Tuesday, January 10, 2012

BLIPS Tax Shelter Investor Denied Bankruptcy Discharge for Fraudulent Return and Evasion (1/10/12)

In In re Vaughn, 463 B.R. 531, 2011 Bankr. LEXIS 5091 (D. CO 2011), here, the taxpayer was denied discharge in bankruptcy for tax arising from his investment in a tax shelter of the BLIPS variety.  As I have noted before, bankruptcy discharge is denied for certain reasons, including in part here pertinent "with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax." "11 USC 532(a)(1)(C).  The Court held that the Government proved that this taxpayer flunked that test.

I will provide a summary below, but note first that the holding is interesting because rarely did the Government put in play the issue of taxpayer fraud with respect to the reporting of the BLIPS and similar Helmer inspired shelters, all of which, the Government claimed, were hokey ("too good to be true") and all of which ultimately failed when tested.  Many of the shelters involved in the current Supreme Court brouhaha over the 6 year statute of limitations were basis boost shelters such as these shelters that positioned the taxpayers to argue that income was not omitted so as to trigger the 6 year statute.  But, if fraud were involved with respect to the reporting, then there is no statute of limitations.  Interestingly, the fraud does not even have to be the taxpayer's fraud to trigger the unlimited statute of limitations; it can be the preparer's fraud (Allen v. Commissioner, 128 T.C. 37 (2007)) or, presumably someone else such as a promoter.  But, certainly the taxpayer's fraud -- the type of fraud  involved alleged and found in In re Vaughn -- suffices to trigger the unlimited statute of limitations.  And, of course, fraud gives rise to a 75% civil fraud penalty.  And, of course, as in In re Vaughn, fraud can preclude bankruptcy discharge for a tax liability.  (Although interestingly, the civil fraud penalty can be discharged in bankruptcy.)  So with all of these incentives to the Government to assert fraud against the taxpayer, why  don't we see the issue arise more often.  I don't know the answer to that question, but the dearth of cases is noteworthy.

Now, let's look more closely at the In re Vaughn case.  The court signals the result at the beginning with the following:
This matter involves the rise and fall of James Vaughn, an obviously intelligent man who made an extremely unintelligent decision. Through hard work and entrepreneurial talent, he gained experience in the options trading, venture capital, and cable television industries, rising to executive positions in several companies. In 1995, he started a successful cable company and began acquiring small cable companies with an eye to selling to a larger entity. The venture was sold in 1999 for a gross sales price of $2.1 billion, of which Mr. Vaughn received approximately $34 million in cash and stock. Sadly, this inspiring business success story then took a very negative turn when Mr. Vaughn made the investment which forms the subject of this action.
I need not get into the details.  The critical features fit the pattern of all of the BLIPS type shelters of which I am aware.  The taxpayer had a lot of gain he wanted to shelter and was willing to pay the promoters (KPMG, RJ Ruble of Brown & Wood, Robert Pfaff and David Makov of Presidio, all of whom played prominently in the KPMG individual defendant criminal prosecution) handsomely.  For a fee inflated because of the taxes that were thus avoided, the promoters oversaw the "investment" -- if that is the right word -- strategy and produced an opinion letter upon which the taxpayer purported to "rely" in claiming the magical tax benefits that were not legal.  Of course, the taxpayer viewed it as a risk free shot at the audit lottery -- i.e., for an acceptable, even if exorbitant, cost (the fees), the taxpayer perceived (and was promoted) a risk of only being audited and, if audited (a big if in perception if not reality), having to pay the tax and interest, because the opinion upon which he purportedly could rely would shield him from more dire consequences -- civil or criminal -- for his tax misbehavior.

The Court found that the taxpayer knew or should have known that the returns were fraudulent.  (I am not clear about the should" have known business" as proof of fraud which seems to be the civil equivalent of the broader contours of conscious avoidance in a criminal context.)  The Court also found that he willfully attempted to evade because of his lavish expenditures after unquestionably knowing of the tax liability and before declaring bankruptcy.  Since the Section 523(a)(1)(C) test is in the disjunctive, either of those findings would preclude discharge.

