Taxpayers Should Be Prosecuted Along with Enablers of Abusive Tax Shelters (3/8/24)

This blog entry is an opinion piece. Individual taxpayers should be prosecuted along with their enablers who promote and implement the abusive shelters (particularly enablers from the tax professions).

The following is from a report of Attorney General Garland's comments (Kerry K. Walsh Deborah A. Curtis Amy Jeffress, “Swift” Justice: Attorney General Garland Vows To Uphold DOJ Priorities in Fireside Chat (Arnold & Porter 3/6/24), here):

Additionally, AG Garland explained how DOJ’s three co-equal priorities — upholding the rule of law, keeping America safe, and protecting civil liberties — implicated corporate accountability. AG Garland stressed that the greatest deterrent of white collar crime is holding individual corporate executives to account. AG Garland also reiterated the importance of applying the rule of law equally, regardless of rank or position of power.

I supplied the bold-face to emphasize the point. There has been a perception that, by delivering up the corporation (or other entity) for criminal consequences, the people in the corporations (collectively, the executives) could escape accountability.

A similar perception and resulting phenomenon exists in the tax area where the promoters of abusive tax shelters (think, for example, the Son-of-Boss shelters in the late 1990s and early 2000s) were prosecuted, but the taxpayers generally were not. Yet all of those taxpayers or at least most of them knew that they were violating the law and participated in the fraud. For example, the abusive shelters wrapped in complex structures and voluminous more-likely-than-not opinions, required at the minimum that the taxpayers represent to the promoters that they had a nontax profit motive when, in fact, they did not. That was a lie that was essential to abusive tax shelter. Moreover, most of those wealthy taxpayers had independent counsel (other than the ones supplied or recommended by the promoters) before buying into the deal. Assuming that most of those independent counsel were competent, those taxpayers knew that the deals were bogus, but nevertheless sought to buy fraud insurance through the legal opinions rendered by the promoter’s supplied or recommended counsel (as opposed to their own independent counsel). That worked as insurance.

My argument has been that the way to discourage abusive tax shelters is to prosecute the taxpayers along with the promoters. This would discourage the tax professional penalty insurance industry and abusive tax shelters generally.

This blog entry is cross-posted on the Federal Tax Procedure Blog here.

Law Firm Tax Partner Sentenced in Germany to 3 1/2 Years for Fraudulent Tax Shelters (2/7/24)

An earlier news item finally reached my consciousness this morning and gave me a déjà vu experience. A Freshfields (prominent law firm) former tax partner who gave legal advice for clients to exploit an abusive tax shelter (aka bullshit tax shelter) was sentenced to 3 ½ years incarceration for his role. The shelter has attracted the name “Cum-Ex.” See e.g., Tom Sims & Kirstin Ridley, Former Freshfields partner sentenced to jail for German tax fraud (Reuters 1/30/24), here; and Olaf Storbeck, Freshfields’ former tax partner sentenced to 3½ years in jail (Financial Times 1/30/24), here.

I don’t know exactly how the scheme worked but the generic description is summarily described in the Reuters article:

Using such dividend stripping schemes, banks and investors would swiftly trade shares of companies around their dividend payout day, blurring stock ownership and allowing multiple parties to falsely reclaim tax rebates on dividends.

The following is from the Financial Times article:

The fraud centred on share deals executed before and after a stock’s dividend payments that duped governments to reimburse taxes that were never paid in the first place.

Maple Bank’s cum-ex transactions were equivalent to “organised [financial] crime”, Gröschel [the judge' said, adding that they were highly organised, took part over several years and led to “ludicrous” financial damage.

The aim of the transactions, said Gröschel, was not just to cut the amount of tax paid but to steal from the government. Johannemann’s legal advice was “a central contribution” to that crime, he added.

“Paying [a tax] once but reclaiming [it] twice just does not work,” he said, and that “a halfway talented elementary school pupil” was able to understand that concept.

* * * *

During the trial, Johannemann acknowledged he had “glossed over the fact that my legal advice was used for illegal means”, and said he had “totally failed” as a lawyer. The judge took issue with that assessment, saying he was certain Johannemann had been aware of all relevant details of the fraudulent transactions when giving his advice.

In his ruling Gröschel also took aim at Freshfields, accusing the tax practice of one of the world’s most prestigious law firms of having developed “its own business model” that specialised in giving affirmative advice on cum-ex transactions. The fees the law firm generated from such business were “almost ridiculously low”, he said.

The latter on fees caught my eye. My experience from the abusive tax shelter era was that the fees were very large compared to the hours expended delivering the opinions when they were "cookie-cutter" opinions marketed to many taxpayers. The excess fees were a form of “get out of jail free’ insurance premium to the taxpayers paying the fees. Viewed alone from a single transaction, the excess fee would be ridiculously low, but when marketed widely among wealthy and high-income earners, the fees really could add up to ridiculous amounts. See e.g., More on the Daugerdas Case - The Role of Nonpromoter Enablers (Federal Tax Crimes Blog 6/5/11), here.

DOJ Tax Publicizes Sentencings and Plea Agreements of Syndicated Conservation Easement Enablers; Where Are the Taxpayers (1/10/24)

DOJ Tax issued a press release about sentencing and guilty pleas of enablers in abusive, illegal (maybe redundant) syndication easement tax shelters. Two Tax Shelter Promoters Sentenced to 25 Years and 23 Years in Billion-Dollar Syndicated Conservation Easement Tax Scheme; Two More CPAs Plead Guilty (Press Release # 24-29 1/9/23), here.

The lengths of the sentences are noteworthy.

The two other individuals pled guilty to a single count each of the Klein/defraud conspiracy, thus capping their potential sentences each to 5 years. Of course, they were not the masterminds of the fraudulent tax shelter scheme, but their pleas indicate that they willfully participated.

Of course, it is late in the Syndicated Conservation Easement game, so enablers in the game should be on notice now that they can be caught and punished. How much effect this will have as a future deterrent is unknown because, I suspect, many who know the downside will attempt maneuvers to prevent the IRS or DOJ Tax from discovering their complicity in such conduct. Most economic crime violators (including enablers) do not think they will be caught or their skullduggery will be understood.

My only comment relates to what I call the elephant in the room—the taxpayers willfully participating in such schemes. My experience in these elaborate abusive shelters is that well-heeled taxpayers are also complicit. Those taxpayers who are complicit feel (or at least hope) that the blizzard of paper (including fake opinions and appraisals) and participation of facially expert promoters will protect them from penalties, civil and criminal, thus giving them cost-free access to the audit lottery. But those who consulted independent counsel (and many, probably most, did at least in the Son-of-Boss shelters and, I suspect, in the Syndicated Conservation Easement Shelters) would have known the shelters did not work.

If the IRS and DOJ Tax want to discourage abusive tax shelters, it should prosecute the taxpayers involved (or at least enough of them, the more egregious ones, to send the message to the abusive tax shelter taxpayer community that there is risk of a criminal reckoning). Even where the enablers of the abusive tax shelters put together a package that facially seems to support the tax benefits claimed, most well-heeled tax shelter investors have their own independent legal counsel. Good advice would certainly include enough warning that the gambit is illegal and that their participation is willful. Prosecuting and convicting taxpayers would send the message of risk to all participating in abusive shelters and could substantially reduce the number of players involved by reducing the market for abusive tax shelters.

Tax Attorneys Indicted for Fraudulent Tax Shelter and Related Conduct (11/18/22)

DOJ announced indictments in a press release, here, titled as follows: Tax Attorneys and Insurance Agent Indicted for Promoting and Selling Fraudulent Tax Shelter. The indictment is here (CL).

