The Wolfe Law Group is an international array of legal and tax experts providing collaborative services for Global High Net Worth Investors on a per client basis.
Gary S. Wolfe, A Professional Law Corporation has over 35 years of experience providing clients with expertise for IRS Civil and Criminal Tax Audits, International Tax Planning, and International Asset Protection.
Since 2015 Gary has been the recipient of 29 separate international tax awards from 10 different global expert societies in London/UK including:
International Tax Planning Law Firm of the Year Award (2017) – International Advisory Experts.
International Tax Advisor of the Year (2017) – Global Business Magazine/Prof. Sector Network.
To date Gary has published or been interviewed in 100+ separate articles published by 15 different US and International magazines. Click here for complete list.
In December 2016 Gary was interviewed by California CEO Magazine and RCBNNews.org on the subject of Criminal Tax Evasion and IRS Tax Audits: Civil and Criminal Issues. This 4 part series, which has been published by Lorman Education, can be viewed below:Read More »
The US Supreme Court has a long history of supporting legal tax planning while disavowing illegal tax evasion (which has both civil and criminal consequences). Please see the authorities cited below.
In 1864, in the case of US v. Isham 84 US 496 (1864) the US Supreme Court considered the Stamp Duty (Tax) and stated their seminal proposition which is the foundation for tax planning: “(the court declared) if a device to avoid the payment of a stamp duty…is carried out by the means of legal forms, it is subject to no legal censure”.
In the Isham case, the Court gave their ruling citing the case of an individual whose tax planning circumvented the Stamp Act of 1862 (which imposed a “duty”(i.e. tax) upon bank-checks for an amount of $20 or more); the Court noted: “A careful individual… who pays no stamp duty (by paying a creditor $20 by two $10 checks not one $20 check) (their) practice and this system he pursues habitually and persistently… while his operations deprive the government of the duties it might reasonably expect to receive, it is not perceived that the practice is open to the charge of fraud (upon the revenue).”
In the landmark 1916 Supreme Court Case of Bullen v. Wisconsin 240 US 625, 630 (1916), the issue was whether the State of Wisconsin could impose an inheritance tax on funds belonging to a resident of Wisconsin, which were held in a revocable trust in Chicago. Justice Holmes, in his opinion, declared that the fund was subject to the tax but he used a clear-cut explanation to explain the difference between legal tax planning and illegal tax evasion:
“We do not speak of evasion, because when the law draws a line, a case is on one side of it or the other, and if on the safe side is none the worse legally that a party has availed himself to the full of what the law permits” (at p. 630).
In the 1923 case of US v. Merriam 263 US 179,187 (1923) upheld the Taxpayer’s rights to minimize taxes thru tax planning rejecting the US Government argument that “taxation is a practical matter and concerns itself with the substance of the thing upon which the tax is imposed rather than with the legal forms or expressions”. This “tax planning legal right” was upheld by both lower federal courts and the Board of Tax Appeals (now US Tax Court) in the following cases:
Weeks v. Sibley, 269 F. 155, 158 (1920) (D. N.D. Tex.) where the court held that planning to “avoid tax” is legitimate and is altogether different from tax dodging, the hiding of taxable property, or the doing of some unlawful or illegal thing in order to avoid taxation”.
Appeal of Peterson and Pegau Banking Co. 2 B.T.A. 637, 639 (1925) which affirmed the “right of any taxpayer to minimize its taxes by legitimate devices”.
Since the US Constitution, nor any express Congressional statutory provision, recognizes any legal right for “tax planning” these rights are based on common law i.e. court rulings. The court rulings on “substance over form” and the US taxpayer right to minimize their taxes by “legal tax planning” is best expressed in two cases:
Appeal of W.C. Bradley, 1 B.T.A. 111, 117 (1924) which stated that “the law… deals not alone with the form but with the substance of transactions, looks if necessary through the form to the substance, and predicates its findings upon realities rather than upon fictions”…
U.S. v. Barwin Realty Co. 25 F.2d 1003 (1928) (D. E.D. N.Y.), aff’d 29 f. (2d) 1019 (where the corporate form is used for the purpose of evading the law, the court will not permit the legal entity to be interposed so as to defeat justice”).
