ataxingmatter

KPMG tax shelter loses again in court

One of the  "son of BOSS" tax shelters popular at the turn of the century and marketed by KPMG-- involving foreign currency straddles and tiered partnerships used to create a loss that could purportedly be shifted to the taxpayer purchasing the partnership interest to offset preexisting capital gains--bit the dust in Mississippi district court.  The case is Nevada Partners Fund, CIVIL ACTION NO. 3:06cv379-HTW-MTP, available on BNA, here.

The taxpayers must have hoped a trial judge would be more sympathetic on this 2001 partnership shelter than a jury, since the case was decided without one.  The IRS in these cases argued the partnership anti-abuse rule set out in Reg. 1.701-2, which indicates that the complex partnership regulations are to be applied in a manner "consistent with the intent of subchapter K" (subchapter K, of course, being the tax code provisions applicable especially to partnerships).  If a transaction is undertaken with a principal purpose of reducing the present value of tax, then it may be recast and the tax determinations based on the recast transaction.  James Williams had an $18 million capital gain, and KPMG suggested he use a marketed tax shelter  by which phantom losses would purportedly shelter the gain from tax.  A hedge fund named Bricolage developed the "Family Options Customize (FOCus) shelter and sold the LLC interests to Williams that were needed to implement the deal.

The marketing strategy was standard.  The judge here footnotes the Chew v. KPMG case, in which Judge Barbour noted that

KPMG marketed these forms of tax strategies to its long-term wealthy clients. The strategy involved using the services of an investment advisor [who] provided the design and rhetoric to recast the tax strategies as investment strategies. A global bank then would provide financing and nominal investment transactions that provided the investment “cover” to disguise the tax driven motives. A law firm would provide the purportedly “independent” opinion letters blessing the proposed strategy and supposedly insulating the clients from IRS penalties in the event of an audit.

Like the similar BDO-Seidman COBRA ("currency options bring reward alternatives") or the BLIPs and OPIS deals, the FOCus deal involved a carefully calculated series of purchases and sales taking place over a short time period, designed to allow the shelter buyer to take into account losses not suffered economically by the taxpayer.  But the marketing discussions advised that after the deal was done, the buyer would retain the interests in the remaining entities purchased and be able to actually engage in investment strategies.  As the judge notes, no mention was made of investment until this post-shelter phase of the transaction entities was discussed.

The judge notes that there was ample notice that these kinds of transactions dealing in noneconomic losses would not withstand scrutiny, citing Notices 99-59 and 2000-44 and, of course, the seminal case in partnership phantom loss tax shelters, ACM Partnership.  The FOCus strategy was tweaked so that KPMG hoped that it would not fall prey to the same result as the original son of Boss shelters, but the marketers all knew it might.  Yet Notice 2002-50 was released just a few months after Williams entered the deal (and before he had made a final decision on how to report the losses) and that notice dealt directly with these types of partnership shelters.  Arnold & Porter nonetheless provided an opinion letter to the taxpayer in October 2002 that the deal was "more likely than not" to receive the tax treatment stated (allowance of the loss to Williams).

The partners argued that this was an integrated investment strategy (that happened to also have a nice tax kicker) that should not be broken apart into a tax strategy and an investment strategy.  Williams made about $23 million through investments, with the advice of Bricolage, the creater of the tax shelter, between 2002 and 2007. 

The judge didn't buy it.  He noted that the tax shelter and the legitimate investments were separate deals that could have taken place without any connection between them, and that the origination of the deal lay in the tax planning.

The central point in 2001 of following the strategy being promoted by KPMG was to ameliorate Williams’ tax situation, regardless of Williams’ investment activity.

***

[Later in the opinion, the judge notes that an economic study of the investment strategy made no mention of the FOCus strategy or its tax advantages.  He concludes]  "The FOCus steps through the three-tiered partnership simply was not a factor in the investment strategy to be pursued through Bricolage."

 

Interestingly, the judge points out a communication between KPMG and the taxpayer that was revealing about the marketer's assessment of the shelter.  A draft of the engagement letter noted that this was "an aggressive strategy."  Counsel for the buyer noted that he recognized it was aggressive and okayed striking the phrase from the final letter.

