaplan said on Monday that he considered nonviolent witness tampering and obstruction a danger to the community and grounds to deny bail.
The judge noted that the defendant had allegedly told a coconspirator that if he were indicted, he would take about $16 million to $20 million he had put in his ex-wife's name and take off.
Kaplan said that Greenberg's April 2004 formation of a limited liability company in the name of his former wife and his father corroborated that claim. The executive put between $11 million and $13 million into the company's accounts.
After analyzing the signatures on papers forming the company, Kaplan concluded that it was "quite unlikely" that Laura Greenberg, the ex-wife, had signed them at all.
The government has maintained that the former wife was unaware of the formation of the asset-holding company and learned of its existence by mistake through a mass mailing. The judge said the circumstances suggest Greenberg formed the company without his former wife's knowledge and kept its existence from her.
Serious business, indeed.
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INDICTED ACCOUNTANT CALLED 'FLIGHT RISK'
November 08, 2005
Prosecutors argued yesterday that a former KPMG executive might flee the country if allowed out on bail. Business Week reports:
David Greenberg amassed more than $24 million and then tried to hide it from the government by transferring money elsewhere, including to his ex-wife, prosecutor Kevin Downing said at a hearing. Greenberg, who earned $500,000 yearly from KPMG, also had real estate investments that appreciated, his attorney said.
IS THE COVERUP THE CRIME?
Some have criticized the prosecution of the former KPMG partners on the grounds that the tax shelters have not been proven illegal. Arguments in Mr. Greenberg's hearing indicate that the firm's response to the government investigation of its shelters may be a critical part of the case:
Greenberg's lawyer, John N. Nassikas III, said he assumed the prosecutor was referring to his client as a financial threat to the community. He said his client was no threat and had strong ties to California, including a pregnant fiance.
"We heavily dispute Mr. Greenberg's alleged role," Nassikas said. "There's not an effort to hide information."
But Downing insisted otherwise, saying the government had a cooperating witness and substantial documents to indicate Greenberg backdated documents and improperly took them out of KPMG offices after he learned he was being investigated in 2002.
No bail decision was reached at the hearing.
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BURN OUT, OR FADE AWAY?
October 18, 2005
Professor Maule addresses the problem of burned-out tax shelters:
But eventually the shelter "burns out." Over time, depreciation deductions diminish and then terminate, while revenue usually increases. At some point, the partnership is passing out net income rather than net deductions. Sometimes this is not a problem, because the partner may have need of passive income and if the income is passive the shelter continues to serve a tax-savings purpose. Often, though, the partner does not want the net income, has no need of passive income, and wants out. The partner's adjusted basis is low, or even zero, because of the deductions. And the capital account probably is negative.
The good professor says the "classic" advice is to die with the shelter. When death becomes an attractive planning option, you know you have a problem.
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KPMG: THE OTHER SHOE DROPS
October 17, 2005
The Department of Justice, facing criticism for its indictments in the KPMG case, has responded by upping the ante. Ten more professionals were indicted today in connection with the case, raising the number of defendants to 19. The Wall Street Journal reports:
The indictment charges the former deputy chairman of KPMG, several former heads of the firm's tax practice, a former chief financial officer of the firm and a former associate general counsel, among others. The shelters were designed so that wealthy individuals who had large income or a large capital gain could eliminate taxes on that income or gain. The shelters were designed to look like legitimate investment transactions, but were in fact intended to generate phony tax losses, with no corresponding economic losses to the taxpayers, according to the charges.
The TaxProf has more.
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GRASSLEY TO STUDY MIERS LAW FIRM TAX SHELTERS
October 13, 2005
Tax Analysts will report in tomorrow's edition that Senator Grassley will study the tax shelter opinions issued by Harriet Miers's law firm. Senator Grassley, the chief Senate taxwriter, will be part of the Miers Supreme Court confirmation process from his seat on the Senate Judiciary Committee.
From the report:
"While it doesn't appear that Harriet Miers was directly involved, Sen. Grassley wants to understand better her work as managing partner as it relates to these tax opinion letters. He also wants to understand better these tax transactions and the role of the law firm in the transactions," a spokeswoman for Grassley, chair of the Senate Finance Committee and a member of Senate Judiciary, told Tax Analysts.
The report also quotes TaxProf Paul Caron on the issue:
"She had the opportunity to have her ethical antennas tweaked here," said Paul Caron, a tax law professor at the University of Cincinnati and the operator of the popular "TaxProf Blog" Web site. "Those ethical antennas were, perhaps, not as sensitive that they should have been."