The Court concluded it detailed discussion of the facts and law with the following:

Throughout this case, Vaughn has argued he is an innocent victim of the machinations and misrepresentations of KPMG and persons in the employ of or hired by KPMG. This Court does not disagree that such machinations and misrepresentations took place. However, a taxpayer cannot reasonably rely on the advice of a professional who has an inherent conflict of interest, such as the  promoter or marketer of a tax investment. KPMG, its employees, and even the law firm employed by KPMG to issue “opinion letters” had such a conflict, because KPMG was the marketer of the BLIPS investment. It is simply not credible that an individual of Vaughn’s extensive business background and demonstrated business skill would have reasonably relied on any such representations, and would not have, if he were seriously considering BLIPS as a legitimate investment, obtained a truly independent opinion as to its potential and its tax implications.
For these reasons,  
IT IS ORDERED Vaughn’s tax debts arising from the sale of Frontier Vision are not dischargeable

1. Anonymous on January 10, 2012 6:24 PM opened with an excellent comment.  I strongly urge readers of this blog to read that comment and hopefully the further comments..  Anonymous has indicated that he / she may make further comments, and I strongly encourage him / her to do so.  I urge interested readers to join in the discussion.

2. Anonymous in that opening comment refers to the Hawkins case (Hawkins v. Franchise Board (Bankr Ct. ND CA No. 07-3139 4/23/10)), here.  I blogged that case here for further background.  As Anonymous notes in his comment, the Hawkins court declined to find that the tax shelter claims on the return were fraudulent, for it moved to the evasion prong and found evasion present.  I should note that the shelters involved in Hawkins were FLIP and OPIS, KPMG marketed shelters that preceded BLIPS.  As in In re Vaughn, the taxpayer in Hawkins urged that the opinion letters created enough fog to eliminate the taxpayers' fraud.

3. I will make further comments in the comments section since that will permit the discussion to proceed in an orderly fashion.


  1. Jack-

    I wish had the time to say everything I'd like to say in response to your post, but I have work to do. I'll make a couple of points and perhaps return later to post more detailed comments.

    First, the burden of proof in this type of litigation (which is on the government) is only preponderance of the evidence. In theory, the government could lose a criminal trial on this issue, lose a tax court trial on the civil fraud penalty, and then win this type of litigation in BK court.

    Second, some courts have badly mangled the "attempt to evade or defeat" concept in section 523(a)(1)(C) of the BK Code, in my opinion. The trial judge in Hawkins specifically refused to find that Hawkins had engaged in traditional "tax evasion" by filing a fraudulent return. Rather he concluded that Hawkins had intentionally violated a known "duty" by not reducing his lifestyle and living expenses to pay a tax that Hawkins knew would likely be assessed. Judge Carlson, in concluding that there was an intentional violation of a known duty, focused a great deal (but not exclusively) on pre-assessment conduct of Hawkins.

    Judge Carlson failed to explain in his opinion that, absent a finding of conduct that constitutes tax evasion, the legal duty to pay an income deficiency only arises after the tax is assessed and a timely notice and demand for payment is sent. While pre-assessment conduct is relevant if you want to prove traditional tax evasion, pre-assessment conduct is not relevant if your focus is an intentional "failure to pay" the tax which does not amount to evasion.

    [Even if you learn after filing the return that what was on your return was bogus, sometimes the IRS messes up and fails to assess the taxes. So waiting for the IRS to assess before you pay what is owed is not by itself improper. if you start giving away all you money prior to assessment, however, you increase the risk that the court will conclude that there was evasion.]

    Carlson erred by focusing on pre-assessment conduct while explicitly refusing to hold that Hawkins engaged in traditional tax evasion. The District Court made the same mistake. (An appeal is pending in the 9th Circuit but per PACER the case has been referred to the 9th Circuit mediator's office.)