Gender reassignment surgery case decided

Back in 2005 when the IRS released CCA 200603025 stating that gender reassignment surgery is not a deductible medical expense, I objected.  Gender identity disorder had been recognized by the medical profession, I argued, so why should the IRS rely on a Catholic Church authority who had fought against such surgery for its decision.  Read the post from 2006 here. 

The Tax Court ruled on the issue today, in O'Donnabhain v. Comm'r, 134 T.C. No. 4 (Feb. 2, 2010). As Caron notes on TaxProf (hat tip), the majority recognized gender identity disorder as a disease and gender reassignment surgery as treatment for a disease (though they thought breast augmentation surgery was merely cosmetic). 

Good decision,  except maybe for that bit about breast augmentation being merely cosmetic.  If we were talking about "Hot Lips" on Mash I'd agree.  Or even about any woman who just wants bigger breasts.  But when the subject is a male with gender identity disorder who is undergoing genital and breast surgery to make himself into the female she believes herself to be, then breast augmentation is a critical part of the picture, which the medical standards quoted in the case make clear.  I couldn't read the court's discussion of this topic without thinking--but, if you had undergone that surgery, wouldn't it be pretty important to have really good breasts?  The court essentially said there wasn't enough substantiation that the breast surgery was because of the gender identity disorder.   One of the examining physicians who concluded that the petitioners was a "good candidate" for the surgery also noted that she already appeared to have developed decent breasts (B cup) under hormone therapy.  Yet the surgery is described as "designed to make petitioner's breasts, which had experienced some development as a result of feminizing hormones, more closely resemble the breasts of a genetic female."   An expert testified how important it is for persons with this disorder to "pass' convincingly in public as female."    That does not sound like elective, purely cosmetic surgery to me, but something that is a singificant part of the change in the gender appearance of the individual-- something that "prevents or treats illness or disease"--i.e., a medically deductible expense.  The court concluded that the petitioner hadn't shown that the breast surgery "treated" the gender disorder.  It seems there was some lack of substantiation, since the recommending physician had not specifically discussed presurgical breast condition.  But I suspect the court is giving more weight to an examining physician's statement of "significant breast development" than it should--that could merely mean "compared to a man without hormone treatment" but nowhere near normal female breasts.  In fact, the physician that had noted presurgical "nice shape" also testified that he meant--compared to other males on hormones and not compared to ordinary female breasts.  That didn't sway the court that there was enough substantiation to support that breast surgery was because of the gender disorder. 

By the way, reading this from the context of a "battle of the experts" is interesting.  One government "expert", Dr. Schmidt, was one who has not had a very important role in the matter since the 1980s (not a listed author on articles, not an author of a chapter in a medical reference text on the subject, but had "participated in evaluation" of about 12 gender disorder patients a year).  He tried to have it both ways--unconvinced about the validity of the gender identity disorder diagnosis at this trial, yet testying regularly in other trials (recently) about the diagnosis and admitting that it is taught at medical schools and is something doctors are required to learn about.  The summary of his testimony reads like what one would expect a creationist to say on a stand to defend the teaching of creationism--hedging and more hedging around the fundamental admission of the disorder, the medical consensus around it, and the real basis for it.  The other government expert was a forensic psychiatrist--odd choice.  He claimed that gender identity disorder is a mental disorder but not a disease because it isn't clear that it arises from a pathological process within the body (in spite of the fact that others have suggested at least three different conditions for disease--either discomfort, or dysfunction or pathology).  So bulimia, to Dr. Dietz, is not a disease, and obsessive-compulsive disorder wouldn't have been one til it was discovered that it has a pathological cause about 20 years ago.  The tax court concluded that the government's position against treating gender identity disorder as a disease was "meritless", with no authority whatsoever other than the one expert's interpretation,  which "is flatly contradicted by nearly a half century of caselaw."  Id. at 37.  Further Dr. Schmidt's claims that the disorder is subject to some debate was found unconvincing, since the court was persuaded by "the widespread recognition of the condition in medical literature" showing that recognition of the disorder "is the prevailing view."   Even these government witnesses undermined the government's claim that the disorder was merely a "social construction" since they agreed that it is a serious condition "sometimes associated with autocastration, autopenectomy and suicide."  Id. at 43.

