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What’s The Worst That Could Happen? Real Taxpayer Situations

  • 23 July 2014
  • Author: Cari Holbrook
  • Number of views: 3639
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What’s The Worst That Could Happen?  Real Taxpayer Situations

Not following tax laws—either by ignorance, misinterpretation, or by deliberate action—can have major consequences. As a forensic accountant often brought in to serve as an expert witness, I’ve seen the cascading effect that it can have on business owners’ professional and private lives.

But, really, what’s the worst that could happen? Let’s take a look at various tax cases against several business owners from the San Antonio and surrounding areas.

Inflating Basis to Avoid Capital Gains

Understating capital gains by inflating basis (the cost of acquiring property that is later sold) can have major consequences. Late last year, Billy Joe "Red" McCombs learned this the hard way when the U.S. Supreme Court upheld a tax-shelter penalty of 40 percent. The decision could lead to the payment of hundreds of millions of dollars in penalties and interest that the government has alleged other taxpayers owe in disputes similar to the McCombs case, reports Reuters.

 

How did McCombs do it? He and his business partner Gary Woods set up a partnership specifically to generate financial losses offsetting gain from the sale of The Minnesota Vikings. These partnerships are called "current options bring reward alternatives," or COBRA. As the attorneys at Scarinci Hollenbeck, LLC, clarify: McCombs and Woods relied upon paper losses to offset real gains. The strategy allowed McCombs to claim $45 million in losses from transactions that actually cost only $1.37 million. While these types of partnerships have been utilized by a number of high net-worth individuals and business owners, lower courts have long seen them as sham transactions and subject to taxation.

 

Participating in Offshore Employee Leasing

Retired San Antonio-based U.S. Air Force Officer and Surgeon Dr. Stanley Alexander and his wife Ruth narrowly avoided a 75 percent fraud charge for getting involved in offshore employee leasing. The Tax Court sustained deficiencies and penalties against the plastic surgeon and his wife, finding “that they had unreported income and weren't entitled to certain deductions; the surgeon’s S corporation was liable for employment taxes and penalties because the surgeon was its employee.” The court also came down hard on Ruth, stating that, as the business’s bookkeeper, she was not entitled to innocent spouse relief from the couple's joint tax liability.

 

However, it was ignorance that saved the couple from an even more devastating tax fraud penalty. The judge ruled, “While Dr. Alexander is highly educated and a very accomplished medical doctor, respondent [IRS] did not establish that he understood complex tax law issues. To be sure, Dr. Alexander has a basic understanding of corporate structures and filed his own tax returns, but nothing in the records establishes that he understood the complex tax laws involved with the OEL [overseas employee leasing] transaction, nor that he possessed the knowledge to determine that the OEL transaction did not comply with applicable tax laws. Similarly, Mrs. Alexander does have some accounting education, but she does not possess the education or experience for the Court to hold her to a higher level of understanding when it comes to the OEL transaction.”

 

Tax Sheltering with Son-of-BOSS

When you try to game the system, the system often wins. That’s what three Rio Grande Valley personal-injury attorneys learned the hard way. According to the Tax Court, “Each tried to reduce his tax bill with a complicated transaction that featured almost perfectly offsetting bets on foreign currency. Each of these lawyers was in the business of estimating risk and reward in evaluating every case he considered, but in this instance each sought refuge in a tax shelter whose builders used flawed designs and constructed it from bad materials that do not survive close inspection.”

That flawed shelter was a variant of a Son-of-BOSS tactic, using digital options and Canadian dollars to create a tax loss. These friends made many mistakes, as reflected in the Tax Court decision, but one of the most pronounced was in attempting a tax shelter using foreign currency transactions, without experience in dealing with foreign currency. In doing this, the attorneys lost on more than one level. As Forbes covered it, “The Tax Court disbelieved the attorneys when they said that they were really in it for the big score they would get by hitting the sweet spot.  Apparently the sweet spot is something of an illusion, because the counterparty Deutsche Bank was in a position to rig the scoring so they would never hit it.  When Deutsche Bank determined the market price on the option expiration it had as much as three cents of play in the pricing.  The ‘sweet spot’ was only two cents wide.” 

The key takeaway? A transaction must have economic substance, a profit potential, and a business purpose outside of any tax benefits.  We pride ourselves on being  a trusted financial advisor on your side to help you make sound tax and business decisions. It can be the best insurance against potentially life-altering mistakes.

Copyright: ra2studio / 123RF Stock Photo

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