Lessons from Largest U.S. Tax Fraud in U.S. History

If you are in the world of finance, accounting or tax chances are you have probably heard of Sam Wyly and his late brother Charles Wyly.  In recent years, the business mogul brothers have been the hot topic of litigation as they battled with the IRS and SEC over alleged tax and securities fraud that may have spanned decades.  In the most recent decision to come out of the Wyly saga, Sam Wyly was ordered by a Dallas bankruptcy court to pay $1.1 billion in back taxes, interest and penalties.  While the litigation is noteworthy because of the massive amount of dollars involved, it can also provide some reminders for tax professionals, particularly those with sophisticated clients.

The alleged scheming started over two decades ago when the brothers created several Nevada corporations and identical entities in the Isle of Man, a self-governed British dependency.  The brothers then transferred millions of dollars to buy stock in companies they ran into the Nevada corporations.  The Nevada corporations immediately turned around and forwarded the options and annuity obligations to the off shore corporations in the Isle of Man.  Each transfer was structured to avoid triggering ownership disclosure requirements to the SEC.  The brothers continued these similarly structured transactions, which resulted in millions of dollars of stock awarded to the Wylys, yet no U.S. taxes were ever paid on the gains.  Not only did these transactions result in tax fraud claims by the IRS, the SEC got involved when it appeared that the Wylys had convinced the option issuing companies not to file tax forms on their behalf, allowing the Wylys to trade the securities secretly.

A decision by a federal bankruptcy judge in Dallas determined that Sam Wyly committed tax fraud by shielding billions of dollars in offshore trusts.   The judge did not buy Wyly’s argument that he reasonably relied on the advice of lawyers and other advisers in creating and utilizing the offshore accounts.   The judge stated she refused to find “that it is appropriate for extraordinarily wealthy individuals to hire middlemen to do their bidding in order to insulate themselves from wrongdoing so that, when the fraud is ultimately exposed, they have plausible deniability.”  She also noted that the offshore system was more complex than it needed to be and there was little credible evidence suggesting a legitimate business purpose requiring such a high level of complexity.  Instead, the “primary reason for making the offshore system this complex was the hope that no one, including the Court, could ever figure out what was going on here and why.”

The decision in the Wyly’s case serves as a good reminder that courts and federal agencies may approach overly complex investment systems and offshore accounts with a high level of skepticism.  Furthermore, while reliance on counsel and other professionals can certainly be a defense in some matters, a taxpayer cannot play dumb when it comes to her own financial structure, particularly when it appears as complex and convoluted as Sam Wyly’s.  Regardless though, tax professionals should be overly cautious when it comes to dealing with offshore accounts, highly sophisticated clients and creating complex tax schemes.