The charges are

• defraud conspiracy 18 USC 371 (Count One),
• aiding and assisting 7206(2) (Counts Two through Twelve and Eighteen through Twenty-two),
• tax perjury via false tax return 7206(1) (Counts Thirteen through Seventeen), and
• wire fraud 18 USC 1343 (Count Twenty-Three). 

The indictment also alleges a Notice of Forfeiture and Finding of Probable Cause.

The pattern of conduct alleged in the press release as:

According to the indictment, from 2011 to the present Michael Elliott Kohn and Catherine Elizabeth Chollet, both attorneys and residents of St. Louis, Missouri, and David Shane Simmons, a licensed insurance agent and broker based out of Jefferson, North Carolina, conspired to defraud the United States by promoting, marketing, and selling to clients a fraudulent tax scheme known as the Gain Elimination Plan (“GEP”). The defendants allegedly designed the GEP to conceal clients’ income from the IRS by fraudulently inflating business expenses through fictitious royalties and management fees. These fictitious royalties and management fees allegedly were paid, on paper, to a limited partnership largely owned by a charitable organization. In reality, Kohn and Chollet allegedly fabricated the royalties and management fees. In total, the defendants allegedly caused a tax loss to the IRS of tens of millions of dollars.

 The indictment further alleges that Kohn and Simmons engaged in a scheme to defraud an insurance company by providing false information on insurance applications on behalf of their clients. The false information allegedly included fraudulent representations concerning the clients’ financials and the purpose of the insurance policies. In total, Kohn and Simmons allegedly caused the insurance company to issue more than $200 million in insurance policies based on false application information. Simmons allegedly earned large commissions for selling the insurance policies, many of which he split with Kohn and Chollet. Simmons also allegedly filed false personal tax returns by underreporting his business income and inflating his business expenses.

The press release alleges sentencing matters as follows:

Good Article on the Abusive Syndication Easement -- Legislative and Judicial Initiatives (6/25/22)

I recommend to readers this article:  Peter Elkind, The Tax Scam That Won’t Die (Propublica 6/17/22), here.  Key excerpts related to tax crimes:

Criminal investigations of industry practices are reportedly underway in three states. The crackdown’s most sensational case became public in February, when a federal grand jury in Atlanta indicted North Carolina developer Jack Fisher, a major syndication deal promoter and owner of Inland Capital Management. The 135-count indictment charged Fisher and six associates with participating in a conspiracy to sell $1.3 billion worth of illegal tax shelters. The charges against Fisher include wire fraud, conspiracy to defraud the U.S., money laundering and aiding in the filing of false tax returns. He has pleaded not guilty.

The indictment was backed by a string of damning statements attributed to Fisher, including several secretly recorded by an undercover government agent posing as an easement promoter.

The indictment, for example, charged that Fisher’s conservation deals relied on “fraudulent” and “grossly inflated” land appraisals, often valuing the easement properties at more than 10 times what he had paid for them just months earlier. It asserted that Fisher routinely “pre-determined” these valuations before any appraisal was actually performed, telling his two “hand-picked” appraisers what valuation he needed to generate the generous deductions he’d promised investors. In one recorded conversation described in the indictment, Fisher said one of the appraisers simply “puts down whatever we say.” In another, he said he always made sure easement valuations were high enough to make sure investors “can still get a good return on their money,” even if a later IRS audit reduced their charitable deduction.

The government also charged that Fisher frequently orchestrated the illegal backdating of checks and tax documents, allowing him to keep offering unsold stakes in his deals to investors as much as nine months after the year-end tax deadline, after the easement was already donated. In one recording, Fisher acknowledged rewarding partners at an accounting firm with free shares in an easement deal because “they participated in basically backdating all the documents.” After learning he was under investigation, according to the indictment, Fisher told one associate he could claim that backdated checks weren’t deposited until after the close of the tax year because they had been “lost” on someone’s desk.

Both appraisers, now among Fisher’s fellow defendants, have pleaded not guilty. One says on his website that his firm decided in mid-2019 to stop doing conservation easement work “until there is greater clarity from the courts on conservation easements.”

Judge Holmes Weighs (At Length) Against Taxpayers Involved in Complex Bullshit Tax Shelters; Fraud Penalties Approved (7/14/21; 7/15/21)

Back in my younger years in the practice of tax law, I heard something like an aphorism or at least a pithy statement meant to suggest some truth that the difference between a doctor and a lawyer cheating on their taxes is that the doctor will file a false return underreporting tax liability (a felony) whereas the lawyer will file no return (generally a misdemeanor).  While there may be some truth in the statement, there is probably not as much truth as those acting on it by failing to file would like to hope.

I was reminded of that statement in today’s opinion in Ernest S. Ryder & Associates, Inc., APLC. v. Commissioner, T.C. Memo. 2021-88, here.  The opinion. 191 pages long and with a table of contents to help one navigate the opinion, is written by Judge Holmes who weighs in with his usual gusto in writing.

Here is the opening (Slip Op. pp.  4-5,  footnotes omitted):

Ryder & Associates, Inc., APLC (R&A), marketed six tax-reduction strategies that produced over $31 million in revenue between 2003 and 2011. The firm’s fixed costs were low, and its out-of-pocket expenses not very large. Yet year after year it paid no income tax. Its revenue flowed instead into 560 accounts and into Ryder Law Corporation, a related S corporation.  It flowed into more than 1,100 ESOPs,  other S corporations, LLCs, and other passthroughs. It flowed into ranches in Arizona, and it flowed into other ranches in New Mexico. And then it mostly seemed to pool in places where it would benefit Ernest S. Ryder and his wife Patricia, who received more than $15 million in distributions between 2002 and 2011 but paid only $31,000 in income tax during the years at issue.

The lead petitioner is a corporation, but the case is consolidated with other cases.  The principal actor in the drama, Ryder, was an accomplished tax lawyer, with an LLM from NYU Law School.  His entry into the law practice in the 1970s was particularly auspicious as noted by Judge Holmes (Slip Op. pp. 6-7): 

His timing was fortunate--he was at the stem-cell stage of his career the year that Congress enacted the Employee Retirement Income Security Act of 1974 (ERISA). When there’s an avulsive change in the law like ERISA, young lawyers can develop valuable expertise in an environment uncluttered with more senior competitors.

Knowledgeable associates in a fast-growing field are a hot commodity, and in 1975 Ryder was hired away by Harrigan, Ruff & Osborne to help that firm’s clients get their retirement plans qualified under the new law. “[T]hat’s when my career really took a turn,” Ryder explained, and he was well on his way to becoming an expert in qualified retirement plans.

Judge Holmes recounts Ryder's trajectory thereafter to include (Split Op. 8 & 9, footnotes omitted):

The aggressiveness of Ryder’s tax-reduction strategies seems to have caused some tension with his partners at Ruff Ryder, and he was asked to leave the firm sometime in 1995. Ruff Ryder’s entire pension department and its profit-sharing clients left with him. With ample experience and a fully staffed pension practice, Ryder decided to open up his own firm in early 1996. And here begins the Ryders’ tax problems. R&A is a professional law corporation and has always been taxed as a C corporation. Ryder has owned 100%, and has acted as president, of R&A since its creation. We find that Ryder also provided 100% of his legal services to clients through R&A during the years at issue. 

Despite its success and longevity, R&A reported zero taxable income from 2002 through 2011. The Ryders also reported minimal taxable income on their individual returns for those years.

