An “economic sham”

by Henry on September 22, 2005

Sounds as though Bill Frist isn’t the only prominent Republican in trouble over stock-market shenanigans. P O’Neill links to an interesting story in the Irish Times (behind their paywall) that deserves more attention. Richard Egan, former US ambassador to Ireland and major Republican fundraiser is in very hot water with the IRS for tax avoidance.

Following an investigation, the IRS claims that Mr Egan set up an “economic sham” whose principal use was to reduce his tax payments. The IRS said that Mr Egan, the billionaire co-founder of Massachusetts’ most valuable technology company, EMC Corp, used two companies to set up the scheme using a European-style options scheme as soon as he resigned as the head of EMC to become ambassador. Mr Egan and his family were the most successful fundraisers for President Bush’s re-election campaign and have long been major contributors to the Republican Party.

Like Mr. Frist, Egan seems to have set up this scheme in order to repackage the proceeds from selling shares in his family company. The Irish Times has been following Mr. Egan’s progress for a while; it ran a story last year on his and his family’s selfless contributions to the campaign of their ideological opponent, Ralph Nader. From that story:

The Egans, now known in the Republican Party as the “First Family of Fundraising”, are reportedly the only US family that has three members who have raised more than $200,000 (€161,767) each for Bush’s re-election campaign.

{ 15 comments }

1

y81 09.22.05 at 10:32 am

It doesn’t appear that either Henry or P. O’Neill knows much about tax law.

1. Mr. Egan is suing the IRS. They are not suing him. So there appears to be no basis for the claim that he is in “hot water”; at worst, he would lose the case and go home empty-handed.

1. This is a civil case. The IRS is involved in a lot of cases. They win some and they lose some. Disagreeing with the IRS is not the same as “being in trouble.”

2. The US taxes all its citizens on their worldwide income without regard to residence. (The U.K. has a different system.) So P. O’Neill’s speculations about Mr. Egan’s time overseas have no basis in, you know, the actual law.

3. Administrative proceedings with respect to tax matters are confidential. This story is in the press because Mr. Egan has chosen to fight the IRS in court, where proceedings are public. This suggests that he (a) doesn’t have anything to hide and (b) thinks he has a decent case.

4. “Economic sham” is a term with a lot of history in the tax law, which I can hardly elucidate here. It is, however, not at all the same as tax fraud.

5. Curious that a professed lefty believes that the government’s response to being sued is strong evidence against the citizen who sued them. Don’t know why we bother with trials.

2

P ONeill 09.22.05 at 11:11 am

The noise machine sure is efficient. Sure, the US taxes worldwide income of individuals. But the domicile of the many corporate entities into which an individual can dump their income is a different story. Otherwise why would Dubya’s pals the Wylys have bothered dumping a whole bunch of stock options into an Isle of Man entity? An “economic sham” is a transaction with no underlying economic purpose — leading to the presumption that its sole purpose was to avoid taxes. Similarly, one could get entangled in the fine details of applicable tax law for George Bush’s friends. But that would just be another sham distraction from 5 years of rampant cronyism.

3

Henry 09.22.05 at 12:42 pm

y81, I’m quite well aware that the US taxes its citizens on the basis of worldwide income. Where did I claim otherwise? Nor do I use the term tax fraud. How on earth do you get from an (entirely factual) claim that Egan is in hot water with the IRS to the straw man that you pummel so vigorously in your comment? Are you able to read?

4

y81 09.22.05 at 2:03 pm

P. O’Neill, physical presence overseas, the subject of your original comments, has nothing to do with the use of corporate entities chartered in foreign countries. I sort of get the feeling that you are not a lawyer.

Henry, you use the terms “in trouble,” “hot water” and “sheenanigans,” all of which are totally inappropriate for a case in which a taxpayer is suing the IRS for a refund. You also quote the words “economic sham,” apparently from the IRS’s pleadings, with no apparent knowledge of its doctrinal history.

It annoys me to see people prattling on who don’t know what they’re talking about. I mean, wouldn’t most economists be annoyed if I wrote that the demand for milk is inelastic, and that therefore the price is very stable, or something equally nonsensical about sociology? The tax law analysis here is on about that level.

5

Henry 09.22.05 at 2:34 pm

y81 – can you

(a) explain to me the doubtless compelling logic under which you aren’t in hot water with the IRS when it tells you that it believes that your $62 million tax shelter is an “economic sham” and seeks to collect?

(b) point out exactly where my apparently widereaching ignorance of the US tax law system has caused me to say something that’s actually factually incorrect?

It annoys me to see people tout their purported expertise to try to close down arguments when they don’t actually have a substantive point to make. On the side of the Atlantic where I was born, the technical term for this is “bullshit baffles brains.”

6

Ugh 09.22.05 at 6:16 pm

explain to me the doubtless compelling logic under which you aren’t in hot water with the IRS when it tells you that it believes that your $62 million tax shelter is an “economic sham” and seeks to collect?

