During the tax shelter boom of the nineties and the turn of the millennium, tax shelter opinions became known as “get of jail free cards” Of course, they didn’t really mean jail, for the most part. It was penalties that were the big concern. If you could be sure that there would be no penalties, even the sketchiest shelter can fall into the “Nothing ventured. Nothing gained.” category. It ended up not working out that way for everybody, but last month, it did work out that way for Keith Tucker in the Tax Court decision delivered by Judge Joseph Goeke. It strikes me that Keith Tucker was not the most likely candidate for someone whose reliance on KPMG for one of its sketchy tax shelters was reasonable, but that is the way it went. Here is the story.
Executive Perks
Keith Tucker became the chief executive officer of Waddell & Reed Financial, a mutual fund, and financial services company, in 1992. When WR went public in 1998, the company established a personal financial planning program that provided financial, estate and income tax planning, and tax return preparation services. Mr. Tucker recommended that KPMG, which was also WR’s auditor, fill that role. This was probably an unfortunate decision, reasonable as it likely was at that the time. To explain that I will give you a bit of an outsider/insider view of public accounting in the mid to late nineties.
The Green-Eyed Monster
One of the recurrent themes of my seven years of tax blogging has been the fallout from the tax shelter debacle, what Jack Townsend refers to as the raids on the fisc engineered by the Big 4 accounting firms. I have an outsider view of that. I believe, however, that I have an insider view of what was fundamentally driving the most prestigious accounting firms in the world to sell their birthright for a mess a pottage. CPAs, especially male CPAs, who still dominate the upper reaches of the profession, tend to over-dramatize the stress of a job that is clean work with no heavy lifting and not at all dangerous. Accountants are more insulated form the seamy side of life than most professions. It was not the job that was the major source of stress in the nineties – pretty much the peak of my career in public accounting.
I remember a wealth of military metaphors being used. There was a tax practice leader talking about “all hands on deck” and someone whose group dealt with the intricacies of capital account maintenance “deploying” his teams. After the national firm where I was an employee at will decided it was better off without me, one of my former partners said I had been shot. Samuel Johnson said “Every man thinks meanly of himself for not having for not having been a soldier, or not having been at sea”. Throw in being in a field where most of the actual work is being done by women and the need to bolster the male ego is severe. All that stress though. What about the stress?
At least in the nineties, ]the source of the stress was not long hours. The source of the stress was envy. One of the hard truths of making a living providing professional services is that you either have to actually do some work yourself or pay other people pretty good money to do the work. And there are only so many hours in the year and not all of them are billable. There just had to be a way to get some free money. For some confounded reason, CPAs were often the most trusted advisers competing with lawyers, stockbrokers and insurance salesman for that enviable role that made you the gatekeeper for other professionals. The insight of the nineties, promoted by a host of consultants, was to cash in that trusted adviser role for some free money.
Auditing, providing an opinion on whether financial statements are fairly stated, gradually became a commodity. There was a cult of “efficient auditing”, which I tended to view as the science of determining how little work you could do and still render an opinion. But there was only so much to be squeezed from that lemon. Regional firms went in for marketing financial services. One of the mysteries of the financial world is that even though financial advisers in the aggregate do not beat the market, any individual group you hear from will inevitably explain why the do. So a regional CPA firm could hook up with one of those groups and by some convoluted method get kicked back may 25 basis points on client assets under management, which seemed like free money.
Then there was “value billing”. R&D studies were billed based on supposed tax savings rather than hourly. The national firms were limited in their ability to sell financial services, but they came up with a brilliant value billing scheme. KPMG led the way. In the Washington National Office, there was group designated the Skunk Works (Another lamentable military metaphor referring to a group at Lockheed Martin that developed stealth aircraft). They designed one-off transactions that would shelter large gains of entrepreneurs experiencing liquidity events and later ordinary income. The charge was a percentage of tax savings. Once the deal was designed it was relatively easy to execute and the elegant simplicity of paying KPMG 3% instead of the government 20% made it easy to sell. And the prestige of KPMG along with an opinion from one of their hand picked law firm cut the risk of penalties.
