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

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

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

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

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

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

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

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

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

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

New LB&I Campaign for Post OVDP Compliance (11/25/19)

I previously reported that IRS LB&I included among its “campaigns” OVDP Declines-Withdrawals Campaign.  IRS LB&I "Campaigns" to Focus on OVDP Declines-Withdrawals, Among Other Issues (Federal Tax Crimes Blog 2/1/17), here.

LB&I’s campaigns are an audit strategy added in 2017 to improve return selection, identify issues representing a risk of noncompliance, and make the greatest use of its limited resources.

In another OVDP related development, in November 2019), the IRS added the following:

Post Offshore Voluntary Disclosure Program (OVDP) Compliance

Practice Area: Withholding & International Individual Compliance 

Lead Executive: John Cardone, director of Withholding & International Individual Compliance 

U.S. persons are subject to tax on worldwide income. This campaign addresses tax noncompliance related to former Offshore Voluntary Disclosure Program (OVDP) taxpayers’ failure to remain compliant with their foreign income and asset reporting requirements. The IRS will address tax noncompliance through soft letters and examinations.

See IRS website for its active campaigns, here.

JAT Comment:  One of the traditional goals of the IRS's voluntary disclosure programs is not only to resolve past issues but, put the taxpayers involved on a track of ongoing compliance, not only with respect to offshore accounts but their tax obligations generally.  It is not clear whether these initiatives will focus narrowly on the compliance issue identify but might sweep more broadly to identify general noncompliance.

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):

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

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

Adkisson notes the potential targets:

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

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

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

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

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

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

Sixth Circuit Holds that Courts Cannot Enjoin IRS From Receiving or Using Alleged Confidential Info from Former Attorney (11/13/19)

In Gaetano v. United States, 2019 U.S. App. LEXIS 33164 (6th Cir. 2019), here, the Gaetanos (husband and wife) sued the United States to enjoin the IRS from receiving and using attorney-client confidential information that their former attorney, Goodman, did or might share with the IRS.  The Court opens with this good succinct introduction of the factual background and holding.

Richard and Kimberly Gaetano trusted Gregory Goodman as their legal advisor and business partner in running a cannabis operation. That trust was spurned.  The Gaetanos ended the relationship after ethics violations undid Goodman's license to practice law. He retaliated by assisting the Internal Revenue Service in a tax audit against them. Concerned about what Goodman might reveal, the Gaetanos sued the government to prevent it from discussing attorney-client confidences with him. The Anti-Injunction Act bars the lawsuit, and the Williams Packing exception does not apply. See 26 U.S.C. § 7421(a); Enochs v. Williams Packing & Navig. Co., 370 U.S. 1, 82 S. Ct. 1125, 8 L. Ed. 2d 292 (1962).

The district court dismissed the complaint.  On appeal, the Sixth Circuit held that dismissal was proper on jurisdictional grounds because of the Anti-Injunction Act, § 7421(a).  In summary, the Court held:

1.  The claim of violation of the Sixth Amendment right to counsel was improper because that is a right that attaches when prosecution is commenced.  There was no prosecution (at least not yet).

2.  The claim of violation of due process was improper.  The Court reasoned (cleaned up):

The Gaetanos next seek refuge in the Due Process Clause of the Fifth Amendment. As a creation of the common law, not the Constitution, the attorney-client privilege cannot by itself provide the basis for a due process claim. Support for the Gaetanos' position thus must come from somewhere else, in this instance from cases holding that deliberate preindictment intrusions into the attorney-client relationship may prove so pervasive and prejudicial as to imperil the fairness of subsequent proceedings.  

Vanishingly few decisions have found a due process violation for government intrusion into the attorney client relationship. The few cases generally involved nefarious government conduct,  such as infiltrating a defense lawyer's office. And in the lion's share of cases, courts treat these due process claims with suspicion. For our part, we have never found a Fifth Amendment violation on this ground. And we recently expressed our skepticism about the continued vitality of the "outrageous government conduct" defense, of which these claims are thought to be a subspecies. 

Even if this deliberate-intrusion concept could form the basis of a due process claim, the Gaetanos still would not prevail. Such claims require an ongoing, personal attorney-client relationship. That's not something the Gaetanos and Goodman have. Such claims also require a deliberate intrusion. But that's not what happened. The government never requested privileged information from Goodman. Such claims also require actual and substantial prejudice. But the Gaetanos seek relief outside the context of any enforcement proceeding, and they offer no explanation why the ordinary remedy—suppressing privileged evidence—would fail to protect them. No Fifth Amendment danger lurks.

