Tuesday, August 01, 2006

Perfectly Legal (Not)

by Tom Bozzo

The estimable David Cay Johnston — whose tax system exposé, Perfectly Legal, is presently a $7.99 no-brainer bargain book at Amazon, BTW — reports on a Senate report on the latest tax shelter abuses. The lede:
So many superrich Americans evade taxes using offshore accounts that law enforcement cannot control the growing misconduct, according to a Senate report that provides the most detailed look ever at high-level tax schemes.
(The report, Johnston notes, was prepared by Senate Democrats, but adopted by the full Senate Permanent Investigations subcommittee by the otherwise wankerrific Norm Coleman.)

This is an increasingly serious wrinkle given the necessity of taxing the rich, as we noted yesterday. A significant way in which "the rich" are different is in their sources, as well as the amounts, of income.

Taxpayers reporting less than $75,000 in AGI in 2003 earned the most of their income from wages and salaries (84%), with pensions and Social Security benefits representing accounting for most of the rest.

Above $75,000, wages and salaries make up more like 2/3 of income — a figure that's itself distorted somewhat by that group including the 'working well-to-do' — people whose upscale lifestyles depend on the household earner(s) keeping their job(s). High income taxpayers (AGI > $200,000) earn less than half their income the old-fashioned way, again with the super-rich working for relatively much less of their keep. Naturally, "the rich" reap most of the benefits of ownership of the means of production, and are also extraordinarily blessed with net capital gains — 75% of which, or nearly a quarter-trillion dollars, appear on the tax returns of the top 0.7%.

Capital gains taxes are considerably more "voluntary" than other taxes. The IRS can easily validate wage earners' tax calculations by comparing the income reported by the taxpayer to the income reported to the IRS by the employer. Not so capital gains, which are effectively impossible to verify short of an audit. Hence the latest scandal, which involves the transrectal extraction of capital losses by highly paid professional tax advisers:
Senator Levin said that when investigators asked for trading records they were first told the trades were private, over-the-counter transactions. He said investigators asked for trading tickets or other evidence of who owned the $9.6 billion worth of stock and were told the stocks were never owned by the parties involved.

“They just wrote down numbers on paper and claimed losses,” he said. “It was just like fantasy baseball, except the taxes not paid were for real.”
The proposed reforms are sensible:
The 400-page report recommends eight changes, some of them aimed at going after the law and accounting firms, banks and investment advisers that the report says enable tax schemes that rely on complexity, secrecy and compartmentalizing information so that advisers can claim they had no idea that the overall transaction was a fraud.

“We need to significantly strengthen the aiding and abetting statutes to get at the lawyers and accountants and other advisers who enable this cheating,” Senator Levin said, adding that “we need major changes in law to stop the use of tax havens” by tax cheats.

Indeed, the activities of the tax advisers looks incredibly corrupt (*).
It also recommends new rules that strip away the underlying legal presumptions that make offshore tax havens like the Cayman Islands, Nevis, the Isle of Man and Panama attractive places for Americans to hide assets and income from the Internal Revenue Service.

Senator Levin said the law “should assume that any transaction in a tax haven is a sham.”
An odd note is the characterization of the tax cheats themselves:
They are expected to say that professional advisers assured them their deals to avoid taxes were more likely lawful than not. The Wyly brothers told the committee that they would invoke their Fifth Amendment right against self-incrimination and thus were not called to testify. The report characterizes them as active participants in tax schemes...

Both Mr. [Robert Wood] Johnson [IV], the football team owner and scion of the Johnson & Johnson health care fortune, and Mr. Saban, the television mogul, are portrayed in the report as victims.
Couldn't have class warfare, now, could we? This would seem to be victimhood of the "Ken Lay can't get justice" variety. One would have to wonder, when paying massive fees to an array of advisers ($54 million in the case of Saban, Johnston reports) for a massively lower tax bill, what do these folks think they're buying? And can I live under that rock, too?

The combination of low audit probabilities plus legally plausible deniability of deliberate criminality means that, as a practical matter, surrender of ill-gotten gains is the likeliest punishment. Meanwhile, since the IRS doesn't have remotely adequate resources to track down every offshore tax sheltering scheme, the rampant cheating costs the government tens of billions of dollars in revenue.


(*) Johnston's account:
“Ain’t capitalism great!” Mr. Wilk wrote to Mr. Scheinfeld in an e-mail message extolling the tax benefits of the Johnson deal. Three weeks later, when the deal was set, Mr. Scheinfeld wrote back: “I just hope Woody doesn’t get cold feet or have the I.R.S. select his return for an audit!”


Mr. Saban told Senate investigators that he never understood the transactions but undertook them after asking two questions of Mr. Wilk and his personal tax lawyer, Matthew Krane.

Mr. Saban said he asked whether the deals were legal and whether a major law firm would certify them as proper. The two lawyers, Mr. Saban said, answered “yes to both,” so he went ahead.

Later, when Mr. Saban learned that he had paid $54 million in fees to Quellos; Cravath Swaine & Moore, a New York law firm; and others for what turned out to be what the report described as fake transactions, he said he felt “misled, lied to and cheated.”

Lewis R. Steinberg, who as a Cravath Swaine partner helped design the deal and wrote an opinion letter attesting that it was more likely than not to work as a tax shelter, told Senate investigators last week that he relied on assurances from Quellos and Mr. Johnson that real transactions took place, not fake trades. Mr. Steinberg, who is now at UBS Securities, another firm named in the report, is a prominent tax lawyer and in 2004 was chairman of the tax section of the American Bar Association.

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