The article reports that both White House and Ms. Miers's firm, Locke Liddell & Sapp, say the nominee had no involvement in the shelter work.
No link to the story is yet available.
LINK: Complete Tax Update Miers coverage here.
UPDATE 10/14: The full story is up on the Tax Analysts subscriber site here. I'm quoted.
The UPDATE 10/14: TaxProf has made the article available here to non-subscribers.
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MORE ON MIERS AND TAX SHELTERS
October 12, 2005
Law Prof and blogger Vic Fleisher takes issue with fellow prof-blogger Stephen Bainbridge's "casual dismissal" of the tax shelter opinions written by Harriet Miers's law firm while she was co-managing partner. He says the opinions raise concerns about her judgment and and approach to statutory interpretation:
Fleisher on judgement:
Miers' alleged success as a lawyer -- co-managing partner, president of the state bar, White House counsel, etc. -- is not about her legal ability. It's about her apparent success as a manager of other lawyers. But even if we are now judging the merits of potential Supreme Court Justices based on her ability to manage rather than her ability to think and write about legal issues, Miers may fail on this sorry metric as well. Miers either was or should have been aware of her firms' involvement in the tax shelters, and she should be called on to explain her failure to act.
Fleisher on approach:
The tax shelters provide a nice window into the problem. As once explained by Taxprof Joe Bankman, there is a split among tax professionals. Some of us, mostly the tax elitists and the older generation of tax professionals, prefer to interpret statutes with purpose in mind. And we frequently look to non-literal interpretations of the Code (business purpose doctrine, step transaction, economic substance doctrine, etc.) as a necessary part of tax practice. Others, especially the younger generation and those trained by or sharing ideologies with the Scalia school of statutory interpretation, prefer the plain meaning approach. They tend to read the Code literally, and see nothing particularly wrong with tax shelters. In the two instances we have seen (the CDS shelter and the Rainbo Club property) Miers seems to have voiced no concern about a literal interpretation of the Code.
His post raises a lively debate in his comments section, including a discussion of what knowledge a firm managing partner will have about the firm's lucrative tax shelter practice.
It's not clear that the CDS shelter, the subject of Ms. Miers's firm's opinions, is a "literal" statutory interpretation; "optimistic," "creative" or "wishful" may be more appropriate. Ms. Miers is likely to face questions on these issues before she dons a Supreme Court robe.
Hat tip: the TaxProf
Link: Complete Tax Update Miers coverage.
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MORE ON MIERS FIRM TAX SHELTER
October 10, 2005
Stephen Bainbridge, the sinister-looking UCLA law professor, doesn't think the CDS tax shelter opinions written by Supreme Court nominee Harriet Miers's law firm should affect her nomination:
Personally, I think this should be a non-issue, even though it seems to be picking up some steam in the blawgosphere. As one of my tax colleagues emailed me to explain:
Although she clearly should have known about this as co-managing partner (billings of $50,000 a pop for 70 opinions is likely to get your attention), it is probably a red herring. Lots of firms were involved in these shelters, including another Dallas firm, Jenkens and Gilchrist, and they don't necessarily disqualify her as a justice as long as she didn't participate in the drafting of the opinions (which were pathetic as a legal matter by the reports of them - evidencing mediocre to bad lawyering, let alone ethics etc). Nevertheless, it is the kind of red herring issue that politicians like to jump on when they want some way to oppose a candidate or get a candidate to withdraw without stating the real objection, which might sound too elitist, too ends-oriented on a particular issue, etc. Kind of like a nanny-gate issue.
"Kind of like a nanny-gate issue." Kimba Wood might have some thoughts about whether a "nanny-gate issue" can be important.
Considering what has happened to Jenkins and Gilchrist, it's surprising that the correspondent discounts the importance of the issue.
Whether or not it should matter, it is likely to. Her role as co-managing partner of her firm is an important credential on a resume lacking any experience as a judge. These lucrative but dodgy tax shelter opinions happened on her watch, and they could tarnish her tenure as co-managing partner. If that doesn't count in her favor, there might not be enough left on her resume to get 50 Senate votes.
Prior Tax Update coverage here.