3.  The Court rejected a claim under § 7525, noting that the privilege could be raised only to prevent compelled production of privileged information, but cannot be used to stop extrajudicial communications unrelated to  proceedings before a court.

Negotiating Misdemeanor Plea in Lieu of Felony in Tax Crimes Cases? (11/13/19)

In United States v. Christensen, 2019 U.S. Dist. LEXIS 193864 (D. AZ. 2019) (Magistrate Report and Recommendation), here, Gary Steven Christensen had been convicted of multiple tax crimes and brought a "Motion Under 28 U.S.C. § 2255 to Vacate, Set Aside, or Correct Sentence by a Person in Federal Custody."  This motion states a standard claim for convicted defendants that they had not received a fair trial and appeal because of ineffective counsel.  The Magistrate R&R linked here recommends that the motion be denied and that a certificate of appealability be denied.

The general claims of ineffective counsel made are interesting.  Those who might be interested in such claims will, I think, find these claims interesting and so I do recommend it for those particularly interested in this type of claims.

But, what caught my eye was the claim Christensen makes about his attorney's plea negotiations.  Christensen was charged with 13 felony counts (7 evasion and 5 tax perjury) and 2 misdemeanor counts (failure to file).  The opinion states that, prior to the trial, Christensen's "Counsel wrote that he was "close to securing a plea offer ... which would dismiss all felonies and allow plead[ing] to three misdemeanor offenses to entirely resolve this criminal prosecution."  (See Slip Op. 5-6.)

Bottom-line, I have not experienced any willingness on tax prosecutors to take pleas to misdemeanor charges in lieu of felony charges.

I point to the DOJ Tax Criminal Tax Manual (CTM) Chapter 5 on plea agreements, here.  I could not find any discussion of offering to exchange multiple felony counts for one or more misdemeanor counts.

I ask readers to offer their comments on this issue, either by comment to this blog or by email to me at jack@tjtaxlaw.com.

Net Worth, Corroboration of Defendant's Statements and Corpus Delecti (11/11/19)

One of my weekly automated searches picked up this recent case quote from United States v. Tanco-Baez, Nos. 16-1322, 16-1323, 16-1563, 2019 U.S. App. LEXIS 32910, at *15-16 (1st Cir. Nov. 4, 2019), here (cleaned up; emphasis supplied):

The Court recognized that the corpus delicti for some offenses -- unlike the corpus delicti for, say, homicide -- is not "tangible." Smith, 348 U.S. at 154. For example, according to the Court, tax evasion is an offense that lacks a "tangible" corpus delicti, id., because the offense results in no "physical damage to person or property," The Court then explained that, for offenses of that sort, evidence that would tend to establish the corpus delicti "must implicate the accused," even though evidence that would tend to establish the corpus delicti of offenses that result in physical damage or injury -- such as evidence of the murdered body in a homicide case -- need not.

Since I don't recall dealing with the concept of corpus delecti before in my tax crimes adventures or the cited Smith case, I thought I would chase down Smith, which may be viewed in it glory here.

In Smith, the Court opens with this statement:  "This is the third of the net worth cases and the first dealing with the Government's use of extrajudicial statements made by the accused."  Tax Crimes fans know (or should know) all about the net worth method for proving taxable income and thus tax due and owing, a key element of tax evasion.  (The net worth method is also used in civil cases to establish tax due.)  I had encountered the other two cases of this net worth trilogy, Holland v. United States, 348 U.S. 121 (1954), here, and Friedberg v. United States, 348 U.S. 142 (1954), here.  I am sure many tax crimes fans had encountered Holland and Friedberg.  So, having not yet consciously encountered Smith, I thought I would educate myself.

I found out that the real reason Smith does not arise prominently in a tax crimes practice is that the key issue it resolved was not a tax issue, but a general criminal issue having to do with the so-called corroboration rule for a defendant's out of court admissions of a crime.  Thus, Smith is prominently linked with the corroboration rule cases; indeed, it is linked with a "trio" of corroboration cases decided the same day.  As the First Circuit in Tanco-Baez said:

But, while the corroboration rule initially served this important but "extremely limited function," Smith, 348 U.S. at 153, the Supreme Court expanded on it in a trio of cases decided on the same day in 1954. See Smith, 348 U.S. 147; Opper v. United States, 348 U.S. 84 (1954); United States v. Calderon, 348 U.S. 160 (1954).

