The IRS got a very welcome belated holiday gift Dec. 27 when the U.S. Court of Federal Claims ruled that a "Son of Boss" transaction was an effort to avoid paying taxes. It was the first such case to go to trial.
The court found that the tax shelter, successor to an earlier scheme known as a bond and options sales strategy (BOSS), generated artificial losses for Jade Trading. The entity was a limited liability corporation allegedly used by Robert Ervin and two of his brothers in 1999 to offset the income taxes due on a $40 million profit from the sale of their cable business.
Judge Mary Ellen Coster Williams noted that the transaction was devised and marketed by BDO Seidman's "Tax $ells" Division as a tax product, not by an investment adviser as a vehicle to earn profit. She ruled that the transaction failed the economic substance test and said the "claimed losses were purely fictional."
The decision is likely to be used as leverage in the similar cases pending against former partners at KPMG LLP and other advisers who structured similar deals for clients.
Tax shelter buyer beware: Every tax season, as folks find out just how much they owe Uncle Sam, they start looking for ways to keep that from happening next time around. That's not a bad strategy.
And a tax shelter isn't automatically illegal. The feds have no problem -- well, less of a problem -- with us taxpayers using any legitimate way to keep our money out of the IRS' grasp.
But for the last couple of years, the IRS has been searching for what it calls abusive tax shelters. This generally is a marketing scheme that involves tax transactions with little or no economic value. Typically, these proposals are marketed in terms of how much you can write off against tax on your tax return, in relation to how much you invest.
The IRS wants to see that the proposal can stand on its own as a money-making investment without the tax consequences.
If you would buy into the plan because you're expecting to make a few bucks and the tax savings is just a bonus, that's OK. But if it's designed just to create a tax loss, look out. Note the comments cited earlier by the judge: the transaction failed the economic substance test.
Also remember that it's not just the creative tax shelter developer and/or seller who ends up paying. If you agree to any tax-saving proposal, you are responsible for what it might bring, good or bad.
That means that if you get involved in one that the IRS rules is abusive, you've got to pay back any tax breaks the set-up originally got you.
Shelter acronyms: Some sketchy tax-saving proposals over the last few years have had some catchy acronyms. Here are some high-profile pitches that the IRS found illegally generated billions in phony tax losses:
- BOSS, Bond & Option Sale Strategy
- COBRA, Currency Options Bring Reward Alternatives
- BEST, Short Option/Basis Enhancing Securities Transaction
- BLISS, Basis Leveraged Investment Swap Spreads
- OPS, Option Partnership Strategy
- BEDS, Basis Enhancing Derivatives Structure
- HOMER, Hedge Option Monetization of Economic Remainders
- BART, Basis Adjustment Remainder Trusts