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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 Mierss 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 Lockes opinion on the transaction, including some from lawyers within E&Y. In an e-mail to E&Y, one clients 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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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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SHELTER SETTLEMENT CAUSES CONTROVERSY
September 30, 2005
A proposed settlement of lawsuits relating to the 1990s tax shelter craze was announced yesterday. The New York Times reports:
The accounting firm KPMG and a law firm have agreed to pay $195 million to as many as 280 wealthy investors who bought four types of questionable shelters, the first major step by the two firms to deal with billions of dollars in potential civil claims.
The settlement relates to tax shelters that led to recent indictments.
The settlment may be controversial, according to the Times:
At least one law firm representing tax shelter investors, Bernstein Litowitz Berger & Grossmann in New York, said yesterday that it intended to oppose the class-action civil settlement.
The firm said it did not like how the terms of settlement created four groups of class members, depending on the size and timing of their claims. Under the terms, class members can receive as little as 12 percent of their losses or as much as 130 percent. The law firm also objects to the undisclosed payments to be made to a special master who will decide which groups class members belong to.
Link: NY Times article
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TELL US HOW YOU REALLY FEEL
September 27, 2005
Some find the indictment of national accounting firm partners disqueting. Not law prof Calvin Johnson.
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IRS DEFENDS INDICTMENTS OF BIG FIRM CPAS TO SCEPTICAL ATTORNEYS
September 20, 2005
A top assistant to IRS Commissioner Everson last week defended the recent indictments of former KPMG partners to a sceptical audience of attorneys last week, according to a Tax Analysts report. Speaking to the American Bar Association Tax Practice Committee in San Francisco, John Klotsche said the indictments are not an overreach by the IRS. Per the report:
Contrary to some published reports, the governments tax fraud conspiracy case against KPMG and the resulting deferred prosecution agreement is not about the IRS and the Justice Department criminalizing the tax practice of technical tax shelters, said John Klotsche, a senior adviser to IRS Commissioner Mark Everson. Nor is it a case about criminalizing aggressive tax planning or tax advice, or about tax opinions on abusive tax shelters with which the IRS disagrees or which turn out to be wrong, he said.
Mr. Klotsche said that KPMG "crossed the Rubicon" from civil to criminal problems in its activities. An attorney at the meeting wasn't so sure:
It remains to be seen whether the Rubicon was crossed, or how many crossed it, responded moderator Larry Campagna of Chamberlain, Hrdlicka, White, Williams, & Martin in Houston. Moreover, no one should characterize the deferred prosecution agreement between KPMG and the government as a negotiated document, he said. The firm had a gun to its head and was given the choice of living with the terms, or not living at all, he said.
Practitioners will be following the case closely to see whether the evidence supports the IRS charges; the defense is likely to assert that the IRS is criminalizing normally aggressive tax practice.
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$458 MILLION KPMG SETTLEMENT APPROVED; SEVEN FORMER PARTNERS INDICTED
August 29, 2005
The KPMG settlement has been approved by a federal judge. The Justice Department then announced the indictment of seven former KPMG partners on tax charges. A KPMG former senior manager and a non-KPMG attorney were also indicted.
Tax Analysts reports the following were indicted on tax conspiracy charges:
Jeffrey Stein, former deputy chairman of KPMG, former vice chairman of KPMG in charge of tax;
John Lanning, former vice chairman of KPMG in charge of tax
Richard Smith, former vice chairman of KPMG in charge of tax, a former leader of KPMGs Washington National Tax;
Jeffrey Eischeid, former head of KPMGs innovative strategies group and its personal financial planning group;
Philip Wiesner, former partner-in-charge of KPMGs Washington National Tax office;
Mark Watson, a former KPMG tax partner in its Washington National Tax office.
Robert Pfaff.
Also indicted were John Larson, a former KPMG senior tax manager, and Raymond J. Ruble, a former tax partner in the New York office of a prominent national law firm.
LINKS:
New York Times: U.S. Indicts 8 Ex-KPMG Employees of Sales of Tax Shelters.
Transcript of Attorney General remarks at press conference on KPMG case.
Investors.com: KPMG to pay $456M to settle tax-shelter charges
UPDATE: Copy of Indictment (pdf)
And the TaxProf has a comprehensive set of links to KPMG settlement documents.
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PROFESSIONAL RESPONSIBILITY AND TAX SCHEMES
August 29, 2005
As indictements start to come down in tax shelter cases, you can expect to see tax professionals use the accountant's version of the Nuremberg defense: "I was only doing it because our national tax office said it was ok."
