Bullshit Tax Shelter Salesman Avoids Fraud Finding for Investment in Bullshit Tax Shelter (4/8/15)

In Jacoby v. Commissioner, T.C. Memo. 2015-67, here, the Tax Court relieved a bullshit tax shelter salesperson who drank his own poison from liability for the tax and penalties (and, as a result, the interest thereon).  How did / could that happen?  The short answer is - I don't know.  The opinion is quite cryptic.  Which may be the answer -- it may be just a mystery.

So, let's wade into the cryptic opinion.

1.  Jacoby had an accounting degree and a law degree.

2.  He had a short stint with a major accounting firm doing financial audit (not tax) work.  In 1987, he joined Twenty-First Securities Corp., a major player in the sophisticated tax strategy market.  He focused on strategies for high net worth individuals and large companies.  The strategies he sold were developed by others in the firm or outside the firm.  During the 9 years he worked there, he earned between $5 and $6 million.  Obviously, he learned enough about the working of the strategies to sell them to others.  (JAT comment:  One example of a strategy developed by Twenty-First Securities is the strategy blessed blasted by the Tax Court and then blessed by the Fifth Circuit in Compaq Computer Corp. v. Commissioner, 113 T.C. 214 (1999), rev’d 277 F.3d 778 (5th Cir. 2002); I have no idea whether Jacoby worked on that strategy, but that strategy was apparently in-house while he was with First Securities.

3.  In 1996, Jacoby joined Diversified Group Inc. ("DGI"), a tax shelter boutique run by James Haber.  DGI and Haber were major players in the bullshit tax shelter market.  See also e.g., Ironbridge v. Commissioner, T.C. Memo. 2012-158 (noting that, "Although he has not been indicted or tried, the principal of petitioners, James Haber, believes he was one of the persons involved in the criminal investigation.Mr. Haber stated during deposition testimony that he believes he became a potential “target” of the criminal investigation around “2002 or 2003;" lot more history there, but not developed in the Jacoby opinion, so I pass for now).  The Jacoby opinion says that Jacoby was interviewed in the criminal investigation, agreed to extend the statute of limitations for criminal prosecution, but was never prosecuted.  (Haber was never prosecuted either.)

4. Jacoby's arrangement with DGI was a joint venture agreement ("JVA") with Jacoby's company, SMD Capital Corp. ("SMD"), through which he would get 50% of the net profits from business he brought to DGI.

5.  Among DGI's offerings of bullshit tax strategies was a transaction commonly called a "Midco transaction."  I won't get into the details of the Midco transaction (see for this blog's entries on it, here) suffice it to say that it was a multi-party transaction designed to rip off the corporate level tax from the federal fisc and share it among the parties structuring it.  The Jacoby opinion cites another Tax Court opinion, Cullifer v. Commissioner, T.C. Memo. 2014-208, for a more-in-depth discussion of the Midco transaction.  So, Jacoby asked Haber whether he (Jacoby) could use a Midco transaction to solve the problem of the tax on SMD's receivables due from DGI.  (This would apparently generate a corporate level tax as well as a shareholder level tax; Midco addresses the corporate level tax.)

6. Jacoby then implemented the Midco transaction.  At the end of the day, Jacoby ended up with most of the financial benefit of the assets of SMD and Jewish Communal Fund got $292,039.  The Midco transaction is designed to shaft the Government for the corporation's tax liability, but the opinion does not develop that feature.  At a minimum, of course, Jacoby had a personal tax liability for the cash he ended up with.

7.  Jacoby then sought to shelter his individual level tax with another bullshit tax shelter -- a variation on Son-of-Boss / Helmer.  Basically, that shelter produces cost-free tax benefits that most courts hold sophisticated investors would know are too good to be true.  (The latter is not in the Jacoby opinion, but readers of this blog have seen that conclusion by courts and me over and over.)

8.  In 2011, the IRS began an audit of Jacoby's 1999 and 2000 returns.  The IRS determined substantial deficiencies and imposed the civil fraud penalty, apparently with respect to the Son-of-Boss shelter.

9.  The sole issue resolved was whether the IRS had met its substantial burden to prove Jacoby's civil fraud by clear and convincing evidence.  That is required in order for the unlimited statute of limitations to apply.  Section 6501(c)(1), here.  The Tax Court (Judge Vasquez) held that the IRS had not met that burden.  Read the opinion on how the Tax Court gets there.  Since the IRS had not met that burden of proof, the Tax Court held, the statute of limitations foreclosed any adjustment.  Jacoby won on that default.

JAT comments:  

1.  Readers should note that the clear and convincing standard -- certainly as applied by Judge Vasquez -- is a major hurdle for the IRS.  The key finding is:  "After reviewing all of the facts and circumstances, we conclude that respondent has failed to sustain his heavy burden of proving by clear and convincing evidence that, some 15 years ago, petitioners intended to evade tax known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of tax for the years in issue." The fact that the burden is heavy is precisely why taxpayer's subject to the willful FBAR penalties should continue to litigate that issue.  As Jacoby clearly suggests, taxpayers can win cases where that burden would apply where they might not if the preponderance burden applied.

2.  I was particularly heartened to see the following:

When he went on to market strategies for Twenty-First and DGI, the record shows that it was the lawyers and accountants, such as Mr. Haber, who handled the development of the strategies. Respondent has not shown, by clear and convincing evidence, that Mr. Jacoby was anything more than a marketer who relied on tax specialists to devise and vet the strategies.

As some of the readers may know, I represented one of the defendants in the KPMG criminal prosecutions from  their versions of Son-of-Boss.  There were several of those defendants (including my client) who filled the role of sales people.  While they were professionals (like Jacoby), the did not have a very clear understanding of the tax concepts exploited and, in the Government's mind, abused.  I felt that, if we went to trial, a jury of good men and women would likely cull some of these people out and acquit on the basic Cheek good faith instruction with a variation of no proof of guilt beyond a reasonable doubt.  It is good to see this type of analysis as to someone who, based on what I infer from the cryptic findings the judge made, was a lot deeper into the weeds than some of the KPMG defendants who were dismissed.

3.  Missing from the opinion is the Allen [Allen v. Commissioner, 128 T.C. 37 (2007), here] analysis which says that fraud on the return invokes the unlimited statute of limitations, even if it is not the taxpayer's fraud.  Clearly, these Son-of-Boss shelters were of the genre determined to be fraudulent beyond a reasonable doubt in the KPMG prosecution that was tried and in the other prosecutions in SDNY (culminating in Daugerdas' conviction).  If that is the case, it is not clear why the IRS proceeded solely on the argument that the taxpayer's fraud was required.