Taxpayer Advocate Report on OVDI/P's Burden on Benign (Relatively) Taxpayers (1/18/14)

In the recently issued Taxpayer Advocate FY 2014 Objectives Report to Congress and Special Report to Congress, here, the Taxpayer Advocate included a report titled OFFSHORE VOLUNTARY DISCLOSURE: The IRS Offshore Voluntary Disclosure Program Disproportionately Burdens Those Who Made Honest Mistakes, here.

Key Excerpts (footnotes omitted):

Definition of the Problem: 

* * * Designed for “bad actors,” these programs burdened “benign actors” who inadvertently violated the rules by requiring them to “opt in and opt out” to get a fair result. The programs were punitive, charging average penalties of more than double the unpaid tax and interest associated with the unreported accounts. Because those opting out faced prolonged uncertainty and a risk of even more severe penalties, some agreed to pay more than they should, as described in prior reports. 

Unlike those who remain in the programs, those who opt out are audited, which essentially penalizes them for coming forward. On average, the IRS assessed penalties of nearly 70 percent of the unpaid tax and interest in the audits of those who opted out. Thus, while those who opt out generally face smaller penalties than those inside the OVD programs, they still face very significant ones. 

For those who remained in the 2009 program, the median offshore penalty applied to those with the smallest accounts (i.e., those in the 10th percentile with accounts of $87,145 or less) was disproportionate — nearly six times the median unpaid tax. Among unrepresented taxpayers with small accounts it was even more disproportionate — nearly eight times the unpaid tax. It was also disproportionately greater than the median penalty paid by those with the largest accounts (i.e., those in the 90th percentile with accounts of more than $4.2 million) who paid about three times the unpaid tax. Given the harsh treatment applied to those with small accounts, some have made “quiet” disclosures by correcting old returns and others have begun to comply prospectively — in each case without subjecting themselves to the lengthy and seemingly-unfair OVD process. 

While 7.6 million U.S. citizens reside abroad and many more U.S. residents have FBAR filing requirements,8 the IRS received only 807,040 FBAR submissions in 2012.9 Yet the FBAR audit rate is less than one quarter of one percent. Thus, the IRS has likely failed to address significant information reporting noncompliance.

Trial Management of the Cheek Good Faith Defense (9/20/14; 9/24/14)

I think all persons familiar with Cheek's requirements for asserting a good faith defense know that a good faith belief that the the tax law did not impose on defendant a duty to pay tax is properly presented to a jury but a good faith belief that the tax law is unconstitutional is not a good faith defense.  See Cheek v. United States, 498 U.S. 192 (1991), here. So, if the taxpayer makes a good faith defense that can easily be classified as one or the other, the gate keeping for avoiding improper consideration by the jury can be easily handled at trial by including or excluding the evidence, by proper cautions to the jury at the time improper evidence comes in, or in the final jury instructions.

The problem, of course, is that sometimes the distinctions are not so crisp.  When does a defense that the taxpayer in good faith believed he did not owe the tax blend into an argument that the tax in good faith believed that the tax was unconstitutional?

In United States v. McBride, 2014 U.S. Dist. LEXIS 126876 (D UT 2014), the Government filed a motion in limine to preclude the taxpayer from asserting a good faith defense that implicated the constitutionality of the tax.  The Court granted the motion, in a way, by advising the defendant in advance that it was going to seriously manage the evidence at trial to insure that the jury is not presented the claim that the defendant acted in good faith because he believed the tax was unconstitutional.  The defendant represented in the case that, even without the motion and order, he would make no such claim.

I am not sure the Court would have to do that by pre-trial order, but it did.  Here is the cut and paste of the order (one footnote omitted):

This matter is before the Court on the government's Motion in Limine to Preclude Defendant from Introducing Evidence of Disagreement with the Tax Laws of the United States.1 

The government seeks to exclude Defendant from presenting (1) evidence of the Defendant's views of the legality and proper interpretation of U.S. tax law, and (2) evidence that Defendant held a good-faith belief that the Internal Revenue Code did not apply to him and that his conduct was legal. 

The government asserts that Defendant has represented to the IRS various arguments about U.S. tax law. Specifically, the government contends that Defendant may seek to introduce at trial evidence of Defendant's view that money received from various limited liability companies and from private real estate transactions is not considered income for purposes of tax liability. Rather, in Defendant's view, only money received from federal government entities is taxable. The government contends that evidence demonstrating Defendant's views of U.S. tax law should be excluded under Federal Rule of Evidence 403, because presenting evidence containing improper statements of law would confuse and mislead the jury. 

Defendant explains that he intends to introduce evidence demonstrating his belief that his wages were not considered to be income and that he was not required to pay income tax under U.S. tax law. Defendant also explains that it does not plan to argue that provisions of the tax code are unconstitutional.

Ms. Sheppard's Article on the UBS Mess and its Permutations (8/29/09)

Today's Tax Notes Today has an article by Lee Sheppard, a noted commentator on the tax law and fashions and movies and other esoterica as segues into her tax law discussions surrounding the foreign bank account mess. In the article, titled, Now What? Dealing with UBS Account Disclosures, 124 Tax Notes 847 (Aug. 31, 2009) , Ms. Sheppard makes a number of points that I thought I would pass on here. Most of the following points probably of most interest to students of Federal Tax Crimes and not to seasoned practitioners.

1. Ms. Sheppard joins what from my perspective is the mainstream in thinking that the U.S. got the short end of the deal in the bargain with the devil (or as I would call it, with the pirates) -- referring to the Swiss Government and its representative pirate, UBS. (Ms. Sheppard graphically refers to Switzerland as the "whorehouse on the edge of town;" her point, is that Switzerland is still out there earning a living with tax evasion still among the services it offers.) While the U.S. certainly got less than it wanted, I disagree that it was all bad or even a defeat for the U.S. See my prior blog here. In typical hyperbolic fashion, Ms. Sheppard calls the deal a "Grubby Deal."

2. Ms. Sheppard's conclusion as to that bargain is tempered by some of her comments. Consider the following:

This deal does not do anything to help other rich countries deal with their own citizens' tax evasion by means of secret foreign accounts. In typically American unilateral fashion, the agreement would serve to scare American customers away from secret bank accounts while allowing the Swiss to continue selling tax evasion services to rich citizens residing in the rest of the world.

* * * *

Should the agreement be counted as a success if it scares potential customers and destroys the Swiss banking business in the United States? It may have done just that.

Ms. Sheppard says that there are two key factors to success for the IRS. First, this particular deal involving UBS must produce a representative number of cases that the U.S. can and will prosecute for maximum publicity / deterrence effect. Second, Switzerland must cooperate similarly (or appear to do so) with respect to other Swiss banks. In this regard, Ms. Sheppard notes that UBS was not the only Swiss bank offering "tax evasion services." Nothing particularly new here. Pirates do have to do something to earn a living. The recent indictments of the two Swiss enablers (I blogged that here) involve another bank.

Another Bullshit Shelter Bites the Dust (12/19/13)

We have yet another of the genre out of the Tenth Circuit, this time proving Michael Graetz's famous observation that an abusive tax shelter is “[a] deal done by very smart people that, absent tax considerations, would be very stupid.”  The new case is Blum v. Commissioner, 737 F.3d 1303 (10th Cir. 2013), here.

