Check the Tax Loss Numbers: A Tale of Ineffective Representation (6/10/09)

We have a cautionary tale of woe in a recent case, Baxter v. United States (E.D. Ill. 6/25/09), available here. In the opinion, the court holds that defense counsel's representation in a tax case was constitutionally ineffective where the defendant counsel failed to engage the tax expertise to verify the tax loss number in the plea agreement that was used for sentencing purposes. The tax loss number is the principal driver of the Sentencing Guidelines calculations, setting the base offense level under the Tax Table at S.G. §2T4.1. (The Baxter court said: "in tax cases the magnitude of the tax loss for which the defendant is liable is a primary factor in determining the sentencing guidelines range.") Without getting into the complexities of the Guidelines calculations, suffice it to say that the tax loss number is the principal component of those calculations in tax cases.

Baxter, a CPA, was involved with the Aegis Trust system that, subsequent to the events involved in the Baxter case, the Government has prosecuted in several high prosecutions. The Government prosecuted Baxter also, charging in the original indictment "eleven counts of criminal income tax violations." The opinion is not more specific as to the charges in the original indictment. By plea agreement, Baxter pled guilty to a single count of § 7212 (tax obstruction) in a superseding information, admitting that she had submitted a false document to an IRS agent. Baxter further agreed in the plea agreement that, for sentencing purposes, "the offense involved a tax loss of more than $ 550,000 but less than $ 950,000." Apparently at some point in the plea agreement, the specific number $576,000 was used. The Government sought then to increase the tax loss amount by supposed relevant conduct to $5.1 million, thus trying to force a sentencing range above the 3-year statutory maximum for § 7212, which would mean that the Guidelines sentence would be 3 years. The claimed relevant conduct was Baxter's overall knowing participation in the fraudulent Aegis Trust system. At the original sentencing, the sentencing court determined that the Government had failed to prove that, at the time of her conduct of conviction, Baxter knew the system was fraudulent, thus rejecting the Government's claimed $5.1 million tax loss. But, at sentencing, the Sentencing Court assumed the correctness of the $576,000 tax loss stipulated in the plea agreement.

As it turns out, however, in reaching the plea agreement, Baxter's counsel did not engage tax expertise necessary to test the $576,000 figure which he had counseled Baxter to agree to in the plea agreement. In truth, much and perhaps even all of that figure was not related to the crime of conviction and was included in the $5.1 million relevant conduct figure that the sentencing court had rejected. In short, it was clear that the actual tax loss which should have been included in the sentencing calculations was far less than the agreed $576,000.

Baxter sought post-conviction relief under 28 U.S.C. § 2255. (Section 2255 is the statutory descendant of the common law writ of habeas corpus. For a good summary, see Allan Ellis and James H. Feldman, Jr., A 2255 and 2241 Primer, 26 Champion 26 (2002).) Baxter alleged that her counsel's failure to engage the necessary tax expertise to test the amount of tax relief related to her crime of conviction only constituted ineffective representation. The court agreed. For the court's analysis, you can read the opinion. The following are the key points:

Civil Tax Arcana Related to Voluntary Disclosure Program (6/29/09)

The expanded FAQs published June 23, 2009 has the following Q&A:

31. How can the IRS propose adjustments to tax for a six-year period without either an agreement from the taxpayer or a statutory exception to the normal three-year statute of limitations for making those adjustments?

Going back six years is part of the resolution offered by the IRS for resolving offshore voluntary disclosures. The taxpayer must agree to assessment of the liabilities for those years in order to get the benefit of the reduced penalty framework. If the taxpayer does not agree to the tax, interest and penalty proposed by the voluntary disclosure examiner, the case will be referred to the field for a complete examination. In that examination, normal statute of limitations rules will apply. If no exception to the normal three-year statute applies, the IRS will only be able to assess tax, penalty and interest for three years. However, if the period of limitations was open because, for example, the IRS can prove a substantial omission of gross income, six years of liability may be assessed. Similarly, if there was a failure to file certain information returns, such as Form 3520 or Form 5471, the statute of limitations will not have begun to run. If the IRS can prove fraud, there is no statute of limitations for assessing tax.

JAT Comments:

1. The question addressed here is the IRS's authority to collect tax beyond if an applicable statute of limitations prohibits the assessment that justifies the collection. For the income tax, penalties and interest (as opposed to the FBAR penalty) under the Areement, Section 6501(a) of the Code unequivocally requires assessment within three years, unless certain exceptions apply. The applicable potential exceptions are (i) the 6 year 25% gross income omission expanding the statute of limitations to year years, and the fraud exception eliminating the statute altogether.

2. If neither of these exceptions apply and depending upon when the taxpayers filed their returns in the early years, some of the early return years statute of limitations is closed depending on when they filed and the IRS is prohibited from making the assessment. If the 6 year statute applies, it would appear that all of the relevant years would be open, provided that the IRS assessed the tax, penalties and interest promptly. And, of course, if the IRS determines there to have been fraud, there is no statute of limitations. We do not understand, however, that, for those participating in the program, the IRS is going to require an admission of fraud nor that they IRS will even make a determination of fraud.

3. In the cases affected (i.e., those where the 3 years statute would otherwise apply), how can the IRS do this? Stated another way, what is to prevent the taxpayer from joining the program and making the payments and then, within the refund period (2 years) seeking a refund? That is the question FAQ 31 answers, albeit cryptically. Basically, the IRS says that it is going to be a settlement, period, in which the taxpayer pays and doesn't get back (in a process similar, I suppose, to the binding effect courts put on Forms 872-AD even where they are not the statutorily authorily authorized closing agreement). By analogy to the Form 872-AD, the agreement is a contract reflecting the parties' bargain, and the parties will be held to the bargain -- the taxpayer pays and does not get back.

