My take-off point for this discussion is a letter by Professor Marvin Chirelstein dated July 13, 2009 published in 124 Tax Notes 183 (July 13, 2009). Professor Chirelstein rails against “the astonishing role that law firms have played in justifying -- that is, helping to promote -- so many of these egregious and transparent tax shelter schemes.” He refers to the law firms whose partners issued the MLTN opinions used by the tax shelter promoters to sell the tax shelters. (I refer to these law firms as the “promoter law firms.”) For purposes of this response only , I accept Professor Chirelstein's premise that the MLTN opinions he refers to were blatantly false. That does not mean that I agree with that premise, but I only want to explore here the consequences if the premise were correct.
I wonder, though, why Professor Chirelstein limits his indictment to the promoter law firms. Indeed, Professor Chirelstein acknowledges that he assists those at the center of the shelters -- the taxpayers without whom the shelters would not have existed to recover against the promoter and promoter law firms. The taxpayers were generally sophisticated taxpayers who had all the objective indicia that the shelters were too good to be true. The too good to be true test is not a tax specific test, but a test that functioning people perform in all of life’s contexts. Accepting the Chirelstein premise as to a blatantly false MLTN opinions, the taxpayers had on their intuition enough indicia of problems with the opinions. Certainly as to the critical representations the taxpayers made as to their own profit motive independent of tax benefits, the taxpayers themselves made those representations, and the taxpayers knew that representation was not truthful (again assuming the premise). It is no answer that the representations were usually scripted by the promoters; they were still the taxpayers’ representations and the taxpayers knew that they were making the representation. Indeed, beyond knowing that the shelter was too good to be true, those taxpayers had their own independent tax advisors -- including partners in name brand law firms -- from whom they received independent advice and paid for that independent advice.
Let's play out the variations that surely occurred between the taxpayer and his independent advisor regarding these shelters:
Taxpayer: This seems too good to be true. By simply paying promotion costs of $20 million dollars, I can avoid $60 million in tax -- $40 million net in my pocket. Since it does seem too good to be true, I need to make sure that it is legal. I don't want to go to jail, and I don't want the ultimate real costs of this gambit to take away my profit (or worse) from entering the transaction.In either of these scenarios, the taxpayer did not rely upon the promoter law firm MLTN opinion and the taxpayer got exactly what he bargained for -- a known faulty opinion that he imagined gave him risk free access to the audit lottery. The taxpayer is certainly equally culpable as the promoter and the promoter law firm. The taxpayer paid the promoter and the promoter law firm to give him the potential for risk free access to the audit lottery.
Taxpayer's Lawyer's Alternative Responses:
Taxpayer's Lawyer: I have spent -- and charged you handsomely for -- for several hours of my time to review the proposed promoter law firm shelter opinion. The shelter is blatantly illegal. I really could have spent less time, because it was so patently illegal, but I knew you wanted me to do some work and I knew you could afford my usual exorbitant rates. This shelter is nothing more than an illegal play of the audit lottery. If you are caught, you lose. Don't get in it. However, if despite my advice, you do play in it, the MLTN opinion from the promoter law firm is patently wrong, and I can give you no assurance that you will not face potential criminal and large civil penalties. You certainly cannot rely upon my advice as reasonable cause or justification for playing the audit lottery, whether in a civil or criminal context.
Analysis of Alternative #1. Under Professor Chirelstein's key premise (blatant illegality), this would appear to be the only advice that the taxpayer's lawyer could give. Of course, under Professor Chirelstein's analysis, if the taxpayer gets in the shelter anyway, he certainly is not relying on the promoter law firm's MLTN opinion except as he imagines it offers him some civil or criminal penalty protection despite his own lawyer's advice to the contrary.
Taxpayer's Lawyer: I have spent -- and charged you handsomely for -- for several hours of my time to review the proposed promoter law firm shelter opinion. The shelter is blatantly illegal. I really could have spent less time, because it was so patently illegal, but I knew you wanted me to do some work and I knew you could afford my usual exorbitant rates. This shelter is nothing more than an illegal play of the audit lottery. If you are caught, you lose. Don't get in it. The shelter is illegal. Still, if you were to win the audit lottery, you stand to gain so much by it (the taxes hereby evaded), that you might find it acceptable on a cost / benefit analysis. Critical to this cost benefit analysis is that you assert to the IRS something that you and I know is untrue – that you really “relied” upon the MLTN opinion from the promoter law firm that you know is garbage. I do have to caution that, based on what you know, that assertion would be a criminal act in itself, but the IRS may have limited ability to determine whether you relied upon the MLTN opinion. There is some possibility that an IRS agent might believe that you really did rely upon that opinion; if so (despite the fact that you did not rely upon the opinion), you avoid both criminal potential and potentially draconian civil penalties. So, get in it and play the lottery if that is your desire. I can't tell you that I recommend that course of conduct for, to quote President Nixon in a not wholly dissimilar context, "that would be wrong;" but you are a big boy and can make your own choices.
Analysis of Alternative #2. Under Professor Chirelstein's key premise (blatant illegality), this advice (or any variation of it) is wrong. The Taxpayer's lawyer is simply signaling the taxpayer that the audit lottery may be right for him depending upon his tolerance for risk.
Would it make any difference if the taxpayer went to his own tax lawyer with a limited request -- I ask that you not advise me as to the merits of the shelter but instead only advise me as to my criminal and civil risks of getting into the shelter? I know what my potential benefit is ($20 million in this example), but want to understand my downside potential (which I would like to be only the promotion cost of $10 million plus the tax involved ($30 million). In this regard, I asked for and the promoters refused to give me a guaranteed return of the fees in the event I have to pay the tax. Could the taxpayer's lawyer give such penalty advice without some predicate assessment of the merits of the shelter which, as posited by Professor Chirelstein, would be blatantly illegal. I doubt it.
Bottom line, I question whether these taxpayers should be recovering damages from anybody. They made their bed and are not men enough to lie in it. They seek comfort from Professor Chirelstein who surely must know that without the taxpayers and the taxpayers' own independent advisors (including prominent law firms), the abusive shelters of which he complains would have gone nowhere. Why should one thief under Professor Chirelstein's analysis recover from another? Is Professor Chirelstein not enabling these culpable taxpayers by assisting them in their recovery for their own culpability?
Indeed, if Professor Chirelstein is correct that the shelters were blatantly and it logically follows that the taxpayers knew they were (whether on their own or with the assistance of their tax advisors), why does the Government not line them up for criminal prosecution. If the Government really wants to stop abusive shelters of the type Professor Chirelstein posits, there should be many taxpayers and taxpayer advisors (including from prominent law firms) who played and enabled, respectively, playing the blatantly illegal game.
I conclude by cautioning that I am not calling anyone a thief here; I merely accept for this discussion Professor Chirelstein's premise that the shelters were blatantly illegal and taking that where it I think it logically goes. I think Professor Chirelstein’s premise is faulty. Perhaps that is why the Government has not lined up the taxpayers and their advisors for criminal prosecution.