Before discussing the case, I offer this description of tax shelters from my Federal Tax Procedure Book (footnotes omitted):

Abusive tax shelters are many and varied.  Some are outright fraudulent, usually wrapped in a shroud of paper work designed to present the shelter as a real deal.  The more sophisticated are often without substance but do have some at least attenuated, if superficial, claim to legality.  Some of the characteristics that I have observed for tax shelters that the Government might perceive as abusive are that (i) the transaction is outside the mainstream activity of the taxpayer, (ii) the transaction is incredibly complex in its structure and steps so that not many (including specifically IRS auditors) will have the ability, tenacity, time and resources to trace it out to its illogical conclusion (this feature is often included to increase the taxpayer’s odds of winning the audit lottery); (iii) the transaction costs of the arrangement and risks involved, even where large relative to the deal, still have a favorable cost benefit/ratio only because of the tax benefits to be offered by the audit lottery, (iv) the promoters of the adventure make a lot more than even an hourly rate even at the high end for professionals (the so-called value added fee, which is often insurance type compensation to mediate shift potential penalty risks to the tax professional or the netherworld between the taxpayer and the tax professional) and (v) the objective indications as to the taxpayer's purpose for entering the transaction are a tax savings motive rather than any type of purposive business or investment motive.  More succinctly, Michael Graetz, a Yale Law Professor, has described an abusive tax shelter as “[a] deal done by very smart people that, absent tax considerations, would be very stupid.”  Other thoughtful observers vary the theme, e.g. a tax shelter “is a deal done by very smart people who are pretending to be rather stupid themselves for financial gain.”

Blum fits the pattern.

Mr. Blum was a very successful businessman.  He was apparently very capable in assessing risks and rewards of financial ventures.  Mr. Blum retained KPMG who sold him one of its tax shelter products which it marketed in the 1990s and early 2000s.  This particular product was OPIS, a basis enhancement strategy. The abusive basis enhancement strategies claimed to create large amounts of basis without the taxpayer having to incur a cost for the basis.  The taxpayer would then use the artificial basis to offset otherwise taxable gain, thereby artificially reducing the tax liability.  Mr. Blum got into the deal when he had a large gain that would otherwise be taxed.

When KPMG's representative made the pitch, Mr. Blum "claims he saw an investment opportunity; the Commissioner claims Mr. Blum saw a tax evasion opportunity."  (Emphasis supplied.) Mr. Blum bought the pitch and made a representation to KPMG that he was doing the deal for a legitimate nontax business or investment purpose.  (That representation was essential to KPMG's participation in implementing the transaction.)  Bottom-line, the Tax Court concluded and the Tenth Circuit concluded that the representation was false.

Ethicist Question About Tax Professionals Exploiting Loopholes (3/24/13)

In this blog, I usually discuss tax crimes and matters related to tax crimes.  At least for tax professionals, there are parallel ethical issues.  The ethical issues certainly are recognized or should be recognized by tax professionals whose conduct approaches the criminal tax line -- that line where they cross over into intentionally violating a known legal duty, the mens rea standard for tax crimes.

The Ethicist, a column in the New York Times, addressed a facet of the ethical issue, in a context that does not necessarily implicate a tax crime.  Chuck Klosterman, A Tax Lawyer's Quandary (NYT Ethicists 3/22/13), here.  The question the anonymous tax lawyer asks is:

I am a tax lawyer. Is advising wealthy companies of ways to reduce their tax bills through sophisticated legal structures ethically permissible? The structures take advantage of legal loopholes in the tax legislation. 

The Ethicist answer, very short, is:

The ethics of specific professions create unique realms of responsibility. In the same way that a defense attorney is ethically obligated to give his client the best possible defense — even if he’s convinced of the individual’s guilt — your principal responsibilities lie with the company hiring you. You need to do your job to the best of your abilities, within the existing rules. You should, however, voice your moral apprehension about the use of such loopholes to the company you represent.

For a good, short general discussion, I suppose this works.

Is Good Faith a Defense to False Claim Charges (4/16/16)

In United States v. Croteau, 2016 U.S. App. LEXIS 6547 (11th Cir. 2016), here, the taxpayer was convicted or "ten counts of making false, fictitious, or fraudulent claims on his tax returns, in violation of 18 U.S.C. § 287 and 2, and one count of corruptly interfering with the administration of internal revenue laws, in violation of 26 U.S.C. § 7212(a)."  Section 287(a), false claims, is one of the panoply of charges that the Government can make for tax crimes.  Today's blog entry will deal with the § 287(a) charges.

Crouteau's misconduct was repeatedly claiming false OID withholding and filing related forms with the IRS, resulting, he claimed, in refunds of well over $3.8 million.  Early on, the IRS caught on and advised him to file corrected returns.  Nevertheless, the taxpayer did not correct and repeated the behavior, which the IRS caught.  And he "Croteau created, submitted, and recorded various fictitious and fraudulent documents claiming rights to millions of dollars owed him by the U.S. Treasury and various government agencies and officials." Finally he "recorded several false, fictitious, and fraudulent liens and documents in the Lee County Clerk's office asserting that the IRS and various IRS officials owed him hundreds of millions of dollars in total."

After several years of trying to get him to behave, the Government had enough:

On August 21, 2013, a grand jury indicted Croteau with ten counts of filing false, fictitious, and fraudulent tax returns with the IRS, in violation of 18 U.S.C. § 287 and 2. Croteau was charged for ten of the false and fraudulent tax returns he filed between September 2008 and September 2010 for tax years ranging from 2006 to 2009, in which he claimed total refunds in excess of $3.8 million. Separately, the grand jury indicted Croteau with one count of corruptly interfering with the administration of internal revenue laws, in violation of 26 U.S.C. § 7212(a) and 18 U.S.C. § 2. This charge was based on the alleged false and fraudulent tax returns covered by Counts One through Ten as well as the supplementary submissions supporting the tax refunds including the 1099-OID forms, the separate fictitious and fraudulent instruments Croteau submitted to the U.S. Treasury Department, and the fictitious and fraudulent liens and documents he recorded in the Lee County Clerk's office.

As in many, perhaps most tax cases, there is little or no defense to the objective elements of the crimes charged, so that the defendant is left to the defense that he did not have the requisite mens rea for the defense.  For the usual tax crimes in the Code, the mens rea is the highest -- that the defendant acted willfully, meaning that he intended to violate a known legal duty.  The defense often deployed in such cases is that the defendant did not act willfully because he acted in good faith belief that what he was doing did not violate the law.  This is commonly referred to as the Cheek defense, based on the leading case of Cheek v. United States, 498 U.S. 192 (1991). Technically, where this good faith defense is properly raised in a criminal case with an element that the defendant have acted willfully, the Government must prove that he acted willfully, which requires that the Government disprove the good faith claim.  I have discussed previously the dicey issue of how the defendant puts good faith in play in order to get a jury instruction on good faith to supplement the standard jury instruction on willfulness.  Bottom line it will usually require the defendant to testify, but sometimes there can be sufficient other evidence to raise the defense, thus permitting the defendant to forgo testifying.

Some crimes deployed for tax misconduct, particularly the Title 18 offenses, do not have a textual element that the taxpayer act willfully.  The crimes for which Crouteau was charged do not have a textual willfulness requirement.  I have previously noted that tax obstruction, § 7212(a), although not having a textual willfulness element might have elements which, as interpreted and applied, rise to the same level as willfulness. But I focus today on the 18 U.S.C. § 287, here, charges.  Section 287 provides

False, fictitious or fraudulent claims
Whoever makes or presents to any person or officer in the civil, military, or naval service of the United States, or to any department or agency thereof, any claim upon or against the United States, or any department or agency thereof, knowing such claim to be false, fictitious, or fraudulent, shall be imprisoned not more than five years and shall be subject to a fine in the amount provided in this title.

Article on British Deal with Swiss to Flush Out Evades and Lost Revenue -- Not So Good (8/3/14)

In this article, the authors discuss the problems to U.K. in it agreement with the Swiss to flush out tax evaders.  Stephen Castle and Doreen Carvajal, Britain Fails to Find Riches It Expected in Swiss Accounts (NYT 8/1/14), here.

Some excerpts:

When the British tax authorities struck a landmark deal with the Swiss to crack down on tax evasion, they sat back and waited for the cash to flow in. Almost three years later, they are still waiting. 

So far, only about $1.7 billion of the $8.4 billion windfall they once expected has materialized, and sheepish tax authorities now hope to eventually collect just a third of their original estimate.
Instead, the deal struck by Britain, which once seemed a pioneer in combating tax evasion, is emerging as a cautionary tale for a growing number of nations that are feeling the pinch of Europe’s flat economy and are desperate to reap revenues from secret accounts held by the wealthy. The amounts at stake are enormous. In 2012, the British government estimated that Britons had amassed more than 40 billion pounds, or $68.5 billion, in Swiss banks. Some conservative estimates of the amount of money tucked away in tax havens and out of reach of governments worldwide range as high as $21 trillion — more than the gross domestic product of the United States. 