Fundamentally, what was driving all this was envy. CPAs, like syndicators, developers and other consultants they saw were freed from the tyranny of the billable hour, the obsolete notion that a professional in order to earn money had to do some actual work or at least pay another professional with more technical ability and less entrepreneurial flair a pretty decent salary to do the work.
More On Mr. Tucker’s Case
KPMG put Mr. Tucker into a deal when the IRS was starting to catch on to the shenanigans. You can read the decision if you want to read about the offsetting long and short currency options, called the FX transaction, that purported to create basis out of thin air. Mr. Tucker was assured that it was different from the deals that IRS had described in Notice 2000-44. It was not different enough when it came to actually working, but along with the stellar reputation of KPMG it was different enough to get Mr. Tucker out of penalties. Here are some of the high points.
Mr. Tucker no longer wanted to engage in the short options strategy because of the potential negative impact on his personal and professional reputation, his career, and Waddell & Reed’s reputation had he engaged in an abusive tax scheme. Mr. Tucker discussed these concerns with KPMG and indicated that he would not want to participate in an abusive tax scheme. As a result of KPMG’s disclosure of Notice 2000-44, supra, and its recommendation against the short options strategy, Mr. Tucker believed he could trust KPMG not to advise him to invest in an abusive tax strategy. He believed KPMG was fulfilling its responsibilities under the WR executive program to prevent senior executives from entering into transactions that could create trouble with the IRS. …..
KPMG represented to Mr. Tucker that the FX transaction was not covered by Notice 2000-44, supra. Mr. Tucker did not read Notice 2000-44, supra, because he did not think that he would understand it and because he trusted his KPMG advisers. Mr. Tucker understood that KPMG would not provide an opinion regarding the tax effects of the FX transaction because KPMG was Mr. Tucker’s return preparer and because Mr. Speiss had planned the FX transaction. KPMG orally communicated to Mr. Tucker that the claimed tax treatment of the FX transaction was warranted. KPMG indicated that it would sign petitioners’ return reporting the FX transaction, giving Mr. Tucker comfort that the FX transaction was a legitimate tax planning solution. (Emphasis added)
The Court’s conclusion was:
We find that Mr. Tucker is not liable for the section 6662 penalty on the basis of his reliance on Mr. Schorr of KPMG. Mr. Tucker had a long-term relationship with both KPMG and Mr. Schorr, whom he viewed as a friend. Mr. Schorr introduced and recommended Mr. Speiss. KPMG had prepared petitioners’ returns for 15 years without audit. Mr. Tucker had recommended Mr. Schorr to manage the WR executive program when it was created. Mr. Tucker did not solicit or initiate the contemplation of a tax strategy. Mr. Tucker believed that KPMG was offering its services as part of the WR executive program, which Waddell & Reed established to ensure that Waddell & Reed’s executives were in compliance with tax law. Mr. Tucker had informed KPMG that he did not want to engage in a transaction that would subject him to IRS scrutiny because of concern for his professional reputation and career and the potential impact on Waddell & Reed’s reputation as its CEO.
At the time of the FX transaction KPMG was one of the largest accounting firms in the United States. Mr. Tucker viewed Mr. Schorr as a preeminent person for coordinating tax return compliance and tax and financial planning. Mr. Tucker believes KPMG misled him. He was forced to resign as CEO of Waddell & Reed and is no longer employable in the financial services industry. In the end, Mr. Tucker lost his position at Waddell & Reed because of his participation in the FX transaction and received a large settlement from KPMG for his lost future compensation. We note that in our order dated August 24, 2015, we found that Mr. Tucker’s representations in his arbitration proceeding against KPMG support his assertion that he relied on the advice he received from KPMG in good faith. Because of Mr. Tucker’s long relationship with Mr. Schorr, he was less likely to question KPMG’s advice. While Mr. Tucker was motivated to reduce his 2000 income tax liability, he consistently represented to KPMG that he did not want to put his own reputation or career on the line as a result of a tax scheme. When KPMG recommended the FX transaction, Mr. Tucker believed in good faith that it was not abusive. (Emphasis added)
So that was the deal. Mr. Tucker didn’t really study the transaction. I mean how could he have understood Notice 2000-44? Only when compared to another decision last month and given Mr. Tucker’s background before coming to Waddell & Reed, it seems too sweet a deal. So let’s look at Mr. Tucker’s pre-WR background.