4. Focusing on the IRS side of the equation, at least for those taxpayers not subject to the 6 year statute, the IRS has no determination of fraud, so how does it post the payments for the years otherwise barred by the statute of limitations, particularly since the statute is so clear that an assessment outside the normal 3-year period is prohibited absent one of the exceptions. I suppose that the IRS could hold the money in a suspense account and, upon the refund period expiring, move the amount to the excess collections account. Cf ILM 200915034 (3/5/2009), reproduced at 2009 TNT 68-16 (involving the abatement of an erroneous assessment that was beyond the refund limitations period; note that, in this case, the refund limitations period will not have expired upon the payment, but the contract (similar to the Form 872-AD will foreclose the taxpayer from getting a refund, so that ultimately, presumably, barring an assessment, the money would go to the excess collections fund). Another way of solving the problem might be to have the contract say that the IRS potentially had a claim for fraud (which, if sustained would open the statute of limitations and subject the taxpayer to a 75% fraud penalty), but which claim is being settled by the taxpayer agreeing that the statute is open for the assessment and getting the benefit of a 20% penalty rather than a 75% penalty. Either way, taxpayer's entering the program should assume that their payments are gone forever.

Sentencing Memoranda in U.S. v. Madoff

For good examples of advocacy in the workings of the post-Booker sentencing, including the necessary Sentencing Guidelines calculations, in a white collar crime case of some current noteriety, I provide links to the Madoff sentencing submissions where the parties are poles apart as to an appropriate sentence. For my students, this might be a good drill to also test the workings of the Setencing Guidelines. The Madoff case is white collar rather than tax, but both are financial crimes where the base offense level is driven by the loss numbers with parallel adjustments to the base offense for similar activity and characteristics.

Madoff Attorney's Letter (from the White Collar Crime Prof Blog) here. For a related NY Law Journal article, click here.

USAO SDNY Memorandum (from the NY Law Journal site) here.

Addition on 6/29/2009: Peter Henning, law professor at Wayne State, has guest summary in the WSJ Law Blog here of the sentencing arguments.

UPDATE ON 6/29/09:

Madoff Got 150 Years. I am sure that readers have already gotten bottom line and much of the details from other sources. I do like this particular comment from Jonathan Turley's blog here:

Sentences of this length often make me think of the judge who sentences a middle aged man to 30 years only to have the defendant say “Judge, I am already 50, I can’t do that amount of time.” The judge looked down kindly upon the man and said, “That’s okay, just do as much as you can.” Bye, bye Bernie.

FBARs required for Offshore Hedge Fund, Equity Fund Investors

According to this morning's edition of Tax Notes Today, an IRS spokeman yesterday asserted that "the IRS's position is that investments in foreign hedge funds and private equity funds are reportable for FBAR purposes." Somehow such investors have felt themselves exempt -- by IRS inaction, if nothing more substantial -- from FBAR reporting. The issue of whether or not they should file FBARs has been a heated topic over the past week.

Such Offshore hedge and equity fund investors who are just having their Eureka moment on this filing obligation with draconian penalties might want to seriously consider filing the 2008 FBAR. If they do not have time to pull it together by June 30, 2009 (the due date for 2008 FBARs, they can use the special grace period through September 23, 2009 announced in the IRS expanded FBAR FAQs issued (as expanded) just this week which may be viewed here (see paragraph 43).

These investors should also consider how to resolve past FBAR delinquencies and any income tax reporting deficiencies related to the accounts. If they have reported the income from the offshore funds on their income tax returns, they can simply file delinquent FBARs under the special procedure in paragraph 9 of the FAQs here. If they have not reported the income, they have two choices: (i) joining the IRS voluntary disclosure program (That program has been discussed previously on this blog (see the links in the column to the right of this blog), but requires significant penalties); or (ii) hunkering down and hoping for the best with a downside of potentially truly draconian penalties. This choice should only be made with legal counsel to help assist the costs and benefits / risks and rewards of the choices.

FBAR Question - U.S. Parent, Foreign Sub with Foreign Account

I ask my readers for help on a question of where on the FBAR form for a parent corporation filing the FBAR form to report foreign accounts owned by a foreign subsidiary. We have been struggling with this question and have no answer. Needless to say the IRS FBAR Hotline is impossible (rolls to voice mail boxes, most of which are filled).

The choices are Parts II, III or IV. I have received suggestions from good practitioners that each of these is the proper Part. I picked up the following email published in today's Tax Notes today that adequately expresses the conundrum and, if I get an answer or, in this case, answers, I will post the one or ones that appear most meritorious. In the meantime, I have a telephone call into the author of the email below which says that, upon inquiry (presumably to the IRS but he does not say that), he was told to use Part II.

Any answers or comments can either be posed or emailed to me at jack@tjtaxlaw.com.

FOLLOWING EMAIL PUBLISHED IN TAX NOTES TODAY ON 6/27/09:

From: Martin L. Scheckner [mls@mlscpapa.com]
Sent: 06/26/2009 10:05 AM
To: 'comments@irscounsel.treas.gov'
Subject: Form 90-22.1 request for comments on 90-22.1

Thank you for requesting our comments with respect to the FBAR form. We, and many other practitioners have struggled this year with the changes and extended definitions of accounts. We appreciate the Service's attempts to amplify their explanations of the requirements.

* * * *

3. There is currently no way to accurately reflect information where the taxpayer owns a foreign corporation (which is not required to file the FBAR) that has a foreign account. Upon inquiry we have been told to enter the above scenario in Part II as an account "Owned Separately" by the filer, but that is misleading and inaccurate. We suggest adding an additional category where the filer has an financial interest, but no direct ownership in an account.

The current options are:

Part II Financial Accounts Owned Separately
Part III Financial Accounts Owned Jointly
Part IV Financial Accounts Where Filer Has Signature or Other Authority But No Financial Interest

Parts II and III indicate direct ownership of an account, which is not the case in the above situation. Part IV indicates no financial interest, which is incorrect when the filer has an ownership interest in the owner of the account.