I can't help but point out the catchy firm name "Ruff Ryder."

CA9 Holds that Suspension of Limitations Act (“WSLA”) Applies to Fraud and Property Offense Crimes Without Nexus to War or Authorized Use of Armed Forces (5/13/21)

In United States v. Nishiie, 996 F.3d 1013 (9th Cir. 5/12/21), here, in a nontax criminal case, the Court held that the Wartime Suspension of Limitations Act (“WSLA”), 18 U.S.C. § 3287, here, applies to suspend the criminal statute of limitations for fraud and property offense crimes “whether or not a nexus exists between these offenses and either war or ‘authorized use of the Armed Forces.’“ (Quote is from the Ninth Circuit’s Summary.)

 After reaching that conclusion, the Court said (Slip Op. 29-32, emphasis supplied):

            We recognize the WSLA “creates an exception to a longstanding congressional ‘policy of repose’ that is fundamental to our society and our criminal law.” Bridges, 346 U.S. at 215–16. The WSLA suspends already-running statutes of limitation when its conditions are met. As we detail, the WSLA unambiguously tolls the statute of limitations during any period of war or authorization of the use of the Armed Forces. We are acutely aware—and somewhat concerned—that this interpretation, while legally correct, may effectively toll the statute of limitations for offenses under the WSLA for 20, 30, even 40 plus years. In large part that results from the expansion of war powers far beyond what they were when the WSLA was codified in 1948. Any policy concern for subjecting defendants to [*30] decades-long liability is subordinated to the WSLA’s unambiguous language.

            “We sit as judges, not as legislators . . .” California v. Ramos, 463 U.S. 992, 1014 (1983). “It is hardly this Court’s place to pick and choose among competing policy arguments . . . selecting whatever outcome seems to us most congenial, efficient, or fair. Our license to interpret statutes does not include the power to engage in . . . judicial policymaking.” Pereida v. Wilkinson, 141 S. Ct. 754, 766–67 (2021). Inducing perpetual limbo for potential criminal defendants under the WSLA is presumably not what Congress had contemplated. Nor did the 1940s era Congress likely anticipate the transformation of warfare. Our interpretation may seem like a gratuitous reading in light of modern criminal justice reform. “But our public policy is fixed by Congress, not the courts.” Bridges, 346 U.S. at 231 (Reed, J., dissenting). Readily apparent from the WSLA’s amendment history is that Congress is fully capable of changing course and cabining the reach of any statute of limitations if it decides public policy warrants such a change. See Ramos v. Wolf, 975 F.3d 872, 900 (9th Cir. 2020) (R. Nelson, J., concurring) (“Our sole responsibility as Article III judges is narrow—‘to say what the law is.’”) (quoting Marbury v. Madison, 5 U.S. (1 Cranch) 137, 177, 2 L.Ed. 60 (1803)); id. (“By constitutional design, the branch that is qualified to establish . . . policy and check any excesses in the implementation of that policy is Congress.”) (citing City & Cnty. of San Francisco v. U.S. Citizenship & Immigr. Servs., 944 F.3d 773, 809 (9th Cir. 2019) (Bybee, J., concurring)).

NYT Article on Bristol Meyers Aggressive Tax Position With Discussion of Role of Professionals Peddling Audit Risk Insurance through Fees for Faulty Opinions (4/3/21)

 Readers of this blog will likely be interested in this article.  Jesse Drucker, An Accidental Disclosure Exposes a $1 Billion Tax Fight With Bristol Myers (NYT 4/1/21), here.  The article recounts Bristol Myers's use of a highly complex offshore arrangement to avoid (perhaps evade) over $1 billion in U.S. tax.

The thing that I think is particularly interesting for those who have watched bullshit tax shelters over the years is the use of professionals (accounting firm and law firm) to attempt to insulate wealthy taxpayers from penalty consequences of their abusive behavior.  As recounted in the article, Bristol Meyers obtained lengthy opinion letters from PWC, the accounting firm, and from White & Case, the law firm.  The article says that the opinion letters omitted a key discussion that might have cast a pall on the opinion and reliance on the opinion.  The article says:

In addition to detailing the offshore structure, the I.R.S. report revealed the role of PwC and White & Case in reviewing the deal. While both firms assessed the arrangement’s compliance with various provisions of the tax law, neither firm offered an opinion on whether the deal violated the one portion of the tax law — an anti-abuse provision — that the I.R.S. later argued made the transaction invalid.

Tax experts said they doubted the omission was inadvertent. The I.R.S. can impose penalties on companies that knowingly skirt the law. By not addressing the most problematic portion of the law, Bristol Myers’s advisers might have given the company plausible deniability.

Both firms “appear to have carefully framed the issues so that they could write a clean opinion that potentially provided a penalty shield,” Professor Burke said.

David Weisbach, a former Treasury Department official who helped write the regulations governing the tax-code provision that Bristol Myers is accused of violating, agreed. PwC and White & Case “are giving you 138 pages of legalese that doesn’t address the core issue in the transaction,” he said. “But you can show the I.R.S. you got this big fat opinion letter, so it must be fancy and good.”

Over the years, many have observed that such opinion letters serve the sole function of insulating the taxpayer (or, in the case of entities, its officers or managers) from potential penalty liability, including criminal liability.  Those taxpayer knows it is misbehaving but, armed with an opinion from "experts," the taxpayer can say that he reasonably believed he was not misbehaving and thus avoid penalty exposure, at least the serious penalty exposure of criminal liability or the more significant civil penalty liability (civil fraud penalty).  Then with only perhaps imagined exposure only to perhaps a 20% or 40% civil penalty, it may be worth rolling the dice in the hopes that the IRS would never discover the matter.  This is likely a cost/benefit analysis.  What are the costs and potential benefits?  Say for a $1 billion in tax, a  downside (if able to mitigate the more serious penalties) so that only a 20% accuracy related penalty could apply, the downside cost is $1.2 billion with interest (fairly low for a $1 billion "borrowing" from the Government).  The upside is $1 billion in avoided (perhaps evaded) taxes.  And, with powerful and expensive in house and out house professionals helping to lower the risk of audit of the transaction, that may seem to some like a pretty good deal.

Corporate Taxpayer (AIG) "Settles" Tax Shelter Litigation Admitting Tax Shelters Were Shams (10/24/20)

The SDNY U.S. Attorney (Acting) issued this stunning press release yesterday:  Acting Manhattan U.S. Attorney Announces Settlement Of Tax Shelter Lawsuit Against AIG For Entering Into Sham Transactions Designed To Generate Bogus Foreign Tax Credits (USAO 10/23/20), here.   Key excerpts for this blog entry (most of the release) are:

Audrey Strauss, the Acting United States Attorney for the Southern District of New York, announced today the settlement of a tax refund lawsuit brought by insurance and financial services company AMERICAN INTERNATIONAL GROUP, INC. (“AIG”) involving seven cross-border financial transactions that the United States asserted were abusive tax shelters designed to generate bogus foreign tax credits that AIG improperly attempted to use to reduce its tax liabilities in the United States.  AIG filed this tax refund lawsuit in 2009, seeking to recover disallowed foreign tax credits and other taxes related to the 1997 tax year.  The United States obtained overwhelming evidence that these transactions lacked any meaningful economic substance, were devoid of any legitimate business purpose, and instead were designed solely to manufacture hundreds of millions of dollars in tax benefits to which AIG was not entitled.  According to the terms of the settlement, approved yesterday by United States District Judge Louis L. Stanton, AIG agreed that all foreign tax credits that AIG claimed for the 1997 tax year and all later tax years for these same transactions, totaling more than $400 million, would be disallowed in their entirety.  AIG further agreed to pay a 10% tax penalty.