SILO transactions: Wells Fargo Loses

Wells Fargo engaged in a number of SILO (sale-out, lease-in) transactions--26 in all  that figured into a substantial refund claim in 2002.  In a Jan. 8 opinion, the Court of Federal Claims held that the transactions lacked economic substance, scuttling the company's claimed deductions. See  Larson, Wells Fargo Loses $115 Million Tax-Deduction Lawsuit, Bloomberg.com (Jan 12, 2010).  The court noted that prominent law and accounting firms Ernst & Young and King & Spalding had merely performed "window dressing ... to generate fees and lengthy documents to give the SILOs an appearance of validity."  Id.

In the late nineties and early "aughts", SILOs were the "new" tax shelter, whereby a municipality or other tax-exempt entity transferred assets such as public transit buses or telecommunications equipment or metro-rail cars to a taxable party and then leased the assets back.  The taxable party would claim ownership that allowed it a depreciation deduction on the assets, reducing its taxable income and hence resulting in significant tax savings.  The municipality didn't suffer from the loss of the depreciation deductions, since it wasn't taxable in the first place.  The municipality generally ended up with an upfront payment, essentially its fee for facilitating the tax shelter for the taxable corporation.  That fee (and similar payments to other parties who facilitated the transaction by creating documents, etc.) was generally the only money that changed hands in SILO deals--all the rest were circular flows of funds,  or mere accounting entires, under the  purported sales documents and the purported lease documents.

In Wells Fargo's case, it claimed more than $115 million in depreciation, interest, and transaction cost deductions for 2002 connected with participation in 26 SILO deals.  The parties dealt with five specific transactions at trial--four involving public transit agencies (in New Jersey, California,  Houston, and Washington)  and one involving cellular telecommunications equipment (Belgacom Mobile, S.A.).  The court ruled that Wells Fargo did not have ownership of the property under the SILO transactions and that they lacked economic substance, since their only goal was to lower the company's tax liabilities.

This case comes after the American Jobs Creation Act of 2004 limited the use of SILOs (Section 848 of the Act) and their designation as an abusive tax shelter in Notice 2005-13.  The IRS provided some transition relief from the 2004 crackdown in Notice 2007-4 (at page 260) (extending the transition relief of earlier notices 2006-2 and 2005-29 for one year).  The IRS also offered a settlement deal to corporate taxpayers, letting them keep 20% of the tax savings from lease-back transactions.  Two-thirds of the 45 companies targeted accepted that offer.  See Schroeder, Federal Judge Rejects Wells Fargo's Bid to Get Deduction for SILO Deals, The Bond Buyer (Jan 12, 2010).

The work of King & Spalding here--that which the court calls mere "window dressing" for a tax shelter deal--is an example of the perverse result of overemphasis among the tax bar on the tax minimization norm.  Attorneys spend time contriving to fit a transaction--one that does not originate in the business but in the desire to avoid taxes--into the "letter" of the tax law, even though they know that it is a transaction that is undertaken solely to generate tax benefits and is undertaken with lots of strings and whistles to confuse auditors or create the appearance of a genuine business transaction. 

We academics bear some blame for the widespread attitude that there's nothing wrong with super-aggressive tax advice that permits taxpayers to undertake transactions that are not germane to their businesses solely for the tax benefits claimed to accrue.  This pushes the tax minimization norm well beyond a reasonably prudent limit.  We should suggest to our students that they and their clients might consider standing far enough back from the "tax minimization" tracks that they are sure they will not be ploughed under when the audit train comes through.

Veritas Software (Symantec Sub) and Transfer Pricing

Transfer pricing adjustments under section 482 are supposed to assure that the Secretary can "distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among [organizations owned or controlled directly or indirectly by the same interests] if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect thye income of any of such organizations, trades or businesses."  That statutory provisions gives considerable discretion to the government to determine whether a company's allocation is a "clear reflection of income."  It is not supposed to permit companies to short-change the government by working out "transfer pricing" deals with subsidiaries that low-ball the figure in order to shortchange the tax revenues.

