A recent study by the Institute on Taxation and Economic Policy details how Fortune 500 Companies are holding a record $2.6 trillion offshore, thereby avoiding $767 billion in U.S. taxes.  While we believe much of this amount is the result of lawful tax planning on the companies’ international operations and the use of tax haven entities, there remains a significant amount of aggressive tax planning here which is ripe for potential IRS whistleblower cases.  For example, a byproduct of holding trillions of dollars offshore is that it is difficult to bring the money back to the U.S. to use it without paying taxes on those deferred profits.  Therefore, many taxpayers have entered into abusive repatriation transactions to bring the cash back.  Or taxpayers have used hyper aggressive tax planning strategies involving financing structures or transfer pricing to get the profits in the tax haven jurisdiction in the first place.  While Congress may eliminate deferral or make other drastic changes to the Internal Revenue Code in the coming year, the fact remains that these tax underpayments already exist and thus are subject to IRS whistleblower claims.  We suspect the transition rules to whatever new international tax regime Congress comes up with will be similarly and abusively gamed by these companies to wring out the last drop of tax savings.

While many of the Fortune 500 companies have set aside reserves for uncertain tax positions that would cover some of this tax avoidance, many other taxpayers have not reserved at all for these positions by convincing their financial auditors that the risk is minimal or by hiding the risk from them altogether. We’ve been carefully tracking these reserves since 2010 and have concluded that the answer is usually a little bit of both.  Either way, whistleblowers with access to tax accrual workpapers would be able to see what those reserved weaknesses are, and whistleblowers who have unique insight to the unreserved positions have valuable information as well about what those skeletons in the closet are.  We’ve had great success reporting both to the IRS under their tax whistleblower program, so if you know of either type of issue you should give us a call to discuss what your opportunities and rights are.

Today’s CFO Journal reported that a warning from the Public Company Accounting Oversight Board (“PCAOB”) late last year has resulted in much more stringent external audits being conducted by auditors of public companies.  PCAOB has been auditing the auditors to make sure public companies’ financials are not being rubber stamped.  Increased audit scrutiny can be a great thing for potential IRS whistleblowers.  When auditors take a closer look at uncertain tax positions this can result in far greater detail being in the tax accrual workpapers.  As we have noted in the past, Schedule UTP has done little to change company behavior.  Knowledgeable insiders with access to a company’s tax accrual workpapers could provide extremely useful information to the IRS and be rewarded handsomely.  Large companies maintain billions of tax reserves to account for tax positions where the company believes the IRS is more likely to prevail on the issue than the company.  We know firsthand that IRS whistleblowers with access to information about the tax positions that make up those reserves can successfully present a submission to the IRS.  Now, more than ever, there are great opportunities for a tax department insider to make a meaningful impact on the tax gap.

Tax shelters are an on-going battle for the IRS and the Department of Justice with large amounts of money at stake for the government, the taxpayer, and possibly for a knowledgeable whistleblower.  Tax shelter cases involve schemes that attempt to manipulate internal revenue laws in order to reduce participants tax liability and are typically marketed to a large number of taxpayers.  Tax shelters tend to involve unnecessarily complicated transactions so that the transaction appears to fit the technical requirements of a beneficial rule, but clearly lack the economic substance.  In these cases, a knowledgeable whistleblower could provide the IRS with information about the scheme allowing the IRS to engage in a promoter audit that would allow the IRS to audit and assess tax, interest, and penalties against the taxpayers that used the tax shelter and the promoter that sold or promoted the tax shelter.  The assistance of a whistleblower in a tax shelter transaction could reduce the time that it takes the IRS to discover and ultimately assess tax on the improperly sheltered income.

For example, Paul M. Daugerdas, a former partner at Jenkens & Gilcrest, was convicted for his role in a tax shelter scheme in which he and his co-conspirators designed, marketed, and implemented fraudulent tax shelters used by wealthy individuals to avoid paying taxes to the IRS from 1994 to 2004.  Over the course of a decade, the scheme generated over $7 billion of fraudulent tax losses and netted Daugerdas approximately $95 million in fees. 