    There is an argument that there can not be an "attempt to evade or defeat" under section 523(a)(1)(C) unless there is traditional tax evasion under section 7201. In other words, a willful failure to pay conviction, as opposed to a 7201 conviction, does not constitute an attempt to evade or defeat the tax under section 523. I think that argument is logically sound, but logic does not always carry the day in these types of matters. And bankruptcy courts, often with the encouragement of the government, don't draw the proper lines in writing opinions (even if they are knowledgeable about tax matters, like Judge Carlson).

    The potential for bankruptcy courts to create bad case law that could bite us in the criminal tax area is there. (I handle criminal tax matters, civil tax litigation, and bankruptcy related tax litigation in private practice-- with 30 years experience. I've litigated one 523(a)(1)(C) case. Many, if not most, 523(a)(1)(C) cases are not worth defending, and that type of litigation is very expensive. )

    The Vaughn opinion is problematical, even if you think the judge reached the right result. And Judge Kroupa's opinion that the fraud of the preparer can extend the statute of limitations on assessment against a taxpayer who had not committed civil fraud is likewise problematical. I don't anticipate the IRS relying on that opinion in the BK area, but then again I've seen the IRS do crazier things.

    I have lots more I'd like to say, but time to get some more work done.

    Best regards,


  2. To Anonymous on January 10, 2012 6:24 PM

    I will try to respond to your excellent comments. At the outset, let me say thanks for the numbered paragraph presentation. That will make reference to your comments easier. So, I will use your numberings.

    First, I infer from this comment that you refer to the differing burdens of proof in the types of litigation. In criminal cases, the Government must prove fraud beyond a reasonable doubt; in most civil tax cases where the Government alleges fraud (e.g., in order to assert the civil fraud penalty or the unlimited statute of limitations), the Government must prove fraud by clear and convincing evidence; in bankruptcy, however, the Government must prove the Section 523(a)(1)(C) elements that arguably are equivalent to fraud only by a preponderance of the evidence. (Anonymous, you state that and I accept that for purposes of this discussion; I do think I have some material on this somewhere that say something about it, perhaps the same thing you say; I may dig into it later and post another comment.)

    As articulated, because of the differing burdens as outlined, it is certainly conceivable that, on the same quantum of evidence, the Government could lose the criminal case and win the civil tax case and the bankruptcy case. That would mean that the quantum of proof establishes fraud by clear and convincing evidence (which is higher than a preponderance) but not beyond a reasonable doubt.

    As articulated, for the same reason (and as you note), the Government could lose the criminal case and the civil tax case but win the bankruptcy case. That would mean that the quantum of proof as to fraud was more likely than not (i.e., a preponderance) but not by clear and convincing evidence of fraud or guilt beyond a reasonable doubt.

    This type analysis is the reason that conviction of guilt beyond a reasonable doubt is preclusive under collateral estoppel in later civil litigation whereas an acquittal is not preclusive in later civil litigation. The acquittal just means that the Government failed to prove guilt beyond a reasonable doubt. In later civil litigation where the issue is whether the Government can establish fraud is lesser, a finding of fraud would not be inconsistent with the finding of not guilty in the criminal case.

    Second, I have not reviewed Hawkins (or what I said in the Hawkins blog, rightly or wrongly, about Hawkins), so I will try to find time to do that and get back if I can conjure anything meaningful to add to your comments. I can say that I am impressed with your comments.

    As to the Allen case (Judge Kroupa's decision), I think it was based on the language of the statute. Section 6501(c)(1) speaks of a fraudulent return and not to the taxpayer's fraud. Now, for most of the years that statute existed, everyone interpreted that to be the taxpayer's fraud, but the literal text does not require the taxpayer be the fraudulent actor if the return is fraudulent (i.e., claims a fraudulent tax benefit). And Judge Kroupa articulated some policy reasons why an enlarged / unlimited statute of limitations was needed for a fraudulent return.