* * * *

Respectfully Submitted,

Martin L Scheckner CPA and
Marcell Hetenyi CPA

Scheckner & Hetenyi, PL
Certified Public Accountants
2525 Ponce DeLeon Blvd.
5th Floor
Coral Gables, FL 33134
Phone (305) 938-2309 (Direct Line)
Fax (305) 726-2804 (Direct Fax)
mls@mlscpapa.com

7th Circuit Says Attorneys Fees Do Not Mitigate Sentence

In United States v. Presbitero, 569 F.3d 691 (7th Cir. 2009) (decision here), the Seventh Circuit sustained convictions for two counts of filing false tax returns under § 7206(1) (tax perjury) and one count of Klein / defraud conspiracy under 18 U.S.C. § 371. The district judge tossed the conspiracy convictions on a motion for acquittal, finding that the Government had no evidence tending to show that one of the two alleged conspirators had joined the conspiracy to impair or impeded the IRS. Since it takes two to tango for conspiracy, the judgment of acquittal for that defendant meant that the conspiracy conviction of the other defendant (who had clearly engaged in conduct to impair or impede) must be dismissed also. (That defendant, of course, might have been but was not charged with the obstruction counterpart, § 7212.) The defendants appealed their convictions on the two tax perjury counts and the Government appealed the acquittal on the Klein conspiracy count. The parties also appealed the district judge's sentencing decisions.

The case appears pretty much garden variety for criminal tax cases. I point out here only a few points I thought were interesting:

1. § 7206(1) (tax perjury) does not have as an element that there be any tax loss to the Government. This is a standard holding, and just barely worth commenting on except as a reminder to students.

2. In a variation of the holding, the court said: "it is not a defense to a charge of willfully and knowingly filing a fraudulent tax return that the amount fraudulently deducted could have been deducted for some other reason." citing United States v. Helmsley, 941 F.2d 71, 92-93 (2d Cir. 1991) among others.

Get in Line Brother #14 - First UBS Customer Charged Pleads Guilty

The newspapers and tax rags reports this morning that Michael Rubinstein, the first of the UBS customers to be indicted has pled guilty. For the DOJ press release, click here. For articles on the plea, see the New York Times article here and the Wall Street Journal article here. For my previous blog on the indictment, click here.

The key points are:

1. Rubinstein pled guilty to one count of filing a false tax return for the year 2004. I presume that this is a tax perjury count under § 7206(1), which carries a maximum 3 year sentence.

2. Rubinstein agreed to pay a single FBAR penalty equaling 50% of the highest year during the period 2001-2007, thereby resolving his liability for all FBAR delinquencies. This single-year penalty is just 30% higher than the penalty being offered under the voluntary disclosure initiative. My gut reaction is that persons considering the costs and benefits of entering the volulntary disclosure initiative may conclude that this is not that great an additional civil cost of hunkering down and hoping for the best rather than joining the voluntary disclosure initiative. Of course, the real unknown is the cost and risk of criminal prosecution from a decision to hunker down.

3. I have not seen any tally of what Rubinstein will have to pay the IRS. DOJ Tax has been requiring plea agreements to include contractual restitution in the amount of the criminal income tax loss and some penalty amount. The reports I have read are silent on that.

4. The plea (and the inducements to the defendant) seems to be timed to remind the taxpayer and practitioner communities that FBAR time is now and more will follow (thus offering the incentive to join the voluntary disclosure initiative). The DOJ press release thus says:

As the FBAR filing deadline of June 30 rapidly approaches, taxpayers should be aware of the serious consequences of failing to report offshore income and foreign bank accounts," said Acting Assistant Attorney General John A. DiCicco. "Taxpayers who hide income offshore and fail to comply with the FBAR filing deadline face criminal prosecution, jail time, and steep fines."

"Today’s guilty plea resolves the first prosecution of a UBS client based upon records received from UBS pursuant to the historic deferred prosecution agreement executed earlier this year. In accordance with this agreement, UBS has disclosed the identities of wealthy Americans who were illegally hiding money to evade U.S. taxes," said Acting U.S. Attorney Jeffrey H. Sloman. "More prosecutions are expected to follow, as we continue to hold accountable those who conceal money and assets in an effort to avoid their income tax obligations."

Get in Line Brother #13 - FAQs Revised

The IRS has revised and substantially added to the FAQs. The revised and enhanced FAQs may be viewed here. These FAQs as revised are must reads for taxpayers who have FBAR and related income tax noncompliance over the past 6 years, and for practitioners who represent them.

The FAQs do raise some interesting issues which I will address in later blogs.

Get in Line Brother #12 - Rumors of FBAR Rule Relaxation

Given the crush of those trying to meet the June 30 FBAR filing deadline, I report here some rumors about Taxpayer friendly relief or at least help, albeit rather small.

1. I have heard that the IRS issued today some new FBAR guidance addressing a number of issues, but I have not been able to get a copy or even a good summary yet. I will post it and make comments when I get it. [Note: the Guidance appeared as a revision of the May 6, 2009 FAQs and may be viewed here.]

2. I have also heard that the IRS might apply some type of timely mailing, timely filing rule. I have not been able to confirm that rumor, so it could be just wishful, hopeful thinking. Still, in the administration of these provisions, I would think prudential administration would not force a penalty for an FBAR that was timely mailed, provided it got to the Detroit Service Center (or even the IRS for that matter) some reasonable time after June 30. In other words, while the IRS may not have the ability to create administratively a timely mailing, timely filing rule, it could achieve the practical equivalent by making prudent judgment calls not to administer the penalty to FBARs that might otherwise qualify if there were such a rule.

Note: For item 2, the Internal Revenue Code section deeming timely mailing to be timely filing, does not apply because the FBAR requirement is not in the Internal Revenue Code and thus is not subject to the timely mailing, timely filing rule.