* * * * 

The lesson is that “you cannot rely on a black hole to get income,” according to Pascal Saint-Amans, a tax expert with the Organization for Economic Cooperation and Development, based in Paris. The organization is currently developing standards for a broader international deal. So far 60 jurisdictions and nations, including Switzerland, have committed themselves. But that agreement is not expected to take effect until 2017, and critics are already pointing out loopholes. 

Britain’s deal with Switzerland had plenty of its own. For those who wanted to evade the British tax authorities, the agreement gave ample warning — 16 months — to shift money to other offshore havens or put it into gold, bearer funds, artwork, insurance or safe deposit boxes. 

The 16-month warning was “almost absurd,” said Ian Swales, a Liberal Democrat and member of Britain’s parliamentary Public Accounts Committee. “If you had 100 pounds in your pocket and I told you that in a few weeks I would take a portion of it, then you wouldn’t really keep 100 pounds in your pocket, would you?” he said. 

Other money is hidden in ever more elaborate mazes of offshore trusts and foundations often managed by trustees, usually foreign lawyers, allowing the real beneficiaries to remain secret. 

* * * * 

Another example is the bribery trial in Germany of Bernie Ecclestone, 83, a billionaire and Formula One tycoon considered one of the richest men in Britain. Mr. Ecclestone is accused of bribing a German banker, Gerhard Gribkowsky, with $44 million, for a favorable business deal. His defense is that he lavished the money to prevent the banker from alerting British tax authorities that it was he, and not his former wife, Slavica, who controlled a family trust set up in Liechtenstein, another famous tax haven. 

* * * * 

The British-Swiss deal was always contentious, with critics arguing that it amounted to an amnesty to tax evaders. The German government abandoned efforts to sign a similar agreement with Switzerland. 

Under the deal with Switzerland about 18,000 Britons disclosed their names to the British authorities. Those who did not want to be identified paid a one-time levy of up to 34 percent to settle past taxes. Then last year, the Swiss started deducting a regular “withholding tax” on the interest on behalf of the British authorities. 

But recently, the Swiss sent the British a list of the international jurisdictions that had received money from accounts held by Britons in Switzerland before the deductions could be made. Jason Collins, a tax lawyer with Pinsent Masons in London, said that the likely locations include Singapore and Dubai. Other experts see money shifting to Mauritius, Seychelles, and Hong Kong.

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.

Economic Substance Jury Instruction in Larson/Pfaff/Ruble (3/22/10)

I previously attached deep in a blog Judge Kaplan’s economic substance charge to the jury in United States v. Larson (S.D. N.Y. No. 05 CR 888 (LAK)), dated 12/11/08, pp. 5225- 5232.  I have decided that, because of the ongoing discussion I should lift it up into a separate blog for those who might have missed it.

In order to prove that element in this case, we focus on the doctrine of economic substance. In this case, the government contends that the taxpayers whose tax returns are the subject of each count of tax evasion, owed more federal income tax then they reported on the returns for one reason only, in each case the taxpayer took a deduction from his taxable income due to a loss that the tax return attributed to one of the four tax strategies at issue in this case. You remember them, FLIP, OPIS, BLIPS and SOS.

The government argues that every one of those tax strategies lacked economic substance. That the tax deduction each one of those taxpayers took was improper, for that reason, and, therefore, that each taxpayer owed more federal income tax than was declared on the tax return. The defendants dispute that. They contend, among other things, that the tax strategies did not lack economic substance, that the deductions were proper, and that the tax returns, therefore, accurately stated the amounts of tax that were due and owing.

This means that your task here, with respect to the first element, is to decide for each count, whether the tax strategy that gave rise to the loss claimed as a deduction on that tax return, lacked economic substance in order to decide whether the relevant taxpayer owed more federal tax, income tax, than was shown that was due on the tax return. So I am now going to instruct you with respect to your consideration of the economic substance issue.

A transaction that lacks economic substance cannot enter into tax computations. Any deduction claimed for a tax loss that allegedly was sustained in such a transaction, therefore, is not properly claimed on a tax return.

In order to establish that a transaction lacks economic substance, the government must prove beyond a reasonable doubt both of two factors. The first factor is that the relevant taxpayer had no business purpose for engaging in the transaction apart from creating the tax deduction.

The second factor is that there was no reasonable possibility that the transaction would result in a profit.

Now, let me define one term and say a few things about each one of these factors.

First the definition. The word profit, as I use it in this context, means a return in excess of the cost of the investment, disregarding entirely any tax benefits. Let me give you an example. If somebody puts a million dollars into a deal, he would have to get a return of more than a million dollars without considering any tax benefits in order for the transaction to be profitable. Common sense. A return of $750,000 on a million dollar investment results in a loss of $250,000, not a profit. That's what I mean by profit. Forget the tax benefits, look at the investment and the return.

Now, let me discuss the first element that I mentioned, whether the taxpayer had any business purpose for entering into the deal. In deciding that question, you, of course, may consider any direct evidence of the taxpayer's motive. But you are not limited to direct evidence in deciding why a taxpayer did a transaction. You can consider circumstantial evidence as well.

I am going to talk to you later about what circumstantial evidence means. But for purposes of the present, think of it just as common sense, and then I will explain it later on.

For example, you may consider the manner in which the transaction was sold to the taxpayer. In other words, you are entitled to consider whether and to what extent it was sold to the taxpayer as a way to create a tax deduction to offset other taxable income, and/or as a way to generate a return, a profit, exclusive of tax benefits on the investment. You are entitled to consider that.

You may consider also whether a reasonable taxpayer would have paid the fees necessary to do the transaction in order to gain the chance of whatever profit potential existed if the transaction did not also carry with it tax benefits.

Now, let me try to put this into plain English. What helped me think about it, maybe it will help you, I am going to give you a couple of examples, so bear with me on the examples. Let's take an example in which a taxpayer has to put up $2 million to enter into some deal or strategy. Suppose further that the strategy in question offers a five percent chance, that's one chance out of 20, resulting in a payout, when all is said and done of $2,050,000. In other words, it's a one in 20 chance of making $50,000 on a $2 million investment.

Assume also that the taxpayer has a huge amount of income, and that there is a very big tax benefit to the strategy, maybe a $10 million tax loss or deduction.

Now, common sense will tell you that few, if any, people, no matter how rich they are, would put up $2 million for a five percent chance, a one out of 20 chance, of making $50,000. So on those facts you might conclude that there must have been only one reason for the taxpayer to have paid the $2 million. And that the $10 million tax loss or deduction probably was the only reason.

Let me give you another example, also an example in which the same taxpayer has to put up the same $2 million.

What's different in this example is this, assume there is a 33 percent chance, now it's one out of three we are talking about, of getting a payout of $3 million. And thus a profit of a million dollars within a year. Now, a 33 percent chance, a one out of three chance of making a profit, is not bad odds, it's pretty good odds. And a million dollars is nothing to sneeze at, even if you are very rich.

In this second example, the high likelihood, relatively high likelihood, and the large size of the potential profit, would be circumstances that might tend to show that the taxpayer had a nontax reason for doing the deal.

Many people might consider it a very good investment opportunity, without regard whether there was any tax benefit.

In the end, what you would do, is to consider all the evidence, direct, if there is any, and circumstantial, to decide whether the government had proved that the tax benefits were the only reason for doing the deal.

Those are my examples.

So let me come back to this case. If you find that the government has proved that the tax benefits were the only reason for doing the deal involved in any particular count, you will go on to consider the second part of the economic substance test that I gave you a moment ago. And that I am going to talk about more in a minute.

If you find, however, that the government has not proved that the tax benefits were the only reason for doing the deal, you must reject the government's economic substance argument. And you, therefore, must reject its contention that there was additional tax due and owing. That in turn would require you to find the defendant or defendants in question, not guilty on the particular tax evasion count that related to the particular taxpayer and year in question.