Two professors at the University of New Orleans (interesting place today, no doubt) look at the conduct of those involved in the scheme, and they conclude that professionals are accountable for what they sign and sell, regardless of what the national tax office says:
As Prof. Calvin Johnson stated, Circular 230 require a
one-in-three realistic possibility of success. The audit
lottery factor and dumb agent are not acceptable
defenses for tax professionals.
That essential and elementary advice went unheeded
at KPMG and other leading accounting firms. Not only
did firms not guide their clients to ethical tax positions,
they went so far as to aggressively market son-of-BOSS
tax schemes. The tax professionals who signed those
fraudulent returns should be systematically identified by
accounting firms and promptly dismissed. Further, the
Treasury should identify signers of those returns and
prohibit them from practice before the IRS.
In other words, the article says tax practitioners can't punt responsibility to higher-ups in the firm; in fact, the higher-ups have a duty to enforce proper behavior and hold all personnel accountable:
If the accounting firms are unwilling or unable to hold
those individuals who signed returns employing son-of-
BOSS tax shelters and similar schemes responsible, then
regulators should hold them accountable (for example, as
part of any settlement agreements, deferred prosecution
agreements, or by IRS enforcement action). Importantly,
the recommendation is equally applicable for lawyers
and investment bankers.
You sign it, you live with it.
Thanks to the TaxProf for pulling this article from behind the Tax Analysts subscriber firewall.
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KPMG - FROM DEFIANCE TO DEFERRED PROSECTION
August 28, 2005
Today's editions of The New York Times provides background on how KPMG went from "stonewalling" government investigators to pledging full cooperation as part of a "deferred prosection" agreement.
According to the story, KPMG felt it was falling behind other firms in the lucrative tax shelter market. Jeffrey M. Sein, a "charismatic lawyer," was brought in to turn it around. From the report:
Throughout the late 1990's, Mr. Stein held mandatory weekly conference calls with KPMG's 500 or so tax partners. A former KPMG senior manager who sat in on the calls and objected to Mr. Stein's approach said Mr. Stein would tell anyone who questioned a tax strategy that they were "either on the team or off the team."
Under Mr. Stein, Mr. Rosenthal and others, KPMG built an aggressive marketing machine to sell tax shelters it created, with names like Blips, Flip, Opis and SC2. From the late 1990's, KPMG operated a telemarketing center in Fort Wayne, Ind., that cold-called potential clients, gleaned from public lists of firms and companies.
By 2002, $1.2 billion of KPMG's $3.2 billion in revenues were generated by their tax deparment.
When the IRS and Congress began to investigate the tax shelter practices of the major accounting firms, KPMG took its own path. While the other firms settled with the government, KPMG fought back. That worked, until it didn't. Congressional investigations were the beginning of the end:
Then KPMG hit a wall. The Senate subcommittee report, brimming with internal e-mail messages and documents obtained from informants and through subpoenas, portrayed the firm's tax department as a place where questions about the legitimacy of shelters were barely considered, where the fees from such shelters were seen as outweighing the risks and where clients could be coaxed into buying them. The Senate hearing "was the beginning of the end" for KPMG, said the former senior manager.
By last year, KPMG's resistance was bearing bitter fruit. A new chief lawyer was brought in and KPMG admitted "unlawful conduct" in the tax shelter business. KPMG is expected to pay $456,000 in fines, and a number of former partners are expected to face charges that could carry 30-year prison terms, according to reports.
If nothing else, tax firms will tread gingerly in the tax-shelter business for a few years, at least. In the eternal battle between greed and fear, fear now has the upper hand.
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KPMG SETTMENT: $456,000,000 / 1600 = $285,000
August 27, 2005
The New York Times reports today that KPMG has agreed to settle tax crime charges with the Justice Department. The report says that KPMG will have to pay $456 million in fines and accept an outside overseer to avoid indictment. That works out to about $285,000 per partner for the 1,600-partner firm.
The report says the settlement is slated to be announced Monday.
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KPMG INDICTMENTS: EIGHT SCAPEGOATS?
August 25, 2005
UPDATE 8-29-05: Seven former KPMG partners and one former senior manager have been indicted. Follow this link for details.
Original 8-25-05 post:
Reuters and Bloomberg News say eight former KPMG partners are expected to face federal criminal charges relating to KPMG's tax shelter activities. From the Bloomberg report, dated yesterday:
Robert Fink said he expects his client, a former partner at KPMG whom he wouldn't identify, to be formally notified of the indictments in New York today or tomorrow. He wouldn't disclose his source of information about the charges or identify the other seven defendants. Fink said he believes the federal charges will likely include conspiracy to defraud the Internal Revenue Service, tax evasion and possibly obstruction of justice.