Second Note to Readers: I had to change this blog because I had a significant error about having heard that the IRS would extend the filing date from June 30, 2009 to July 2, 2009. I think I got that notion from an IRS announcement for 2007 when June 30 actually fell on a Saturday, so that moving the filing date to the following Monday was logical (see here). Projecting that to 2009 was sheer operator error. Apologies to my readers.

Get in Line Brother #11 - FBAR Compliance for Offshore Hedge and Equity Funds

The Wall Street Journal has an interesting article here for tomorrow's print edition discussing the recent revelation that offshore hedge and equity fund accounts may be subject to the FBAR reporting requirements. One may wonder why this is such a revelation. Doesn't the relatively plain English cover such accounts? We have heard the term in todays economy "too big to fail." Those persons now discovering perhaps just felt earlier that they were too big to report. Stay tuned.

Addendum #1. See a Sullivan & Cromwell Memo here.

Get in Line Brother #10 - Never Mind, DOJ Going Full Bore After All

This supersedes today's earlier post here to the effect that the DOJ / IRS juggernaut against UBS might be going away. Never mind. See the Wall Street Journal article here.

Get in Line Brother #9 - UBS / DOJ Settlement on Names?

The New York Times reports here a possible settlement soon in the UBS case.

The article is cryptic, but as best I understand it, what's in it for the DOJ/IRS to drop the John Doe Summons action action is:

1. UBS / the Swiss Government would turn over the names of U.S. persons who have filed suit in Switzerland to block the turnover of names. ("But prosecutors are more likely to learn the identities of UBS clients after some filed legal papers in Swiss courts contesting the Justice Department’s names summons. Swiss government officials are considering conveying these Swiss-based filings to the Justice Department as part of a deal in which the United States agency would drop the entire case, something that would allow Switzerland to say that it has not breached its own secrecy laws.") This seems to me to be a bit of a game, but let's see if and how it plays out.

2. Many the ultra wealthy persons affected have joined the voluntary disclosure program and the suit would involve lengthy appeals proceedings. (This explanation of a reason to settle makes no sense to me.) But, in this regard, the following statement is made:

Of the 52,000 clients on the agency’s original list, prosecutors are focused on several thousand ultrawealthy Americans with offshore accounts containing from tens to hundreds of millions of dollars. Some 30,000 of the accounts are smaller, cash-only accounts, and many of those have been repatriated to American-based banks in recent months, the official said.

There are a lot of questions left unanswered in this cryptic article. Stay tuned.

Sentencing Guidelines Loss Calculations -- No Double Counting Please

The key first step in the Sentencing Guidelines calculations is to determine the tax loss. Normally, this is rather cut and dried, except that the practitioner must assure that the tax loss only includes tax amounts related to fraudulent items (as opposed to just nonfraudulent civil adjustments). But every now and then controversy flares up about double counting, as it did in the recent case of United States v. May, 568 F.3d 597 (6th Cir. 2009), here.

In May, the defendant ran a business. At his direction, the business withheld tax amounts from the paychecks of all employees (including himself) but did not pay them over to the IRS. The taxpayer was subsequently prosecuted for personal tax evasion (§7201) and for willful failure to pay over the withholding amounts (§7202). He was convicted of both. The district court included in the tax loss the amount that was withheld and not paid over (including the amount related to the defendant's own salary) and also included the defendant's underpaid tax liability which underpaid amount included the amount withheld but not paid over. In effect, both amounts relating to the defendant's single income tax liability got counted twice, thus affecting his tax loss number and potential sentence under the Guidelines. The Court noted pungently: "Despite the fact that the taxes were only owed once, the government contends that the Sentencing Guidelines demand that we count the tax loss twice, once for the payroll tax loss calculation and once for the personal income tax evasion calculation." The court held that the Government's authority for this startling proposition were inapropos and concluded (p. 605):

As the government has admitted, the funds on which May failed to pay taxes were only subject to being taxed once. May could pay them as payroll taxes or pay them on his individual income tax form. (Gov't Br. at 37-38.) Section 2T1.1(c)(3) requires that "[i]f the offense involved willful failure to pay tax, the tax loss is the amount of the tax that the taxpayer owed and did not pay." (emphasis added). Thus, Section 2T1.1(c)(3) applies here because both of the statutes under which the jury convicted May require willfulness. See 26 U.S.C. §§ 7201-7202. Once again, the government does not argue that May owed the tax twice. (Gov't Br. at 22-23.) Because the plain text of the Sentencing Guidelines requires that only amounts actually owed should be aggregated, the district court erred in counting the tax loss twice. On remand, the district court should calculate the amount of taxes May owed on his own income. The district court should then add to this amount the amount of payroll taxes from the other employees of Maranatha that May collected but did not actually pay over to the government. These amounts may be aggregated because the payroll tax owed for the other employees was a separate taxable amount that was owed. See U.S.S.G. § 2T1.1(c)(3). n4

Tax Crimes -- the Role of the Lie (6/20/09)

In several prior blogs I have asserted that tax crimes -- particularly tax shelter crimes -- are about the lie. Some who have read the Title 26 criminal tax provisions and the common Title 18 provisions used in prosecutions of what are at the core tax crimes will not find the word lie mentioned. Some of the tax crimes do require a lie via false statement under penalty of perjury (tax perjury, §7206(1) or false document (aiding and assisting, §7206(2)), but as I develop in this blog, the lie is the common feature critical for proscution of tax crimes even where the text of the criminal provision does not have some similar meaning.

I divide the universe of the crimes usually charged in tax crimes into two categories as follows:

The Daugerdas Indictment - Part #4 - The Lie (6/16/09)

I have blogged before that tax shelter prosecutions are about the lie. Often, the claim is that the tax shelters lack economic substance, but in these prosecutions the real complaint is the lie that is designed to give an appearance of economic substance. The jury will not understand the complex, convoluted tax structure and byzantine legal analysis, but the jury will understand the lie. In this blog, I will look principally at the indictment's claims as to the big lie. I caution readers that I address here only my understanding of the Government's unilateral claims about the lie in the indictment. I make no attempt here to develop nuance or present defenses to those claims that the defendants may have.