Now, let me say a word about the second fact in the economic substance test, which is whether there was a reasonable possibility that the strategy involved on the count you are considering would result in a profit.

Now, at one level this is largely self-explanatory, but I want to emphasize to you that this factor requires you to come to an objective judgment about whether the government has proved that there was no reasonable possibility that the strategy would result in a profit. In other words, this doesn't depend on what the taxpayer believed about the tax potential -- excuse me, the profit potential -- it requires you to consider all the evidence that you have, and reach a conclusion about whether the government has proved beyond a reasonable doubt, that there was no reasonable possibility of a profit.

In doing this, you are going to have to consider the evidence concerning investment aspects of each of the four tax strategies at issue in this case. For example, the transactions involving the Argentine peso and the Hong Kong dollar that were involved in the BLIPS strategy, and the foreign currency options that were involved in the SOS strategy. Of course, you have to consider the particulars of the other two strategies, as well, I mentioned those because they come immediately to mind.

Now, in considering whether the government has met its burden on the second factor, you should take into account whether the taxpayer, considering all the aspects of the strategy, had any reasonable chance of making a profit or suffering a loss as a result of changes in the market.

To take one example, if you are considering a BLIPS deal, you should consider whether the taxpayer had any reasonable chance of making a profit or suffering a loss as a result of changes in the value of the Argentine peso and the Hong Kong dollar, given the terms of the deal. If you find that the government has proved beyond a reasonable doubt both prongs of the economic substance test, in other words, both that the taxpayer had no nontax reason for doing the deals on the count in question, and that there was no reasonable possibility of making a profit, you may find that the requirement of additional tax due and owing will have been satisfied, and you will go on to consider whether the government has proved that the additional tax due and owing was substantial.

The U.S. Deal with Switzerland and UBS -- Good Deal or Bad Deal? (8/19/09)

As revised 8/20/2009 8:00 am. and 8/25/12 (to Include the Annex at the end)

Some pundits are already speculating that the deal the U.S. got was not so good. At the surface, it does not look all that good. The U.S. wanted 52,000 names and is getting 4,450 (approximately) in addition to those it already received (perhaps 250). That's less than 10% in of the claimed UBS account universe.

Now let's scratch the surface. The agreements as released do not state the criteria that will be used to identify the 4,450 (approximate) that UBS will disclose. The criteria are set forth in an annex to the agreement that will be release in 90 days, well after the current voluntary disclosure initiative has closed (on September 23, 2009). Without the criteria, UBS' U.S. account holders will not know whether they have drawn the black bean. Each UBS U.S. depositor who has not already joined in the IRS' voluntary disclosure program will not have certainty that his name and account(s) will not be picked. It is true, that the letter UBS is required to use to notify the account holders who draw the black bean will notify the account holders that they can still get in the program. But, the program only lasts through September 23, 2009, and it appears that the picking of names will extend beyond that date. IRS Commissioner Shulman has confirmed that the voluntary disclosure program will be open only for clients who receive UBS letter notices prior to the September deadline.

Moreover, there will be criteria which probably is designed to get the biggest, most blatant abusers. It has been speculated that the criteria will include accounts with entities as an additional layer of secrecy and threshold dollar amounts. But the IRS press release yesterday cautioned that (IR-2009-75)

The IRS will receive information on accounts of various amounts and types, including bank-only accounts, custody accounts in which securities or other investment assets were held and offshore company nominee accounts through which an individual indirectly held beneficial ownership in the accounts.

Still, you can be sure that the IRS will design the criteria to pick up the big abusers, sort of like its DIF sampling techniques for auditing (except probably much more focused). So, perhaps -- and I too speculate here -- on a dollar tax-evaded weighting, perhaps the IRS will pick up well in excess of 50% of the loot on the table simply by careful selection of the criteria. This careful selection is implied by the indication that some $18 billion is involved under the criteria selecting the 4,450 accounts. The average account, therefore, is over $4 million. This does not indicate that there was a single selection criteria of a threshold dollar amount because there are undoubtedly other criteria (use of entities to further obscure the trail). And, besides criteria designed to identify the worst abusers, the IRS may also want to at least hold out the possibility that there will be some random sampling, so that those with direct accounts below whatever the general dollar threshold is (say $2,000,000) cannot rest easy and will still have an incentive to get into the voluntary disclosure program. In this regard, the criteria will not be released for 90 days, well after the voluntary disclosure program has ended.

Also, an essential part of the voluntary disclosure program and the names that get targeted by this round of UBS turnovers will be to learn the identities of the as many of the U.S. taxpayers' enablers that the U.S. can then bring to justice -- at least the most abusive of the lot. There will be lots of tentacles into U.S. lawyers, financial advisors and others who, like ordinary tax shelter promoters, raked off their share of the taxes that should have been paid to the Government. My gut tells me that many of these enablers are probably not resting easy, particularly because there is no voluntary disclosure for them that will negate criminal prosecution or mitigate any civil penalties that might apply. Moreover, if the U.S. gets to these enablers, the Government might sweep up many more U.S. taxpayers who were assisted by these enablers.

Finally, and perhaps most importantly in the long run, there is a breach in the dam because the Swiss Government has decided that its double tax treaty is more flexible than it had imagined before. The strict definition of tax fraud to permit disclosure under the treaties is being relaxed. And, the agreements contemplate that the U.S. will be able to make similar exchange of information requests on the basis of similar criteria against other Swiss banks involved in UBS-type shenanigans (probably all of them to some degree or another). And, as the Swiss feel similar pressures from other organized and powerful countries, its wall of secrecy is likely to erode even more.

So, bottom line, I think these developments are good for the U.S. Large goals often are achieved in increments. And this particular increment is not just incremental -- it is a big jump.

Addendum:  As mentioned, the criteria for the request are in the annex.  The Annex may be viewed in an official pdf here or in html here.  The entire document is relatively short and a good read, but here are some key excerpts:

2. The agreed-upon criteria for determining “tax fraud or the like” for this request pursuant to the existing Tax Treaty are set forth as follows:

A. For “undisclosed (non-W-9) custody accounts” and “banking deposit accounts” (as described in paragraph 1.A of this Annex) where there is a reasonable suspicion that the US domiciled taxpayers engaged in the following: 

a. Activities presumed to be fraudulent conduct (as described in paragraph 10, subparagraph 2, first sentence of the Protocol) including such activities that led to a concealment of assets and underreporting of income based on a “scheme of lies”[i] or submission of incorrect and false documents.  Where such conduct has been established, persons with accounts of less than CHF 1 million in assets (except those accounts holding assets below CHF 250,000) during the relevant period would also be included in the group of US persons subject to this request; or 

b. Acts of continued and serious tax offense for which the Swiss Confederation may obtain information under its laws and practices (as described in paragraph 10, subparagraph 2, third sentence of the Protocol), which based on the legal interpretation of the Contracting Parties includes cases where (i) the US-domiciled taxpayer has failed to provide a Form W-9[ii] for a period of at least 3 years (including at least 1 year covered by the request) and (ii) the UBS account generated revenues of more than CHF 100,000 on average per annum for any 3-year period that includes at least 1 year covered by the request. For the purpose of this analysis, revenues are defined as gross income (interest and dividends) and capital gains (which for the purpose of assessing the merits of this administrative information request are calculated as 50% of the gross sales proceeds generated by the accounts during the relevant period). 

