This post was originally published on Forbes Jul 2, 2015
So here is a truly brilliant, if slightly ghoulish tax plan. Jeffrey Webber is a venture-capital investor and private-equity fund manager. His advisor, William Lipkind, came up with a vehicle that would not only defer gain on some of his investments, but also totally avoid income tax when he and his family members cashed in. It’s a real shame that the Tax Court agreed with the IRS that the scheme did not work. My only consolation is that it illustrates a couple of Reilly’s Laws of Tax Planning.
A policyholder of an investment annuity contract issued by a life insurance company must include in gross income, under section 61 of the Code, interest and dividends or other income received by the custodian of the investment account created in conjunction with the contract and over which the policyholder has investment control.
Mr. Lipkind explained to petitioner that it was important for tax reasons that petitioner not appear to exercise any control over the investments that Lighthouse, through the special-purpose companies, purchased for the separate accounts. Ac-cordingly, when selecting investments for the separate accounts, petitioner followed the “Lipkind protocol.” This meant that petitioner never communicated—by email, telephone, or otherwise—directly with Lighthouse or the Investment Manager. Instead, petitioner relayed all of his directives, invariably styled “recommendations,” through Mr. Lipkind or Ms. Chang.
Although almost all of the investments in the Policies’ separate accounts consisted of nonpublicly-traded securities, the record contains no compliance records, financial records, or business documentation (apart from boilerplate references in emails) to establish that Lighthouse or the Investment Manager in fact performed independent research or meaningful due diligence with respect to any of petitioner’s investment directives.
The record includes more than 70,000 emails to or from Mr. Lipkind, Ms. Chang, the Investment Manager, and/or Lighthouse concerning petitioner’s “re-commendations” for investments by the separate accounts. Mr. Lipkind also appears to have given instructions regularly by telephone. Explaining his lack of surprise at finding no emails about a particular investment, Mr. Lipkind told petitioner: “We have relied primarily on telephone communications, not written paper trails (you recall our `owner control’ conversations).” The 70,000 emails thus tell much, but not all, of the story.
The net result of this process was that every investment Boiler Riffle made was an investment that petitioner had “recommended.” Apart from certain broker-age funds, virtually every security that Boiler Riffle held was issued by a startup company in which petitioner had a personal financial interest, e.g., by sitting on its board, by investing in its securities personally or through an IRA, or by investing in its securities through a venture-capital fund he managed. The Investment Manager did no independent research about these fledgling companies; it never finalized an investment until Mr. Lipkind had signed off; and it performed no due diligence apart from boilerplate requests for organizational documents and “know your customer” review. The Investment Manager did not initiate or consider any equity investment for the separate accounts other than the investments that peti-tioner “recommended.” The Investment Manager was paid $500 annually for its services, and its compensation was commensurate with its efforts. (Emphasis added)
Mr. Lipkind provided petitioner with “advice.” Mr. Lipkind did not himself render a written legal opinion, but he reviewed and considered written opinion letters from reputable law firms addressing the relevant issues. Three of these opinion letters specifically addressed the “investor control” doctrine; they concluded that the Lighthouse policies, as structured, would comply with U.S. tax laws and avoid application of this doctrine. By informing petitioner that he concurred in these opinions, Mr. Lipkind provided petitioner with professional tax advice on which petitioner actually relied in good faith.
We likewise conclude that petitioner’s reliance was “reasonable.” Petitioner made multiple filings with the IRS setting forth details about the Trusts and Lighthouse, including gift tax returns filed for 1999 and 2003 and Form 3520 filed when the Policies were transferred to an offshore trust. Petitioner did not attempt to hide his estate plan from the IRS. This supports his testimony that he believed this strategy would successfully withstand IRS scrutiny, as Mr. Lipkind had advised.
For their work preparing Trust documents and all other work for petitioner, Mr. Lipkind and his colleagues charged time at their normal hourly rates. Neither Mr. Lipkind nor his firm received from petitioner any form of bonus or other re-muneration apart from hourly time charges. Neither Mr. Lipkind nor his firm re-ceived compensation of any kind from Lighthouse or the Investment Manager. IRS Examination and Tax Court Proceedings The IRS examined petitioner’s timely filed 2006 and 2007 Federal income tax returns.
But trusty lawyer wasn’t an enabler; he didn’t get more than his usual hourly rate. And relayed JT’s orders to the Caymans. But he did do some due diligence, had credentials, knew the whole story, and JT didn’t understand variable life insurance and its anfractuousities.
JT beats the 20% chop.