The background for Smith is that, in the application of the net worth method, the agent received statements from Smith as to opening net worth but then, through further investigation, increased the opening net worth.  In the net worth method, it is better for the defendant (or taxpayer in a civil case) to have a higher opening net worth, so the agent's further investigation helped Smith, although it still indicated enough income in the convicted years to convict for tax evasion.  In effect, the agent’s further work “corroborated” the statements as to components of the opening net worth made by Smith.

This still does not have the context of the other two contemporaneous corroboration cases of the development of the law since Smith and the two other cases.  The Court in Tanco-Baez covers that quite nicely, so I won’t plow that ground here for those wanting to get further into the issue.  I do offer this excerpt, rather extensive to tee up the topic in its current context:

Court of Appeals for Federal Circuit Affirms CFC Norman Holding that Taxpayer is Subject to FBAR Willful Penalty (11/10/19; 11/13/19)

In Norman v. United States, (Fed. Cir. 11/8/19), here, the Federal Circuit sustained an FBAR willful penalty, holding:

1. FBAR willfulness includes recklessness, as held by two other Circuits:  Bedrosian v. United States, 912 F.3d 144, 152–53 (3d Cir. 2018); United States v. Williams, 489 F. App’x 655, 658–59 (4th Cir. 2012).

2.  The Court of Federal Claims ("CFC") did not err in holding that Norman was willful for the following reasons (Slip Op. 7-8):

The Court of Federal Claims did not clearly err in finding that Ms. Norman’s failure to file an FBAR was willful. Ms. Norman signed her 2007 tax return under penalty of perjury, and this return falsely indicated that she had no interest in any foreign bank account. She did so after her accountant sent her a questionnaire that specifically asked whether she had a foreign bank account. In addition, the evidence shows that Ms. Norman took the following steps, each of which had the effect of inhibiting disclosure of the account to the IRS: (1) Ms. Norman opened her foreign account as a “numbered account”; (2) she signed a document preventing UBS from investing in U.S. securities on her behalf; and (3) the one time she withdrew money from the account, her Swiss bank account manager delivered the money to her in cash. 

Moreover, once the IRS opened an audit of Ms. Norman, she made many false statements to the IRS about her knowledge of, and the circumstances surrounding, the account. Ms. Norman told the IRS, both during an interview and in a letter, that she first learned of the account in 2009. In her letter, she stated that she “was shocked to first hear about the existence of foreign accounts” in her name. In 2014, after retaining counsel, Ms. Norman sent the IRS another letter “to correct several misstatements.” Although Ms. Norman admitted in this 2014 letter that she knew [*8] “more than a decade ago” that she had an “interest” in a foreign bank account, she maintained in the 2014 letter that “none of the money in the Swiss account(s) was mine[,] and I did not consider myself to have any kind of control over the account.” J.A. 146. In fact, Ms. Norman knew long before 2009 that she owned a foreign bank account and controlled its assets. She opened the account in 1999, actively managed the account for many years, and even withdrew money from the account in 2002.

3.  In making the holding, the Court rejected that argument that her mother advised her do it.  (Slip Op. 8.)

4.  Also, the Court rejected the claim that she did not know because she did not read the return she signed.  Even if she did not, she had constructive knowledge and acted recklessly.  (Slip Op. 8-9.)

6.  The Court rejected her argument that the unamended regulations after the 2004 amendment increasing the penalty to $100,000 or 50% of the acccount prevented a penalty exceeding $100,000 (the maximum under the pre-amendment statute).  Basically, the court held that the amendment trumped the regulations that preceded the amendment.

7.  The Court declined to reach Norman's argument, launched too late, that the FBAR willful penalty was an excess fine under the Eighth Amendment.

8.  For an excellent discussion of the Norman case, see Robert S. Horwitz, Federal Circuit Upholds Liability for FBAR Willful Penalty, Determines the Regulation Limiting Penalty to $100,000 Is Invalid (Tax Litigator Blog 11/11/19), here.

JAT Comments: