Sam Wyly's Continuing Travails -- the Bankruptcy Edition (5/15/16; 5/21/16)

I have previously written about the travails, visited upon themselves, by the Wyly brothers, Sam and Charles, very wealthy men who decided that they did not have to play by the rules.  All blog entries on the Wyly's are here.  The Wyly brothers lost a previous round on disgorgement by the SEC.  See Wylys Ordered to Disgorge Hundreds of Millions of Tax Benefits With Interest (Federal Tax Crimes Blog 9/27/14), here.

The latest chapter is a bankruptcy decision involving Sam Wyly, Charles Wyly and Charles' wife, Dee Wyly.  In re Samuel Evans Wyly, et. al. (Bkr No. 14-35043-BJH 5/10/16), here (because of the length of the opinion, I have used the Adobe bookmarking feature to bookmark in outline format because of its length; readers can download and use the bookmarks to more easily move around the lengthy document).  [JAT Note I just discovered on 5/21/16 that I had the wrong link to the opinion; I have corrected that and apologize to readers.]  The opinion is 459 pages (including Exhibits).  Without exhibits and excluding the table of contents, the opinion is 427 pages long.  This is a substantial read, depending on the level the reader chooses to drill down into the opinion.  For those merely wanting the judge's own summary, see the Conclusion which is 9 pages, beginning on p.418 and ending on page 427.  The bottom line (my summary of the judge's summary as to the key holdings):

1.  The issues (p. 418, footnote omitted):  "First, did Sam and Charles commit tax fraud? Second, if they did, what role, if any, did Dee have in that fraud?"

2. The conclusion as to Sam and Charles (p. 419):  "the Court is convinced — by clear and convincing evidence — that Sam and Charles committed tax fraud."

3.  The linchpin for the offshore structure was that a key trust created in 1992 was a nongrantor trust as to Sam and Charles.  Although Sam and Charles, through their advisor, received a number of opinions as to various facets of the structure, he never received an opinion that this key nongrantor trust linchpin was met until 2003.  Actually in 1993, Sam's and Charles' advisor had been told by a lawyer that an expert on this subject had concluded that there was a "significant risk" that the trust would be characterized as a grantor trust, which would defeat the planning.  At that point, the lawyer advised that the Wylys needed a real nongrantor trust settled by someone other than Wylys so that the Wylys were not grantors.  The characteristics of such a nongrantor trust were:

(i) the grantor of the trust has known the Wylys “for a considerable period of time,” (ii) the trust is being established as “an entirely gratuitous act,” and (iii) the grantor has not received and will not receive any “consideration, reimbursement or other benefit” for settling the trust, “directly or indirectly.”

4.  Then, pursuant to the advice, "an individual residing in the IOM [Isle of Man] who Sam barely knew, King, settled a trust in February 1994 naming Sam and his family members as beneficiaries."  The factual predicates stated in the documents for the new trust were false.  But, Sam began acting as if the façade was real.

Sam starts transacting business through it offshore by undertaking two more complicated private annuity transactions in 19961672 and a myriad of extremely complicated real estate transactions involving, among other things, homes, an art gallery, and an office for himself and other family members in Texas and Colorado in the late 1990s and early 2000s1673—all tax and reporting free.

5.  Sam then causes to be settled a similar supposed nongrantor trust through the façade of a stranger, again with false statements in the documents.  The Court takes the trouble to quote the key lies in its Conclusion, so here it is with the nominal nongrantor making the statement:

I wanted to take this opportunity to let you know what a pleasure it has been knowing you over the past years and dealing with you on both business and social matters. I appreciate your many courtesies. As you know, I have established a trust with Wychwood Trust Limited, called The La Fourche Trust, for the benefit of you and your family, and have provided this trust with the sum of $25,000.00. This is to show my gratitude for your loyalty to our mutual ventures and your personal support and friendship. I hope that, wisely managed, this trust fund can grow for many years and inure to the benefit of many generations of your family.

