Bill Yung and Columbia Sussex Sue Grant Thorton

I am reading Yung v Grant Thornton. This is a mammoth decision – it runs over 200 pages.

William Yung (Yung) owns a hotel and casino company (Columbia Sussex) based in northern Kentucky. I remember meeting with some of his tax people several years ago.  I have watched fireworks from his Kentucky office location.

Then there is Grant Thornton (Grant), a national accounting firm, and its former partner, Jon Michel (Michel). Jon and I worked for the same accounting firm, although not at the same time. I remember having lunch with Jon a few years later and discussing joining Grant Thornton’s tax team. I also remember the unacceptable sales pressure that went with joining Grant. I passed on that, and I am glad I did.

Jon is in the tax literature, and not in a good way. It has a lot to do with that sales pressure.

Today we are talking about tax shelters.

CPA firms - especially the nationals - in the 1990s and aughts became almost pathologically obsessed with profitability. Accounting practice was changing, and the tradition of accountants being business advisors and confidantes was being replaced with a new, profit-driven model. We saw metrics like “write-ups” and “write-downs” by individual accountants. There were “individual” marketing plans for accountants two or three years into the profession and having another five or seven job changes ahead of them. I remember a CPA whose promotion to manager was delayed because she missed her “chargeable” budget by approximately 40 hours – over the course of an entire year.

And tax departments were leaned upon to come up with new “products” to market to clients.

COMMENT: Referring to tax advice as a “product” tells one a lot about the underlying motivation of whoever is promoting it. I for example do not sell a “product.” I provide business and tax advice. If you want a product, go to Amazon.

So what flavor of tax shelter are we talking about?

Yung and family and family entities (such as Columbia Sussex) own casinos and hotels. Some of them are in the Cayman Islands, which would make them controlled foreign corporations (CFCs). You may recall that the U.S. wants to tax all U.S. businesses on their worldwide income. Since doing so would almost guarantee that there would be no U.S. - based international businesses, the tax Code allows for tax deferrals, then exceptions to those deferrals, and then exceptions to the exceptions, and so on. It borders on lunacy, frankly, but this is what Yung and entities were caught in. Yung and entities had monies overseas, but it would have cost a fortune in taxes to bring the monies back to the U.S. Yung’s son Joe traveled regularly to the Caribbean, Central and South America seeking acquisition opportunities as a means to reinvest the Cayman monies. Grant was their accounting firm. Jon Michel even assisted in the acquisition of a Canadian hotel.

There was opportunity there for a sharp tax advisor.

Here is opportunity knocking:

·        A partnership contributes cash to a foreign corporation (FC). It receives the common stock.

·        Another party also contributes cash. In return it receives preferred stock.

·        The FC borrows money from a bank.

·        With the money, the FC buys marketable securities.

·        FC then distributes the securities, with its attendant debt (sort of), to the partnership, liquidating the partnership’s investment in FC.

·        There is a technical tax rule concerning a distribution with debt attached. The debt reduces the fair market value of the securities. If the debt were equal to the value of the securities, for example, the net distribution would be zero (-0- ).

·        The partnership received a liquidating distribution worth zero (or near zero) but had an investment equal to the cash it put in FC. This leads to a big tax loss.

So far, so good. The partnership received marketable securities, but it also has to pay back the bank. Where is the tax shelter, then?

·        The FC later pays off the debt.

Whoa!

The partnership is out no money but has a big tax loss.

The key to this was being able to reduce the liquidating distribution by the bank debt, even though the partnership never intended to pay the debt. Some tax CPAs and tax attorneys argued that this was fine, as tax Code Section 301(b)(2)(B) reduced the distribution…

“… by the amount of any liability to which the property received by the shareholder is subject immediately before, and immediately after, the distribution.”

We are talking the Bond and Optional Sales Strategy tax shelter sold by Price Waterhouse in the 1990s. The nickname was BOSS, and the IRS was determined to come down hard on the BOSS transactions and enablers. Frankly, I don’t blame them.

In 1999 the IRS published Notice 99-59, which warned that tax losses claimed in a BOSS transaction were not allowable for federal income tax purposes. The Service also warned of substantial and numerous penalties.