It looks like Symantec may get away with just that--"selling" a supported intangible property developed in the US for a lowball figure of a not even 200 million when the income stream (to the now-foreign owner) will be worth billions, based on the taxpayer's claim that its method of determining the worth of the product is better than the Service's income method.  See Veritas Software, 133 TC No. 14 (2009), Download Veritas Software transfer pricing case.121009 (BNA).

Folks, the primary (and often only) reason US software companies established two-tier Bermuda and Irish subsidiaries like Veritas did--i.e., Bermuda-resident subsidiaries incorporated in Ireland's low-tax jurisdiction that have  Irish-resident and incorporated subsidiaries-- was to offload income from their products to that area from the US and avoid US taxes.  If they could "sell" their software cheap, and then have a hefty royalty income stream going directly to the foreign subsidiary, they could substantially reduce US taxes.  Veritas established the subsidiaries and then assigned "exclusive and permanent rights" its existing sales agreements with European subsidiares and to various "covered intangibles" (inventions, patents, copyrights, computer programs, updates, translations, adaptations, specifications, etc.)  to the Irish subsidiary of the Bermuda-resident Irish corporation, while still agreeing by contract to provide R&D and technology support for the product to its subsidiaries and the right to use "trademarks, trade names, service marks".  This deal was done for an initial $166 million lump sum buy-in (later adjusted to $118 million) and royalties.  

The IRS thought the buy-in payment should be somewhere between $1.9 billion and $4 billion, settling on $2.5 billion in the notice of deficiency, based on the forgone profits and market capitalization methods applied by Brian Becker.  But in the court, the IRS indicated that it would no longer use Becker as a witness or rely on the market capitalization method, but rather, based on actual income figures, assert a new forgone income amount of $1.67 billion, developed by cost-sharing expert John Hatch using a discounted cashflow analysis.

The company assserted that its "comparable uncontrolled transaction method" was appropriate and that the IRS's new determination was arbitrary and capricious.  The tax court agreed, arguing that the IRS's mechanism was inappropriate because it did not refer only to preexisting intangibles in disregard of Reg. section 1.482-7(g)(2) and because it valued short-lived intangibles as though they had a perpetual useful life and because the court found Hatch's determinations "unsupported, unreliable, and thoroughly unconvincing."

This opinion illustrates yet again the problem with offering multinational corporations various "elections" about how to determine a matter relevant to their taxable income and in the variability of numbers that financial "experts" can come up with.   The opinion appears to rely very heavily on the company's description of its industry and mode of operation, resulting in a very low figure for the value of the intangible transferred.   Of course, the lack of credibility of the IRS's expert is problematic as well--the IRS needs to better prepare its cases at the early stages and the DOJ and Treasury need to work together to make sure that litigation strategies are implemented appropriately.  The Tax Court also refused to consider new regulations as relevant, when the old regulations did not explicitly cover workforce, goodwill or going concern value.

In the long run, it would be reasonable for sales of intangibles to affiliates to apply a uniform hind-sight calculation based on present valuing expected future income streams, so that the full value of an asset is taxed when it is transferred to another country.  Congress, and the Treasury, need to reconsider the value of "flexibility" in  the Code and regulations.  The Tax Court ought generally to grant greater deference to the Secretary in these transfer pricing cases--the Code makes it clear that the Secretary has authority to reallocate.

Another day, another indictment for failure to pay taxes

Maybe, just maybe, the number of high profile indictments for failure to report income and pay taxes will begin to sink in to that minority who thinks they are above the (tax) law.  At any rate, here's another one to chalk up to the "gotcha" side today. 

Tsen Toma, a resident of Queens, was indicting for tax evasion for a business that he ran in the late 1990s, Tomo Painting Construction.  Download Toma Tsen Indictment.121009.  According to the indictment, he received checks in payment for painting contracts and cashed them at check cashing businesses for his personal use.  But he never recorded the receipts--amounting to more than a million dollars over three years' returns-- on the books of his business or reported the income on his income tax return.  For example, in 1998, Tsen reported only $29,901 of taxable income, when the IRS corrected amount was $452,244, resulting in additional tax due of $168,718.