Acting U.S. Attorney Audrey Strauss said:  “AIG created an elaborate series of sham transactions that were designed to do nothing – and in fact did nothing – other than generate hundreds of millions of dollars in ill-gotten tax benefits for AIG.  Our system of taxation is built upon the premise that all citizens and corporations must pay the taxes they owe, no more and no less.  People and companies who game that system to avoid paying their fair share of taxes undermine public trust in our tax laws.  We will continue to be vigilant in holding accountable those who use economically empty transactions to avoid paying their taxes.”

As alleged in filings in Manhattan federal court:

During the mid-1990s, AIG Financial Products Corp. (“AIG-FP”), a wholly-owned subsidiary of AIG, designed, marketed, and entered into seven cross-border structured finance transactions with various foreign banks.  These complicated transactions, involving hundreds of agreements, numerous shell companies, and intricate cash flows, had no economic substance but rather exploited differences in U.S. and foreign tax laws to create profits from U.S. tax benefits.  In particular, the transactions generated more than $400 million in foreign tax credits that AIG used to reduce its U.S. tax liabilities.  The U.S. has a worldwide tax system that taxes companies on income earned abroad, but also grants credits for foreign taxes paid.  AIG, was able to turn a profit by obtaining credits from the U.S. Treasury for foreign taxes it did not actually pay in full.  AIG obtained more than $61 million in foreign tax credits during the 1997 tax year alone, the tax year resolved by the settlement. 

In 2008, the Internal Revenue Service (“IRS”) issued a Notice of Deficiency to AIG that, among other things, disallowed the foreign tax credits AIG had claimed in connection with the seven transactions and asserted a 20% tax penalty.  In 2009, after paying the deficiency, AIG filed a lawsuit against the United States in Manhattan federal court challenging the IRS’s determination and demanding a refund.  In response, the United States asserted that the IRS had correctly disallowed the tax benefits because the transactions had no economic substance, a basic requirement for seeking tax benefits. 

According to the terms of the Settlement, AIG agreed that all foreign tax credits that AIG claimed in connection with the seven cross-border transactions that were the subject of the litigation would be disallowed in full for the 1997 tax year and all subsequent tax years during which the transactions were operating, totaling more than $400 million.  AIG further agreed to pay a 10% penalty.  The settlement allows AIG to retain certain income expense deductions relating to six of the transactions that were structured as borrowings, as well as remove certain amounts related to the transactions from its taxable income.  In addition, the settlement resolves certain of AIG’s tax refund claims unrelated to the cross-border transactions stemming from AIG‘s restatement of its publicly filed financials.

One nuance not in the press release is that the press release suggests that the penalty is 10%.  The IRS originally proposed a substantial understatement penalty and a negligence penalty.  Both of those penalties are 20% but only one can apply, so that the taxpayer's maximum exposure before the settlement was 20%.  Under the settlement, the taxpayer concedes the substantial understatement or negligence penalties for the bullshit transaction.  (See paragraph 7 of the Stipulation and Order of Settlement.)  That might suggest that the settlement could be read to imply some level of merit in the taxpayer's position, although I suspect that, from the Government's perspective, it was viewed that as simply a nuisance cost to the Government to resolve this bullshit litigation without expenditure of resources required to litigate the matter.

Of course, large corporations who should know better making sham (aka bullshit) tax shelter claims are not particularly unusual as I have noted on this blog.  But this litigation has one nuance that jumped out that I had not really focused on before – that is, the role of counsel bringing suits to sustain tax shelters that are shams.  I guess that problem lurked in all of the other civil litigation involving bullshit tax shelters.  But it just hit me here.  (I never personally had to face that issue because over my career of practice, I declined to represent taxpayers or promoters in civil tax cases involving bullshit tax shelters; although I do have an anecdote about that which I recount at the end of the blog.  See JAT Comments par. 2)

The question I ask is how exactly does an attorney sign the initial pleading and otherwise participate in a suit, either in the Tax Court or in one of the refund forums (district court or Court of Federal Claims), alleging that a sham tax shelter is entitled to the claimed tax benefits?  OK, I know, the argument is that sham is in the eye of the beholder so long as the technical tax traps appear to be checked off (even when sometimes they are not)?  The question I ask and cannot answer here is what is the role of the lawyers making such claims in litigation?  But, just think about how much energy (creative and  otherwise), time and resources were spent unnecessarily in creating the sham tax shelter to start with and then marshaling it through the administrative audit process (audit and appeals) and litigation before the taxpayer admitted the whole deal was a sham.  Isn’t there some better way to deploy our resources?

Extradited E&Y Tax Shelter Enabler Sentenced (6/9/20/ 6/10/20)

I have often posted on the Government’s criminal prosecution of persons promoting abusive tax shelters.  There were a number of prosecutions starting around 2005 as the Government focused on major accounting firms, law firms and financial firms and the persons involved with them.  One set of the prosecutions related to principals at Ernst & Young, the accounting giant.  I blogged on a major Second Circuit decision in the prosecutions and included further links to the blogs on the E&Y prosecutions.  Major CA2 Decision on E&Y Tax Shelter Convictions (Federal Tax Crimes Blog 11/29/12), here; see also E&Y Admits Wrongdoing on Bullshit Tax Shelters; Will Pay $123 Million (Federal Tax Crimes Blog 3/1/13), here.

One of the E&Y defendants in the prosecution, David Smith, reached a plea agreement but left the country before he could be sentenced and serve whatever time would be imposed.  After fighting extradition for years, Smith, an attorney and one of the major facilitators at E&Y, was extradited and sentenced yesterday to three years in prison, the maximum that he could be sentenced under his plea agreement.  The Bloomberg news report is here:  Chris Dolmetsch, Lawyer Who Ran From Ernst & Young Tax Shelter Case Gets 3 Years (Bloomberg News Wire 6/8/20), here. 

According to the article, Smith requested that “he be sentenced to the 11 months he’d already served in New York’s Metropolitan Correctional Center,” after extradition.  Apparently, he also cooperated earlier during the initial investigation phase and reached the plea agreement before he fled the country, so that would be a positive factor for him.  And, in mitigation, Smith claimed that he did not go on the lam to avoid incarceration, but because of the 9/11 events; moreover, he claimed, "he feared prosecutors would renege on promises of leniency after he fully cooperated with their investigation."  The judge imposed the harshest sentence he could under the plea agreement.  I gather that the judge did not buy Smith's claims.  

It is a good thing that his attorneys negotiated a plea with a maximum possible sentence of three years.  The plea was to tax perjury, § 7206(2).  Attached here is a copy of the judgment on CourtListener.  The plea agreement was quite very favorable for Smith given his apparent role in the overall scheme.

Note the last paragraph was revised 6/10/20 12:00pm to reflect that the plea agreement was to § 7206(1), tax perjury, rather than § 7212(a), tax perjury, as I had speculated in the original version.  Either way, the incarceration period is limited to three years.  And, the major point was that the plea was a sweet deal given his apparent role.  Of course his time being held from the date of extradition to the sentencing does not count toward the sentence, but that period is really attributable to the fact that he fled the country rather than punishment for the underlying crime.

