Government Asserts Wylys' Fraud in Bankruptcy Court (1/7/16)

Sam Wyly, about whom I have written before, here, is back in the news today over his offshore tax gambits.  See Lisa Maria Garza, Texas tycoon Wyly engaged in massive tax fraud, IRS tells court (Reuters 1/6/16), here.  This iteration of the dispute over taxes, penalties and interest alleged to exceed $3 billion is in bankruptcy court in the Northern District of Texas where the formerly fabulously wealthy Wylys seek mitigation of the tax liabilities claimed by the IRS.  Federal tax procedure enthusiasts will know that sometimes interesting and complex tax issues are resolved in the bankruptcy court.  The article the lawyers high level summary of the case as follows:

Texas tycoon Sam Wyly engaged in "lies, deception and fraud" in a years-long scheme to dodge taxes on $1.1 billion held in offshore trusts, a lawyer for the Internal Revenue Service said on Wednesday. 

The IRS made those claims at the start of a trial in federal bankruptcy court in Dallas in which the agency is seeking $3.22 billion in back taxes, penalties and interest from Wyly and the widow of his late brother Charles, Caroline Wyly. 

Cynthia Messersmith, a U.S. Justice Department lawyer representing the IRS, said the Wylys had since 1992 used offshore trusts to avoid paying taxes on $1.1 billion in proceeds while exercising stock options and warrants of four companies on whose boards the brothers sat. 

"This is a case of lies, deception and fraud," she said. "This is not about tax avoidance but rather tax evasion."

Don Lan, the Wylys' lawyer, countered that the family "left the details to their advisers," relying on lawyers who vetted the offshore system and advised them on their taxes. 

Regarding Sam Wyly, Lan said: "He's a brilliant man, but he's not a tax guy."

The emphasis on the lie as the central issue in a white collar crime case is a theme I have discussed before in various blogs, here.  The case as presented is the civil analog to a criminal case.  Tax criminal trials, like white collar criminal trials generally, are about "lying, cheating and stealing."  See e.g., the FBI's web page on white collar crime, here:

Lying, cheating, and stealing. 

That’s white-collar crime in a nutshell. The term—reportedly coined in 1939—is now synonymous with the full range of frauds committed by business and government professionals.

As to the fraud and fraud-like issues, the Government will try the case like a white collar crime case, as indicated by the reports of the opening arguments at trial and the Government's pretrial brief (linked and quoted below).

So, I thought I would present the issues as framed by the parties in their pretrial briefs (Wylys 132 pages, here, and Government 156 pages, here).  I do not have time to scour these lengthy tomes for any nuggest buried therein, but perhaps readers with an interest can make comments on the nuggets they fined.  The issues as framed are:


Wylys' Statement of the Issues

Issues Presented n2
   n2 Dee also claims that she is entitled to relief under the innocent spouse provisions of I.R.C. § 6015(b) and (c) for all income tax deficiencies and interest. 

(1) What is the correct income tax liability given this Court’s acceptance by collateral estoppel of the District Court’s finding that the IOM trusts are “grantor trusts” to the Wylys?\ 

(2) Were any taxable gifts made by the Wylys during the tax years at issue? If so, what were they and what are the amounts of any such gifts? 

(3) Are the Wylys liable for the civil fraud penalty regarding:
(a) any income tax deficiency?
(b) any gift tax deficiency? 

(4) What tax years are open for the Wylys absent fraud? 

(5) Are the Wylys liable for failure to file Forms 3520, 3520-A, and/or 5471? If so, what are the reportable transactions and what is the amount for each such failure? 

(6) Which party has the burden of proof for each claim and defense? 

(7) Are the IRS Proofs of Claim adequate, and, if not, what impact does this have on the burden of proof?\ 

(8) What is the proper calculation of interest in light of the suspension of interest under Internal Revenue Code § 6404(g)? 

(9) If they apply, are the failure to file penalties excessive fines barred by the Eighth Amendment? 

(10) Are laches or estoppel defenses applicable by the Wylys to the IRS claims?