The press release Download Tsen PleaPR.121009 notes that Tsen left the US during the investigation and was arrested at Kennedy Airport when he flew back from Taiwan on Nov. 24.  He faces a maximum sentence of 5 years in prison for the tax evasion count and a fine of $250,000 or twice the gross gain from the offense.

 

Plaintiff Discovery of IRS-collected tax opinions ruled out

The IRS has litigated a number of cases in the Son-of-Boss  tax shelters involving digital options on foreign currency described as listed transactions in Notice 2000-44. See, e.g., Jade Trading, LLC, 80 Fed. Cl. 11 (2007).  IN the course of the litigation, the IRS has apparently collected a number of tax opinions relating to the shelters.  One plaintiff partnership in its own Son-of-Boss tax shelter administrative proceeding relating to one of the shelters sold by (now defunct) Jenkens & Gilchrist sought to compel  production of all such tax opinions (in redacted form) collected by the government, as well as names and addresses of law firms and accounting firms that the IRS knows has issued such opinions.  (The IRS had already provided copies of two opinion letters that Jenkens & Gilchrist had issued for one of the parties--one of them was "nearly 150 pages" long.) See 3K Investment Partners v. Comm'r, 133 T.C. No. 6 (Sept. 3, 2009).

The partnership's position was that the tax opinion letters would provide evidence of a "general consensus of national law firms across the country" that would bolster the case that these tax shelters worked to achieve the tax reduction intended.  As the court notes, this is the "everybody's doing it" defense--it is a claim that since lots of people were doing it, it must be ok that this particular partnership did it.  The court makes short shrift of the claim.  It rejected (in a footnote) "any suggestion" that the collected opinions represented a "general concensus" among tax advisers about the tax consequences of a Son-of-Boss transaction.  Further, it noted that "Petitioner must establish the reasonableness of its position on the basis of the facts and merits of its own case....The legal analysis, conclusions, and recommendations that some tax advisers may have given other taxpayers are irrelevant to the reasonableness of the positions the partnership took on its return."  IN addition, the fact that the partnership didn't know there were other letters (or what firms produced them) when it filed its return means that the partnership cannot now use those letters to establish that it was acting in good faith.

The court held the materials were neither relevant nor likely to lead to plaintiff's discovery of admissible evidence.  The materials were also return information under section 6103(b)(2) and therefore not discoverable.

Textron's SILOs and its tax accrual workpapers: First Circuit Sides with the Service

[edited to add link to case]

In a 3-2 en banc ruling in United States v. Textron, the First Circuit today reversed the earlier three-judge panel decision on the accessibility of Textron's tax accrual work papers to the government.  It held that the IRS should have access to tax accrual workpapers prepared in 2001, at the time that the aerospace conglomerate had undertaken various SILO (sale-in, lease-out) tax shelters, involving telephone networks and an overseas railway system, to lower its tax liability.  The IRS, the court noted, "serves the legitimate, and important, function of detecting and disallowing abusive tax shelters."  See, e.g., Saunders & Levitz, Court Lets IRS Access Textron Leasing Papers, Wall St. Journal (Aug. 14, 2009) (subscription required); Donmoyer, Textron Ordered by Appeals Court to Give IRS Tax Shelter Papers, Bloomberg.com (Aug. 14, 2009).

Textron had claimed (among other claims) that the papers were protected work product--i.e., prepared in anticipation of litigation.  The First Circuit adheres to a lax work product standard, first set forth by the Second Circuit in the Adlman case, that merely requires that the material be prepared "because of" litigation.  Since tax standards require an assessment of the likelihood of success on the merits, success on this claim would likely result in most any materials prepared in connection with accounting issues about tax accruals being protected.  At trial, Textron had produced testimony that its workpapers were used to determine "whether Textron was adequately reserved with respect to any potential disputes or litigations that would happen in the future.  On appeal, the First Circuit panel treated resolution of disputes even in preliminary administrative proceedings before the IRS--which are often cooperative and at best only quasi-adversarial-- as satisfying the definition of "litigation" for work product purposes and the need to estimate success to determine accrual reserves as "anticipation of litigation," rejecting the government's position that business and regulatory objectives for preparation of material per se defeats a work product claim.

