Tax Probe Blames Accounting Giants

A Senate subcommittee spent a year unraveling four tax shelters sold by accounting giant KPMG to determine that modern tax shelters are driven less by unscrupulous taxpayers than by those who devise and sell them.

"The real engine are the professional groups that design and market these tax shelters, that hawk them, frequently telemarketing these tax schemes," said the panel's senior Democrat, Sen. Carl Levin of Michigan.

KPMG, which sold four tax shelters that will be the focus of two days of hearings this week, said the era of big-dollar tax shelter products has come and gone.

"KPMG is committed to restoring confidence and trust in the accounting profession," the firm said in a statement. "The tax strategies that will be discussed at the subcommittee hearing represent an earlier time at KPMG and a far different regulatory and marketplace environment."

Staff members on the investigations panel of the Senate Governmental Affairs Committee said the probe uncovered a complex infrastructure inside KPMG devoted to developing, marketing and selling tax shelters. They said employees were put under intense pressure to develop profitable ideas and sell them aggressively.

KPMG mined confidential taxpayer information gathered by the firm's tax preparers and ran a telemarketing operation in Indiana to find customers for tax shelters it developed and marketed, it said.

KPMG said it has revamped its tax practices and removed much of that infrastructure. It no longer develops tax products to mass-market to its clients and closed the two departments responsible for developing, packaging and marketing those products, it said. In 2002, the firm installed an internal ethics hot line.

A hearing Tuesday is aimed at giving an inside look at tax-shelter development and marketing. A session Thursday is meant to reveal roles played by other financial institutions that support and enable tax sheltering.

Treasury Department officials say they see some evidence that the market for tax shelters has started to dry up, but Levin disagreed. "I don't think we have any evidence that it's slowed down at all," he said.

With the help of whistle-blowers inside the company, the Senate panel spent a year unwinding four tax products that KPMG sold to more than 350 people in the late 1990s and early 2000s.

Subcommittee aides said the transactions that were part of the tax shelter had virtually no business purpose other than reducing taxes for the individuals who used them. The IRS ruled in 2000 that the basis for three of the four transactions make them potentially abusive shelters. The fourth, aides said, is under investigation by the IRS.

KPMG said it had shut down the four tax shelters by 2001. Levin's staff said KPMG insiders told them the firm has 500 active tax products for sale in 2003.

One past transaction scrutinized by the subcommittee, called S-Corporation Charitable Contribution Strategy or SC-squared, targeted individuals who owned a type of corporation that passes income, and thus taxes, through to its shareholders. The individuals typically had a 100 percent stake in the corporation and made at least $3 million.

The individuals reduced taxes on the company's income by temporarily allocating it to a tax-exempt entity. They also got a tax deduction for donating nonvoting stock, which was created specifically for this transaction, to the tax-exempt group. It eventually got the stock back.

The subcommittee found evidence that about a half-dozen tax-exempt entities participated in SC-squared, but they learned the identity of only two — the Los Angeles municipal pension fund and an Austin, Texas, firefighters' pension fund.

A second transaction, dubbed Bond Linked Issue Premium Structure, or BLIPS, generated a loss for taxpayers who typically had $20 million or more in capital gains or ordinary income.

The structure generated a complex web of loans and investments that appeared to lead to the establishment of a strategic investment fund for currency investments.

Subcommittee aides said the real purpose was to secure a loan that, when eventually paid back, generated a loss for the taxpayer equal to the income that would be sheltered.

Two other transactions called OPIS and FLIP relied on losses generated to offset income.

KPMG said in response, "KPMG no longer offers or implements aggressive tax strategies specifically designed to be sold to multiple clients, such as FLIP, BLIPS, OPIS and SC2(squared)."

According to IRS statistics for the most recent year on which detailed data is available, more than 5 million corporations filed corporate income tax forms in 2000, but only 2.8 million — 55 percent — reported any net income.

Of those who did report net income, receipts totaled $16 trillion and deductions $15 trillion. These corporations paid $203 billion in tax — or about 1.4 percent of their business receipts.

Of the 239,000 individual taxpayers with incomes in excess of $1 million, 236 did not file taxable returns.