Bullshit Shelter Taxpayers Continuing FOIA Litigation to Identify Informants Turning Them In to IRS (3/30/20)

FOIA requests and litigation have not been featured prominently on this blog.  For this entry, FOIA litigation is front and center, but interesting for a tax crimes blog because of what the FOIA requesters (in the role of taxpayers in this case) seek from the IRS – the identity of the whistleblower, if one exists, who turned them in for attempting a raid on Treasury via a bullshit tax shelter.  In United States v. Montgomery (D. D.C. No. 17-918 (JEB) Memo Op. Dtd 3/25/20), here, the Court starts:

This Freedom of Information Act dispute represents the latest round in Plaintiffs Thomas and Beth Montgomery’s never-ending heavyweight bout with the Internal Revenue Service over their multi-billion-dollar tax-shelter scheme. After settling various financial disputes with the agency, Plaintiffs submitted FOIA requests to Defendant in order to discern whether a whistleblower had incited the agency’s investigation. The Service’s responses, however, did not bring Plaintiffs any closer to discovering the source of their woes. Frustrated in their pursuit of this information, they filed suit in this Court. 

In response to the previous round of summary-judgment motions, the Court held that Defendant had appropriately invoked Glomar with respect to one category of Plaintiffs’ requests but had failed to conduct an adequate search as to the other. History repeats itself here in regard to the current dispositive Motions. Once again, Defendant has justified its invocation of  Glomar as to certain potential documents, but it has otherwise not conducted an adequate search. The Court will therefore grant in part and deny in part the parties’ Motions for Summary Judgment and direct the IRS to renew its search.

A Glomar response a FOIA response that “neither confirms nor denies the existence of documents responsive to the request” because it would cause cognizable harm under a FOIA exception.  E.g., Ctr. for Constitutional Rights v. C.I.A., 765 F.3d 161, 164 (2d Cir. 2014).  Obviously, the IRS does not either want to disclose that there was an informant or the name of the informant if there was an informant.

Then the Court recounts the facts:

The Court has recounted the facts surrounding this prolonged tax saga in several of its prior Opinions, but it will provide a brief recap here. See, e.g., Montgomery v. IRS, 292 F. Supp. 3d 391, 393–94 (D.D.C. 2018). In the early 2000s, Plaintiff Thomas Montgomery helped form several partnerships that were structured so as to facilitate the reporting of tax losses without those entities’ experiencing any real economic loss. Id. at 393. These “tax-friendly investment vehicles” allowed Thomas and his wife Beth, filing jointly, to report the entities’ alleged losses as part of their individual tax returns. Id. (alteration omitted). In other words, Plaintiffs were able to enjoy the tax benefits of experiencing an investment loss without shouldering the consequent burdens of such a loss. Somehow — and the Montgomerys are determined to learn exactly how — the IRS caught wind of their use of these vehicles, setting into motion over a decade of litigation on the issue. 

After examining the structure of the partnerships, the IRS issued “final partnership administrative adjustments” (FPAAs) as to two of them, which resulted in the agency’s imposing certain penalties and disallowing some of the losses the Montgomerys had claimed on their individual returns. Id. at 393–94. Next, the partnerships sued the Service in several separate actions, seeking a readjustment of the FPAAs (for those keeping score at home, this would amount to a readjustment of the adjustments). See Bemont Invs., LLC v. United States, 679 F.3d 339 (5th Cir. 2012); Southgate Master Fund, LLC v. United States, 659 F.3d 466, 475 (5th Cir. 2011). Ultimately, the Fifth Circuit affirmed the IRS’s determination that the partnerships had substantially understated their taxable incomes, Bemont, 679 F.3d at 346, but held that one transaction by the Southgate partnership had a legitimate investment purpose. Southgate, 659 F.3d at 483. With these mixed verdicts in hand, the Montgomerys and the partnerships pursued thirteen separate suits against the IRS, seeking, inter alia, a refund of assessed taxes and penalties. Montgomery, 292 F. Supp. 3d at 394. The cases were ultimately consolidated, and the parties reached a global settlement agreement in November 2014 that entitled the Montgomerys to more than $485,000. Id.

Thus, while the Montgomerys did get a substantial refund, it appears that they lost their claims to even more substantial refunds.  The Montgomerys walked away from the settlement of their tax liabilities with an ax to grind--with an informant causing their woe, if there was an informant.

The Court then addresses the particular skirmish in this long running saga, calling it "Another turn of the hamster wheel."

I don’t know that there is anything more to say about this continuing saga other than that the bullshit tax shelter abusers must have more money than they apparently need.

Cross posted on Federal Tax Procedure Blog, here.

Follow Up on the Biggest Tax Heist Ever (1/30/20)

I wrote previously about an alleged scheme to steal revenue from various European countries based on claims for refund from so-called “cum-ex” trading.  NYT Article on Perhaps Biggest Tax Heist Ever (1/24/20), here.

I still don’t know the details of the precise scheme but have read in cases I cite at the end of this blog that it operated by having entities (retirement and pension plans) purportedly owning Danish stock on which Danish tax was withheld make claims for refund of the withheld tax under certain double tax treaties.  The cases I cite below involve the U.S. double tax treaty with Denmark.  In very high level summary, the basis for the claim for refund required, at a minimum, that the claimant own the stock that paid the dividend from which tax was withheld and paid over to the Danish tax authority (acronymed in the U.S. to SKAT).  SKAT came to believe that the claimants did not own the stock on which thy claimed the refund.  SKAT took steps under its tax procedures to recover the refunds; under those procedures pending in Denmark, SKAT claims that it is entitled to recover the erroneous refunds.  In addition, SKAT filed U.S. suits against the various U.S. entities causing the claims to be made.  In the U.S. suits, Denmark is not invoking its tax claims qua tax claims but is instead invoking “six common law claims against the defendants. Counts One and Two allege fraud and aiding and abetting fraud. Count Six alleges negligent misrepresentation. And Counts Three through Five allege payment by mistake, unjust enrichment, and money had and received.”  That U.S. litigation has been consolidated into a multi-district litigation (“MDL”) case being managed by Judge Lewis Kaplan of S.D.N.Y.  (Judge Kaplan, here, is one of the best trial judges I have appeared before in my career.)  The cases below were rendered in that MDL.

Here is a key allegation from In Re SKAT Tax Refund Scheme Litigation, 356 F. Supp. 3d 300, 309 (S.D. N.Y. 2019) (footnotes omitted):

SKAT alleges that these refund claims were fraudulent because the defendant plans did not own shares in the Danish companies that they purported to own.[12] It argues that it was not possible for the plans to have owned the shares they purported to own because many, including The Bradley London Pension Plan ("Bradley Plan"), were single-participant 401(k) plans limited to approximately $116,500 in contributions per year, yet they claimed to own millions of dollars of stock in Danish companies within the first year of their existence.[13] The numbers, the plaintiff argues, simply do not add up. The defendants therefore were not entitled to the dividends they claimed to have earned and were not entitled to the tax refunds they claimed under the U.S.-Denmark Treaty.[14] SKAT allegedly paid out approximately $2.1 billion as a result of this fraudulent tax refund scheme.[15]

I infer that the claim to have owned millions of dollars of stock when they had limited contributions must have require some "phony" loans of the type often see in bullshit tax shelters.

NYT Article on Perhaps Biggest Tax Heist Ever (1/24/20)

The NYT has this article:  David Segal, It May Be the Biggest Tax Heist Ever. And Europe Wants Justice (NYT 1/23/20), here.  I haven't yet figured out how the scam works, but it is a cum-ex deal.  The article says cryptically:

Through careful timing, and the coordination of a dozen different transactions, cum-ex trades produced two refunds for dividend tax paid on one basket of stocks. 