In the realm of legal tax planning (as contrasted to illegal tax evasion) the US Supreme Court has issued numerous pro-taxpayer opinions, including:
So. Pacific Co. v. Lowe 247 US 330 (1918), which applied substance over form to prevent taxation of dividends issued prior to the enactment of the 1913 Income Tax Act (so the dividends could not be taxed by the 1913 income tax act);
Gulf Oil Corp. v. Llewellyn 248 U.S. 71 (1918) in which Justice Holmes declared substance over form should be the rule declaring
“that one should ignore forms when analyzing the taxable nature of earnings transferred for bookkeeping purposes from subsidiaries to a holding company”;
Weiss v. Stearn 265 U.S. 242 (1924) held that a reorganization exempted the stock distributed as taxable income subject to tax;
Prairie Oil & Gas v. Motter 66 F.2d 309 (C.C.A. 10th, 1933) “taxation is an intensely practical matter and that the substance of the thing done, and not the form it took, must govern). See: Arctic Ice Machine Co. v. Commr 23 B.T.A. 1223 (1931) in which the court rejected the taxpayer’s attempt to designate a sale as a tax-free reorganization, basing the decision on “the substance of the transaction rather than its mere form”.
Due to the US Supreme Court rulings, lower courts have enforced a taxpayer’s right to minimize taxes by “legal tax planning”:
Iowa Bridge Co. v. Commr, 39 F.2d 777 (1930) where the court held “unless fraud exists, the fact that a corporation attempts to avoid its taxes is not a reason to recharacterize the transaction”;
Jones v. Helvering 63 App. D.C. 204 (1934) stating that “it has been the invariable holding that a taxpayer may resort to any legal method available to him to diminish the amount of his tax liability”;
Satwell v. Commr 82 F.2d 221 (1st Cir. 1936) stating that “nothing is better settled than that persons are free to arrange their affairs to the best advantage for themselves under the law as it stands. A purpose to avoid taxation is not an illicit motive”.Read More »
Helvering v. Gregory
In the landmark case, Helvering v. Gregory 69 F.2d 809, 810 (2d. Circuit Court of Appeals, 1934), reversed a decision of The Board Of Tax Appeals (precursor to US Tax Court) see: Gregory v. Commr. 27 B.T.A. 223 (1932), and found against the taxpayer (Mrs. Gregory); Hand’s decision was affirmed by the US Supreme Court in the case: Gregory v. Helvering 293 U.S. 465, 469 (1935).
In Helvering v. Gregory, Judge Hand stated two tax rules:
1) ”a transaction does not lose its immunity, because it is actuated by a desire to avoid, or, if one choose, to evade, taxation. Anyone may so arrange (their) affairs that (their) taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”
2) The purpose of a business transaction (in this case a business reorganization and a dividend distribution) was to “exempt transactions (from tax) undertaken for “reasons germane to the conduct of a business” not when the sole purpose of a transaction was tax avoidance”… (the purpose of the transaction should be) to “exempt (from tax) the gain from exchanges (i.e. in this case a “reorganization”) made in connection with a transaction (reorganization) in order that the “ordinary business transactions will not be prevented”.
At the time of the US Supreme Court decision in Helvering v. Gregory, the Internal Revenue Code (adopted in 1913) was barely 20 years old, so the case had far reaching implications on the rule of law and tax planning to minimize allowable taxes due to be paid.
Several major cases followed in which lower courts (Federal Courts of Appeal and the Tax Court) expounded:
1) Asiatic Petroleum Co. (Delaware) Limited v. Commr. 79 F.2d 234 (1935) (Swan J. citing Gregory in support of the proposition that taxpayers can legitimately decrease their taxes);
2) Commr. V. Eldridge 79 F.2d 629 (1935), citing Gregory in support of the proposition that a “taxpayer may resort to any legal method available to him to diminish the amount of his tax liability”);
3) Rands v. Commr 34 B.T.A. 1094 (1936) citing Gregory for the proposition that “the purpose to save income taxes is now legally above reproach”).
Regarding tax planning and the intricacies involved, it is left best to Judge Learned Hand who stated:
“The words of such an act as the Income Tax… merely dance before my eyes in an meaningless procession: cross-reference to cross-reference, exception upon exception- couched in abstract terms that offer no handle to seize hold of-leave in my mind only a confused state of some vitally important, but successfully concealed purport which it is my duty to extract, but which is within my power, if at all, only after the most inordinate expenditure of time. I know that these monsters are the result of fabulous industry and ingenuity, plugging up this hole and casting out that net, against all possible evasion; yet at times I cannot help a saying of William James about certain passages in Hegel: that they were no doubt written with a passion of rationality; but that one cannot held wondering whether to the reader they have any significance save the words are strung together with syntactical correctness.” (Learned Hand, Thomas Walter Swan, 57 YALE L.J. 167,169 (1947).