The Big Lie

The big lie is the taxpayers' representations that they had a nontax business reason for participating in the shelter. "In truth and fact," the indictment asserts repeatedly, the taxpayers participated in order to achieve the touted artificial tax benefit and not for a nontax business reason (sometimes the indictment alleges "substantial" nontax business reason). And, in truth and fact, the promoters knew the taxpayers' real tax motivation, despite their formalistic reliance on the taxpayers' "representations" of business reason.

The Daugerdas Indictment - Part #3 - The Shelters

The tax shelters alleged in the indictment are of two generic types.

1. The first is the contingent liability / Helmer type of shelter. (Indictment ¶¶ 26-31.) This type of shelter was employed by other tax shelter promoters, including KPMG (e.g., the indictment of the KPMG related individuals including BLIPS and SOS, both of which were this type of shelter.) Three of the four shelters involved used this strategy - Short Sale, Short Option Strategy ("SOS") and Swaps. The tax play in this genre of shelter is based on cases, exemplified by Helmer v. Commissioner, 34 T.C.M. (CCH) 727 (1975) that treated some types of debt as contingent debt that is not characterized by tax rules dealing with true debt. To illustrate, If individual A borrows $1 and contributes the $1 cash borrowed and the offsetting debt to a newly-created partnership in which he is a 99% partner (with no special allocations), A will take his partnership with basis calculated by the cash contributed $1 and the debt deemed shifted to another partner -- i.e., $ .01, and so has a $ .99 basis in the partnership. Suffice it to say for present purposes that, in that scenario, any way the debt gets resolved or A leaves the partnership holding the debt, A will get no free losses -- losses he has not paid hard dollars to achieve. However, if in making the calculations, the debt contribution to the partnership is not treated as debt at all (let's call it contingent debt and therefore not true debt because the calculations take into account only true debt), A can take a full $1.00 basis in the partnership interest, A never has to account for the fact that economically he shifted $1 of offsetting debt to the partnership, and A will have $1 basis in his partnership interest which he can, at least theoretically, claim as a loss even though economically A has paid nothing for the partnership interest (i.e., he put in $1 cash and $1 debt characterized for tax purposes as contingent but economically an offsetting position making his economic contribution $0). As presented in this simple example, the arrangement is a pure tax play, having no business or nontax purpose which is required in order to sustain the loss that appears to arise from the transaction. Pomoters peddling this type of shelter inserted various investment gambits, of various cosmetic opaqueness, that were intended to put some business or nontax purpose flavor to the transaction (at least enough, they hoped, to deflect the IRS's attention or even be sustained by a court). Thus, for example, in the SOS strategy long and short paired offsetting options would form the portfolio -- the long option position would be substantially paid for with the proceeds realized upon selling the short option position and the economic risks and opportunities of the offsetting positions would balance effectively to zero. Both positions would be transferred to the partnership with the short position being treated as a contingent debt that did not have to be accounted for in tax calculations. Economically, it is the equivalent of the example of borrowing $1 and obligating to pay with something that will be treated for tax purposes of a contingent obligation to repay. The net effect, the taxpayers and promoters hoped, is to leave the taxpayer with a very large artificial basis (very large because much more nominal dollars than $1 were involved) that the taxpayer never paid for and will never pay for, to claim as a very large (albeit very artificial) tax loss. That artificial tax loss would be reported on the tax returns as an offset the taxpayer's very real taxable gains.

2. The HOMER Shelter. The HOMER shelter is described in Indictment ¶¶ 32-34. I am unusure precisely what the tax play was, but the bottom-line, the indictment alleges, was the same as the other shelters -- the parties' liabilities and risks were eliminated through offsetting investment positions, the "tax losses purportedly created by the tax shelter vastly exceeded any actual economic loss suffered by the client[, and] the reporting of the tax shelter's tax benefits on the client's tax returns substantially reduced or eliminated the amount of taxes owed by the client." (Indictment ¶¶ 34.)

The economic effect of these shelters is that the very larlge tax liabilities that taxpayers otherwise would have paid on the their very real gain disappears, with the Government holding the bag and the promoters sharing in the amount the Government lost. What economically motivated person would not be willing to pay $1 to save $4 of taxes? (That might not be the right ratio, but that is the concept.) But the question as to the promoters / enablers indicted in the Daugerdas indictment is not just the economic motivation, but whether that economic motivation drove them to do something the law (or jury) has called or will call criminal.

JAT Comment on the tax aspects of the Helmer play. I believe that the promoters' hopes for the Helmer play was off balance in a tax accounting sense. Those hopes assume the ability under general tax principles to achieve a cost-free cost basis. The counter to that is that tax books don't balance with a cost-free basis. Alright, I know that Gitlitz says perhaps not in the S Corporation context, but that was a special case and it appears to have slipped into tax history without affecting much in its wake and certainly not affecting general rules that look for tax books to balance. I think the more pertinent authority is Tufts where the Supreme Court forced the tax books to balance (and it really did not take much forcing, just a healthy dose of solid logic). Focus on the simple example above where the taxpayer gets $1 cash by undertaking a debt somewhat artificially labeled for tax purposes as contingent debt. If the debt were real, noncontingent debt, the taxpayer's tax books will balance and be consistent with the economic results, with perhaps only some interperiod differences that ultimately resolve. But, if it is contingent debt (whatever precisely that is) and the taxpayer never resolves that debt, the promoters claim he has achieved a cost free $1 basis asset (originally the cash but a partnership interest if he contributes it to a partnership) and his books can't balance unless he pays for it either with phantom income (not unlike Tufts) to match the phantom basis (analogous to the debt driven cost basis in Tufts). A tax event not unlike Tufts to balance the books would have fixed the problem in the shelters relying upon Helmer. The opinion letters I read on the subject pretty much ignored the issue. I guess, if the writers spotted the issue at all, they ignored it in hopes that it would go away. It has since the IRS has prevailed, both civilly and, based the instructions in the Larson case, criminally with a more blunderbuss approach in the economic substance doctrine.