One basket of stocks. Abracadabra. Two refunds.

Another quote:

Before it all unraveled, the cum-ex ecosystem of lawyers, advisers and auditors enjoyed heady days. Last year, the lawyer who testified anonymously at the Bonn trial described the culture of the cum-ex world to Oliver Schröm and Christian Salewski, two reporters on the German television show “Panorama,” under disguising makeup. It was a realm beyond morality, he said: all male, supremely arrogant, and guided by the conviction that the German state is an enemy and German taxpayers are suckers.

And another quote:

American bankers didn’t try cum-ex at home because they feared domestic regulators. So they moved operations to London and treated the rest of Europe as an anything-goes frontier. Frank Tibo, a former chief tax officer at a bank where Mr. Shields and Mr. Mora worked, said American and British cum-ex traders regarded the Continent as a backwater of old economies ripe for swindling.

The article says that the traders were reluctant to pull the scam in the U.S., so did so in Europe.  One of the larger scammers is reported to tell his cohorts queasy about the scam:

“Whoever has a problem with the fact that because of our work there are fewer kindergartens being built,” Dr. Berger reportedly said, “here’s the door.”

As I read the article, I kept thinking about the Son-of-Boss bullshit tax shelters where lawyers, major law firms, accountants, major accounting firms, brokers, brokerage firms, financial and math gurus and others came together to create and implement raids on the U.S. Treasury.

JAT Comment:

More on Abusive Conservation Easements (12/28/19)

Peter Reilly has a good discussion on an abusive conservation easement.  IRS Grinch Ruining Christmas For Syndicated Conservation Easements (Forbes 12/24/19), here.  The fatal flaw in such easements is the valuations (dare I say bullshit valuations).  These are just variations of many shelters in the 1970s and early 1980s where the fatal flaw was the valuations.  They are therefore just a variation of bullshit tax shelters when the crux of the shelter is major overvaluations.

Peter points to the IRS News Release, IR-2019-213, here, Excerpts from the release:

On Dec. 13, 2019, the U.S. Tax Court entered its first decision on a syndicated conservation easement transaction. In TOT Property Holdings, LLC v. Commissioner, Docket No. 005600-17, the Tax Court sustained in its entirety the IRS's determination that all tax benefits from a syndicated conservation easement transaction should be denied and that the 40% gross valuation misstatement and negligence penalties applied. The Tax Court found that the transaction failed the legal requirements applicable to donations of land easements and, in imposing the gross valuation misstatement penalty, found that the actual value of the easement donation was less than 10 percent of what was originally reported on the tax return. 

"In denying the deductions and upholding the 40% gross valuation misstatement penalty, the Tax Court confirmed that aggressive syndicated easement transactions simply will not survive scrutiny," said IRS Commissioner Chuck Rettig. "We will not stop in our coordinated pursuit of these abusive transactions while seeking the imposition of all available civil penalties and, when appropriate, various criminal options for those involved." 

"If you engaged in any questionable syndicated conservation easement transaction, you should immediately consult an independent, competent tax advisor to consider your best available options," Rettig added.

Peter's posts are usually very good, and this is not exception.

Also, in a related development, in United States v. Zak (N.D. Ga. Dkt. 18-cv-05774-AT Order dated 12/10/19, here), the Court considered a government suit against allegedly abusive shelter promoters.  The Court rejects the defendants' motions, except for one count against Zak which is dismissed without prejudice.

Key excerpts from the Order are (emphases supplied by JAT):

"The Government alleges that defendants ran a “conservation easement syndication scheme.'"

* * * * 

The Government laid out eleven discrete steps that represent the “general pattern” the defendants took in enacting their conservation easement offerings. (Doc. 1 at 18–22.) In brief, according to the Government, the defendants first formed an LLC to take ownership of a piece of land, then hired an appraiser to provide an appraisal of the land, which would be used later in tax filings. (Id. at 18–19.) The defendants then marketed ownership interests in the LLC – whose value is derived only from the possible future tax benefit of converting the land to a conservation easement – to wealthy persons who may seek to maximize their tax benefits. (Id. at 19–20.) The marketing of the LLC clearly explains how the conservation easement might benefit a person in a particular tax bracket by reducing his or her tax burden substantially. (Id.) Once all stakes are sold, the LLC designates the land as a conservation easement, finalizes the appraisal of the land’s value, and prepares its own tax return. (Id. at 20–21.) The LLC is formed as a pass-through entity, so the sizable tax benefit it incurs for designation of the land is then passed through it to the investors themselves. (Id. at 16.) The investors list the conservation easement tax burden on their personal income tax returns, reducing their own tax liability. (Id. at 21–22.)

D.C. Circuit Swats Down Bullshit Tax Shelter (11/29/19)

In Endeavor Partners, LLC v. Commissioner, ___ F.3d ___ (D.C. Cir. 2019), here, the Court affirmed the Tax Court’s strike-down of yet another bullshit tax shelter, Endeavor Partners, LLC v. Commissioner, T.C. Memo. 2018-96, here.  In broad overview without getting into the weeds, these shelters do very large highly leveraged offsetting trades with relatively little cash outlay and no real economic risk.  The resulting transactions produce very large nominal gains with offsetting nominal losses, with in net no material risk and no material gain.  The nominal gains are allocated to tax indifferent parties, and the nominal losses are allocated to wealthy taxpayers with high taxable income to offset their income and thus avoid (or, in many cases, evade) tax on their income.

I start with the marvelous Tax Court opinion by Judge Lauber because he does get into the weeds.  Here is the overview from p. 3 of the Slip Op.:

Finding that the transactions lacked any economic substance whatsoever, we will sustain respondent’s disallowance of the loss deductions in question. But we are unable to sustain the accuracy-related penalties determined under section 6662(a). Although the partnerships’ conduct is plainly deserving of penalty, respondent has conceded that the IRS did not secure, prior to the issuance of the FPAAs, written supervisory approval of the penalties as required by section 6751(b)(1). 

Basically, the principal behind one of the promoters was Andrew D. Beer, but he had many enablers, including prominent accounting firms (Arthur Andersen and Ernst & Young), at least one prominent law firm (Arnold & Porter, whose more likely than not opinion was highly marketable), and Deutsche Bank ("DB", which implemented the illusory financial transactions and made the purported loans backing them).  Arnold & Porter alone was paid about $10 million for something.  I started to call them legal fees, but that gives them a dignity they do not deserve.  A better description is that they were insurance premiums sold to wealthy participants in the shelter to protect them (they hoped) from criminal and civil penalties for claiming tax shelter benefits that any reasonable and half-way intelligent person would have known were too good to be true.

So, the Tax Court in 66 pages lays bare the perfidy of these actors, albeit dressed in tax lingo that somehow detracts from the fact that these bullshit shelters, and this one specifically, were simply fraudulent raids on the U.S. Treasury.

So, how does one defend such nonsense?  I have not looked through the Tax Court briefs, but the Tax Court did find Mr. Beer and the expert witnesses not credible on any issue in the case.  So, further obfuscation was the defense.  It did not work at the trial level.

To their credit, the attorneys for the bullshit shelter in their appellate brief opened as follows:

Delta and its affiliates (collectively the “Delta Group”) were involved with certain so-called “tax shelters” that we recognize this Court has viewed with disfavor. At issue here, however, is not whether any transaction was a “tax shelter” or whether any “tax shelter” was valid. Rather, the issues on this appeal are principled ones of evidence and fundamental procedural fairness. We respectfully urge the Court to focus on how the Tax Court applied the rules of evidence rather than on the subject matter to which it applied them.