Or more clearly, as Hand stated in Helvering v. Gregory 69 F.2d 809, 810 (2d. Cir. 1934) “just as a melody is more than the notes (so the) meaning of a sentence may be more than the of the separate words”.
US v. Wigglesworth
The United States of America, founded in 1776, has a long history of interpreting tax rules so they favor the individual citizen and not the government. In the historic 1842 case US v Wigglesworth, 28 F.Cas. 595, 596-7 (D. Mass. 1842) the Court stated: “It is, as I conceive, a general rule in the interpretation of all statutes, levying taxes or duties upon subjects or citizens, not to intend their provisions, by implication, beyond the clear import of the language used, or to enlarge their operation as to embrace matters, not specifically pointed out, although standing upon a close analogy. In every case, therefore, of doubt, such statutes are construed most strongly against the government, and in favor of the subjects or citizens, because burdens are not to be imposed, nor presumed to be imposed, beyond what the statutes expressly and clearly import. Revenue statutes are in no just sense either remedial laws or laws founded upon any permanent public policy, and, therefore, are not to be liberally construed”.
Since this case was decided over 70 years before the adoption of the Internal Revenue Code (1913) it is a clear expression of American tax planning policy not to be found in IRS or Treasury Dept. code sections, regulations or other rulings. More to the point it is not the type of advice that the IRS or Treasury Dept. would voluntarily offer to US taxpayers. Yet, nearly 200 years later (in 2017) it is still the law of America.
The US Supreme Court echoed the decision in” Wigglesworth” in their 1917 case Gould v. Gould 245 U.S. 151,153 (1917) when they stated: “In the interpretation of statutes levying taxes it is the established rule not to extend their provisions, by implication, beyond the clear import of the language used, or to enlarge their operations as to embrace matters not specifically pointed out. In case of doubt they are construed most strongly against the government and in favor of the citizen.”(Justice McReynolds).
Since Wigglesworth, many Federal and U.S. Supreme Court Cases have profoundly supported the US Taxpayers rights to have US law applied in favor of US citizens when there is any dispute as to the rule law cited. Among these cases include:
Powers V. Barney 19 F.Cas. 1234 (S.D.N.Y. 1863) “duties are never imposed on the citizen upon vague or doubtful interpretations”;
U.S. v. Isham 84 U.S. 496 (1864) “a tax cannot be imposed without clear and express words”;
Hartfanft v. Wiegmann 121 U.S. 609 (1887) “duties are never imposed on the citizen upon vague or doubtful interpretation”;
In the Matter of Hannah Enston, Deceased 113 N.Y. 174 (Ct. App. N.Y. 1889) “it is well established rule that a citizen cannot be subjected to special burdens without the clear warrant of the law”;
American Net and Twine Co. v. Washington 141 U.S. 468 (1891) “where Congress has designated an article by a specific name and imposed a duty upon it, general terms in the same act… are not applicable to it”);
Rice v. U.S. 53 F. 910 (1893) “in cases of doubtful construction the court should refrain from imposing a tax or charge upon the citizen”;
Eidman v. Martinez 184 U.S. 578 (1901) “laws should be liberally interpreted in favor of the taxpayer(importer) and the intent of Congress to impose or increase a tax (upon imports) should be expressed in clear and unambiguous language;
Benziger v. U.S. 192 U.S. 38 (1904) “tax statutes should be liberally construed in favor of the taxpayer (importer), and if there were any fair doubt as to the true construction of the provision is question the courts should resolve the doubt in taxpayer’s favor.
In summary, in case of any doubts as to tax law interpretations, any doubts should be resolved in taxpayer’s favor.