Internal Revenue Service, Criminal Investigation Chief Richard Weber described the conviction saying: “Mr. Daugerdas’s use of convoluted mechanisms to conceal income from the IRS is criminal activity.  He designed and marketed tax shelters making him $95 million in illegal profits from the ten-year scheme.  Taxpayers deserve our vigilance in making sure everyone pays their fair share of tax.”  However, the jury acquitted Denis Field, the former CEO of BDO Seidman, on seven counts against him including conspiracy and tax evasion.

According to the Department of Justice, Daugerdas participated in a scheme to defraud the IRS by designing, marketing, implementing, and defending fraudulent tax shelters between 1994 and 2004.  As part of this scheme, Daugerdas and others undertook to prevent the IRS from: (i) detecting their clients’ use of these shelters; (ii) understanding how the transactions operated to produce the tax results reported by the clients; (iii) learning that the shelters were marketed as cookie-cutter products designed to eliminate or reduce large tax liabilities; (iv) learning that the clients were not seeking profit-making investment opportunities, but were instead seeking huge tax benefits; and (v) learning that, from the outset, all the clients intended to complete a pre-planned series of steps that had been designed to lead to the specific tax benefits sought by the clients. Daugerdas and others created, and assisted in creating, transactional documents and other materials that falsely and fraudulently described their clients’ motivations for entering into the tax shelters and for taking various steps in order to yield the tax benefits.  As a result of the scheme, the defendant and his co-conspirators made millions of dollars in fees and bonuses.  Specifically, Daugerdas made $95 million in profits but used tax shelters to reduce the taxes he paid to less than $8,000; without the shelters, he would have owed over $32 million in taxes.

In addition to Daugerdas and Field, five others were indicted for their roles in this scheme, including David Parse and Donna Guerin.  David Parse, a former broker at Deutsche Bank was convicted of various tax fraud charges in May, 2011 after an 11-week jury trial, and was sentenced in March, 2013 to 46 months in prison.  Donna Guerin, a former lawyer at J&G’s Chicago tax practice pled guilty for her role in the scheme to various tax fraud charges in September, 2012.  She was sentenced in March, 2013 to eight years in prison and ordered to pay $190 million in restitution.  

Thumbnail image for MartySullivan1-800x531.jpgKudos to Martin Sullivan, Chief Economist and Contributing Editor at Tax Analysts who had a nice piece in the Washington Post published about him over the weekend.  I’ve always admired Marty’s ability to cut through the political BS and revenue scoring to see the true cost and impact of our tax laws and proposed tax legislation.  In this article Marty tells it like it is and where the real money is in large corporate tax avoidance.

USA Today last week also published the results of their recent review of the Annual Statements of the Standard & Poor’s 500, and found that 57 companies had a effective tax rate of zero.  Nada.  0%  That’s zero point zero. (Some were even negative, but that often occurs temporarily with losses or significant NOL carryforwards.)  

 

They said that “The effective tax rate is a popular measure used by investors to compare how much companies pay in tax relative to profit” and it’s no surprise to us that there are so many companies paying no taxes.  We see companies paying no Federal Income taxes every year when we compile the Ferraro 500 list of companies based on the size of their uncertain tax position reserves.  

And finally, on a related note, just this morning Jesse Drucker at Bloomberg profiled an advisor in Ireland who is instrumental in helping multinationals with Irish tax avoidance strategies.  Jesse wrote: “In 2010, U.S. companies attributed $95 billion in profits to Irish subsidiaries, up more than sevenfold from $13 billion in 2000… Many of the Irish subsidiaries have no offices or employees and pay no income taxes. They are merely ways to move profits out of countries where sales take place to mailbox subsidiaries in zero-tax island havens.”  

 

I saw an interesting article today by the President and Publisher of Tax Analysts in which he drew attention to the role of tax professionals in the growing crisis over reduced corporate tax receipts in a time of record corporate profits. He focused his audience’s attention on a recently released study by The Organisation for Economic Co-operation and Development (“OECD”) which described the need for the international tax community to solve the problem of base erosion and profit shifting (“BEPS”). Sure, that’s a lot acronyms to the uninitiated, but at its heart this is a giant shell game of “where’s the income?”, and unfortunately for those of us living in civilized society, the offshore tax haven shell is where it’s at. Large multinationals frequently use abusive strategies, some of highly questionable legality, to minimize their worldwide tax bill. Many politicians have made hay over US based multinationals reporting billions of dollars of income in e.g. the British Virgin Islands, and hardly any here where their employees and a large portion of their sales actually are.