Just as the shelter dodged the bullet on the accuracy related penalty because of the IRS’s footfault on the § 6751(b) written manager approval requirement, it tried to avoid the consequence of its bullshit because, it alleged, the Tax Court treated it unfairly from a procedural perspective.

Report of IRS Criminal Interest in Captive Insurance Shelters (11/17/19)

It is reported that the IRS is looking to make criminal referrals to CI in § 831(b) captive insurance cases.  Jay Adkisson, IRS Suggests Criminal Referrals To Be Made In Abusive 831(b) Captive Tax Shelter Cases (Forbes 11/17/19), here.  The article cites as its source an article written by Aysha Baghi in Bloomberg's Tax Management Weekly Report™ which in turn cites SB/SE Commissionier Eric Hylton at a conference.

Adkisson notes the potential targets:

1. Promoter (captive manager) who could have been subject to promoter examination and continued to market the product even after Notice 2016-66.

2. Actuaries who provided studies making “unsupportable predictions about claims and losses, i.e., so-called ‘whore actuaries’.”

3. The captive owners who continued to take deductions after the Notice.

Adkisson speculates that, while referral to CI is one thing, as to referral from CI to DOJ Tax, the target environment is “ not so rich since DOJ-TAX would have to prove tax fraud beyond a reasonable doubt, which is a much higher standard than that something is a mere tax shelter.”  Adkisson notes:

Here, it would likely be a captive manager and their client who was caught fabricating claims after-the-fact so as to try to justify the premiums paid to the captive, or the IRS had audio tapes or other evidence of the captive manager selling the captive as a tax shelter but then later falsely testifying that there were no tax motivations for the arrangements.

Adkisson notes that the IRS may seek promoter injunctions, but that “the forecast for a criminal injunction before 2020 is probably pretty low.”  I think he means criminal prosecution rather than criminal injunction.

11th Circuit Affirms Convictions of Promoters of Insurance Premium Scam Bullshit Tax Shelter (3/27/19)

In United States v. Donaldson, 2019 U.S. App. LEXIS 8684 (11th Cir. 2019) (unpublished), here and here, the Tenth Circuit affirmed the district court's convictions of Dionaldson and Crithfield for conspiring to defraud the United States, 18 U.S.C. § 371, and willfully aiding the submission of false and fraudulent income tax returns, 26 U.S.C § 7206(2).  Basically, they sold their clients bullshit tax shelters in the guise of a Business Protection Plan (BPP). Essentially, the customers would pay purported business insurance premiums, purportedly deductible for tax purposes, for a plan that was not insurance but returned most of the "premiums" to the clients, less the promoter's rake off.  I have previously written on the prosecutions and convictions.  Bench Trial Convictions on Offshore Business Insurance Scams (Federal Tax Crimes Blog 7/13/17), here.  That prior blog entry contains much of the detail for better understanding the scam.

The Court of Appeals held:

1. The evidence was sufficient to support the convictions, going through the facts and the elements of the crimes of conviction. The essential holding on appeal was that the BPP was a substantive sham and the defendants were willful in promoting the sham, thus supporting the conviction for the defraud conspiracy (18 USC § 371)  and aiding and assisting (§ 7206(2)).

2.  The District Court did not improperly deny the motion for acquittal or new trial.  The claim asserted on this basis related to Donaldson.  Donaldson claimed that the district court had improperly "persuaded" him not to call a witness, a lawyer who gave an opinion supporting the BPP, who might have supported his reliance on counsel defense.  The actual opinion was in evidence.  The judge simply stated, after admitting the opinion, what the lawyer's testimony would add.  Donaldson's lawyer then made a strategy decision not to call the lawyer as a witness.  No error there.  The Court of Appeals discussion includes this:

Moreover, the district court did not find, as Donaldson suggests, that the coverages offered within the BPP were superfluous for all purposes. Rather, the district court found that the coverages were superfluous for the specific customers who bought them, including one doctor's office that purchased wholly unnecessary insurance for protection against international kidnapping.

3.  The District Court properly rejected the appellants' motion to suppress evidence seized by search warrant.

JAT Comment: All in all, a fairly routine case which is why, I suppose, the opinion is nonprecedential.  However, for those wanting more about the case, please go to the prior blog linked above discussing the bench opinion convicting the defendants/appellants.

Court Orders Disgorgement of $50 Million Gross Receipts for Bullshit Tax Shelter (10/6/18)

I wrote yesterday on the bullshit tax shelter of the Exelon Corporation, a major corporation.  Today, I write on another, less sophisticated, genre of bullshit tax shelter -- those promoted to the less sophisticated.  I say less sophisticated because it was not wrapped in a smog of paper like Exelon and others of its genre and, at the end of the day, relies on less sophisticated techniques, principally overvaluation, that has been the problem in abusive tax shelters for years.

DOJ announced here that, in United States v. RaPower-3, LLC, et. al. (D. Utah 10/4/18), here, the Court (i) ordered abusive tax shelter promoters "to disgorge over $50 million in gross receipts" from the abusive tax shelter and "barred defendants from promoting and marketing the scheme and ordered them to take steps to ensure that the public is not further harmed by their actions." 

Key excerpts from the announcement:

Based upon evidence the government submitted to the court during a 12-day bench trial, the court found that the defendants engaged in a “massive fraud.” The court stated that the defendants “each knew, or had reason to know, that their statements about the tax benefits purportedly related to buying solar lenses were false or fraudulent.” 

The court stated that “[b]ecause of the manner in which Defendants promoted the scheme, the court concludes that $50,025,480 in gross receipts from the solar energy scheme came from money that rightfully belonged to the U.S. Treasury.” The court found that the defendants “obstructed discovery about their gross receipts and other topics involving their finances.” 

The court stated that the United States showed a “reasonable approximation” of the total gross receipts from lens sales. In addition, the court held that defendants would not be allowed any credit of operating expenses because such credits “are not consistent with principles of equitable disgorgement.” 

According to the opinion, defendant Neldon Johnson claimed to have invented purported solar energy technology involving solar thermal lenses placed in arrays on towers. The court found that to “make money from this purported solar energy technology, Johnson decided to sell a component of the purported technology: the solar lenses.” 

Under the proper circumstances, the Internal Revenue Code allows a taxpayer engaged in a trade or business certain tax deductions for expenses the taxpayer incurs while generating income. Likewise, if all of the requirements are met, the tax law allows an “energy credit” for certain “energy property.” 

However, in this case, the court concluded that the defendants “knew, or had reason to know, that their customers were not in a trade or business of leasing out solar lenses and, therefore, that their customers were not allowed the depreciation deduction or solar energy tax credit.” 

The opinion also concluded that the defendants made “gross valuation overstatements” when they sold lenses to customers. The court found that the defendants sold each lens for a total purported price of $3,500. The court stated that the evidence showed that the raw cost of each supposed “lens” was very low and found that “[d]efendants’ technology does not work, and is not likely to work to produce commercially viable electricity or solar process heat. Therefore, each ‘lens’ is just one component of an inoperable system. It is not a piece of sophisticated technology such that premium pricing is appropriate for it.” 

The court also barred defendants from promoting and marketing the scheme. The court stated that the defendants sold lenses using a multi-level marketing approach, and encouraged distributors to “bring still more people in to the multi-level marketing system and build an extensive ‘downline.’” The court concluded that, in this case, “[t]he toxic combination of multi-level marketing and misleading information creates an urgent need [for] an injunction.”  