Congress followed this up with new tax Regulations to Section 301 in 2000.

So what did Grant Thornton do? It developed a new “product” which it called “Leveraged 301 Distributions” or Lev301.  How did it work? Here is an internal Grant document:

           

The objective of the Leveraged 301 Distributions tax product is to structure distributions in order to permanently avoid taxability to shareholders. Either closely-held C corporations or S corporations can distribute assets subject to liabilities … and provide this benefit to shareholders.”

           

How similar is this thing to BOSS, which provoked Notice 99-59 and new tax Regulations? Back to that Grant internal document:

Further the IRS may assert arguments it used against the BOSS transaction in Notice 99-59 and against the subject-to language of former IRS Section 357”

This has to be a finalist for the “Worst Timing Ever” award.

Grant goes live with the product in June 2000. Jon Michel begins to promote the thing, including to Yung and Columbia Sussex.

You already know this thing went to trial, so let’s fast-forward to some language from the Court:

           

No one associated with Grant Thornton, even those intimately involved in the process who testified to the court, has stepped forward and taken credit for the idea and creation of Lev301.”

Hey, but Lev301 is substantially different from BOSS, right?

Here is the Court:

Grant Thornton believed that there was a 90% chance that the IRS would disallow the tax benefits on the Lev301 on audit.”

Good grief! Why would a self-respecting tax advisor be associated with this?

Yung and Columbia Sussex were not told about the 90% chance.

The court finds that Yung and associates brought income into the United States from his CFC’s on a routine basis. Yung and his associates looked for ways to accelerate this process but vetted possible means of doing so with a close concern for the risks involved, as evidenced by the decision not to participate in other tax strategies presented to them. Yung and his associates maintained a very conservative risk level about income tax reporting as evidenced by the IRS complimenting the consistent approach to paying taxes. The court finds the Yung’s testimony to be consistent with this approach to tax reporting and, therefore, to be credible.”

What did the Court say about Grant?

The evidence indicates everyone who participated was on high alert regarding this product. As a result, while this court certainly understands the fading of memory, the failure of some of Grant Thornton’s witnesses to recall anything about their participation in the research and development of this product is disingenuous and not credible.”

Let’s continue. Would Jon Michel have been permitted to meet and pitch Lev301 to Yung had Yung’s tax department been informed of the risk?

The likelihood that the IRS would view the Lev301 as an unlawful abusive tax shelter was a present risk that would have impacted … (Columbia Sussex’ CFO) decision to allow …. J(on) Michel to present Lev301 to Yung. Had the risk been disclosed … (Columbia Sussex’ CFO), (as he had done with the prior proposals) would have terminated discussions about Lev301 at that point.”

So Jon Michel and Yung meet. Yung wanted to know if other Grant clients had used this scheme.

J(on) Michel told Yung that, while he could not divulge the names of other Grant Thornton clients, he could disclose that a local jet-engine manufacturer and a local consumer products manufacturer had successfully used the Lev301 strategy to transfer foreign wealth to the U.S.”

For those of us who live in Cincinnati, the reference to GE and Proctor & Gamble is unmistakable. Still, if GE and P&G did use the strategy…

When Michel made this representation to Joe Yung, he had no knowledge as to whether GE and P&G had utilized a Lev301-like strategy.”

All right then.

In 2002 the IRS initiated an examination of Grant Thornton. The IRS issued a summons asking for documents relating to Grant’s promotion of Lev301 and the names of clients who participated in the product.

Grant Thornton did not notify the Yungs … about the summons, which further increased the likelihood that the Yungs … would be audited by the IRS on account of their participation in the Lev301.”

In November of 2002 the IRS audited Columbia Sussex for reasons unrelated to Lev301.

NOTE: This is fairly common for larger, higher-profile corporations. It does not necessarily mean anything.     

Grant was hired to represent during the tax audit.

In 2003 Yung and Columbia Sussex received an Information Document Request from the IRS. The IRS wanted to know whether they had directly or indirectly participated in any transactions that were the same or substantially similar to a “listed” transaction.

            NOTE: Like a BOSS or a BOSS-like transaction.

Jon Michel answered the question “No.”