B. For “offshore company accounts” (as described in paragraph 1.B of this Annex) where there is a reasonable suspicion that the US beneficial owners engaged in the following: 

a. Activities presumed to be fraudulent conduct (as described in paragraph 10, subparagraph 2, first sentence of the Protocol) including such activities that led to a concealment of assets and underreporting of income based on a “scheme of lies”[iii] or submission of incorrect or false documents, other than US beneficial owners of offshore company accounts holding assets below CHF 250,000 during the relevant period; or 

b. Acts of continued and serious tax offense for which the Swiss Confederation may obtain information under its laws and practices (as described in paragraph 10, subparagraph 2, third sentence of the Protocol), which based on the legal interpretation of the Contracting Parties includes cases where the US person failed to prove upon notification by the Swiss Federal Tax Administration that the person has met his or her statutory tax reporting requirements in respect of their interests in such offshore company accounts (i.e., by providing consent to the SFTA to request copies of the taxpayer’s FBAR returns from the IRS for the relevant years).  Absent such confirmation, the Swiss Federal Tax Administration would grant information exchange where (i) the offshore company account has been in existence over a prolonged period of time (i.e., at least 3 years including one year covered by the request), and (ii) generated revenues of more than CHF 100’000 on average per annum for any 3-year period that includes at least 1 year covered by the request. For the purpose of this analysis, revenues are defined as gross income (interest and dividends) and capital gains (which for the purpose of assessing the merits of this administrative information request are calculated as 50% of the gross sales proceeds generated by the accounts during the relevant period). 

[i] Such “scheme of lies” may exist where, based on the Bank’s records, beneficial owners (i) used false documents; (ii) engaged in a fact pattern that has been set out in the “hypothetical case studies” in the appendix to the Mutual Agreement concerning Art. 26 of the Tax Treaty (for example, by using related entities or persons as conduits or nominees to repatriate or otherwise transfer funds in the offshore accounts); or (iii) used calling cards to disguise the source of trading. These examples are not exhaustive, and depending on the applicable facts and circumstances, certain further activities may be considered by the SFTA as a “scheme of lies”. 

[ii] For “banking deposit accounts” based on the Contracting Parties’ legal interpretation a reasonable suspicion for such tax offence would be met if the US persons failed to prove upon notification by the Swiss Federal Tax Administration that they have met their statutory tax reporting requirements in respect of their interests in such accounts (i.e., by providing consent to the SFTA to request copies of the taxpayer’s FBAR returns from the IRS for the relevant years). 

[iii] Such “scheme of lies“ may exist where the Bank’s records show that beneficial owners continued to direct and control, in full or in part, the management and disposition of the assets held in the offshore company account or otherwise disregarded the formalities or substance of the purported corporate ownership (i.e., the offshore corporation functioned  as nominee, sham entity or alter ego of the US beneficial owner) by: (i) making investment decisions contrary to the representations made in the account documentation or in respect to the tax forms submitted to the IRS and the Bank; (ii) using calling cards / special mobile phones to disguise the source of trading; (iii) using debit or credit cards to enable them to deceptively repatriate or otherwise transfer funds for the payment of personal expenses or for making routine payments of credit card invoices for personal expenses using assets in the offshore company account; (iv) conducting wire transfer activity or other payments from the offshore company’s account to accounts in the United States or elsewhere that were held or controlled by the US beneficial owner or a related  party with a view to disguising the true source of the person originating such wire transfer payments; (v) using related entities or persons as conduits or nominees to repatriate or otherwise transfer funds in the offshore company’s account; or (vi) obtaining “loans” to the US beneficial owner or a related party directly from, secured by, or paid by assets in the offshore company’s account. These examples are not exhaustive, and depending on the applicable facts and circumstances, certain further activities may be considered by the SFTA as a “scheme of lies”.

Private Equity Guru Smith Got a Hell of a Deal (10/23/20)

Today, the Wall Street Journal published what, I understand, is called an “explainer” about the Brockman indictment and the Smith nonprosecution agreement (“NPA”).  See Laura Saunders The IRS Reels in a Whale of an Offshore Tax Cheat—and Goes for Another (WSJ 10/23/20), here.  I previously wrote on these events.  One Big Fish Indicted and Lesser Big Fish Achieves NPA for Cooperation (10/16/20), here.  

The WSJ article provides a good bullet point high-level summary of the events.  I write today to provide some nuance to a sound bite quote that I gave for the article.  The quote, at the end, is:  "Jack Townsend, a lawyer who publishes the Federal Tax Crimes blog, says, 'He got a hell of a deal, considering what he did.'"

My statement was based only on the publicly disclosed facts in the NPA and the Statement of Facts (Exhibit A) with the NPA, which are here and here, respectively.  Those publicly disclosed facts may not tell the whole story as to why Smith achieved an NPA rather than some other disposition (I discuss some possible other dispositions below.)  

Just on those facts, Smith’s deal is exceptionally good for him.  He committed years of tax evasion, then attempted to do a Streamlined disclosure (after being rejected from OVDP) where he had to certify nonwillfulness and submit amended returns and delinquent or amended FBARs which he did and which were false.  That pattern, particularly, the second step Streamlined disclosure was just incredibly stupid.  If he had done only the OVDP and been accepted into OVDP, he likely would have avoided prosecution if his OVDP submissions and cooperation were truthful and complete.  Two caveats on that, however: (i) OVDP did not “guarantee” nonprosecution but, as a practical matter it would if the disclosure and cooperation were good (I am not aware of any prosecution of an OVDP participant whose cooperation was truthful and complete); and (ii) his behavior on the subsequent Streamlined suggest at least that his amended return and delinquent or amended FBAR submissions in the posited counterfactual OVDP if it had gotten that far likely would not have been truthful and thus would not have resulted in the key relief generally offered by OVDP – nonprosecution.

What I address today is why, given the facts in the NPA and Statement of Facts, DOJ would have given Smith an NPA for such egregious behavior (by which I don’t mean just the dollars involved, but more importantly his overall behavior to cheat and avoid getting caught with continued lies).

The Statement of Facts and the NPA do not really address that issue, except that in the press release his cooperation was emphasized.  I presume that the cooperation is not only the cooperation in exposing his own criminal conduct but more importantly in indicting and prosecuting Brockman.  So, this raises some speculations / questions.

1. Did Smith get an NPA because the Government did not have the necessary proof to convict Smith and the NPA was the best the Government could do, particularly if it helped nail a bigger fish?  In other words, the facts in the Statement of Facts could have been provable only after Smith’s cooperation after his lawyers negotiated the commitment for an NPA.  Hence, rather than indicting Smith with a weak case, the Government might have been motivated to grant the NPA in order to get his cooperation against Brockman as well as obtain the monetary benefits accorded by the NPA.  That’s a matter of what each party’s hand was as they negotiated Smith’s disposition.  I just don’t know that.

RICO Claim Dismissed Against Bullshit Tax Shelter Promoters (11/19/19; 11/22/19)

In Menzies v. Seyfarth Shaw LLP, __ F.3d ___ (7th Cir. 2019), here, the Court dismissed a RICO claim arising out of an alleged fraudulent tax shelter peddled to the taxpayer (Menzies) by a lawyer, law firm and two financial services firms.  The Court held that fraudulent tax shelters can be subject of RICO claims, but Menzies had failed to properly assert the claims in the pleadings.

The particular shelter involved was of the bullshit shelters, often a topic discussed on this blog.  Here is my definition from my Tax Procedure books (Practitioner Edition p. 905 (footnotes omitted); Student Edition p. 616):

Abusive tax shelters are many and varied.  Some are outright fraudulent, usually wrapped in a shroud of paper work and cascade of words designed to mask the shelter as a real deal.  The more sophisticated are often without substance but do have some at least attenuated, if superficial, claim to legality.  Some of the characteristics that I have observed for tax shelters that the Government might perceive as abusive are that (i) the transaction is outside the mainstream activity of the taxpayer, (ii) the transaction is incredibly complex in its structure and steps so that not many (including IRS auditors, if they stumble across the transaction(s)) will have the ability, tenacity, time and resources to trace it out to its illogical conclusion (this feature is often included to increase the taxpayer’s odds of winning the audit lottery); (iii) the transaction costs of the arrangement and risks involved, even where large relative to the deal, offer a favorable cost benefit/ratio only because of the tax benefits to be offered by the audit lottery, (iv) the promoters (and other enablers) of the adventure make a lot more than even an hourly rate even at the high end for professionals (the so-called value added fee, which is often insurance type compensation to mediate potential penalty risks by shifting them to the tax professional or the netherworld between the taxpayer and the tax professional) and (v) the objective indications as to the taxpayer's purpose for entering the transaction are a tax savings motive rather than any type of purposive business or investment motive.   