The IRS advances this argument in every case it believes someone entered into a tax shelter. It’s their litigating position, they might not even think it’s substantively correct, but there’s a non-frivolous argument that it applies so they make it.

Sometimes they win, sometimes they lose (in the last five major corporate tax shelter cases to have reported decisions, the IRS lost three of them, including one in which the taxpayer stipulated in its motion for summary judgment that its sole purpose in entering into the transaction was tax avoidance). It’s essentially a backup argument to the technical ones under the tax code and regulations that the transaction the taxpayer entered into didn’t work under the code (which it almost invariably does, so the IRS has to rely on the various judicial doctrines, including “economic sham” which is usually titled “economic substance”). Egan will never spend a day in jail for this, at most will have to pay a penalty plus interest, and very well could win the case, have his transaction vindicated and get all his money back.

7

Henry 09.23.05 at 7:18 am

ugh – useful information, but this invalidates the argument that Egan is in hot water with the IRS how?

8

Ugh 09.23.05 at 8:28 am

ugh – useful information, but this invalidates the argument that Egan is in hot water with the IRS how?

Well, I guess it depends on what you mean by “hot water.” It is likely that Egan, if he had a tax opinion, will only have to pay his back taxes plus interest, and then only if the IRS wins the case. That is, he will be in the same basic position he would have been had he paid his taxes the way the IRS wanted him to in the first place; and if he wins he pays nothing (other than his attorney fees). If that’s “hot water” then I guess he is in hot water.

He might have to pay a penalty if he didn’t have a tax opinion or the court determines he did not reasonably rely on it. If that is the case then he will pay an additional fine of 20 to 40% (depending on the penalties asserted by the IRS) of the taxes the IRS says he should have paid. Again, if that is hot water, then he is in hot water.

But, from what I’ve read here, he is basically in a dispute with the IRS over whose interpretation of the tax law is correct, similar (though not exactly the same) to a civil dispute between two parties over whose interpretation of a contract is correct. It’s not something that tax practitioners normally think of a taxpayer as being in “hot water” over (just as when one party to a contract sues another, we don’t think of either being in “hot water”).

9

No Matter 09.23.05 at 9:37 am

I’m in hot water too! Oh, wait. The IRS ended up owing me money when they audited my last return. More hot water, please. I am glad to see they are auditing billionaires as well as hundredaires though.

10

wcw 09.23.05 at 11:02 am

While there would have been an interesting post here, it isn’t the one you wrote, which is why the commenters have been piling on so much. In my case, I jumped when you used the phrase “tax avoidance” as if there were something wrong with it. Avoiding taxes is not only legal, but except in extreme circumstances it’s something you owe yourself to do. The proper response to bad tax code is to take advantage of it, while pushing for it to be changed.

That, in the end, is the good post you didn’t make. Let’s say Egan wins in court (I don’t know the law well enough to speculate, but perhaps he does). Does that mean he was in trouble, or that the law that let him avoid his fair share of taxes while screwing the working poor was blatantly regressive?

Egan’s real sin was his enabling the coming of the new Gilded Age by helping Bush get elected and subsequently tilting the tax burden well away from his and Bush’s wealth onto my and my wife’s future incomes. That’s not only perfectly legal, but also an ethical anathema. If only I believed in hell..

..but that’s another post.

11

y81 09.23.05 at 2:49 pm

I’m glad to see some commentary more informed than the original post above, but I still think that people are missing one point, which is that, according to the Boston Globe (the article cited by O’Neill is behind a firewall), this is a REFUND suit. Egan paid whatever the IRS assessed, but thinks his case is strong enough to go to court to get the money back. If he loses, the IRS keeps the money he already gave them, and he goes off and starts another computer company or whatever he does. I just don’t see the “hot water.”

12

Tim 09.23.05 at 4:44 pm

“Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant.”

–Judge Learned Hand

13

Henry 09.23.05 at 6:55 pm

(1) There is a difference, albeit a gradated one, between not paying more taxes than you are supposed to pay, and setting up bespoke schemes that are designed specifically to avoid taxes. The latter frequently tilts into illegality, and sometimes (not in this case as I understand it) into outright criminality – ask KPMG.

(2) When the IRS tells me that I have set up an illegal tax avoidance scheme, an “economic sham,” it is hardly taking licence to say that I am in hot water with the IRS.

y81 – still waiting …

14

y81 09.23.05 at 7:46 pm

Well, henry, if Mr. Egan wins his suit, will that be enough? Would he be out of “hot water” then? Or do you appeal to a higher authority than the federal courts? I’ll put up $100 against a public apology on this blog. If you accept, I’ll contact you offline.

15

Henry 09.23.05 at 8:54 pm

Yes y81, if Egan wins his suit he will be out of hot water – but the rather straightforward point that I’m making is that he would have been in aforementioned hot water in the first place before he got out. And, as stated, I am still waiting for you to point out something factually wrong in my original blogpost.

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