The oft-used warning about investments is also used for tax shelters: If it seems too good to be true, it probably is.
But given the reality of tax laws, that axiom has little meaning, said attorney George Clarke of the Washington office of the law firm Miller Chevalier. Taxes are so complex that expecting a layman — especially one who has been brought a deal by a self-proclaimed expert — to decide what is legal is like "telling a kid he can play for Yankees if he learns to swing at the right time," he said.
The federal court trial of one tax lawyer, Paul M. Daugerdas, under way in New York, is calling attention to the sometimes blurred lines between an illegal tax shelter and a sophisticated tax strategy. Daugerdas was among a group of seven accountants and lawyers who sold tax strategies to wealthy business owners in a joint venture between the now-defunct law firm Jenkins & Gilchrist and the accounting firm BDO Seidman. A verdict could come soon.
Financial advisers say it takes more than just common sense to stay out of tax shelter trouble. The best route is to find an independent legal adviser to review a proposed tax structure, and pay for time spent on the matter, rather than a contingency fee.
Independent is the critical word. The person who reviews a strategy must be completely unconnected with those who suggest the transaction to the client, and certainly not recommended by them. Daugerdas is accused of writing opinion letters that purported to certify independently that the tax shelters were legitimate, and of profiting big-time from that activity.
Still, said Robert E. McKenzie, an attorney in the Chicago law firm Arnstein & Lehr LLP who has represented numerous taxpayers stung by illegal tax shelters, the starting point is a gut feeling that something might be wrong.
A red flag, McKenzie said, would be if someone says "if you have $50 million in capital gains, I'll make it all disappear," without the taxpayer doing more than signing a few papers. Earlier in the decade, big accounting firms and some prestigious law firms made these promises.
Daugerdas was a longtime tax partner at the accounting firm Arthur Anderson and later head of the tax department at the Chicago law firm Altheimer & Gray. In 1999, he joined the Chicago office of Dallas-based Jenkins & Gilchrist, where he helped create and market tax shelters. The next year, BDO joined with the firm to work on the shelters, and the advisers took a generous share of the profits.
The tax shelter landscape has changed dramatically since then, said Scott Michel, an attorney at Caplin & Drysdale in Washington. A few years ago, a statute was added to the tax code to discourage financial planners from getting into the kinds of transactions that got Daugerdas in trouble. And, all of the litigation over the shelters has had a chilling effect on unscrupulous marketers.
Often, complicated tax strategies are offered when someone is about to come into a large amount of money, such as when an owner sells a business or some other asset and would face a big capital gains tax. Many of the shelters in the Daugerdas case were so-called Son-of-BOSS shelters (the name stands for The Sales Option Bond Strategy). They featured complex investments, often taking long and short positions in foreign currencies. When the vehicles in a strategy start to get exotic like that, it's another cause for concern.