A KPMG Veteran
The decision goes into Mr. Tucker’s background. He majored in accounting and finance at the University of Texas, graduating in 1967 and went on to a UT law degree in 1970. He never practiced law. He became a CPA working for KPMG or one of its predecessors. He became a partner in 1975, which indicates he was really on the ball. He started out preparing individual returns and moved on to life insurance company returns, developing a life insurance practice and a national reputation. He was the national director of KPMG’s insurance practice. In 1984 he left KPMG and went into investment banking. Apparently though his memories of KPMG were fond enough to use them for the WR executive program.
That background, however, makes me a little skeptical that he would not have understood Notice 2000-44 if he concentrated real hard while reading it. On the other hand, maybe it does make his claim of implicit faith in KPMG more credible. The KPMG that he grew up in might have had different standards than the turn of the millennium firm that put him in a bad deal.
By Contrast
It is interesting though to compare Mr. Tucker’s faith in KPMG, to the stand that KPMG is taking in a different case that was decided by the Eleventh Circuit last month. John Baldwin is suing KPMG for one of its shelters that went awry. District Court had given KPMG summary judgement. but the Eleventh Circuit has told them to take another look. Mr. Baldwin is an impressive entrepreneur, but his bio gives no evidence of accounting or legal education. Certainly there is nothing to compare to Mr. Tucker’s stellar public accounting career. Yet in defending itself against his lawsuit, KPMG argued that he should have figured out that they were not to be relied on.
There can be no dispute that plaintiffs would have discovered the falsity of KPMG’s representations had they properly investigated. (Plaintiffs’ expert opined that a tax preparer with only a “fundamental level of competence would understand that … he cannot deduct fictional losses.”) Instead, they contend that Hasting sufficiently assured them, on the strength of KPMG’s reputation and experience, that the tax strategy was legal. But even viewing the evidence in the light most favorable to the plaintiffs, we think no reasonable juror could find that the investigation they performed in response to the red flag was sufficient.
That argument convinced the District Court the first time around, which I find an interesting contrast to the Tax Court’s decision in Mr. Tucker’s case. I’ll leave it at that.
Other Coverage
The decision broke out of the tax ghetto with coverage on Jim Fitzpatrick’s blog that covers the juncture of “journalism and daily life” in Kansas City – Keith A. Tucker: Guilty on two counts – “gaming the tax code” and depriving area residents of a view of one of the most beautiful homes in KC. Mr. Fitzpatrick was glad to see Mr. Tucker lose the tax case mainly because he has a grudge against him blocking the view of a great example of Prairie Style architecture with some plantings. I wounder if there might be the potential for a facade easement deduction there.
Jim Malone covered the case on Tax Controversy Posts with Tax Procedure: Sometimes It’s Who You Know, Not What You Know.
This is a case that could easily have come out differently on the penalty determination. The Tax Court was apparently swayed by the taxpayer’s testimony; plainly, he was very well prepared by his lawyers.
It will be interesting to see if the government elects to appeal. The court’s determination appears to rest largely on factual determinations, which are difficult to overturn on appeal as they are subject to the clearly erroneous standard of review. In some circuits, however, the ultimate conclusion of a fact-sensitive determination such as reasonableness is subject to plenary review as a mixed question of law and fact. This could be a case where the determination of the standard of review becomes particularly important on appeal.
For practitioners, the case is a reminder of the pivotal importance of the taxpayer’s testimony in penalty cases.
Law360 had a summary by Natalie Olivo.
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