The Government's Statement of the Issues (with a high level summary of its arguments):

The United States believes the issues in this matter can be narrowed into two general categories. The first category involves the Debtors’ liability for income and gift taxes and for international penalties due to their failure to file required IRS forms relating to the Debtors’ grantor trusts located in the Isle of Man. The second category relates to the Debtors’ liability for the civil tax fraud penalty under I.R.C. Section 6663 (for the income tax) and Ms. Wyly’s liability under Section 6651 relating to the failure to file gift tax returns. Specifically, the issues in this matter can be described as follow: 

Income/Gift Tax/International Penalty Liability: 

The Court must determine the correct amount of (1) income tax liability for the Debtors for the tax years 1992-2013;3 (2) gift tax liability for (a) Sam Wyly for the tax years 2000-2005, and (b) Dee and Charles Wyly for the tax years 2001-2005 and 2010; and (3) liability for international penalties due to the Debtors’ failure to file Forms 3520, 3520-A, and 5471. The United States does not believe Dee Wyly is entitled to innocent spouse relief from any of the income tax or gift tax deficiencies, but will defer the substantive discussion of this issue pursuant to the extension of time the Court has given Ms. Wyly on this issue. 

Statute of Limitations: 

The United States asserts that the statute of limitations for the income and gift tax periods at issue is open due to the fact that the Wylys committed civil tax fraud. Notwithstanding the fraud issue, however, the United States asserts, and the Wylys admitted, that I.R.C. § 6501(c)(8) keeps open the statute of limitations for tax years 1998-2013. Thus, the fraud issue is only necessary to keep the statute of limitations open for tax years 1992-1997. The United States is not subject to the defense of laches in enforcing its rights. United States v. Summerlin, 310 U.S. 414, 416 (1940); see also Redstone v. Comm’r, T.C. Memo 2015-237, at *23-24 (Dec. 9, 2015) (“The inapplicability of the laches doctrine is especially clear where (as here) the Government seeks to enforce tax claims that are governed by an express statute of limitations.”); Jacksonville Paper Co. v. Tobin, 206 F.2d 333, 334 (5th Cir. 1953). 

Grantor Trusts 

In SEC v. Wyly, the District Court found that the IOM Trusts were “grantor trusts” from their inception through 2004. The United States contends that this finding applies to years after those in the SEC litigation, i.e., 2005-2013, because the Debtors failed to identify material factual or legal changes relating to the IOM Trusts beyond 2004 (the final year addressed in the District Court’s findings). 

Fraud 

In this self-reporting system, the United States relies upon taxpayers’ own disclosures for the collection of its income tax. The Debtors engaged in intentional wrongdoing with the specific intent to avoid taxes. The Debtors’ fraud is established, in part, by several badges of fraud, including (1) their understatement of income; (2) inadequate records; (3) failure to file tax returns; (4) implausible or inconsistent explanations of behavior; (5) concealing assets; and (6) failure to cooperate with tax authorities. 

The Debtors’ reasonable cause defense fails because:  

a. they relied on the opinions of the promoters who designed the offshore system and drafted the documents used to implement the offshore system in the first place; 

b. the Wylys, as the principals, are charged with the knowledge that their agents Michael French, Sharyl Robertson, Michelle Boucher, and Keeley Hennington had concerning
the opinions and advice of various legal counsel employed by the Wylys; 

c. the Wylys were on notice from their attorneys as early as 1993 of the significant risks of the aggressive tax posture encompassed in their offshore system; 

d. the Wylys failed to provide all of the necessary facts to the legal and tax professionals upon whom they rely as their defense in this matter; and/or 

e. the Wylys misrepresented facts to, or disregarded factual assumptions made by, their legal and tax professionals upon whom they rely as their defense in this matter. 

Fraud as related to Dee Wyly  

Dee Wyly does not escape the fraud penalties merely because she purposefully engaged in a pattern of “willful blindness” seeking to ignore the tax fraud being used to finance her opulent lifestyle. 

Also with respect to Ms. Wyly, the United States asserts that the joint income tax returns Ms. Wyly signed with her late husband, Charles Wyly, beginning in 1992 until his death, were fraudulent returns without regard as to whether Ms. Wyly is liable for the fraud penalty. 

Security Capital Limited 

As part of their fraudulent scheme, the Wylys created and employed an entity, Security Capital Limited, merely as an intermediary of their Offshore System to funnel money the IOM to the Wylys.