The Daugerdas Indictment - Part #2 - It's About the Money / Greed

The Daugerdas indictment is all about greed for money (and perhaps power and sex, which often accompany money, but the indictment does not allege anything about that). Taxpayer greed for money (or more money) attracts enabler greed for money. With that shared interest, taxpayers and their enablers went boldly into the future. So let's take a look at the money, the root of the evil alleged in the indictment. 

The Defendants 

The indictment alleges (¶ 60) the following "approximate aggregate amounts" of payments to them (or at their direction) related to tax shelters during the tax years 1998 through 2002 (the years Daugerdas was with J&G): 

PAUL DAUGERDAS $ 95,700,000 

ERWIN MAYER $ 28,700,000

DONNA GUERIN $ 17,500,000

DENIS FIELD $ 24,600,000

ROBERT GREISMAN $ 4,200,000

CRAIG BRUBAKER $ 3,300,000

DAVID PARSE $ 6,000,000

Total $180,000,000 

Other individuals were in the feeding chain, but they were minor relative to the indicted defendants. One cosmetic intermediary third party did earn in excess of $1,000,000 but he was not indicted and for this purpose is relatively minor. 

The Institutions (Business Entities) 

The Daugerdas Indictment - Part #1 - the Players (6/11/09)

OK, I've finally gotten around to discussing the Daugerdas indictment. I will have several installments, so I start by making the raw material available -- the indictment itself. A pdf of the indictment can be downloaded from the Tax Prof Blog here. I have OCRd the indictment into a PDF (making it easier for searching) here, although I caution that the OCRing may not be perfect. Other convenient links are: (i) the USAO SDNY press release here; (ii) Taxing Matters Blog (with some moralizing) here; (iii) a Bloomberg article here.

I don't have a final outline of the installments, but here is a tentative outline is.

#1 The Players
#2 Follow the Money
#3 The Shelters - the Technical Superstructure
#4 The Shelters - Economic Substance - the Lie
#5 The Really Ugly

Convicted Tax Evader Complains About His Enabler

Ok, I will get to the really big news about the SDNY indictment of Paul Daugerdas and his some of his alleged co-conspirators, but first I thought I would offer a light moment -- at least a light moment for tax crimes geeks.

Bloomberg reports here that convicted tax felon Igor Olenicoff -- the mega-millionaire -- who pled guilty to massive tax fraud via his friendly UBS banker (who also pled guilty) is complaining that the devil -- aka UBS -- made him do it. The article has a good summary of the twisted background of UBS's activity generally and in relation to Mr. Olenicoff. Perhaps UBS really is the devil; that could explain, perhaps, why the judge was so lenient at sentencing -- 2 years probation, 150 hours of community service, and paying what he already owed of $52 million in taxes, penalties and interest.

It is a substantial article and good reading. I pick some of the snipetts I think are choice:

Snippet #1

The judge asked Olenicoff why he had failed to fill in a box on his tax returns asking if ye controlled foreign bank accounts. “It’s not crystal clear to me why someone of Mr. Olenicoff’s intelligence would answer a question that seems to be so easily proved to be false,” the judge said. He praised Olenicoff’s business success and charitable work for eastern European orphans.

“You are an incredible man,” the judge said. “When I find out that people of your stature and standing lie on your tax returns, it frustrates me, saddens me.”

Olenicoff told Carney that bankers gave him bad advice.

“Should I have known that that income should have been reported here probably two years into it?” Olenicoff said. “Yes, your honor. I probably should have checked the box, but I didn’t.”

Does he equivocate as to his responsibility? Sure the bankers gave him bad advice. He is not guilty of anything for receiving bad advice. He is guilty for his own actions which, after all, required willfulness, an intentional violation of a known legal duty.

Snippet #2:

“I would have clearly gotten my ears boxed in by the Justice Department,” Olenicoff says at his Newport Beach office, which is filled with paintings, sculptures and artifacts from Russia and his travels to Latin America and Greece. “Once you do something wrong, you fess up to it and you pay for it.”

Well, the lesson is that you fess up when you know you are going to get your ears boxed in. Isn't that why most defendants plead?

Snippet #3:

Still, he believes UBS hasn’t been sufficiently penalized for aiding tax evasion over seven years.

“They pay $780 million,” Olenicoff says. “That’s lunch money for them, right? But there’s nobody being penalized for this. I have been -- and I paid. There will be 52,000 Americans that will be somehow affected by their fraud. The bank needs to be exposed and needs to pay for its wrongdoing.”

How about his payment of the $152 million in tax, penalties and interest that he already owed. Isn't that lunch money for him? Did he refuse to pay the cost of the society that had earned him so much for mere lunch money?

Snippet #4:

Olenicoff says no one at UBS told him about the qualified intermediary accord.

“Had somebody said, ‘Igor, we have this QI agreement, right, and so we have to report it or you have to report it,’ the answer would have been real simple: ‘Sure,’” he says.

No comment.

More on the Quellos Individuals Indictment - It is About the Lie (6/8/09)

I have now had the opportunity to review the Quellos indictment in more detail. It is all about the lie that, if the allegations are proved, a jury will understand. A jury almost certainly would not understand -- or need to understand -- the complex tax rules which might have applied if the key factual underpinning were true. The jury will understand the lie. And, the gravamen of the instructions to the jury will be that, if the jury finds that prosecutors prove the lie they allege, the defendants should be found guilty.