"My client has always believed that KPMG did legitimate tax planning that accountants throughout America were doing and that the government is distorting that into an alleged tax crime," said Fink, a partner at New York-based Kostelanetz & Fink. He said his client will plead not guilty to all charges and go to trial.
Meanwhile, the Wall Street Journal reports that former SEC Chairman Richard Breeden is the tentative pick to serve as "outside monitor" of KPMG under a still-pending "deferred prosecution" arrangement that would enabale KPMG itself to avoid indictment. From the Journal story (subscriber-only link):
Other provisions of a deferred-prosecution agreement likely would include new restrictions on the firm's tax practice and heightened government supervision, including Mr. Breeden's appointment as an outside monitor. Deferred-prosecution agreements, which have become more common, allow companies to avoid prosecution in exchange for adhering to certain conditions over time.
Interesting times for our profession.
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TAX ANALYSTS: JUSTICE DEPARTMENT TAX DIVISION OK'S KPMG PARTNER INDICTMENTS
August 24, 2005
Tax Analysts reports this morning that the Justice Department Tax Division has given the go-ahead for indictments of "most" of the 22 ex-KPMG partners who had been identified as targets. From the story:
The individual indictments, which have to be presented to the grand jury that has been investigating KPMGs shelter involvement for the past 18 months, are likely to be announced Thursday, according to lawyers familiar with the cases. But the tail wagging the dog is when the deferred prosecution agreement with the firm is ready, according to one lawyer.
The governments lead charge against the former KPMG partners is that they conspired to defraud the IRS, according to lawyers involved.
The governments chief witness is likely to be Domenick DeGiorgio, the former banker with the German bank HVB, who earlier this month pleaded guilty to wire fraud, tax evasion, and tax shelter fraud conspiracy, charges related to his involvement in promoting the tax shelter transactions known as bond linked issue premium structures, or BLIPS, which were sold to KPMG clients.
The subscriber-only version of the story hints at the likely defense:
Not only is DeGiorgio's credibility suspect at the outset because of his personal problems, but much of the information he provided that the government is relying on regarding the transaction's profit potential and the investors' income tax returns is not based on DeGiorgio's own knowledge, said one defense attorney.
Furthermore, conspiracy thrives on secrecy, argued another criminal defense lawyer. The BLIPs product at issue was approved after a very long, deliberative process among a number of lawyers and accountants at KPMG, the lawyer explained. "If the intention from the beginning had been to scam the IRS, it would never have made any sense to have all those people involved."
The indictments are tied to a deal that would enable KPMG itself to avoid prosecution. KPMG's cooperation may be the Governments trump card in prosecutions of the former partners.
We don't much care for KPMGs tax-shelter practices. Still, the prosecutions are scary to all tax practitioners. If the Justice Department goes ahead with indictments, we hope that it has evidence of criminal behavior, rather than, say, malpractice.
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WASHINGTON POST: KPMG MAY SETTLE CRIMINAL CHARGES THIS WEEK
August 23, 2005
The Washington Post reports today that KPMG may sign an agreement by the end of the week to avoid indictment in connection with its tax shelters. In exchange, KPMG will pay a fine of between $300 million and $500 million and operate under "independent review," according to the report.
While KPMG may dodge this bullet, some of its former partners may not be so lucky:
The deal would mark an end to months of intense negotiations among prosecutors and KPMG leaders, who took the unusual step of issuing a public statement in June that said the firm took "full responsibility for the unlawful conduct by former KPMG partners."
Several of those former partners could face criminal charges by a New York grand jury within the next few days related to their work on the shelters, which brought the firm $124 million in fees between 1997 and 2001, according to Senate investigators.
.
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BANKER PLEADS GUILTY IN SHELTER CASE
August 12, 2005
A former banker for the German bank BHV pleaded guilty yeasterday to tax charges for his role in promoting a KPMG-related tax shelter. Domienick Degiorgio was involved in selling the "BLIPS" tax shelter, which the IRS declared abusive in 2000 (Notice 2000-44).
The New York Times reported yesterday that KPMG is likely to avoid indictment for its role in promoting tax shelters. "Fragile" negotiations are leading towards an agreement that will require KPMG to pay a large fine and establish an independent monitor to keep an eye on the firm, according to the report.
