Chair of the New York State Bar Association, Tax Section
What is it that happens in the '90s that upsets you as a tax lawyer?
The game changed. The game changed in a number of ways, subtly, in a very major effect. First of all, taxes became for corporations a serious profit center -- the idea of reducing your taxes from a corporate standpoint and [achieving] a substantial bottom-line effect for their earnings -- and it became a very important part of their process to reduce their taxes in whatever capacity they could accomplish that. …
For most of my career, my job was to accomplish real transactions in the most efficient way from a tax standpoint. That meant developing a form of transaction that would accomplish the business purpose of what was attempted to be achieved in the most efficient tax manner.
What happened -- post the change in the tax law in 1986 -- was the development of somewhat artificial transactions. … A client would call with a transaction that was being promoted for purposes only to reduce taxes, having no business reality. That's bothersome, because it changes the dynamic of what you're doing. You're now no longer doing real things, but you're doing artificial transactions for the purpose of reducing tax only.
So, you had clients come in to you and talk to you about things that had been marketed to them by law firms, accounting firms, investment bank[s] that you didn't think were proper? Is that what you're saying?
You would find frequently [that] clients come to you with proposals that had been developed independently by investment bankers, accountants, or lawyers -- or all three -- that were designed to accomplish a certain tax result, having nothing to do with the business of the organization that you represented. They were simply transactions that were off-the-shelf, that were being marketed to any number of corporations to accomplish certain tax ends. …
Is that a big change in the way that the tax shelter professionals were operating?
It was a change that made the tax professional a businessman rather than an advisor. There was a product that they were developing solely for the purpose of creating transactions that were widely, or maybe privately, disseminated to a relatively small group of corporations.
What's wrong with that?
There's nothing wrong with that, per se. The problem is that in many cases, the transactions had nothing to do with the business the corporation was engaged in, or even the transactions they wanted to accomplish. They were solely developed for the purpose of reducing corporate tax on normal business transactions.
Is that illegal, or not allowable, or against the ethics of the profession?
Illegal? No. Certainly, they were perfectly legal transactions. As a matter of fact, in many cases, the technical development of these transactions were very imaginative and could well have been more than just an artificial transactions. They could well have been perfectly sustainable transactions that would accomplish the result that was sought to be achieved.
The problem is that in many cases they had nothing to do with the business of the corporation. They were being developed solely for the purpose of reducing taxes.
IRS commissioner, Large and Midsize Business Division (1999-2003); former tax director of Hewlett-Packard
The interesting thing about the corporate tax shelter phenomenon is that they had series of very interesting characteristics. Perhaps the most noteworthy one is that, to skilled tax professionals, it resulted in a result that was too good to be true. If a result was too good to be true, you should be very suspicious about it, because it really meant that the tax system was being abused.
But then there were some other interesting things that made for an interesting story. They were sold by a large firm that came in under a cloak of secrecy. Namely, before they'd even show it to you, you had to sign a confidentiality agreement.
Secondly, they had a humongous amount of fees. They would never sell these deals based on, "This is the hours that we've spent in developing this. We want you to pay for these hours." No, it was a fee that was tied in to the amount of tax savings, and it was a fairly high percentage.
Then, third, they really wanted to manage your dispute resolution process with the IRS. In effect, you could not handle that. You had to communicate to them if the IRS discovered what was going on.
All of these things kind of gave a real sense that this is [a] shadowy transaction, because in normal business transactions, these aren't the elements of what occurs.
These are cases where the accountants are cooking up these deceptive schemes, and which are then going out and mass marketing these schemes to people who had made major amount of money or had big profits in the last year. These are frequently done just through telemarketing.
We know KPMG did telemarketing, where they would have lists of people who made a lot of money the previous year, and they're getting cold calls from telemarketing people saying, "We know you made a lot of income. Do you want to pay less taxes on that income?" And the people who are supposed to pay taxes will say, "Well, is it legal? Is it proper?" They say, "Yes, we got a legal opinion saying it's proper."
Then the taxpayer might say, "Send me a copy of the opinion. What does it cost me?" Then they'd be told what the cost would be and what the benefit would be in reduced taxes. It was pretty tempting to a whole lot of taxpayers, and very, very lucrative to accounting firms and lawyers and investment advisors. …
You investigated this for a long time. What was your most surprising or worrisome finding?
That so-called "legitimate" firms -- accounting firms, law firms, tax investment firms -- were the engine of these deceptions. They were the promoters, the designers [of] the marketing that went into them.