More succinctly, Michael Graetz, a Yale Law Professor, has described an abusive tax shelter as “[a] deal done by very smart people that, absent tax considerations, would be very stupid.”  Other thoughtful observers vary the theme, e.g. a tax shelter “is a deal done by very smart people who are pretending to be rather stupid themselves for financial gain.”  Others have described the abusive tax shelters as “too good to be true.” 

I could not ascertain precisely what the steps in the fraudulent tax shelter scheme were other than, like Son-of-Boss transactions, the scheme created artificial losses that, presumably, offset the gain on sale of AUI stock, although it is not clear whether that gain was ever reported in order to use artificial losses. (I perhaps just missed something there.)  Here is the best explanation from Judge Hamilton’s dissenting opinion (Slip Op. 33-35):

IRS Issues Publication Warning of Abusive Tax Shelters and Scams (2/17/16)

The IRS issued  IR-2016-25 (2/16/16), here, titled Abusive Tax Shelters Again on the IRS “Dirty Dozen” List of Tax Scams for the 2016 Filing Season.  In this announcement, the IRS singles out some particularly abusive kinds that appear to be ripe for criminal investigation and prosecution.  They are:

• Abusive Tax Structures (which I call bullshit tax shelters)
• Misuse of Trusts
• Captive Insurance.

I cut and paste just the discussion on Abusive Tax Structures (bullshit tax shelters):

Abusive Tax Structures 

Abusive tax schemes have evolved from simple structuring of abusive domestic and foreign trust arrangements into sophisticated strategies that take advantage of the financial secrecy laws of some foreign jurisdictions and the availability of credit/debit cards issued from offshore financial institutions. 

IRS Criminal Investigation (CI) has developed a nationally coordinated program to combat these abusive tax schemes. CI's primary focus is on the identification and investigation of the tax scheme promoters as well as those who play a substantial or integral role in facilitating, aiding, assisting, or furthering the abusive tax scheme, such as accountants or lawyers. Just as important is the investigation of investors who knowingly participate in abusive tax schemes. 

Multiple flow-through entities are commonly used as part of a taxpayer's scheme to evade taxes. These schemes may use Limited Liability Companies (LLCs), Limited Liability Partnerships (LLPs), International Business Companies (IBCs), foreign financial accounts, offshore credit/debit cards and other similar instruments. They are designed to conceal the true nature and ownership of the taxable income and/or assets.
Whether something is “too good to be true” is important to consider before buying into any arrangements that promise to “eliminate” or “substantially reduce” your tax liability. 

 If an arrangement uses unnecessary steps or a form that does not match its substance, then that arrangement is an abusive scheme.  Another thing to remember is that the promoters of abusive tax schemes often employ financial instruments in their schemes; however, the instruments are used for improper purposes including the facilitation of tax evasion.

Here is my discussion of the features of abusive tax shelters from the current working draft of my Federal Tax Procedure Book (footnotes omitted):

GE Ducks Any Penalty for Its Bullshit Tax Shelter -- For Now (4/17/14)

I have previously written on GE's bullshit tax shelter twice blessed by the district court and twice swatted down by the Court of Appeals..  See Second Circuit Strikes Down Another BS Tax Shelter (Federal Tax Crimes Blog 1/24/12); here, and Thoughts on the the Corporate Audit Lottery (Federal Tax Crimes 2/11/12), here.  The irrepressible district court, smarting over two failed attempts to approve a GE raid on the fisc, makes another go at it in TIFD-III-E Inc. v. United States, 2014 U.S. Dist. LEXIS 41472 (D. Conn. 2014), here.  (The judgment entered shortly thereafter is here.)

The Second Circuit had already approved the application of the 20% substantial understatement penalty, but, as it turns out, when pushed to the taxpayer, the tax involved, though large, would not meet the threshold requirement that the understatement be "substantial" -- defined as exceeding "(i) 10 percent of the tax required to be shown on the return for the taxable year."  Section 6662(d)(1)(A)(i), here.

Readers will recall that the 20% accuracy related penalty has another basis -- if the position is due to negligence, which has no threshold limitation.  Section 6662(c), here.  So, the Government made another run to extract from GE some penalty for having played the audit lottery and lost for its bullshit tax shelter.  Again, this time, the district court tilted for GE, thus insulating GE from any cost or penalty for playing the audit lottery.  Why?

The Court opens its opinion as follows:

Defendant, the United States, moves for an order imposing a negligence penalty on plaintiff TIFD III-E Inc. ("TIFD") for tax years 1997 and 1998. During the 1990s, TIFD's parent company, General Electric Capital Corporation ("GECC"), joined with a pair of Dutch banks ("the Dutch Banks" or "the Banks") to form an aircraft leasing company. TIFD considered the Dutch Banks to be its partners in the venture, and did not report any income allocated to the Banks on its own tax returns. During the course of this litigation, I twice found that decision to be more than reasonable; indeed, I found that the company correctly deemed the Banks to be equity stakeholders rather than lenders. TIFD III-E v. United States, 342 F. Supp. 2d 94 (D. Conn. 2004)  [*4] ("Castle Harbour I"); TIFD III-E v. United States, 660 F. Supp. 2d 367 (D. Conn. 2009) ("Castle Harbour III"). The Second Circuit twice disagreed. TIFD III-E v. United States, 459 F.3d 220 (2d Cir. 2006) ("Castle Harbour II"); TIFD III-E v. United States, 666 F.3d 836 (2d Cir. 2012) ("Castle Harbour IV"). So, after more than a decade of litigation, TIFD ultimately lost this case. In addition, the Second Circuit held that the IRS could impose a 20% accuracy penalty against TIFD for substantial understatement of its income taxes in 1997 and 1998.

Despite having "twice found that [GE's] decision to be more than reasonable," the judge candidly acknowledges that the Second Circuit disagreed.  The court then proceeds to find GE reasonable again.

I won't review the facts, for the court itself that "I assume the parties' familiarity with the facts underlying this case."  I will note that, as is common in these bullshit corporate tax shelters, a foreign bank was the linchpin to make it have the superficial appearance of working.  (Foreign banks also played an essential role in the bullshit individual Son-of-Boss tax shelters; in this regard, see my postings Credit Suisse DOJ Investigation Status and New NY Investigation (Federal Tax Crimes Blog 4/7/14), here; and NY State Agency Makes New Moves in Investigation of Credit Suisse (Federal Tax Crimes Blog 4/17/14), here.)

Faulty Tax Shelter Opinions and Appraisals and Resulting Civil Penalties (9/24/16)

Two recent cases highlight the role of the tax professionals' legal opinions in so-called tax shelters.  During the abusive tax shelter proliferation in the late 1990s and early 2000s, the linchpin to abusive tax shelters was tax professionals' opinion letters pronouncing that the tax benefits were "more likely than not" to be sustained if the IRS contested.  Those opinion letters -- being just tax professionals' opinions -- did not affect how courts would resolve the issue of whether the tax shelters worked.  They served solely to give the tax shelter "player" some basis to claim exemption from the penalties that might otherwise apply to aggressive tax reporting positions.  Relying on tax professionals' opinions might permit the taxpayers to claim § 6664(c)'s "reasonable cause" and "good faith" exception to the penalties in § 6664(c), here, or, possibly, a reduction in the penalty base for the substantial understatement penalty in § 6662(d), here (in an earlier iteration).  Many of the tax shelter players did not in the final analysis actually rely upon the promoted tax shelter professionals' opinions, but rather discretely had their own independent counsel advise them on the shelter.  As I understand it, many of these independent advisers gave roughly the following advice:  "No way the shelter will be sustained if contested, but at least the promoted tax professionals' opinions will give the taxpayers a pretty good shot at avoiding the penalty."  (Of course, for this to work, the taxpayer would have to successfully keep from the IRS or ultimately the courts, the substance of the independent adviser's opinion.)