While KPMG struggles to avoid indictment, two plaintiffs firms are battling in federal court over who gets to be the lead firm in a class action against KPMG. While we don't have particular concern for KPMG, watching class-action law firms at battle is sort of like watching the Yankees play the Mets: it's too bad only one team can lose.
LINK: Slide show explaining the BLIPS shelter.
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KPMG TAX SHELTER CLASS ACTION FILED
August 08, 2005
The Wall Street Journal reports today that former KPMG tax-shelter client has filed a lawsuit seeking class action status against KPMG (link only works for WSJ online subscribers).
The complaint, filed last week in a federal District Court in New York, centers on a shelter that KPMG sold under the name S-Corporation Charitable Contribution Strategy, or SC2. The Internal Revenue Service in April 2004 declared SC2 to be an abusive tax-avoidance scheme. The shelter was one of four KPMG tax shelters that were criticized by the Senate Permanent Subcommittee on Investigations in public hearings in November 2003.
From 2000 to 2001, KPMG sold SC2 to 58 closely held corporations, according to a report by the subcommittee, generating $28 million in fees for the accounting firm. The shelter was one of the firm's 10 best sellers at the time, the report said.
The SC2 shelter was designed to allocate taxable income to tax-exempt entities that would later be harvested by the tax-shelter investor tax-free - and with a charitable deduction, to boot. It's described in more detail here.
As unwelcome as this suit is to KPMG, they have more serious problems. Perhaps they are starting to regret their big push into tax shelters during the 1990s.
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WILL LAWYERS, BANKERS JOIN KPMG PARTNERS IN THE DOCK?
August 04, 2005
The New York Times reports that Attorneys with Sidley Austin Brown and Wood and bankers at Deutsche Bank may also face charges in connection with the KPMG tax shelter investigation:
But former KPMG partners are not the only potential individual defendants, the people briefed on the case said. While it is unclear whom else the government might be investigating, several financial and law firms worked with KPMG on the tax shelters; government documents show that the group included Deutsche Bank and a law firm formerly called Brown & Wood, now Sidley Austin Brown & Wood.
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REPORT: KPMG PARTNER INDICTMENTS IMMINENT
August 04, 2005
Tax Analysts reports on their free site this morning that indictments of KPMG partners are expected within days. The report also says that the Justice Department may seek life sentences for the partners on charges of conspiracy to evade taxes.
POUR ENCOURAGER LES AUTRES
Life in prison? That sort of takes the fun out of the tax shelter business. Presumably that is to encourage the rest of us in the tax world to more circumspect behavior.
Last night Bloomberg.com reported that the Bush Administration does not want to indict KPMG itself.
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REPORT SAYS ADMINISTRATION DOESN'T WANT TO INDICT KPMG
August 03, 2005
Bloomberg.com reports tonight:
Bush Administration Seeks Settlement in KPMG Case, People Say
The Bush administration has instructed federal prosecutors to seek a settlement with KPMG LLP over its sale of tax shelters to avoid criminal charges that could drive the accounting firm out of business, people familiar with the case said.The Justice Department in Washington directed David Kelley, the U.S. attorney for the Southern District of New York, to negotiate a deal, said the people, who requested anonymity. One issue is the size of the fine the Big Four firm must pay, with prosecutors demanding as much as $500 million, the people said.
Follow the link for more.
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GOOD NEWS FOR KPMG: REPORT SAYS 20 PARTNERS MAY BE INDICTED
August 03, 2005
Times are tough for an accounting firm when a report that 20 of your former partners may face federal criminal charges is actually good news. Times are tough for KPMG.
Citing "people familiar with the case," The Washington Post says as many as 20 partners, including "members of its senior managment team," have been notified that they may be indicted in connection with KPMG tax shelter promotions.
How is this good news for KPMG? If prosecutors are targeting a herd of ex-partners, it may mean they won't indict the firm itself. The Andersen firm collapsed after it was convicted of federal tax charges (since thrown out), and KPMG would likely share the same fate. From the Washington Post story:
Analysts say those moves could help persuade regulators to forgo an indictment and instead impose lesser sanctions, such as requiring the firm to pay millions of dollars in financial penalties and admitting facts that could implicate former employees. Negotiations between prosecutors and the firm continue and a resolution could be weeks away...
The final agreement could be similar to Merrill Lynch & Co.'s pact with the Justice Department over its dealings with Enron, in which the firm agreed to increased monitoring and other business changes.
