Ernst & Young to Pay $123 Million to Resolve Federal Tax Shelter Fraud Investigation

Mar 12, 2013   

Ernst & Young has entered a non-prosecution agreement admitting “wrongful conduct by certain E&Y partners and employees in connection with the firm’s participation, from 1999 to 2004, in four tax shelters that were used by approximately 200 E&Y clients in an effort to defer, reduce, or eliminate tax liabilities of more than $2 billion.” The press release from the U.S. Attorney’s Office for the Southern District of New York (which includes Manhattan), is available here. As part of its agreement with the United States, E&Y agreed to pay $123 million to the United States and acknowledged a detailed Statement of Facts in which it admitted the wrongful conduct of certain partners and employees. E&Y also agreed to certain permanent restrictions and controls on its tax practice, including a prohibition against planning, promoting or recommending any “listed transaction.”

Generally, the term “prohibited tax shelter transaction” means listed transactions, transactions with contractual protection, or confidential transactions. When a taxpayer participates in a listed transaction he/she/it must file Form 8886, available here, with the IRS. Treasury Regulations also require taxpayers to disclose listed transactions on their tax returns. The applicable Treasury Regulation is 26 C.F.R section 1.6011-4, available here.

The non-prosecution agreement also requires E&Y’s continued cooperation with the Government’s investigation. In exchange, the United States agreed not to criminally prosecute E&Y for its participation in the tax shelter scheme. The agreement applies only to E&Y and not to any individuals. E&Y has cooperated with the Government’s investigation into these tax shelters since approximately 2003. In the event that the firm violates the NPA, the U.S. Attorney’s Office may prosecute E&Y.

E&Y admitted to the following facts:

Beginning in 1999 and ending in 2002, E&Y, in conjunction with various law firms, banks, and investment advisers, developed, marketed and implemented four tax shelter products called COBRA, CDS, CDS Add-On, and PICO. E&Y implemented these four tax shelter products for approximately 200 high net worth clients in an effort to defer, reduce, or eliminate $2 billion in aggregate tax liabilities. E&Y prepared tax returns reflecting tax losses claimed to have been derived from those tax shelter products and subsequently defended certain of its clients in connection with audits of those transactions by the IRS.

A small group within E&Y known as the Strategic Individual Solutions Group (“SISG”) was primarily responsible for supervising and coordinating the marketing, implementation and defense of E&Y’s tax shelter products. Certain SISG tax shelter products were designed to appear to the IRS to be substantive investments that had favorable tax consequences when, in reality, the products were actually designed and marketed to clients as a series of preplanned steps that would defer, reduce or eliminate their tax liabilities. The typical client participating in these shelters was primarily, if not exclusively, motivated to achieve a desired tax savings.

In order to deceive the IRS as to the true nature of the tax strategies, and to bolster arguments that the transactions had economic substance, some SISG personnel agreed upon and directed other E&Y employees to participate in a concerted effort not to create, disseminate, or publicize documents reflecting the tax motivation behind the strategies, or the preplanned sequence of steps necessary to effect the strategies. These SISG personnel thereby sought to prevent the IRS from detecting their clients’ purposes in employing these strategies. For example, in certain instances, members of SISG falsely portrayed the transactions under examination as purely investment-driven transactions, and falsely denied a tax motivation for the transactions in response to IRS Information Document Requests and in testimony to the IRS.

Further, in implementing the sale of tax shelter products, certain members of SISG also prepared documents or correspondence that falsely and inaccurately reflected events or conversations, and that were designed to improperly influence the IRS’s view of the merits of the transactions in the event of an audit. These activities continued into 2003 and 2004.

The Ernst & Young case demonstrates that the U.S. Department of Justice together with the IRS will continue to attack tax shelters from every possible angle, including the taxpayers themselves and the professionals designing and promoting the tax shelters. The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience litigating against the IRS and the U.S. Department of Justice in the U.S. Tax Court, the U.S. Court of Federal Claims, the various U.S. District Courts and Courts of Appeals in both civil and criminal tax cases. You can contact us by emailing us at: contact@fidjlaw.com or by telephone at 305.350.5690.