The tax director at Columbia Sussex later read in a trade journal that the government was summoning Grant Thornton. He called Jon Michel. Jon informed Yung and associates that Grant was likely to comply with the summons and that client names would be turned over to the IRS.

And they were.

The IRS expanded its audit of Columbia Sussex to include more years, the Yung family, family entities and any unfortunate soul driving past corporate headquarters on I-275 in northern Kentucky. On the other hand, in 2004 Jon Michel wrote a nice letter to Yung and entities offering limited tax representation before the IRS.

Do we need to continue this story?

The Yung family and entities owed over $18 million in tax, interest and penalties to the IRS.

If this were you, what would you do next?

You would sue Grant Thornton.

           

COMMENT: Be honest: this is a Mr. Obvious moment.

A Kentucky circuit court has just ordered Grant Thornton to pay Yung and family and entities approximately $100 million, including $80 million in punitive damages. The judge described Grant’s actions as “reprehensible.”

Grant intends to appeal, saying:

We are disappointed in the Court’s ruling and believe we have strong grounds for an appeal, which we will pursue.”

Grant has to appeal the decision, of course.

My thoughts?

Remember that Yung is in the hotel and casino business, an industry subject to higher financial and personal scrutiny. What is the collateral and reputational damage to him and his entities from an abusive tax shelter? Yung has said the ordeal has already cost him a casino license in Missouri.

I have little patience for this type of practice. What was motivating Grant with the Lev301 “product”- solving a client’s tax problem or generating a million dollar fee? Could it be both? Sure, but the smart money would bet the other way. This type of behavior is not “practice.” It is greed, it is an abuse of a professional relationship and it is disreputable to those of us who try to practice between the lines.

Civil War Horses, Con Men and Lois Lerner

I think I have been insulted.

I am reading this morning that the Court of Appeals for the D.C. Circuit is hearing the IRS appeal of the Loving decision.  That decision concerned the recent effort by the IRS to regulate tax preparers, and the IRS lost the case. There were three parts to the IRS effort:

• a unique preparer identification number, called a PTIN (“pea tin”). The PTIN would allow – in theory - the IRS to track which individuals prepared which returns. I say “in theory” because it is not uncommon for larger returns to have two or more preparers and one or more reviewers. Traditionally the highest-ranking last person in the chain is considered the official preparer, but the IRS did not write its regulations that way.

• a competency test. CPAs, enrolled actuaries, attorneys and enrolled agents were exempt, as their credentialing already includes a competency test.

• a continuing education requirement. Tax laws change frequently, so the IRS thought that continuing education would be a good idea. It is.

Here is the rub: where does the IRS get the authority to make these proclamations? I know it sounds a bit quaint to talk about “government of laws rather than of men” in the current political environment, but there are a few sticklers out there who still believe in the concept. One of them was Judge Boasberg in the Loving decision.

Yesterday the IRS trotted out its attorneys, arguing that they have the right to regulate whatever they want under the “Horse Act of 1884.” Folks, that is “18” 84. 

Do you remember the following words?

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

This is the 16^th amendment, creating the income tax and ratified in February 1913. That is “19”13. Which comes after “18”84, for most people. Let’s be blunt here: how can a law from the 1800’s give the IRS any authority over income tax preparers when the income tax was not even created until 1913?

I have to admit, I had to look up the Horse Act of 1884. We must have missed that bright shiny in high school American History. After the Civil War, people brought claims against the U.S. for dead or missing horses. Makes sense, as horses were required to work the farm or for transportation, and their loss would have been keenly felt. Always seeking a vacuum, fraudsters soon appeared to help people press horse claims against the government. Soon all horses were thoroughbreds, and the government was facing more actions than there were horses lost in the Civil War. The government realized they were being scammed by con men and, in defense, starting regulating those people. The government even used the term “enrolled agent,” a term still used today for a class of preparer who has passed a competency examination given by the IRS itself.

So the IRS attorneys are arguing that tax CPAs like me are akin to fraudsters who inflated the value of dead or missing horses in action against the government following the Civil War?

As I said, I think I have been insulted.