 

We agree that for the most part companies abide by, and optimize their behavior for, the rules that are set for them. However, the grey line is often crossed. In our Ferraro 500 last year we noticed that reserves for uncertain tax positions exceeded total US corporate tax collections*, and that’s just for the Fortune 500 companies. While moving the line to collect more revenue (while maintaining international competitiveness) and to make it more of a black line than a grey line should be the goal of legislators, governments need to get better at enforcing the existing rules. Utilizing valuable information obtained from knowledgeable whistleblowers should be a critical component of that enforcement. Without enforcement, a change in the rules is meaningless.

 

*Fiscal 2011 Fortune 500: Profits $824 billion & Reserves $187 billion; Total IRS Corporate Tax Collections $181 billion. Whereas in Fiscal 2010, Fortune 500: Profits $708 billion & Reserves $197 billion; Total IRS Corporate Tax Collections $191 billion.

Joseph A. Insinga, retired Rabobank Finance Specialist, filed a petition with the Tax Court arguing that the IRS’s continued refusal to issue a formal determination constitutes a de facto rejection of his claim and appeals this de facto rejection.  This filing details five years of interaction between Mr. Insinga and the IRS and has brought the operations of the IRS’s Whistleblower Office to the public’s attention.  Mr. Insinga’s petition also raises several questions that should be looked at closer…

What information is award eligible?

Mr. Insinga goes to great lengths to state that he was the only way the IRS could get the information.  However, this goes above and beyond the requirements of section 7623(b).  The statute does not say that the IRS needs to proceed with an administrative or judicial action based “solely” on information provided by the tax whistleblower.  The statute simply requires the IRS utilize the information.  This is shown clearly in the last sentence of section 7623(b)(1), “The determination of the amount of such award by the Whistleblower Office shall depend upon the extent to which the individual substantially contributed to such action.”  

There are many ways for a whistleblower to make a substantial contribution even if they are not the sole or initial source of information about an underpayment.  The IRM section on Award Computations, 25.2.2.9.2 (06-18-2010), itself does not require that a whistleblower’s information be the sole or initial source of information in order to be eligible for an award, so long as the case is not based on public information under section 7623(b)(2).  Even if the whistleblower’s information was not the IRS’s original source of information and was public information about the underpayment, section 7623(b)(2)(A) still provides for an award of up to 10% of the collected proceeds “taking into account the significance of the individual’s information and the role of such individual and any legal representative of such individual in contributing to such action.”  

It follows that one does not need to be the sole basis for the action, if you can get an award for “contributing” to an action.  It appears from the Petition that Mr. Insinga’s information went to the Field Revenue Agents directly working on the examination of the taxpayers.  If this is the case, to actually use his help and not pay is both contrary to the statute and so patently unjust that we are concerned for the survival of the program if this position of the IRS is sustained.

When is there a de facto denial of a claim?

The Tax Court faces a new issue in Mr. Insinga’s Petition.  Does the court have jurisdiction when the IRS fails to make an award determination?  The answer must be yes otherwise a tax whistleblower could effectively be denied judicial oversight if the IRS just chooses not to act by simply never issuing an award determination.  In Cooper v. Commissioner, the IRS was taking the position that a denial letter was not an award determination, and therefore the Tax Court did not have the jurisdiction to review their award denial. The Tax Court saw through that charade in Cooper and held that they have jurisdiction over negative award determinations, but Mr. Insinga has the harder argument that when the IRS sits on their proverbial hands, that is a de facto negative award determination.  How long does a tax whistleblower need to wait before there is a de facto determination?  Here, Mr. Insinga alleges there has been an administrative action and collection of tax.  This may be a case where the court can determine that the IRS’s failure to make an award determination is arbitrary, capricious, and unreasonable.

When should partial payments be made?