    By contrast, Section 523(a)(1)C) seems to visit nondischargeability as a punishment and the text is quite clear that the debtor must have made the fraudulent return or otherwise attempted to evade. Hence, I think the Allen result would not obtain in bankruptcy. (If that is not what I said or suggested in the original blog, that is my position now; consistency is the hobgoblin of small minds.)

    Again, I may add more comments in reaction to Anonymous' comments, but for now I am spent for the evening.

    Thank you, Anonymous, and please add more comments. I appreciate them and I know readers do also.

    Jack Townsend

  3. Jack,

    What would happen to an immigrant if convicted and deported for tax evasion and cannot pay his tax due. Will DOJ issue another warrant for him?

  4. Question for Anonymous on January 10, 2012 6:24 PM

    Are you surprised that the Government has not pursued the fraud angle, at least in some cases, as a way to fix an otherwise closed statute of limitations on these shelters. I know that, in the KPMG investigation, many taxpayers felt the heat of zealous prosecutors and some taxpayer independent tax advisors felt the heat as well. So far as I know, none were ever prosecuted.

    And, in the big three shelter prosecutions (Larson/Pfaff/Ruble, Coplan, and Daugerdas), the prosecutors conceded that the taxpayers had not committed fraud. They did this as a litigation tactic to avoid having to prove fraud taxpayer by taxpayer, which would have required, in effect, separate quasi-criminal trials for each of those taxpayers thus substantially prolonging the trial. (There are some issues affected by that concession -- most specifically related to derivative liability, whether, if the defendants were accomplices, who were the principals they aided and abetted under 18 USC 2(a) and whether the defendants were causers liable under 18 USC 2(b). But those are technical details as to why the Government made the concession in the trials of the promoters and I don't think signaled a concession that the taxpayers had not committed fraud if the Government chose to pursue that claim in some later proceeding involving the taxpayers.

    I would appreciate your thoughts on this.

    Jack Townsend

  5. To Anonymous at January 11, 2012 8:11 AM

    In the cryptic facts you give, it appears that the person of whom you speak has been convicted of tax evasion and has been deported as a consequence. The underlying tax liability is a civil matter. The taxpayer will not be subject to arrest for the tax liability unless the taxpayer commits evasion by trying to avoid payment of the tax. And, in the facts you posit, the taxpayer has been deported so it is hard to see how the U.S. could arrest him at all even if they thought he, from his overseas location, were attempting to evade payment of the tax.

    I guess that gives deported taxpayers who have no financial assets in the U.S. little incentive to pay the underlying taxes.

    I should note that the Supreme Court is now considering whether conviction of tax parjury, Section 7206(1), is a deportable offense. Miller & Chevalier's Tax Appellate Blog has some good discussions of this case here: http://appellatetax.com/category/pending-cases/kawashima-pending-cases-2/.

    And, of course, I have had some discussions on the case as well: http://federaltaxcrimes.blogspot.com/search?q=kawashima

    Jack Townsend

  6. On burden of proof for discharge, see Grogan v. Garner, 498 U.S. 279 (1991) (preponderance of evidence for fraud exception to bankruptcy discharge because of the nature and context of that exception).

    Jack Townsend

  7. Jack-

    I'm back to add some more comments. Responding to your question of whether I am surprised that the government has not pursued fraud to extend the statute of limitations, no I am not surprised. Proving that the taxpayer should have known better is not difficult in most of these shelter cases. Proving intent to evade tax by the taxpayer is difficult in almost all cases and requires additional resources.

    Look at Judge Carlson's opinion in Hawkins. He ducked the civil fraud (evasion) issue, even under a preponderance of the evidence standard. He's a very smart judge, very tax savvy. He obviously was reluctant to conclude that Hawkins engaged in evasion (such as committing fraud when he signed the return).
    So I'm not surprised that the government is reluctant to assert fraud by the taxpayer in shelter cases in an effort to extend the SOL.

    Nor am I surprised that the government has not relied on the issue it prevailed on in Allen to extend the statute of limitations for taxpayers. My guess is that the top level government attorneys realize that there would be a huge outcry if they attempted to rely on Allen to extend the statute of limitations based on (allegedly) fraudulent conduct of the preparer.