The injunction requires, among other things, that the defendants stop making statements that a person who buys a lens is in a trade or business with respect to that lens; may lawfully claim a depreciation deduction or any other business expense deduction related to a solar lens; and may lawfully claim a solar energy credit related to a lens. 

Further, the court ordered that the defendants disclose, in their marketing materials for lenses that the court “has determined that the solar energy technology of RaPower-3 in place from 2005 to 2018 is without scientific validation or substance and ineligible for tax credits or depreciation by individual purchasers of lenses.” 

* * * * 

In the past decade, the Tax Division has obtained injunctions against hundreds of unscrupulous tax preparers and tax scheme promoters. Information about these cases is available on the Justice Department’s website. An alphabetical listing of persons enjoined from preparing returns and promoting tax schemes can be found here. If you believe that one of the enjoined persons or businesses may be violating an injunction, please contact the Tax Division with details (link sends e-mail).

JAT comments:

Another BullShit Tax Shelter Rejected But With Slight Penalty (10/5/18)

In Exelon Corp. v. Commissioner, ___ F.3d ___, 2018 U.S. App. LEXIS 28023 (7th Cir. 2018), here, the Seventh Circuit affirmed the Tax Court's rejection of a bullshit tax shelter and rejection of a reasonable cause defense to the 20% § 6662 penalty.  I wrote earlier on the trial level case: Faulty Tax Shelter Opinions and Appraisals and Resulting Civil Penalties (Federal Tax Crimes Blog 9/24/16), here.

It is clear from the tenor of the decision that the Court of Appeals like the Tax Court (Judge Laro) was not impressed with the taxpayer's arguments.

I think some portion of the penalty discussion is worth excerpting (partially cleaned up):

One common method of demonstrating reasonable cause is to show reliance on the advice of a competent and independent professional advisor. American Boat, 583 F.3d at 481 (citing United States v. Boyle, 469 U.S. 241, 251 (1985) ("When an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on that advice.")). 

Simply relying on a professional does not necessarily relieve a taxpayer of penalties. To constitute reasonable cause, the reliance must have been reasonable in light of the circumstances. This is a fact-specific determination with many variables, but the question turns on the quality and objectivity of the professional advice obtained." To establish the defense the taxpayer, at a minimum, must show that the advice was (1) based on all relevant facts and circumstances, meaning the taxpayer must not withhold pertinent information[;] and (2) not based on unreasonable factual or legal assumptions, including those the taxpayer knows or has reason to know are untrue. The taxpayer's education, sophistication, business experience, and purpose for entering the questioned transaction are also relevant factors to be considered. 

In the instant case, the tax court sustained the Commissioner's imposition of penalties based on its findings that the underpayments for those years were attributable to Exelon's negligence or disregard of rules or regulations. In doing so, the court necessarily rejected Exelon's "reasonable cause" defense of reliance on its professional advisors. In particular, the court found that Exelon did not rely in good faith on Winston's tax opinions because Exelon "knew or should have known" that Winston's conclusions were flawed in light of the "obvious inconsistency" of the physical return condition specified in the contracts and the capacity factors projected by Deloitte for the plants at the end of the subleases, which made exercise of the purchase options more likely. The tax court found that Exelon must have appreciated that it would be very expensive for the sublessees to sufficiently upgrade the plants to meet the return capacity requirements. Thus, the court concluded that Exelon must have understood that Winston's tax opinions, based on the Deloitte appraisals, were flawed. 

Exelon's attack on this finding mimics its argument that the tax court confused capacity factor with availability factor and thus compared apples to oranges in its determination that the sublessees were reasonably likely to exercise their purchase options. We rejected that argument above and we reject it again here. We agree with the tax court that as a sophisticated plant operator, Exelon knew or should have known that, given the way these transactions were structured and given what the tax court found to be tainted appraisals, it was reasonably likely, or even highly likely, that the sublessees would exercise their options. 

Exelon continues to argue that the Deloitte appraisals were not tainted by Winston's input. More importantly, it argues that even if the appraisals were tainted, Exelon had no way of knowing that and cannot be penalized for its reliance on Winston's opinions. The record is replete, however, with evidence that Exelon knew full well that Winston was supplying Deloitte with the necessary conclusions. Both Walter Hahn and Robert Hanley of Exelon were copied on the emails sent by Winston first to Stone and Webster and then to Deloitte. Indeed, it was Hahn who concluded that most of the requested conclusions were items for Deloitte, and sent the list of Winston's necessary appraisal conclusions to Deloitte multiple times. 

Whether reasonable cause exists, and the finding underlying that determination, are questions of fact which we review for clear error. We find no such error and affirm the tax court's conclusion that penalties are warranted under § 6662.

JAT Comments:  

District Court Holds that Santander's Arguments to Avoid Penalty for Bullshit Tax Shelter (No Substance) Lack Substance (7/24/18)

In Santander Holdings USA, Inc. v. United States (D. Mass. Dkt. 09-11043-GAO Dkt Entry 344 7/17/18), here, Santander previously lost the merits of its bullshit tax shelter on appeal, with the Court of Appeals holding that the shelter lacked economic substance.  Santander Holdings USA, Inc. v. United States, 844 F.3d 15 (1st Cir. 2016), here, cert. denied sub nom. Santander Holdings USA, Inc., & Subsidiaries v. United States, 137 S. Ct. 2295 (2017).  See my discussion of the Court of Appeals decision, First Circuit, Reversing the District Court, Rejects Santander's Bullshit Tax Shelter (Federal Tax Crimes Blog 12/17/16), here.

Santander argued that, although its tax shelter lacked economic substance -- i.e., was bullshit -- it should be able to avoid the accuracy related penalty.  Well, basically, the district court held that that argument too lacked substance -- was bullshit.  The opinion is short and, I think, predictable, so I forego addressing it further.

However, the district court did include a quote from the Court of Appeals' decision that I had included in my prior write up but was in a larger quote so that I had not focused on it.  The district court did focus on it as follows.  This is the quote (cleaned up):

When a transaction is one designed to produce tax gains not real gains—such as when the challenged transaction has no prospect for pre-tax profit—then it is an act of tax evasion that, even if technically compliant, lies outside of the intent of the Tax Code and so lacks economic substance.

The district corut did not quote the whole paragraph from the Court of Appeals which includes "tax evasion" twice, so I offer the whole paragraph (cleaned up):

The economic substance doctrine is centered on discerning whether the challenged transaction objectively lies outside the plain intent of the relevant statutory regime. A transaction fails the economic substance test if, though it actually occurred and technically complied with the tax code, it was merely a device to avoid tax liability. Courts may disregard the form of transactions that have no business purpose or economic substance beyond tax evasion. In other words, when a transaction is one designed to produce tax gains not real gains -- such as when the challenged transaction has no prospect for pre-tax profit -- then it is an act of tax evasion that, even if technically compliant, lies outside of the intent of the Tax Code and so lacks economic substance.

Readers of this blog will recognize the term "tax evasion."  At least in this blog and in other authorities on criminal tax matters, tax evasion is a term of art.  Narrowly, it means the specific tax evasion crime in § 7201, but is often used to cover the panoply of tax crimes where tax was evaded (e.g., the Sentencing Guidelines require that for a tax loss as the first step in the sentencing calculation).  But, the term usually does connote conduct that is criminal.  See e.g., the Wikipedia entry for Tax Evasion, here.