The en banc court, however, recognized that the doctrine "does not protect from disclosure documents that are prepared in the ordinary course of business" rather than for litigation.  That is the right answer, and in accord with Supreme Court precedent.  Further, the court acknowledged that the IRS "serves the legitimate, and important, function of detecting and disallowing abusive tax shelters" (see Bloomberg.com)--something very important, in these days of right-wing tax-protest mobs who  apparently don't understand the centrality of taxes, and an adequately informed IRS, to their well-being.

This is an important decision and one that was correctly decided.  It is time the court's recognized the boundaries to work-product protection.  Tax accrual workpapers do not merit protection.  Textron should hand over the workpapers and determine to engage in less aggressive tax planning in the future. 

Aside:  The company was faced with another lawsuit today, as investors complain that it faked back orders to make its business look better.  Sounds like the company could use a primer in basic integrity--after all, buying telephone networks is not exactly germane to the business of the world's largest corporate jet manufacturer, is it?

Some background on the Textron challenge to the IRS workpapers summons:

The district court case, United States v. Textron INc., 507 F. Supp. 2d 138 (D.R.I. 2007) held that the tax accrual workpapers were protected.  For contemporary commentary summarizing the case, see, e.g., McDermoot, Will &  Emery, Textron Protects Tax Accrual Workpapers from IRS Summons (Sept. 4, 2007); Pawlow, Ryan & Spencer, Hands Off My Tax Accrual Workpapers: Textron, Fin 48, and Related Issues, Fall 2007 The Tax Executive Magazine 421.  For my own analysis (and a link to the district court's decision), see ataxingmatter, Textron, Inc: Tax Accrual Workpapers, Attorney-Client Privilege, and Work Product Protection (Aug. 30, 2007)

The First Circuit heard the case on appeal with two circuit judges and one district court judge.  The panel affirmed the trial court's decision on general applicability of work product doctrine to tax accrual workpapers, but remanded for consideration of waiver.  See, e.g., Greenhouse, Spencer, and Selby, Textron Decision Deems Tax Accrual Workpapers Protected Work-Product, Mondaq Business Briefing (Feb. 16, 2009).  Circuit Judge  Boudin dissented, arguing that "tax accrual work papers are not protected because they are prepared for reasons independent of the need to prepare for or conduct litigation." 

The First Circuit vacated the opinion and ordered rehearing en banc on March 25, 2009 (No. 07-2631). See, e.g., Sullivan & Cromwell, First Circuit to Reconsider Work Product Privilege for Tax accrual Workpapers (Mar. 27, 2009).

More on Jenkins & Gilchrist Shelters--attorney liable in connection with tax opinion

The Fifth Circuit upheld an attorney's liability to an investor for his opinion in connection with the investor's entering into a Jenkens & Gilchrist/ Bank One digital options tax shelter for generating artifical losses, but reversed the district court's RICO award of $6.43 milllion to the investor.  Ducote Jax Holdings LLC v. Bradley, No. 08-30037 (5th Cir. Jun 19, 2009) (unpublished decision). 

The court confirmed that the attorney, Bradley, was liable under RICO and various state law claims for negligent representation, fraud, civil conspiracy and breach of fiduciary duty.  The attorney admitted that he spent very little time on the project, though he got paid $25,000 (ultimately by the promoters).  Lesson here--don't think you can get something for nothing--i.e.,  don't give an opinion when you really don't do any work on which to base the opinion.

The complaint alleged that the investor (various Ducote enterprises) had been induced to participate in the tax strategy by documents with misleading representations, including that the IRS wouldn't assess any peanlties.  The investor claimed "extensive monetary damages consisting of unexpected tax liability, fees and commissions paid to the Bank One Enterprise, as well as interest and penalties which the [IRS] will likely seek."  Id. at 2.  Ultimately, the investor was subject to a tax assessment of $3.14 million, a penalty of $315,000, and interest of $500,000, after paying fees to Jenkens & Gilchrist and Bank One of more than $1 million.  Attorneys fees for the litigation were about $650,000.  In other words, they were out about $5 million for fees and taxes.  (But the taxes were due anyway.)