So these are firms that we look to, to kind of help referee and keep the system sound. You're saying they're the ones who are actually turning it into a rotten system?
Exactly. In Enron, it was the opposite. You had Enron that was rotten, that went to significant firms -- banks, stockbroker houses, brokerage houses -- and got them involved in helping Enron cook the books. There was a lot of aiding and abetting going on by some major banks with Enron, and by major stock brokerage houses with Enron. But Enron was the engine. They were the driver. …
Here, with these kind of tax shelters, we've got the accounting firms and the lawyers working with them who are the designers. They're the cooks. They're the ones who are initiating these schemes, and then going out looking for people who had a profitable year and urging them to buy their tax product to reduce the taxes.
IRS commissioner (1997-2002)
Who is driving this process? Are these corporate tax directors who are saying, "Boy, I've got to do something to impress my CFO, my CEO. I'm fixing the bottom line by finding tax losses," or is it accounting firms and law firms and investment banks who are saying, "Hey, we've got this product?" What's the dynamic here?
The dynamic was that these things were being sold, not bought, mostly -- in other words, by promoters. And there were a whole range of promoters. They're lawyers, accountants, Wall Street firms. [There] were many of them, all involved in it -- big ones and little ones, regional ones and national ones. They were structuring deals, structuring proposals, going systematically to large taxpayers and offering ideas, as they would call them, in how they can reduce taxes. That's what they were doing.
Now again, there's a legitimate aspect of that. That's always been the case. I mean, there's nothing new about this. Tax advisers have always been going to taxpayers and saying, "We can be smart. We can help you how to structure your business through these taxes." So there's nothing inherently wrong with somebody going out and marketing their services, to try to tell somebody they can come in and look at their business and try to figure out how to reduce taxes.
[What was] the new wrinkle?
The new wrinkle was that they were packaging very complex products. They were literally marketing, as products, prepackaged documentation that showed how you could basically dial for dollars. …
[Are you] talking about wholesale marketing of tax shelters [as opposed to] individual tax advice about you and your situation?
This is the key thing. There was still individual tax advice. But I think the thing that really proliferated it was, people would sit down and devise a product -- literally, they call it a "product" -- and then market it to anybody that might be in the position to use that product. That was basically the idea, and that was what was proliferating in the 1990s.
There was tax shelters way back in the 1970s and 1980s, but they were generally a very different kind. They were generally marketed to individuals with the idea that you would buy something like an oil well or a cattle ranch or something, and supposedly take a depreciation deduction on it. That was the old style, and Congress wiped that out in the 1980s.
This was different. This is a [transaction made by someone in the] upper bracket, because there is an expense to this. I mean, to pay all those advisers to come up with those shelters, to devise them to do all the complex paperwork -- these are pretty complex. In order to make them appear to be legitimate, you had to oftentimes, most of the time, recruit some counterpart, some other party that you'd get a transaction with, like the offshore bank in the other countries or the municipality in the European country. Whoever it was that you were doing the transaction with, you had to go through all the paperwork to do that. Not [just] money being wired back and forth.
Then there were lawyers and accountants all over the place. Then there were the promoters. All those people took a fee. It was expensive. So it wasn't the kind of thing that you could market to the average middle-income or even upper-income taxpayer. It had to be a very large taxpayer, or a very large corporation, and a lot of tax or a very high-income individual who maybe sold a business or got a huge gain on some stock options. Those are the only people that really were paying enough tax to make it worthwhile to pay all these fees.
IRS Commissioner (2003-present)
What happened in the 1990s to the professionals who work on the tax system, the tax professionals who advise us all … that caused the kind of problem with promoting and selling and marketing abusive shelters that we've seen?
I think at the core of it was the way people viewed their services. When I started out, there was a clear pecking order in these kinds of things. There were investment bankers who made lots of money, but they took personal equity risk in a lot of these transactions. Then you had lawyers further down the hierarchy, and then at the bottom, accountants. I was one of them.
But you billed for your time, both lawyers and accountants. What's happened here is, somewhere along the line, the accounting profession took a different view of itself and said, "We're just as good as those investment bankers and those lawyers, and we ought to earn just as much as they earn," which was not the expectation 20 or 30 years ago.
So they started to try [to] view their job as value creation, instead of helping their clients comply with the law and with professional standards. They brought transactions that created value -- or in this case, what we're talking about, minimize taxes to the clients. That generated larger fees, because it was worth more to the clients. That was a change, and a dangerous and damaging change for the ethic of the profession, I would suggest.