Saturday, October 11, 2014

Frontiers of quasi-tax fraud

Pleasant day at the Boston College - Tax Analysts conference yesterday; I'll post the slides from my talk in a couple of days, and perhaps post the paper on SSRN not long after that.  One nice thing about the "biz" is that you keep periodically seeing old friends and making new ones on the talks & conference circuit.

The conference had 3 sections.  The first, at which I spoke, was on corporate tax reform.  My paper expresses great skepticism about (though a hair short of outright opposition to) the mania among DC policymaker types these days for 1986-style corporate tax reform, via a cut in the rates that's financed by broadening the base but without otherwise significantly changing the existing US federal income tax system.  Although nothing like this view appears to be heard within the DC policymaker echo chambers, plenty of people at the conference were quite inclined to take a similar view.  It would be nice to think that I talked them into it, but in fact I got the sense that they already felt similarly about it.

The second session was on partnership taxation, and the third on international taxation.  Because I am so much more familiar with the latter, I found the former more eye-opening.

Talks and papers by Karen Burke, Andrea Monroe, and Greg Polsky suggested something that I gather is well-known in partnership tax circles, and that I must admit to finding a bit shocking.  Because (a) partnership tax rules are so complex that only a handful of people really understand them - perhaps a thousand across the entire country? - and (b) people at the IRS generally don't understand them, and (c) the audit rate for partnership tax returns is below 1%, compliance with partnership tax rules that are meant to block abusive tax planning that contradicts the actual tenor of the rules has pretty much completely collapsed.  Wildly unsupportable tax return positions, backed by the issuance of dishonest tax opinions or no tax opinions, are taken routinely, costing the US government billions of dollars per year.  These mainly involve (a) claiming capital gains treatment for what is clearly ordinary income under the existing rules (even taking as given the capital gains character of certain "carried interests" under existing law, (b) trumping up and specially allocating losses, without regard to economic substance type rules regarding transactions and allocations, and (c) similar game-playing to avoid income or gain recognition and/or assign it to the wrong people, including tax-indifferent parties.

The basic problem is that you have esoteric, complicated rules, understood by few and verging on never being audited, so that the lack of transparency means one can give dishonest and clearly false opinions that meet the standard of a "reporting position."  This is all taxpayers need if they are not publicly traded companies (which may need to meet "more likely than not" for accounting reasons).  And if you are a partnership expert, even if you understand the dishonesty of the opinions you are writing and signing, (a) there's no risk, (b) you wreck your career if you won't write these opinions and get large billings if you do, (c) everyone else is doing it, (d) the IRS isn't enforcing the rules anyway, so maybe you can persuade yourself that the rules don't actually mean what they clearly say?, and (e) even though the positions you endorse, at least to the "reporting position" level, are clearly wrong, they are not so wrong that you'd go to jail for tax fraud if it came to light.

Someone compared this to the Son-of-BOSS style scam tax shelter opinions of 10+ years ago, and said this means not much has really changed, despite people's congratulating themselves that the abusive tax shelter era is over.  So why couldn't people go to jail for this, as they did in Son-of-BOSS?  The answer is that, in Son-of-BOSS, they went to jail for fraudulently backdating documents, providing false information to the IRS, etc.  They didn't go to jail for the opinions themselves, which were ludicrously erroneous (I have read some, and even critiqued them as an expert witness in an administrative proceeding), because bad though the opinions were the author could pretend to just be stupid, wrong-headed, or dense - they weren't quite wrong enough to lead to a jail term, even if wrong enough (as many courts found) to suggest that clients could not in good faith rely on them.

This is certainly an area where a lot can be done.  And one of the panelists suggested that, whereas the IRS typically makes $10 in underpaid taxes per $1 spent on audits, here the yield would be far higher.  But it would take IRS resources, and might also risk complaint from members of Congress on behalf of well-connected taxpayers who have benefited from the quasi-fraud.


blissex said...

«Wildly unsupportable tax return positions, backed by the issuance of dishonest tax opinions or no tax opinions, are taken routinely, costing the US government billions of dollars per year. These mainly involve (a) claiming capital gains treatment for what is clearly ordinary income under the existing rules (even taking as given the capital gains character of certain "carried interests" under existing law,»

There is indeed a perception that tax fraud by rich persons with access to congresspeople is usually off-limits to the IRS, only tax-fraud by the little people will be investigated seriously.

Here there is the shielding of arguably corrupt professional opinions, in a previous case there was outright document forging.

The previous case a few years ago was forged backdated "in-the-money" stock option grants for many billions of dollars; the backdated "in-the-money" stock options were given instead of cash bonuses in large part because they could be fraudulently reported as capital gains instead of as current income, saving hundreds of millions if not billions for the recipients, who would of course be entirely complicit in the forging.

As far as I know none of the recipients has gone to jail for a long time for what seems to me conspiracy to forge documents and commit tax-fraud for very large amounts. They are wealth-creators, and enforcing the law discourages wealth-creators...

My usual quote from famous historian Gingrich:
«If you have a society where almost every middle class person routinely fudges the law, that's telling us something. We have laws that matter - murder, rape, and we have laws that don't matter. Speed limits are an example. Why would you think that a regulatory, process-oriented bureaucratic model would work?
The first thing that every good American says each morning is "What's the angle?" "How can I get around it?" "What does my lawyer think?" "There must be a loophole!" Then he proceeds to work the angle, and the bureaucracy spends its time chasing that and writing new regs to stop him. America is the most incentive-driven society on the planet.»

And from rather more serious de Tocqueville from the 1830s:
«Consequently, in the United States the law favors those classes that elsewhere are most interested in evading it.
It may therefore be supposed that an offensive law of which the majority should not see the immediate utility would either not be enacted or not be obeyed.
In America there is no law against fraudulent bankruptcies, not because they are few, but because they are many. The dread of being prosecuted as a bankrupt is greater in the minds of the majority than the fear of being ruined by the bankruptcy of others; and a sort of guilty tolerance is extended by the public conscience to an offense which everyone condemns in his individual capacity.»

Iain said...

From this side of the Atlantic a tax barrister recently posted what is becoming a very widely read piece on very similar issues.
It opens:
"I have on my desk an Opinion – a piece of formal tax advice – from a prominent QC at the Tax Bar. In it, he expresses a view on the law that is so far removed from legal reality that I do not believe he can genuinely hold the view he says he has. At best he is incompetent. But at worst, he is criminally fraudulent: he is obtaining his fee by deception. And this is not the first such Opinion I have seen. Such pass my desk All The Time."