From a public policy standpoint, it makes no sense to ruin one of the four remaining auditors of large public companies; if KPMG is willing to throw partners to the wolves, the firm itself is likely to avoid criminal charges.
Prior coverage here.
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DEBUNKING THE 'OPIS' SHELTER
July 27, 2005
Thanks to the TaxProf, a great Tax Analysts article on the KPMG FLIP/OPIS tax shelters is now available free to non-subscribers. The article, "Tales from the KPMG Skunk Works: the Basis-Shift or Defective-Redemption Shelter," looks under the hood of this widely-marketed shelter and finds it wanting:
KPMG seems to have lost its internal compass as what was fair game to do to our country. By February 1998, FLIP/OPIS had been subjected to scathing internal criticism at KPMG. KPMG counsel internally criticized the KPMG opinion as not handling the argument that the FLIP loss was a sham: "No further attempt has been made to quantify why IRC 165 should not apply to deny the loss. Instead, the argument is again made that because the law is uncertain, we win."97 Indeed, KPMG has no defense against the argument that the loss was a sham and yet KPMG went forward with the opinions for FLIP without disclosing its internal criticisms. In a closely related shelter, KPMG's question internally was whether it was receiving enough fees and internally its judgment was that the fees were high enough to assume what would be a huge risk.
The article includes exerpts from internal KPMG memos debating the shelter, as well as a technical explanation of how the shelter is supposed to work, but doesn't.
KPMG is now apparently under threat of indictment for its tax shelter promotions. If that happens, whatever money they made on tax shelters isn't enough.
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HOOK, LINE, SINKER
July 08, 2005
The New York Times has a piece this morning about how the Keeter family, owners of Royal Oak Charcoal, invested $188 million in KPMG-sponsored "bogus" tax shelters. They aren't happy. They are now suing KPMG.
The tax shelter the Keeters bought was named Blips, for bond linked investment premium strategy. Never valid in the eyes of the Internal Revenue Service, Blips was one of four abusive tax shelters that the Senate Permanent Subcommittee on Investigations in 2003 found that KPMG had sold to at least 350 people from 1997 to 2001, earning fees of $124 million. Those shelters cost the Treasury at least $1.4 billion in unpaid taxes, according to the subcommittee.
$188 million. That's a lot of charcoal.
One family member made a statement that is certain to be used in KPMG's defense:
Still, Steven Keeter, 46, Daren's brother, said that the huge tax bills and the litigation had not caused tensions within the family. "It hasn't really changed things between us," he said, referring to the tax shelter. "We are business people, and it was a calculated risk."
KPMG is likely to say this is evidence that the shelter is merely tax between consenting adults. You pays your $188 million, you takes your chances...
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DON'T SEAT THESE GUYS TOGETHER
June 23, 2005
Interesting juxtaposition in our visitor listing this morning:
The KPMG visitor stopped by to read "VIC FLEISHER TO KPMG: DIE." The Dept. of Justice visited "KPMG TO BE INDICTED FOR TAX SHELTER MISDEEDS?" They behaved and didn't cause a scene in our virtual shop here.
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TORT SHARKS CIRCLE WOUNDED KPMG
June 23, 2005
An article in yesterday's New York Times reports that KPMG's courtroom problems don't end even if it avoids being indicted. Their admission of "unlawful conduct" has had a calming effect on its civil litigation akin to that of throwing bloody meat into shark-infested waters:
With the admission of unlawful conduct, "the firm's willingness to help the government presumably can be used against it in civil actions," said Howard E. Abrams, a white-collar defense lawyer in Atlanta.
Indeed, lawyers for investors who bought questionable shelters from KPMG were delighted by the admission.
"It's stunning," said Gerald H. Silk, whose New York firm, Bernstein Litowitz Berger & Grossmann, is pressing a lawsuit against KPMG in a state court in Arkansas. "Obviously, it's very helpful."
The report also quotes "a former top Internal Revenue Service official" on the likely outcome of the KPMG criminal investigation:
A former top Internal Revenue Service official said he expected that prosecutors were "not trying not to bring down the firm" but wanted to impose a deferred-prosecution agreement, with "a penalty in the tens of millions of dollars," as well as a ban lasting months on accepting publicly traded companies as new clients. The former official also said that he expected the Justice Department to pursue individual partners.
The tax-shelter industry may turn out to be as profitable to the accounting professon as a methamphetamine addiction.
