Another in a Long Line of Phony Foreign Currency Tax Scams

Tax evasion is a growth industry. Yet another example is found in Mark and Lucy Kerman, 2011 T.C. Memo. 54, released 3/8/11.

Mark Kerman founded Kenmark, a successful eyeglass frame importing business. He built it up to a multimillion dollar S Corp. He sold part of his stock for a huge capital gain. Not wishing to pay tax, he turned to his old friend Bruce Cohen, who attended a seminar sponsored by Chenery, marketer of tax avoidance deals. Intrigued by the complex series of offshore intermediaries, counterparties and sleight of hand, Bruce passed the Chenery specialty, the Custom Adjustable Rate Debt Structure (CARDS) on to his friend Mark.

We take up the story in the words of Judge Goeke’s decision. “Mr. Cohen, a longtime friend of Mr. Kerman and one of his financial advisers, introduced him to Mr. Hahn and Mr. Stone of Chenery, the CARDS promoters. Mr. Cohen learned about the CARDS transaction while attending a meeting discussing ways to avoid paying taxes and knew that Mr. Kerman was interested in a way to eliminate his large income tax liability from selling his Kenmark stock. Mr. Cohen’s gross fee from Chenery for Mr. Kerman’s CARDS transaction was 10 percent of Chenery’s fee, or $50,000. Mr. Cohen testified that before the CARDS transaction, Mr. Kerman had considered another tax shelter called the “basis boost” to mitigate petitioners’ tax liability. He also testified that Mr. Kerman’s interest in the CARDS transaction had nothing to do with Kenmark or its operating needs but was based solely on reducing petitioners’ tax liability from their sale of the Kenmark stock.” 2011 T.C. Memo 54, at pp. 3-4.

The scheme itself is a purported loan, fully collateralized by top-class collateral, initially made to an offshore entity (a Delaware LLC with offshore members) by another offshore entity (in this case Bayerische Hypo-und Vereinsbank AG). Mark buys into this arrangement as a minority partner, becoming jointly and severally liable to repay the entire loan. The loan is so structured as to be without economic effect. In fact, the lender bails out of the loan in year one, collecting some interest and some fees, but leaving Mark with a tax loss in excess of $4,000,000, offsetting his gain from the sale of the Kenmark stock.

Not even analyzing the Code and Regulations, Judge Goeke finds the deal to be a sham. The loan proceeds were so tied up that the lender ran no risk, and the borrower merely paid some fees and interest. No economic benefit from the loan proceeds ever got to Mark.

His tax loss evaporates, leaving Mark facing the 20 and 20 penalty, 20% substantial underreporting and the second 20% for gross overvaluation of an asset to increase basis.

Mark turns to friend Bruce, whose valuable assistance netted Bruce $50,000, while hanging Mark out to dry. Mark claims reasonable reliance. Judge Goeke puts the brakes on that one: “Reliance on the professional advice of a tax shelter promoter is unreasonable when the advice would seem to a reasonable person to be ‘too good to be true’.” 2011 T.C. Memo. 54, at p. 41.

The three-legged stool of reasonable reliance requires taxpayer to show that: (1) The adviser was a competent professional who had sufficient expertise to justify the taxpayer’s reliance on him; (2) the taxpayer provided necessary and accurate information to the adviser; and (3) the taxpayer actually relied in good faith on the adviser’s judgment.

Chenery provided Mark with an off-the-rack tax opinion from Brown & Wood, a well-known New York City law firm. Judge Goeke shreds this opinion. “The Brown & Wood tax opinion contains several misstatements, and petitioners admitted that the representations in the tax opinion are false and fraudulent. It states that the assets were released to petitioners when they purchased them and that they provided substitute collateral. … [P]etitioners never received any of the loan proceeds and never substituted collateral. Additionally, the tax opinion states that petitioners sold the assets on December 28, 2000, even though they actually exchanged portions of the euro on December 22 and 27, 2000. The tax opinion states that petitioners represented that they had reviewed the transaction summary in the tax opinion and that it was ‘accurate and complete’. However, Mr. Kerman testified that he never reviewed the transaction summary.” 2011 T.C. Memo. 54, at pp. 46-47.

Bottom line? Mark gets thoroughly nailed, and friend Bruce walks away with his $50,000. With friends like him….