The investors had gotten about $2.85 million in a settlement with the defendants.  The district court found the attorney liable and awarded about $5 million in damages (which included the $3 million in taxes assessed against the investors), minus the settlement amount paid, yielding about $2.14 million.  That figure was then trebled under RICO. 

Bradley contested the damages, claiming he didn't cause the tax liability.  The investors countered by claiming that if they had been informed about the problems with the tax shelter they used, they "would have employed another tax management or deferral strategy and therefore would not have incurred a tax liability of over three million dollars" but never really explained how they would have been able to do so, according to the 5th Cir. opinion.  The court said the appropriate damage measure would be the difference between the amount of money the investors had to pay the IRS versus the amount they would have paid if the attorneys had advised them correctly.  Id. at 14.  Accordingly, the court subtracted the tax assessment from the damage award (prior to trebling), leaving no damages from the violation.

More on the Jenkins & Gilchrist/BDO Seidman Tax Shelters

Back in March 2007, I noted the disbanding of Jenkens & Gilchrist after the firm settled tax fraud charges that had been under investigation since 2003, with a payment of $76 million.  See Jenkens & Gilchrist: Settlement and Disbanding of Firm, Mar. 29, 2007.  These were option shelters, like the Boss and Son-of-Boss shelters still in the news.  Then in 2008, I noted the guilty plea of Douglas Steger, the head of American Financial Capital Corporation that promoted tax shelters with Jenkens & Gilcrhist's Paul Daugerdas and others.  See Banks, Law Firms, CPAs--everybody wanted the money from tax shelters, July 10, 2008.  Steger agreed to cooperate, which suggested either more guilty please or indictments would be forthcoming.    Last week, Former BDO Seidman vice chair Charles Bee pled guilty to similar charges, as did BDO former members Michael Kerekes and Adrian Dicker earlier in the year.  Today seven more lawyers, bankers and accountants were indicted in connection with these shelters.  Download Daugerdas et al Press Release, Download Daugerdas et al Indictment.

Today's indictment charges the seven individuals--three from J&G, 2 from BDO Seidman, and 2 from foreign "Bank A" with headquarters in New York--with 27 counts of tax evasion, tax fraud conspiracy and impeding and impairing the lawful function of the IRS over a decade from 1994 through 2004.  They are Paul Daugerdas (former head of J&G's Chicago office), Erwin Mayer (former shareholder in J&G's Chicago tax practice), Donna Guerin (former shareholder in J&G's chicago tax practice), Denis Field (former CEO and board chair at BDO Seidman and former tax practice head), Robert Greisman (former tax partner at BDO), Raymond Brubaker (former investment rep at Bank A in Dallas--presumably Deutsche Bank, see this tidbit on Brubaker and other former Deutsche employees establishment of Bluffview Securities), and David Parse (former investment rep at Bank A in Chicago).  Many of these people had LLM degrees in taxation and were CPAs as well.  They clearly knew what they were doing--at BDO, they first called their group the "tax sales executive group" before tampering it down to "tax solutions group" in 1999.  They charged fees "far in excess" of their normal billing rates for these deals, according to the inictment.

The various option shelters (SOS, HOMER, Short Sales) generated about $7.5 billion in artifical tax losses for hundreds of wealthy individuals.  Several of the indicted group used the tax shelters for themselves, for which they got "free" opinion letters from J&G. Each of the conspiracy charges could land a defendant in jail for 5 years, with 3 years' supervised release and a fine of the greatest of $250,000, twice the gross gain to the defendant, or twice teh IRS loss (as well as costs of prosecution). Add an additional 3 years in jail, 1 year supervision, and the same fine on the charges of corruptly endeavoring to impede the tax laws.  As IRS Commissioner Shulman states int he release, "In today's economic environment, it's more important than ever that the American people feel confident that everyone is playing by the rules and paying the taxes they owe." 

There are two big problems with these tax shelters:  tax laywers who have lost their ethical guidestar, and banks that have seen serving as accommodation parties in shelters as just one more lucrative gig, the public be damned. 