Let's look at the counts and the lie. At the risk of oversimplication, I simplify and thus omit much of the detail.

FBAR Reminders and Update

1. 2008 FBARs (form here) are due by 6/30/2009, and must be physically filed by that date (i.e., the timely-mailing/timely-filing rule does not apply). There is no extension of time available for filing this form. I a delinquent form is filed, taxpayers must attach a statement explaining the reason for the delinquency.

2. Taxpayers with foreign accounts and entities who are contemplating not joining the special voluntary disclosure program must file these FBARs. This should be an considered in the decision as to whether to join the program.

3. The new form (link above) is the one that must be used, but, according to a June 5 IRS press release, taxpayers and advisers can rely on the definition of a U.S. person contained in the July 2000 instructions to the old FBAR form, which was limited to a U.S. citizen or resident, domestic partnership, domestic corporation, or domestic estate or trust.

New Tax Shelter Enabler Indictments - More About the Lie (6/8/09)

On June 4, 2009, the Federal District Court in Seattle unsealed a previously sealed indictment of certain Quellos-related individuals. A Wall Street Law Blog article is here, and the indictment is here. Quellos was a bona fide investment company that got in the tax shelter business. The indictment contains the same pattern as the KPMG related indictment -- (1) conspiracy as the ubiquitous Count One and 8 Counts of Tax Evasion. But the indictment and goes beyond that pattern to add 3 counts of wire fraud and one count of money laundering conspiracy. Wire fraud and money laundering conspiracy often accompany traditional tax crimes (including the general defraud conspiracy), but are not often charged together in the same indictment. See Tax Division Directive No. 128. And, such piling on of charges addresses a concern that Congress recently stated in FERA (see the prior discussion here)).

I focus in this blog not on the charging decisions (how many crimes can a creative prosecutor imagine and charge), but rather upon the basic pattern of conduct that is reported to be behind the indictment. I have previously discussed here the common feature -- the lie -- of tax shelter crimes. See prior blogs here and here. If tax shelter crimes are really about the lie, who is the target of the lie? It is not a lie unless it is told to someone who might rely upon the lie. Let's take the quintessential lie that the Government claims in tax shelters -- that the taxpayer has a business or profit motive independent of the tax benefits. The lie is intended for IRS consumption to distract the IRS from the truth -- no profit motive and no right to the tax benefits claimed. In all events, it is imagined, the lie might avoid penalty relief if all else fails. The lie is also intended for persons in the tax shelter chain who might not know the truth otherwise and relies upon the lie as truth as a condition to their participation in the chain.

The WSJ Law Blog today asks the question of whether attorneys for the taxpayers entering Quellos shelters were also the intended targets of such lies in order to give them the comfort they needed to, in turn, give the taxpayers whatever comfort they needed. In other words, in the simple example posited above, the lie about the intended business or profit motive might be required for the taxpayers' lawyers to bless the deal. That is the focus of the WSJ Law Blog discussion.

But in the simple example I posit, what lie is being told? It is true that in these deals, the promoters require the taxpayer to make the independent business or profit motive representation. But who is making the representation? It is the taxpayer. The taxpayer has the relationship with his own counsel -- i.e., the taxpayer's lawyer is not in bed with the tax shelter promoters but truly an independent lawyer representing only one person, the taxpayer. The taxpayer's lawyer is supposed to understand the overall structure including any of its components relevant to the taxpayer's representation as to independent business or profit motive. If the taxpayer believes the representation and his lawyer believes that, properly counseled by that lawyer, the taxpayer believes the representation, there should be no criminal conduct on behalf of either the taxpayer or the lawyer. Of course, even if the taxpayer's lawyer believes that the taxpayer believes the representation and nevertheless, based on the lawyer'sw independent review of the structure, believes that the taxpayer is misguided as to the belief, the lawyer's job is to counsel the client that the facts do not support the belief, however sincerely held, and the taxpayer should reconsider. But, if the taxpayer persists in his belief after proper counseling, however misguided that belief may be, it is not the taxpayer's lawyer's job to call his client a lier. It is, after all, a subjective belief, and there is no litmus test of a subjective belief. (Of course, the lawyer will surely advise the taxpayer that the risk is that, if the belief is not credible, the lawyer and the taxpayer take the risk that no one -- specifically the IRS, a prosecutor or a juror -- will believe that the taxpayer really believed he had an independent business or profit motive or that the lawyer really believed that the taxpayer had that belief, and the Government may convict the taxpayer and the lawyer for hiding behind the known lie to particpate.)

DOJ Tax Division Criminal Tax Investigation Authority (6/5/09; 12/29/14)

In the KPMG-related criminal case in the Southern District of New York, two issues arose regarding the scope of the authority of the Department of Justice Tax Division ("DOJ Tax") with respect to criminal tax matters. The issues were:

1. Does DOJ Tax have authority to conduct a criminal tax investigation independent of a grand jury investigation?

2. Does DOJ Tax have authority to prosecute or authorize prosecution of a federal tax crime if the IRS does not agree with the prosecution?

Each of these questions have a context that I shall discuss. Suffice it to say at this point that I made a FOIA request to DOJ Tax (here) to try to obtain answers to these questions. The DOJ Tax FOIA response (here) is quite cryptic and simply refers to the provisions of 28 CFR Section 0.70 (online version here). (Actually, the copy of the CFR provision enclosed with DOJ Tax's response is an earlier version than the current one I link to, but I don't think there were any changes in the later version, other than that redesignating the provision as subpart M rather than subpart N in the earlier version provided by DOJ Tax.) The DOJ Tax response also refers generally to the IRS Internal Revenue Manual ("IRM") (access here) without specific citation; I have been unable to discern how the IRM could possibly establish DOJ Tax authority in the subject areas, since the IRM deals with internal IRS procedures.