I discussed United States v. Daugerdas, ___ F.3d ___, 2016 U.S. App. LEXIS 17219 (2d Cir. 2016), here, recently, Daugerdas Conviction and Sentencing Affirmed by Second Circuit Court of Appeals (Federal Tax Crimes Blog 9/21/16), here.  I quoted the part of the opinion relevant to today's discussion, but will present the quote again here:

As an essential part of the marketing of all the tax shelters, Daugerdas and his colleagues issued "more-likely-than-not" opinion letters to clients who purchased the shelters. Such letters state that "under current U.S. federal income tax law it is more likely than not that" the transactions comprising the shelters are legal and will have the effect sought by the clients. They protect clients from the IRS's imposition of a financial penalty in the event that the IRS [6]  does not permit the losses generated by the shelter to reduce the client's tax liability. Paralegals or attorneys who worked for Daugerdas generated these letters and Daugerdas often reviewed and signed them himself. The letters stated that the clients had knowledge of the particular transactions underlying the shelter and that the clients were entering into the shelter for non-tax business reasons. Multiple clients testified that they never made representations of knowledge to Daugerdas or his associates and that, in any event, these representations were false because the clients knew little or nothing about the underlying transactions and entered into the shelters only to reduce their tax liability.

Daugerdas' shelters were clearly of the abusive -- aka bullshit -- variety.  In essence, for the tax shelters Daugerdaus and his partners in crime hawked, the play in the shelter gave the taxpayer a shot at the audit lottery and some way potentially to mitigate the penalty damage if he did not win the audit lottery.  But, as it turns out, these shelters were so bad, that they did not really offer much in the way of penalty mitigation except, sometimes, through IRS amnesty programs.  In essence, most of the taxpayers -- certainly the more sophisticated taxpayers who had millions and millions of income to shelter -- got into the shelter on a wink and a nod, hoping for the best with some downside protection.

In Exelon Corp. v. Commissioner, 147 T.C. ___, No. 9 (2016), here, the taxpayer had $1.6 billion in gain that it perceived a need to shelter -- i.e., avoid paying tax on.  The transactions are convoluted (as in the case of many tax shelters where the convolutions masks lack of substance).  (The complexity of the opinion is suggested by the fact that the substantive discussion concludes on p. 161 of the slip opinion.)  The details of the transactions are not important for purposes of this blog, but they are variations on leveraged leases with their own acronym that is familiar to affionados of bullshit tax shelters -- SILOs (to be contrasted from related tax shelters called LILOs).  In the opinion, Judge Laro offers the following "Primer on Leveraged Leases, LILOs, and SILOs:"

Key Points from Panel Discussion on OVDP and Streamlined (10/30/15; updated 11/3/15)

I participated in a panel at the Texas State Bar Advanced Tax Law Seminar, here.  The topic was the offshore voluntary disclosure programs (OVDP and Streamlined).  Dan is a major player with the IRS in these initiatives.  Chad is a major player from the private bar. Chad's bio is here.  The written presentations provided attendees is attached here, consisting of an outline by Chad Muller and Jack Townsend and an IRS Powerpoint which was presented by Dan Price during the panel presentation.  [Note to readers: the update on 11/3/15 was providing a download link for the pdf of the presentations (both in a single pdf).  If you download the pdf, you can work your way around the pdf with Acrobat's bookmark feature; if the bookmarks do not show on the left side, hit and that should show the bookmarks.]

Here are some major points that I thought readers may be interested in.  On some of these points, I expand with reasonable inferences from what was actually said.  Anything said below should not be attributed to Dan unless I specifically attribute it to him.

1.  OVDP is for the willful taxpayer.  For that type of taxpayer, the inside OVDP penalties are a pretty good deal (relative to the panoply of penalties that might otherwise apply.  Further, it is not just the willful taxpayer but the willful taxpayer who would be at risk of criminal prosecution or the devotion of IRS resources to investigate and impose the significant related income tax penalties and FBAR penalties.  Thus, I infer, it is possible that there are some willful taxpayers who may not be good candidates for OVDP because they are at fairly low risk.  For example, a taxpayer whose offshore income never exceeded $500 per year and tax never exceeded $150 per year.  Although other factors must be considered, that profile of taxpayer is not at material risk on either count.  That does not mean that other persons who are somewhere beyond the mid-point on the spectrum from nonwillful to willful should do OVDP.  The facts and circumstances might show that, even though potentially willful, there are other factors that might mitigate against full bore penalties if the taxpayer does not join OVDP.

2.  The IRS encourages nonwillful taxpayers to do streamlined if they otherwise qualify.  Although there will be no closing agreement at the end and the willful certification and narrative will be reviewed, if the narrative supports the certification and there is no indication that the certification is incorrect, it is not likely to be scheduled for audit.  However, other general audit techniques (such as DIF, etc.) might cause the return to be reviewed.  But the general audit coverage rate is fairly low, so the taxpayer pursuing streamlined has relatively low chance of audit.  But, there will be inherent uncertainty because no closing agreement is signed.

3.  In the Streamlined Program (either SFOP or SDOP), the IRS has the burden of proof if it conducts an audit and desires to assert the FBAR penalty or the income tax civil fraud penalty.  This is not like the Streamlined Transition where the taxpayer must persuade the IRS that he or she is nonwillful.  In this sense, in Streamlined Transition, the taxpayer has a burden of proof which, if he or she fails to meet that burden, Streamlined will likely be denied.

4.  In both Streamlined and Transition, the key is in the narrative in support of the nonwillful certification.  Dan made the point that the narrative (and any supporting materials, such as affidavits, etc.) should be proportionate to facts presented -- such as significantly the amount of income and the amount of the deposits.  I infer, for example, if the certification shows $100,000,000 in offshore deposits, more detail and support should be provided than $100,000 in offshore deposits.  Zeros or, more precisely, digits matter.

Sixth Circuit on Klein Conspiracy and Tax Evasion (9/16/10)

On September 15, 2010, the Sixth Circuit decide United States v. Damra, 621 F.3d 474 (6th Cir. 2010). The decision is long (51 pages) and addresses a number of issues. I deal here only with three of them that I think are in the mainstream for readers of this blog.

1. Klein Conspiracy - Is Willfulness An Element of the Crime?

Damra was convicted of a Klein conspiracy. Most readers will know that the federal conspiracy statute, 18 USC 371, defines two types of conspiracies -- an offense conspiracy and a conspiracy to defraud, known in the tax arena as a Klein conspiracy. If the offense underlying the offense conspiracy has a willfulness element, that element is imported as an element of the offense conspiracy. Specifically, a conspiracy to commit a tax crime having a willfulness element must meet the Cheek spin of intentional violation of a known legal duty. But, the Klein conspiracy has no reference point to import a willfulness element. So the question is what is the mens rea required in a Klein conspiracy?

Damra complained on appeal that the trial court did not instruct the jury that the Government must have proved that the defendant acted "willfully." Bottom line, the Sixth Circuit held that the instructions as given sufficiently conveyed the concept to the jury that the trial court did not commit reversible error. In the process of reaching that bottom line, the Sixth Circuit reiterated a prior holding willfulness is a required element of a Klein conspiracy, quoting an earlier case (United States v. Beverly, 369 F.3d 516, 532 (6th Cir. 2004) (citations omitted)) as follows (p. 498).

To establish a conspiracy, in violation of 18 U.S.C. § 371, the government must prove beyond a reasonable doubt that there was "an agreement between two or more persons to act together in committing an offense, and an overt act in furtherance of the conspiracy." This requirement has been broken down into a four-part test, which requires the government to prove that: "1) the conspiracy described in the indictment "was wilfully [sic] formed, and was existing at or about the time alleged; 2) the accused willfully [sic] became a member of the conspiracy; 3) one of the conspirators thereafter knowingly committed at least one overt act charged in the indictment at or about the time and place alleged; and 4) that overt act was knowingly done in furtherance of some object or purpose of the conspiracy as charged."