One of the issues raised in the Petition is that of “partial payments.”  There are two parts to this issue and both appear to be at play in Mr. Insinga’s case.  The first is what years must close for the IRS to make a determination.  Most of the hundreds of submissions made by The Ferraro Law Firm to the IRS Whistleblower Office involve more than one tax year of a taxpayer, and many involve multiple taxpayers.  If a tax whistleblower outlines five years of tax cheating by a taxpayer and the IRS is auditing on two-year audit cycles, when does the award determination get made?  In all other areas of tax law the rule is clear that each tax year stands on its own.  Following that line of thinking, whenever a year is closed and tax collected, the IRS should make an award determination for that year.  To take a different position could cause decades of delays.  Consider an amortization case, will the IRS wait 20 years until all of the years with improper amortization play out?  The even more egregious position would be that in a case involving multiple taxpayers, all taxpayers identified must have all tax years at issue closed before an award determination can be made.  It simply cannot be that case that this is the proper way to make award determinations.  If 999 out of 1000 identified taxpayers close and pay and one tax cheat has one tax year open for unrelated issues the IRS cannot delay payment on the 999 taxpayers it collected from – to do so would be arbitrary, capricious, and unreasonable.

Is the naming the target taxpayers appropriate?

The Tax Court’s proposed rule for redacting taxpayer names would have pulled the target taxpayers names out of this Petition but the rule itself misses the point.  Mr. Insinga is not seeking to file anonymously.  He has a first amendment right to tell the world of the evils he believes Rabobank et al. committed.  Were he to file this Petition after the rule took effect he could provide his redaction index to any and all who would listen.  The Proposed Rule will only be effective in anonymous cases where the Tax Court could already require that redaction as a condition of anonymity.

Is this an example of a larger pattern of Whistleblower Office dysfunction?

We have always said that with tax whistleblower cases you can lead a horse to water but you cannot make him drink.  What would really be dysfunctional would be if the IRS had been offered quality information from Mr. Insinga that it did not otherwise have and failed to use it.  Or if the IRS did in fact use his information and the IRS is failing to make an award determination in order to avoid judicial review of a denial or paying an award even though section 7623(b) requires paying an award.  

In the tax world, unlike Hollywood, we really don’t get that many juicy stories.  However, when the “stars” embarrass themselves with their tax troubles, we are provided relief from yet another story about, for example, the material participation regulations’ conjunctive test for determining whether an interest is treated as a limited partner interest for purposes of section 469.   Sorry, back to the scintillating stuff.

The NY Daily News just released a slideshow of the top celebrity tax scandals.  Our favorite story is about Willie Nelson, who famously released an album called the “IRS Tapes” to pay off his $32 million tax bill.  What’s yours?

The IRS estimates that the gross tax gap for 2006 is $450 billion, or 17 percent of taxes.  The gross tax gap is the amount of the true tax liability faced by taxpayers that is not paid on time.  After its enforcement efforts, the IRS estimates that the net tax gap is $385 billion, having collected $65 billion through audits of returns for the 2006 tax year.  This suggests that there are significant opportunities for whistleblowers to come forward and help close the tax gap by providing information as to which taxpayers should be audited. 

Tax Gap = The amount of money per year that the IRS thinks taxpayers owe minus what they actually paid. 

While attention has been given to the tax positions taken by large multi-national corporations and billionaires, these may not be the worst offenders when it comes to not paying their tax liability.  Most of the net tax gap, 84 percent, is due to underreporting of income.  Nearly one third of the net tax gap, $122 billion, is attributed to underreporting of business income by individuals.  Business income reported by individuals includes income from partnerships, s corporations, and sole proprietorships.  Whether the underreporting of income is intentional or not, it is relatively easy for these taxpayers to underreport their income by not including all of their receipts in income, overstating their expenses, or claiming incorrect amounts of credits due to lax reporting requirements.  The IRS noted that compliance rates are highest when there is third-part reporting of income; compare the one percent of income that is not reported when subject to substantial information reporting requirements to the 56 percent of income not reported when the income is subject to little or no information reporting (see the chart below from the IRS).  This suggests that the areas ripest for whistleblowers are areas with little or no information reporting.

 http___www.irs.bmp 

Bloomberg News/Businessweek’s Jesse Drucker makes an astute observation about how billionaires either delay or escape income taxes in his article “U.S. Billionaires Avoid Reporting Cash to IRS.”  The article describes how several people on the Forbes 400 list have used sophisticated and complex transactions to characterize the cash that they receive from the sale of capital assets as something other than taxable income.  Transactions similar to those described in the article are often misused to artificially create a tax benefit, allowing billionaires to engage in tax alchemy to recharacterize what should be taxable income into something else.