The Gould case, decided by the US Supreme Court in 1917 (4 years after the adoption of the 1913 Internal Revenue Code) enabled both other Supreme Court justices and lower federal and state courts to decide in favor of the taxpayer, which cases include:
U.S. v. Field 255 U.S. 257, 262 (1920)(citing Gould for the proposition that “tax acts should not be extended by implication”;
U.S. v. Merriam 263 U.S, 179, 188 (1923) using Gould as the basis for deciding that sums given to the executor of a will are not to be considered “income”;
Crooks v. Harrelson 282 U.S, 55,62 (1930) “in taxing acts, adherence to the letter of the law should be applied with peculiar strictness”;
Weeks v. Sibley 269 F. 155, 158 (1920) (D. N.D. Tex.) citing Gould to support the contention “that courts must uphold transactions even when they are motivated by the desire “reduce or avoid taxation”.
Studebaker Corporation v. Gilchrist 244 N.Y. 114, 126 (1926) (Ct. App. N.Y.; J. Cardozo) citing Gould for the proposition “that a statute levying a tax will not be extended by implication by the clear import of its terms”;
Irwin v. Gavit 268 U.S. 161, 168 (1926), rejecting technicalities, J. Holmes noted that “it is said that the tax laws should be construed favorably for the taxpayers”Read More »
The “mechanics” are as follows:
1) For clients with over $3m (investable) have them consider funding a Private Annuity (“PA”) (Nassau, governed under Puerto Rico law) for asset protection, investment diversity (including closely held companies) and confidentiality. The PA funds a non-modifed endowment contract (“non-mec”) Private Placement Life Insurance (“PPLI”) over 5 separate years so then policy withdrawals are either tax-free (return of basis) or tax-free loan proceeds (i.e. earnings over basis are borrowed out and repaid from policy death benefit on a leveraged basis i.e. policy premiums which pay for the death benefit are on a leveraged basis)
2) Tax and other advantages include: under the PA, tax deferred compounded earnings (not subject to tax until withdrawn as annuity payments, the annuity policy is collapsed, or the annuity is used for a loan to the annuitant). Under the PPLI, tax-exempt earnings withdrawn as either basis recovery or received as a tax-free loan.
3) Under either the PA and/or PPLI no annual reporting for earnings to the IRS (which minimizes audit risk);
4) Under either the PA and/or PPLI no 3rd party creditor attachments (absent a fraudulent conveyance) since under the governing law (Puerto Rico) annuities and life insurance are exempt from creditor attachment.
5) Complete confidentiality (very important for asset protection) since in Nassau disclosure of financial information is a crime subject to jail.
In addition, the funds may be held in the US, in an account with a major company, under the direction and control of the designated investment advisor and invested accordingly (included selecting a Depository US bank, and Custodian).
For tax compliance purposes, a Puerto Rico annuity or life insurance policy is not considered a foreign jurisdiction for FBAR reporting (i.e. foreign accounts over $10k re: FinCEN Form 114). Since the annuity and life insurance policies are not owned by an individual (they are owned by a California Limited Liability Company, one-member disregarded entity, which is wholly owned by a California trust; CA has very favorable asset protection laws for Trusts and LLCs) there is no requirement to file Form 8938: FATCA annual filing (attached to Form 1040 Individual Tax Return) for annual disclosure of foreign financial assets over $50,000 (see IRS instructions to Form 8938 which confirms the filing is only due for an individual not a limited liability company or other entity).
For estate and gift tax savings:
1) If the California trust is irrevocable, the assets contributed up to $10.98m (2017) husband and wife are exempt from gift tax and if the trust has additional beneficiaries under the withdrawal provisions (known as “Crummey” withdrawal rights, under the federal case of the same name) each beneficiary listed will increase the withdrawal rights by $28k per done (“gift splitting” husband and wife”). So if there are 5 beneficiaries of the trust, an additional $140k per year may be contributed estate and gift tax-free.
2) The estate and gift tax advantages of funding the trust (irrevocable) with the maximum $10.98m (2017) is that the future appreciation (after asset contribution) is excluded from 40% federal estate and gift tax upon death of trust settlors. For example, if $11.38m is contributed in 2017 (e.g. trust with 5 beneficiaries) and the trust is worth $21.38m at death the $10m in appreciation escapes 40% estate tax (i.e. a $4m estate tax savings.
3) In addition, estates over $10m have a nearly 100% audit tax rate. While gift tax returns have a 1.42% current audit tax rate for Form 709 Gift tax returns.