Too many tax lawyers have followed the money for too long--they've lost sight of their obligation as officers of the court to uphold the law, and put service to their clients (and their pocketbooks) above everything else.  That will require toughening of standards and loosening of some of the protections provided currently by evidentiary privileges.  Tax returns are like confessions--the taxpayer is supposed to "fess up" to all income and pay appropriate tax.  I am convinced that attorney-client privilege (or the somewhat less broad section 7525 tax-practitioner privilege) in respect of planning and justification of transaction reporting positions is unjustifiable.  Similarly, work product protection should not be available to documents or materials that form the basis of information reported on returns, including tax accrual workpapers.  The courts don't get work product right--they are extending it, rather than retaining it as a litigation-based doctrine.  So Congress should step in and legislate, in clear language, that opinion letters and other materials related to positions on a tax return are disclosable and not protected by either evidentiary privilege.

Worth noting in addition is the role of big banks in promoting these strategies.  Brubaker's bank worked with J&G to structure and implement the shelters. The indictment also mentions national "Bank B" that had its principal office in Chicago and arranged estate planning and tax shelter strategies for wealthy individuals, include the HOMER deals. (This is presumablly the former Bank One, since acquired by JPMorgan Chase, at which John Ohle worked in the "innovative stragies group" and promoted shelters like HOMER.  Ohle was indicted last November for his tax shelter role--and apparently didn't bother to note that to his malpractice insurance carrier.  See  Insurer Sues Indicted Lawyer, Chicago Law, June 9, 2009.)  So why have we not yet instituted tough regulations on derivatives?  Isn't the bailout from the credit crunch (domestic and foreign banks that weren't direct recipients also benefitted, as they were often counterparties to AIG on credit default swaps or other transactions that paid out when the US funneled money to AIG) and the avarice represented by the participation in the planning and promotion of tax shelters enough to make clear the need to regulate Big Finance?  I'm waiting for Congress to act, but I am worried.  Both Senator Dick Durbin (D-IL) (responding to the failure of Congress to enact the most obvious and likely most beneficial remedy to the pain hitting Americans in the credit crisis--the ability of homeowners to modify their mortgage loans in bankruptcy) and Representative Collin Peterson (in response to the failure of Congress to enact meaningful measures to cut banks and their use of speculative derivatives down to size)  have suggested that the "banks run the place".  See In Crisis, Banks Dig In to Resist New Limits on Derivatives, New York Times, May 31, 2009 (noting the lobbying heft of JPMorgan Chase and others regarding banking and derivatives regulation). 

These events make me wonder whether we can ever have decent legislation--on the financial system, on taxes, or on health care--while Big Banks and Big Pharm wield so much power.

Deutsche Bank's tax shelters

The Northern Illinois District Court has stayed the pending case brought by investors Leslie and ronnie Leff against Deutsche Bank pending arbitration.  See Leslie Leff and Ronnie Leff v. Deutsche Bank, Case No. 08-CV-733  (May 14, 2009)(available on BNA).

In 1999, the Leffs entered into a "COBRA" strategy involving currency options, for whichJenkens & Gilchrist (the now-defunct Texas firm) provided a tax opinion and Deutsche Bank served as accommodation party.  In 2000, the Leffs entered into a "PICO" shelter, again with Deutsche Bank as an accommodation party.  The Leffs were audited and assessed back taxes as well as interest and penalties.  Then in February 2008, they filed a lawsuit against Deutsche Bank for marketing the COBRA and PICO shelters, claiming that they were induced by Deutsche Bank to undertake the shelter transactions.  In the course of executing the transactions, the Leffs entered into various agreements with counterparties (Counterpoint and Delta), in which Deutsche Bank was named as manager of various aspects of the accounts.  The Counterpoint and Delta agreements included an arbitration provision covering "any controversy arising out of or relating to this Agreement or the breach thereof."  Deutsche Bank therefore filed a motion to compel arbitration in the Leff's case against it, even though it was not a signatory to the agreements.  The court concluded that the Leffs' "complaint alleges substantially interdependent and concerted misconduct between Deutrsche Bank and singatories to the contracts containing the arbitration provisions" and therefore the Leffs were equitably estopped from avoiding arbitration.