The Court says "All of this is a lie, except that the La Fourche IOM Trust was established with Wychwood Trust Limited."  [Those who have watched bullshit offshore planning will easily recognize this type of façade built on lies.]  Based on the lies and the façade of a nongrantor trust, a legal opinion was then forthcoming that the structure depending on the façade would work tax magic.  Of course, Sam claimed not to know about the lies (meaning, if believed, Sam's own lawyer had kept him in the dark), but the Court notes:

did Sam not wonder why King and Cairns, one individual he barely knew and the other who he did not know at all, each settled a trust with $25,000 in the IOM and named him and his wife and children as beneficiaries? Perhaps that happens all the time in Sam’s life, but if it happened in mine, I would be asking questions—lots of them.

Taxpayer Denied Bankruptcy Discharge For BLIPS Related Tax Liability (8/30/14)

11 U.S.C. Section 523(a)(1)(C), here, provides in relevant part that a taxpayer may not be discharged in bankruptcy for a tax debt if one of two circumstance exist:  (i) "with respect to which the debtor made a fraudulent return" or (ii) the debtor "willfully attempted in any manner to evade or defeat such tax."

In In re Vaughn, ___ F.3d ___, 2014 U.S. App. LEXIS 16417 (10th Cir. 2014), here, the Court denied Vaughn a discharge for his tax debt arising from the bullshit tax shelter (the BLIPS variety).  In so doing, the court affirmed the bankruptcy court and the district court below.

It appears that, in denying the discharge, the courts relied principally upon the second basis for denial of discharge -- "willfully attempted in any manner to evade or defeat such tax."  The 10th Circuit found that Vaughn participated in a shaky shelter and then voluntarily depleted his assets during the long period of time before the Government finally assessed the tax liability.  (Readers will recall that substantial periods of time can elapse from  the time an  unreported tax liability arises and when it finally is assessed.)  The taxpayer claimed that his conduct was negligent at best, but not willful as required by the text of the statute, because it was before the IRS assessed the tax.  The 10th Circuit rejected the argument, holding as it had previously held that assessment of the tax is not required for the denial of discharge to apply.

Although the 10th Circuit apparently did not rely upon the first basis -- the taxpayer made a fraudulent return -- it appears from the history of BLIPS that the return was fraudulent because the BLIPS shelter was fraudulent.  I have noted that in another context -- Section 6501(c)(1), here, which has an unlimited statute of limitations "In the case of a false or fraudulent return with the intent to evade tax."  See for the most recent discussion, BASR Briefs On Issue of Unlimited Statute of Limitations for NonTaxpayer Fraud (Federal Tax Crimes Blog 8/27/14), here.  There is no textual requirement in Section 6501(c)(1) that the taxpayer make the fraudulent return; the text only requires that the return be fraudulent.  Taxpayers, of course, argue that, despite the lack of a textual requirement that the taxpayer be complicit on the fraud on the return, the text properly interpreted has an implicit requirement that the taxpayer have known the return was fraudulent and thus made a fraudulent return.  The few courts that have addressed the issue are split, with, as of now, the weight of authority that the taxpayer's fraud is not required.

In any event, the bankruptcy provision does seem textually to require the taxpayer's fraud.  Promoter or preparer fraud without the taxpayer's fraud is not sufficient to deny discharge.  So, that is not an issue.  And, as noted, the 10th Circuit seemed to have relied upon the taxpayer's fraud.  Nevertheless, the 10th Circuit did seem to at least advert to the issue of some culpability on Vaughn's part in filing the return claiming the fraudulent benefits of BLIPS (emphasis supplied):

Second, Appellant argues his "reliance on the advice of KPMG, his longtime tax advisor, that the BLIPS transaction was an aggressive but ultimately legitimate tax position might have been at worst unreasonable under the circumstances, making [Appellant] negligent," but not willful. (Appellant's Opening Br. at 23.) Appellant contends that because he innocently, even if unreasonably, relied on KPMG's advice, he cannot be found to have acted willfully. We find this argument unpersuasive under all of the circumstances in this case, particularly in light of the bankruptcy court's finding that Appellant's assertion of innocent reliance was "simply not credible." In re Vaughn, 463 B.R. at 548.