In the IRS 2012 Data Fact Book, reported during fiscal year 2012 (through 9/30/12), latest publicly available report, Estates between $5m and $10m audited nearly 60% rate, estates over $10m, 100% audit rate compared to Form 709 gift tax returns 1.42% audit rate i.e. of 223,090 tax returns filed, 3,164 audited).
The estate and gift tax planning are for the maximum allowable estate and gift tax free contribution of $10.98m (plus annual donee gifts). For assets over $10.98m they may be sold tax free to the trust under
the grantor trust rules.
The trust is an intentionally defective grantor trust (i.e. the income is taxed to the Settlor/Grantor and does not require a separate annual Form 1041/541 Fiduciary Income Tax Return filing, rather than income may be reported on Schedule E attached to the Settlor’s Form 1040). The tax status as a grantor trust means there is a tax bifurcation: the income is annually reported and subject to income tax by the grantor. The assets in the trust are exempt from estate and gift tax on the grantor’s death (saving a 40% estate and gift tax on the Settlors’ death on the value in excess of $10.98m (2017).
Grantor trust status is secured by including prohibited administrative powers in the trust: unsecured loans, power to substitute assets). Any assets over $10.98m may be contributed by a sale i.e. assets are “sold to the trust” under a Promissory Note. Since the trust is a grantor trust, there is no capital gain tax (due to the Seller/Grantor) by the sale of assets to the trust. The “interest” paid to the grantor, for sale of the assets, from the trust is also not a taxable transaction and does not have to be reported to the IRS on the Grantor’s Form 1040 annual income tax returns.
For more information please see an article I recently wrote for Lorman.com, Tax Planning for US Investors – Doubling Net Return on Investment.Read More »
The IRS reported that in fiscal year 2016 they initiated 3,395 federal criminal tax cases thru the IRS/Criminal Investigation Division (which is the only federal law enforcement agency with jurisdiction over federal tax crimes). The focus of these cases included: money laundering, public corruption, cyber-crimes. For FY 2016, the IRS/CI conviction rate was 92%.
The IRS/CI investigates criminal violation of the Internal Revenue Code, which overlaps into related financial crimes e.g. money laundering which are subject to criminal prosecution by the US Dept. of Justice.
As stated by Commissioner of the IRS, John Koskinen: The IRS continues to work to ensure that everyone is playing by the same rules and paying their fair share (of tax)…. The IRS is committed to fairly administering and enforcing the tax code, and our criminal investigation division plays a critical role in that effort”.
Regarding IRS Civil Tax Audits, the audit rate has declined for individual taxpayers (in 2007: 1.38m taxpayers audited, 2010: 1.58m, 2016: 1.03m taxpayers were audited which is 0.7% i.e.1 in 143 risk) and for business taxpayers (Corporations, Partnerships and S-Corporations audit rate was 0.49% lowest level since 2004 (0.36%).
High Income Earners also saw a decline in IRS tax audits for taxpayers making over $200k (1.7% audit rate), over $1m in income (5.8% audit rate).
The decline in IRS audit rates is due to a reduced IRS budget (2010: $12.2B; 2016: $11.2B) and less employees in the IRS (between 2010-2016 the IRS lost more than 17,000 employees so now a little more than 80,000 people work at the IRS).
However, due to 3rd party information reporting, there is less opportunity for taxpayers to cheat on their taxes. The IRS collects information to verify taxpayer’s tax reporting including: Employers report wages, Banks report interest, Brokerages report sales/capital gains, and Lenders report mortgage interest.
As stated by the IRS Commissioner, “the IRS still audits over 1m tax returns per year… spinning the roulette wheel and risking an audit can be an expensive bet… considering unpaid tax, penalty and interest from an audit”.
IRS budget cuts may be illusory since the IRS collects 93% of US tax revenue. As stated by Tony Reardon (President of the National Treasury Employees Union, which represents IRS workers: “You cannot increase defense spending (as proposed by the new administration to increase defense spending by $54B) and cut IRS funding at the same time. It does not add up…” which was echoed by Steven Mnuchin the new Secretary of the Treasury in his confirmation hearings.
For US taxpayers concerned with either IRS civil tax audits/ or criminal tax issues the keys are to maintain good records, have legal authority in the form of a tax opinion citing favorable law which supports the Taxpayer’s tax returns, and be professionally represented.
In the words of Mark Twain: “Do the right thing. It will gratify some people and astonish the rest.”Read More »