Notwithstanding that holding, the Sixth Circuit's pattern jury instructions defined the crime in terms of "knowingly and voluntarily" participating in the conspiracy rather than willfully doing so. In effect, Court held that these terms are sufficient to convey the willfulness concept, concluding (p. 500):

As the district court's instructions tracked our pattern instructions, as we have repeatedly approved of the "knowingly and voluntarily" formulation of the second element of conspiracy to defraud the government under 18 U.S.C. § 371, and as "willful" is in fact defined in part as "voluntary," we find that the district court did not omit the willfulness element of § 371 conspiracy when it instructed the jury, and so did not commit plain error in issuing its instructions as to Count 1.

JAT Comment: I think the Court did not crisply address or resolve the issue. The issue is whether, if indeed willfulness, at least in the Cheek sense, is an element of the Klein conspiracy, the words "intentionally and voluntarily" cover the same ground adequately to inform the jury. I don't believe that the Government believes that it does. I address that notion in my article, See John A. Townsend, Is Making the IRS's Job Harder Enough?, 9 Hous. & Bus. Tax L.J. 260 (2009). As I note in that article, the Government has taken the position that the Klein conspiracy is free of the Cheek willfulness spin that the defendant intend to violate a known legal duty but simply has to intend to join the conspiracy to defraud (defraud encompassing acts that are not necessarily illegal). And, if you parse the language of Beverly quoted above, the use of the word willfully does not seem to address the Cheek willfulness requirement in the sense of an intentional violation of a known legal duty. Indeed, in a later footnote (footnote 7), the Sixth Circuit says: ""The intent element of § 371 does not require the government to prove that the conspirators were aware of the criminality of their objective . . . ." United States v. Khalife, 106 F.3d 1300, 1303 (6th Cir. 1997) (quoting United States v. Collins, 78 F.3d 1021, 1038 (6th Cir. 1996))."

2. Tax Evasion - Separate Good Faith Instruction?

The defendant argued that the trial court erred in failing to give a good faith instruction on the tax evasion charge. Bottom line, the Court said that the standard Cheek willfulness instructions adequately covered the ground. The Court reasoned (p. 502):

Uncertainty in the Law and Willfulness (10/13/09)

In an article in today's New York Times here, Adam Liptak discusses Justice Scalia's dissent from denial of certiorari in Sorich v. United States, 129 S.Ct. 1308 (2009). Justice Scalia's lament is that the "honest services" crime does not provide an intelligible standard for criminal conduct. This theme is presented in the tax cases from James forward requiring a knowable law for tax crimes. Since the tax law requires willfulness, defined as the intentional violation of a known legal duty, then the legal standard must be knowable so that the defendant -- any defendant, even the hypothetical reasonable defendant -- charged with the crime must be able to ascertain the legal standard in order to intend to violate the standard.

Mr. Liptak notes with respect to "honest services" that "If you can make sense of that phrase, you have achieved something that has so far eluded the nation’s appeals courts." As a result, it is fair to say that citizens cannot ascertain the legal standard with any certainty and, correspondingly, judges and juries cannot predictably hold them to that uncertain standard. This phenomenon, Justice Scalia notes, violates fundamental constitutional principles, and gives the prosecutors too much unchecked power to pick and choose their defendants in a wide swath of conduct. Liptak notes:

All the President's Joint Defense Agreements (10/8/18)

I have previously written on joint defense agreements ("JDAs") (in reverse chronological order):

• On Trump, Manafort and Joint Defense Agreements (Federal Tax Crimes Blog 9/14/18; 9/15/18), here.
• More on Joint Defense Agreements (Federal Tax Crimes Blog 5/15/18), here.
• On Joint Defense Agreements (Federal Tax Crimes Blog 11/23/17), here.

A very good discussion of JDAs in the special counsel's investigation appeared today, addressed to the general public:  Darren Samuelsohn, Trump team’s contact with Mueller targets could taint findings (Politico 10/8/18), here.  The author discusses the Trump legal team's use of JDAs and whether the use may have goals beyond those normally contemplated by JDAs.  I urge readers who are interested in the intersection of politics and the criminal law to read the article because I believe it is quite good.  (Full disclosure, I am quoted in the article.)

JAT Comments:

1.  In my experience, a participant in a JDA withdraws at least by the time the participant agrees to cooperate and tell all.  Of course, that participant will not be able to disclose items that the participant learned earlier from others in the JDA which are within the scope of the JDA.  And, if the participant disclosed information to the other participants that is confidential to himself within the scope of the JDA, the participant can still disclose that information to the prosecutors pursuant to the cooperation agreement.  The only prohibition on the cooperating participant is that he cannot disclose confidential information that the other participants in the JDA disclosed to him within the scope of the JDA.  So, to use the stark example discussed in the article, if Trump or Trump's lawyers disclosed to Manafort or Manfort's lawyers Trump's admission to a crime within the scope of the JDA, Manafort could not disclose that admission to the prosecutors and, if Manafort did disclose the admission in violation of the JDA, the prosecutors would not be able to use the admission, directly or indirectly, in criminally prosecuting Trump.  Other information that Manafort or his lawyers know that was not disclosed by Trump or his lawyers pursuant to the JDA can be disclosed to the prosecutor and can be used to prosecute Trump.

2.  The problem comes in separating what the witness, here Manafort, knows independent of the confidential information he received pursuant to the JDA.  If the prosecutor wants to prosecute Trump for a crime and uses information from a person in a JDA (here that would be Manafort), the prosecutor will have to prove that the prosecution is not based on any Trump confidential information that Manafort learned from Trump or his lawyers under the JDA.  Unless the parties in the criminal action can agree, that would require a Kastigar-like hearing where the prosecutor would have to prove that the case does not rely on that "tainted" information, directly or indirectly.  That can, in many cases, be an impossible burden and would require suppression of any possibly tainted evidence or even, if so intertwined with the prosecution, dismissal of the case.

3.  For this reason, JDAs can sometimes limit the benefit that prosecutors can get from cooperation from participants in a JDA and make prosecutors less willing to strike a deal with the participant if it appears that the evidence the participant has is tainted or potentially tainted.  This requires delicate negotiations in reaching a cooperation agreement (usually by plea).  Accordingly, in complex multi-target investigations, the marginal or less important actors may want to either not join a JDA or limit and carefully document what is received under the JDA so that that participant can maintain maximum flexibility in cooperation/plea negotiations.

Mr. Cummings' Defense of Aggressive Tax Shelter Professionals (2/28/13)

I write to offer readers the following article:  Jasper L. Cummings, Jr., DOJ Criminal Tax Overreach, 138 Tax Notes 745 (Feb. 11, 2013), here, permitted with the permission of Tax Analysts.  I also offer below a brief summary and my comments.

Mr. Cummings, a frequent commentator on the tax law and its ripples (including criminal tax law), advises right up front that his principal points are:

This article makes the following principal points: 

•  The tax bar should have been somewhat more concerned about the way the Department of Justice Tax Division has prosecuted selected major law and accounting firm tax professionals who participated in the planning of, opinions on, or audit defense of some structured transactions during the most recent tax shelter boom that ended in the early 21st century. 

•  The type of arguments that the DOJ pursued against defendants like those in the Coplan case, recently affirmed in part and reversed in part by the Second Circuit, n1 might produce numerous convicted felons if applied to activities in which many readers have participated in.
   n1 United States v. Coplan, No. 10-583 (2d Cir. 2012), Doc 2012-24490, 2012 TNT 231-17 . [JAT Note:  the citation for Coplan is 703 F.3d 46 (2d Cir. 20122) and the opinion is here.]

•  The most troubling aspect of the Coplan and other prosecutions is that they follow a trend to criminalize advising, and even defending, a transaction that the DOJ believes does not produce the desired tax results under the (civil) economic substance doctrine.

Mr. Cummings uses the Coplan case as a point of departure.  (For my prior blogs on Coplan, see Major CA2 Decision on E&Y Tax Shelter Convictions (11/29/12), here, with links to the 8 other blogs on aspects of the Second Circuit's decision in Coplan.) He laments that the tax bar has just rolled over to prosecutions and convictions in tax shelter cases as a way to do damage control for their franchise in the aggressive tax planning area.  (Let a few be prosecuted so that the others can continue to play with relatively minor risk because only a few can be prosecuted).  He says (footnote omitted):