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IRS Cracks Down on Attorneys Writing Phony Tax Shelter
Opinions
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Introduction
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The tax shelter industry has finally caught the attention of
Congress and IRS. This practice is replete with nationally prominent law and accounting
firms willing to write bogus legal opinions for fees reaching $1 million or more per
opinion. Previously, efforts to punish these firms had largely been left to disgruntled
clients who, despite paying seven-figure professional fees, were then stuck with millions
in back taxes, penalties and interest when IRS rejected their attorney's argument. Of
course, just a fraction of those participating in these shelters have been caught, which
means the Treasury is out billions of dollars - and they know it.
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Purpose of Tax Shelter Opinions
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The legal tax shelter opinion serves as
"insurance" against penalties should a taxpayer ultimately be caught - greatly
reducing the financial risk of engaging in the proscribed behavior. Since the taxpayer
claims reliance on an expert legal opinion as the basis of the investment, the negligence
penalty is negated on the theory that the taxpayer relied on an expert, therefore was not
negligent.
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IRS Fights Back
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Embarrassed by Congressional scrutiny and criticism regarding its
inability to make a serious dent in the proliferation of tax shelters, IRS has resurrected
its moribund Office of Professional Responsibility to regulate professionals practicing
before the agency. Cono Namorato, a tax lawyer with Caplin & Drysdale, has been
appointed its new director and is responsible for investigating allegations of misconduct
and negligence against agents, attorneys, and accountants representing taxpayers before
IRS, including negligent or fraudulent tax shelter opinions.
The IRS strategy is to make sure the person in charge of a firm's tax department is on
the hook for tax shelter opinions emanating from partners and subordinates. Under the new
rules -
Lawyers who head tax practice departments of legal firms will now be held responsible
for violations committed by lawyers under their command.
Disciplinary actions, leveled against a department head personally, could include a
proscription against his representing clients before IRS.
NOTE: This sanction would be more effective if it provided that the entire firm
was barred from representing clients before IRS - which would mean the firm could not be
involved in IRS tax audits and appeals, thus risking a substantial portion of their
tax-related business.
This personal responsibility applies even if the lead attorney did not actually
participate in the opinion; he is responsible for the acts of all those who work in his
practice group. Supervision of other partners, should take on a prominent role in light of
these new standards.
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Congress Weighs In
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The new IRS rules do not levy direct financial penalties against
those crafting these tax shelters; however, Congress is focusing on legislation intended
to circumvent increasing tax shelter abuses. Senators Baucus and Grassley have authored a
bill that would impose penalties on firms that "knew or reasonably should have
known" of IRS violations by any of its partners. This approach is reminiscent of the
recent SEC response to accounting scandals in the securities industry involving Enron and
Worldcom.
Understand, the tax shelters created by these firms never involved bona fide
transactions with true economic substance; these deals would never have occurred absent
the lure of major tax benefits. Many shelters involved business strangers joining forces
to jointly benefit from a complex and legally unsupportable transaction that purportedly
generated huge tax savings with negligible economic risk -- other than the enormous fees
paid to the promoters! The tax shelter opinions invariably did not address the actual
facts of the deal - instead, they relied on a hypothetical set of facts and danced around,
or expressly ignored, the legal precedent that would apply to deny the tax benefits if the
transaction were challenged in court.
As with other tax evasion schemes, such as the trust scam and off-shore banking
charlatans, IRS has subpoenaed firms to obtain the names of clients who may have used
potentially illegal tax schemes. Naturally, several of these firms have not responded to
the subpoenas, claiming attorney-client privilege, although it appears the courts will
eventually rule against them, because the Internal Revenue Code requires that tax shelter
promoters maintain listings of their clients.
Recently, some of these firms have been sued by disgruntled clients who found
themselves audited by IRS and their deductions disallowed. Many tax-shelter buyers contend
that the firms are guilty of legal malpractice alleging that they should have known the
shelters they designed and promoted would not pass IRS scrutiny.
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Big Business - Fattening the Bottom Line
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Moving away from hourly billing or flat fee
charges in the 1990s, many firms began billing on a value basis. Firms would write opinion
letters and then bill for a percentage of the amount the client saved in taxes. Treasury
official Gregory Jenner, says that, "The practitioner then, to a certain extent, had
a stake in the conclusions. Whereas previously the practitioner tended to be more
independent."
Following the lead in the securities industry, where investments were fractured into
component parts, accountants and attorneys began devising investment structures to
bifurcate income and deductions, distributing the income to an entity exempt from U.S.
taxation (either a foreign corporation or a tax exempt organization) while providing
deductions to the U.S. taxpaying corporation or wealthy individual.
In the wake of an under-funded IRS, resulting from Congressional displeasure with the
agency during the mid 1990s, tax shelter sales became big business. IRS lacked sufficient
resources to go after the promoters, staff reductions resulted in fewer returns being
audited, and there was less manpower to scrutinize complex and esoteric tax shelter
schemes. Currently, it appears the pendulum is swinging back and Congress and IRS appear
united against the tax shelter promoters and their rich clientele who are not paying their
fair share of taxes.
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Conclusion:
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IRS has several of the major law and accounting firms within their
gun-sights and if it gets access to their client lists, there will be many wealthy
taxpayers squirming in their gilded chairs. Time will tell whether the government is
serious about cracking down on these tax cheats, or whether, as a skeptical public has
witnessed time and time again, this politically-connected group will skate and IRS will
continue hassling the lower and middle class taxpayers over such things as the child care
credit and the dependency exemption.
For more information on this topic, see: Busted Tax Shelters - Wealthy Sue
Accountants for Bad Advice.
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| © 1995-2004 Robert L. Sommers, attorney-at-law, all rights reserved. This article and internet site provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet® is a registered trademark of Robert L. Sommers.
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