I am also reading that Lois Lerner, the former head of the IRS Exempt Organizations Division, is retiring. You may remember that she invoked the Fifth Amendment when appearing before Congress on May 22, 2013. She was the political hack from the Federal Elections Commission who somehow wound up at the IRS reviewing and delaying applications from conservative groups, especially Tea Party organizations, seeking 504(c)(4) status in time for the 2012 presidential election. Good thing she was there too or the election may have gone a different way. She was quite happy to initially throw a few Cincinnati IRS employees under the bus, saying they had gone “rogue.” Later investigation, including e-mails, put a rest to that lie. Congress could have instead spoken with a few practicing tax CPAs, and we could have told them the same thing.  

She has been on “administrative” leave since then, drawing an approximate $170,000 salary. Now she gets to retire. It’s a nice retirement too, as she able to look for another government position and still collect her retirement pay, estimated over $50,000 annually. 

I would love a deal like that. Unfortunately, the IRS thinks of me as a con man.

IRS Apologizes For Targeting Tax-Exempt Applications By Conservative Groups

This has been a difficult few weeks for the IRS.

In March Rep. Charles Boustany (R-La.), chairman of the House Ways and Means oversight subcommittee chastised the agency upon discovering a series of IRS training videos that parodied “Star Trek” and “Gilligan’s Island.” The videos cost the IRS approximately $60,000. The IRS initially refused to make the videos public. They later did after mounting criticism.

In April the American Civil Liberties Union released documents obtained under the Freedom of Information Act showing that the IRS criminal tax division believed the agency could access e-mails and text messages without obtaining a warrant. Rep. Charles Boustany demanded the IRS present its policies for when search warrants are needed to review private e-mails and communications.

Last week the IRS announced that it was changing its policy to require search warrants both for criminal and civil tax proceedings.

Last week we found out that an IRS employee at the Covington campus had been charged with destroying at least 800 fiduciary income tax returns. “Fiduciary” is a fancy term for a trust, and the term includes an estate which receives income and has to pay income tax. The employee – Brady James – is only 30 years old, and he could be facing a maximum prison term of 20 years.

One has to wonder what Brady James was thinking.

Last Friday an IRS employee – Lois Lerner, head of the IRS tax-exempt division – responded to a question concerning tax-exempt applications by conservative groups at an American Bar Association conference. A firestorm ignited, and the IRS quickly scheduled a media conference call for the same day.

She apologized for “inappropriate” targeting of conservative political groups during the 2012 election. IRS employees in Cincinnati singled out approximately 75 organizations using “patriot” or “tea party” in their name. The IRS was trying to get ahead of an AP news report, as well as an expected report by the Treasury Inspector General for Tax Administration.

Why Cincinnati? The IRS breaks up its work functions into units, and these units are located throughout the country. The unit under discussion handles the review of applications for tax-exempt status, and that unit is located in Cincinnati.

The number of organizations filing for tax-exempt status has more than doubled since 2010. To handle the volume, the IRS centralized its review of the applications in Cincinnati. Makes sense, as it allows the development of expertise within the unit and consistency in the process.

Until it goes wrong. Terribly wrong.

The IRS for example responded to the Richmond (VA) Tea Party’s application by requiring additional documentation on 17 different matters. When it did so, the IRS responded by requiring documentation on 53 additional matters. Oh, and the Richmond Tea Party had two weeks to respond.

 “We made some mistakes,” said Lois Lerner. “Some people didn’t use good judgment. For that we are apologetic.”

Heartfelt apology, isn’t it?

Lerner went on to explain that low-level employees initiated the IRS practice. It was not motivated by bias, she said.

COMMENT: Who would even think of bias? Do not pay attention to the fact that groups with words like “progressive” in their name did not receive the same scrutiny.

"It's the line people that did it without talking to managers," Lerner continued. "They're IRS workers, they're revenue agents."

COMMENT: Are there no supervisors in Cincinnati? She makes it sound like her revenue agents are doing whatever they want, without review and apparently without accountability.  I am throwing the B.S. flag on Ms. Lerner.

Lerner told the AP that no high-level IRS officials knew about the practice.

COMMENT: This means some non high-level will take the fall, of course. Hey, there are perks to being a high-level.

Friday was not Lerner’s best moment. At one point she said, "I'm not good at math." Granted, she is an attorney and not an accountant, but still.  That is not a comforting comment from an IRS high-level.

Good grief.