Hat tip: The TaxProf Blog, which has a roundup of KPMG coverage this morning.
UPDATE:: Firms Compete for Class Settlement Action in KPMG Investor Suits
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VIC FLEISHER TO KPMG: DIE.
June 22, 2005
Victor Fleisher, a UCLA Tax prof and blogger, writes in A Taxing Blog:
KPMG is getting its arm twisted over some tax shelters. Larry Ribstein thinks the government, or at least the criminal division, should back off. Christine Hurt also thinks the government is being a little harsh. I disagree.
...
One problem with both criminal indictments/staggeringly high civil penalties is that they may punish the whole firm for the misdeeds of a few. But this threat is necessary to encourage internal monitoring among law firm and accounting firm partners. Law firms will invest a lot more resources in reviewing tax opinions if their future livelihoods depend on it.
A conviction would destroy KPMG and leave only three firms in the business of auditing the largest companies. A Wall Street Journal piece yesterday (subscribers only) indicates that even with the existing four firms, it can be impossible to get an acceptable competing bid for a big company audit:
Intel Corp. is one of the many big companies now bumping up against the limitations. After using Ernst & Young LLP as its auditor for more than three decades, the semiconductor maker considered switching recently for a fresh look at its financials. But it stuck with Ernst after receiving proposals from the other Big Four firms: Deloitte & Touche LLP, KPMG and PricewaterhouseCoopers LLP. That is because federal regulations bar the three other firms from serving as Intel's independent auditor unless they give up valuation, computer-software and other work they do for Intel
While certainly KPMG partners should go to jail for crimes that KPMG seems to admit took place, and KPMG should be sanctioned, it's hard to see where anybody benefits from destroying the firm.
UPDATE: Today the Wall Street Journal reports:
Securities and Exchange Commission officials are privately discussing steps to take in the event of a collapse of one of the Big Four accounting firms, including temporarily relaxing some rules they put in place two years ago to try to improve the quality of audits.
It would be morbidly funny if the effort to punish KPMG for tax crimes led to weaker audits.
Prior Coverage:
KPMG TO BE INDICTED FOR TAX SHELTER MISDEEDS?
WE LEAD, WALL STREET JOURNAL FOLLOWS
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WE LEAD, WALL STREET JOURNAL FOLLOWS
June 20, 2005
Last week we posted pieces on the unwisdom of the potential indictment of KPMG and on the conviction of the Tyco looters. Today the first two editorials in the print edition of the Wall Street Journal:
But unlike the Wall Street Journal pieces, ours are available without a subscription! You're welcome.
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KPMG TO BE INDICTED FOR TAX SHELTER MISDEEDS?
June 16, 2005
The Wall Street Journal reports this morning that U.S. prosecutors are debating whether to indict the world's fourth largest CPA firm. The article says that KPMG's tax shelter promotions have put it in peril of following the Andersen path to oblivion:
Federal prosecutors and KPMG's lawyers are now locked in high-wire negotiations that could decide the fate of the firm, according to lawyers briefed on the case. Under unwritten Justice Department policy, companies facing possible criminal charges often are permitted to plead their case to higher-ups in the department. These officials are expected to take into account the strength of evidence in the case -- the culmination of a long-running investigation -- and any mitigating factors, as well as broader policy issues posed by the possible loss of the firm.
These "policy issues" are the existence of only four firms now in the business of auditing the largest enterprises. When Andersen was convicted of securities violations - charges recently thrown out by the Supreme Court - it lost its state licences and was forced out of business.
KPMG issued a statement that doesn't exactly proclaim innocence:
KPMG issued a statement early Thursday in which the firm said it "takes full responsibility for the unlawful conduct by former KPMG partners" during the period under investigation by the Justice Department. KPMG said it has taken actions "to ensure that this type of conduct does not occur again," including "firm-wide structural, cultural and governance reforms." The statement said KPMG employees "no longer provide the services in question."
We have no affection for KPMG, but it is mind-boggling that the government would even consider indicting another national firm after the Andersen debacle. By all means they should go after lawbreaking partners, but it's hard to see any point in killing one of the four big auditing firms -- especially seeing how they are all swamped now with the additional audit work triggered by Sarbanes-Oxley.
Link to WSJ Article: KPMG Faces Indictment Risk On Tax Shelters
(probably only works for WSJ online subscribers).
Link: KPMG statement
Link: NY Times Article "KPMG Says Tax Shelters Involved Wrongdoing"
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