    I could go on for a long time on the topic of why the result in Allen is problematical. Here I will make just a couple of points. First, if a return is fraudulent as the result of the preparer's conduct, under the Allen holding the government can seek to adjust the taxpayer's return at any time and on any issue, just as the government can do when fraud is committed by the taxpayer.

    Such a result for the taxpayer seems completely incongruous to me. A taxpayer should not be forced to keep their records forever out of fear that the person who prepared their returns committed some sort of fraud in preparing their returns. Nor should a taxpayer face the possibility of an unlimited statute of limitations for adjustments unrelated to the preparer's fraudulent conduct when the taxpayer themself did not commit fraud.

    A second, but related, point is that there are many cases out there where preparers do things to returns without the knowledge of their clients. I've been involved in quite a few tax preparer criminal investigations and prosecutions. If, for example, a taxpayer reviews a prepared but unfiled return and signs the authorization form for the return to be electronically filed, and the return is altered to increase a deduction before the return is e-filed without the knowledge of the taxpayer, I don't think that taxpayer ought to be suffer the consequences of an unlimited statute of limitations.

    Finally, most tax litigation occurs in Tax Court. The Tax Court's rules, even after being recently amended to make it somewhat easier to take depositions, are not very well suited to conducting third party discovery prior to trial. You can't issue a document subpoena until the case is set for trial, and the subpoena is not legally returnable until the first day of the trial calendar. Depositions are disfavored by the Court. Thus, there can be difficulties in litigating the issue of whether fraud was committed by the preparer. Those difficulties could even create due process problems in extreme cases. It would not surprise me if some Tax Court judges (other than Kroupa) were very unhappy about the result in Kroupa's case and have quietly but firmly let others in the government know how they feel.

    Best regards,


    1. To Anon,

      Your comments are excellent. Thanks, and keep them up as you feeled moved to do so.

      I agree with you that the Government might have great difficulty proving civil fraud as to the taxpayer. Still, I suspect that, if the Government could get past the attorney-client privilege as to the taxpayer's independent advisers, you will find that some of the independent advisers in fact advised the taxpayer that on the substantive merits, the transaction would not work (i.e., not even a reasonable basis to claim the tax benefits). But, the adviser could have advised the taxpayer that the promoter related attorney's opinion letter could give the taxpayer risk free access to the audit lottery. Perhaps like a penalty insurance opinion from a combination of the promoter related attorney and the taxpayer's own independent attorney. I suppose that, if the taxpayer relied upon the independent attorney's advice that thet transaction really would be penalty free (without getting into the semantical areas of reasoanble basis, etc.), then the taxpayer might be protected. But, then if the taxpayer participated in activity with not substance other than to hide the transaction (such as grantor trusts, how the positions are presented on the returns, a maze of entities, etc.), the taxpayer might still have some potential criminal exposure for attempting to defeat the lawful functions of the IRS (either Klein conspiracy or the one person conspiracy of 7212, tax obstruction).

      In any event, as best we know, the Government has not pursued that route. Having said that, in the KPMG case, the Government did allege that one of the taxpayer's participated in an overt act of the conspiracy in representing to the IRS that he had a profit motive for the transaction. I am sure that, for those representing taxpayers in these transactions (not me, becuase my practice from the early 1980s has been not to represent these people on the civil side) who were aware of this allegation must have had some concern.

      I agree with you that the Allen opinion is problematical from a policy perspective. Still, for one not willing to apply those policy concerns and having a predilection to not veer from the statutory language, it appears to me that Allen is a reasonable interpretation of the statutory text. Now, it is not the only possible interpretation, but a reasonable one. Now, there are other reasonable interpretations -- yours being one -- so wouldn't it be nice if the IRS iteself used its Chevron deference power to resolve the issue in the way you think is the better reasonable interpretation!

      Best, and, of course, keep up the good work!

      Jack Townsend


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