DOJ Adds Another Notch in Its Abusive Tax Shelter Belt - BDO Vice-Chair Pleads re J&G Shelter

The Government announced here yesterday a guilty plea by Charles W. Bee, a former vice-chair of BDO Seidman, with respect to a Jenkins & Gilchrist shelter marketed by BDO Seidman. The counts to which Bee pled were (i) conspiracy (the standard count in these cases), (ii) tax evasion with respect to a client's reporting of the the shelter, and (iii) giving false deposition testimony. The following is the key part of the press release:

Bee knew that the tax shelter transactions would be allowed by the IRS only if there was a reasonable possibility of a profit. Bee also knew that, given the costs and fees to the clients, and the nature and duration of the transactions, the tax shelters had no reasonable possibility of resulting in a profit. In addition, Bee knew that the clients who purchased the tax shelter had no non-tax business reasons for entering into the transactions, and that the fees were set as a percentage of the tax loss sought by the clients. To make it appear that the tax shelter clients had the requisite business purpose and that there was a possibility of profit, Bee and his co-conspirators reviewed and approved the use of a legal opinion letter issued by J&G that contained false and fraudulent representations purportedly made by the clients about their motivations for entering into the transactions. Bee and other TSG members also developed a consulting agreement containing false and fraudulent statements to disguise the fact that the fees clients would be charged by BDO Seidman were solely for the tax shelters. Finally, Bee and his co-conspirators caused the clients to file false and fraudulent tax returns incorporating the supposed tax shelter benefits. In total, the fraudulent tax shelters implemented by Bee, BDO Seidman, J&G, and the financial institution that assisted them, caused clients to report over $1 billion in false and fraudulent tax losses, resulting in the evasion of over $200 million in taxes.

Bee also specifically admitted criminal responsibility based on the sale by BDO of a tax shelter known as the "short option" transaction to one client, who was charged fees of approximately $133,000 by BDO Seidman and $201,000 by J&G. The short option tax shelter purportedly generated losses sufficient to offset the taxes due on $6.7 million the client had received from a stock sale. In fact, the short option transaction had the reasonable possibility only to net a profit of $67,000, thus resulting in no potential profit to the client. The client nonetheless filed tax returns with the IRS reporting false and fraudulent losses purportedly generated from the short options shelter, thereby evading a substantial amount of taxes that he would otherwise have had to pay.

Finally, Bee admitted that in February 2005, while under oath during a deposition in Jade Trading v. United States, a Court of Federal Claims case involving a tax shelter sold by BDO and another promoter, he knowingly made false material statements concerning BDO's tax shelter practice.

You will note that all three counts relate to the theme in tax shelter criminal cases -- the lie. See my blog posting here about the lie.

Get in Line Brother #8 - Enablers' Exposure from IRS Voluntary Compliance Initiative

The IRS initiative for offshore accounts and entities offers benefits only to the taxpayers involved. Those benefits are substantial indeed -- avoidance of criminal prosecution and substantially reduced penalties -- and offer a strong incentive for taxpayers to join the program. Many of those taxpayers had U.S. tax professionals who were enablers as to the foreign accounts and foreign entity structures. These enablers' activities may come under scrutiny as the taxpayers open their kimonos. Since the taxpayers must cooperate and disclose, tax professional enablers who came close to or crossed the magic line should have some concerns. Much of the planning by tax professionals that I have observed in the offshore context involves strained and technical interpretations of the Code that often defy common sense, and we know from the spate of tax shelter enabler prosecutions that the Government will prosecute and convict on strained interpretations that cross the line. At a minimum, tax professionals who assisted clients in their offshore adventures should seriously consider whether they should be involved in their clients' decisions with respect to this new IRS incentive for foreign accounts and structures. Can these professionals render objective advice as to whether the taxpayer should even enter the program? And, assuming the clients decide to enter the program, can these professionals properly represent the clients in effecting the required cooperation and disclosures where they may be tempted to shape the cooperation and disclosures to protect their own interests rather than the clients' interests?

And, on a related topic, could the clients -- or some of them anyway -- enter a dialog with the IRS about avoiding at least the penalties by delivering up the professional on a silver platter?

And, could the clients even qualify for whistleblower rewards if the professional has enabled others? (In this regard, taxpayers tempted to hunker down and not join the program might consider whether they are at risk of being discovered by this process as other taxpayers disclose the role of the common professional.)

Voluntary Disclosure and FBAR Resources

I post below some voluntary disclosure and FBAR resources. Where I have found them available on the web, I post the web link to them. This is not an exhaustive list, but as I find further useful articles that might be helpful, I will revise this blog post to include them.

Forms:

FBAR Form (TD F 90-22.1)

IRS Resources:

IRS Web Site Link Page

Articles:

Fred Feingold, Further Guidance on Who Must Report Foreign Accounts, 123 Tax Notes 1023 (May 25, 2009)

John A. Townsend, Federal Tax Crimes Blog -- All Blogs on FBARs

John A. Townsend, Federal Tax Crimes Blog -- All Blogs on Vountary Disclosure

Scott D. Michel, IRS Issues Revised FBAR Reporting Form, 121 Tax Notes 165 (Oct. 13, 2008)

Steven Toscher and Michel Stein, "FBAR Enforcement -- Five Years Later," Journal of Tax Practice & Procedure, June-July 2008, p. 37.)

Calculator:

John A. Townsend, Offshore Account Initiative Voluntary Disclosure Calculator

This is an excel spreadsheet that I make available only to tax professionals and then only upon specific request and proof that they are tax professionals and agreement that (i) they will use it only in their practices, (ii) they will rely on it only for rough calculations and (iii) they will always independently verify the calculations before advising any client to take any action. Tax professionals desiring a copy of this Excel spreadsheet program should email me at jack@tjtaxlaw.com with proof that they are tax professionals (resume) and their statement of the agreements above which they should cut and paste into the email request. Please advise whether you want the spreadsheet in Excel 2003 format (.xls) or 2007 format (.xlsx)