Quatloos! > Investment Fraud > Financial Planning > Black Holes & UFOs

Black Holes & UFOs

Introduction

This is a scam which is perpetrated by high-profile "offshore" tax attorneys, usually at seminars which advertise "offshore asset protection" strategies. Most of these attorneys were essentially put out of business by the 1996 Small Business Protection Act (which nixed all offshore trusts as a tax shelters), and they simply never figured out any good and legal tax strategies, so they just stick with what they know although the law has changed. Almost all of the discussion is on how good offshore secrecy is, and how the IRS will never find out if money is hidden offshore. There is scant little discussion of how assets are protected from creditors, except that the assets are hidden offshore.

These tax attorneys will pitch a variety of strategies which has at their end result that the client's money "disappears" over a period of years from the IRS's radar screen, but is still controlled by the client, who avoids investment income taxes and capital gains taxes, and then later by the client's children, who get to avoid estate tax and then also their investment income taxes and capital gains taxes.

Definition -- Black Hole

In offshore tax planning parlance, a "Black Hole" is a strategy whereby you transfer your money into some structure, openly declaring to the IRS that you have done so (and usually taking a deduction for so doing). By hook or by crook the money eventually ends up in a UFO (described below), and is thereafter "off the radar screens" of the IRS, so that you can invest it and pass it on to your kids completely tax free. These strategies are called Black Holes because the money goes into the structure but never comes back.

• Obvious Downside #1: Despite a bunch of legal research and theory, usually by tax attorneys with impressive degrees, this is tax evasion.

• Obvious Downside #2: In the worse case, the term "Black Hole" is aptly descriptive insofar as not only can the IRS not get the money back, but neither you nor your kids can get the money back either.

The offshore guru of Black Holes was ex-patriate CPA Marc Harris of The Harris Organisation. Marc, a really bright and fundamentally likeable guy, set up an organization called The Octopus, which used a Panamian Foundation to own, variously, insurance companies, banks, leasing companies, and a bunch of other entities which would own a Harris client's assets and suck all of the money out of the client's business. Marc would have his in-house tax counsel issue a private opinion that the Panamanian Foundation  was neither a trust nor a corporation and thus did not have to be reported to the IRS, and so a Harris client would not report the Panamanian Foundation as the ultimate owner, although all the money was upstreamed to it. This sounded great in theory (and Marc is a charismatic guy who could sell these all day long), but there was no real substantial authority for the theory that the Panamanian Foundation did not need to be reported (thus this was tax evasion by the client -- later proven by some successful tax-evasion convictions by the IRS), and, much worse, according to Offshore Alert more than $20 million of clients' money didn't quite make it back to the clients.

But Marc was in Panama, and you almost always had to travel to Panama to facilitate these transactions. Now, there are quite a few U.S. tax attorneys and CPAs who will essentially put you into the same transaction as Marc was promoting -- except (1) these transactions are actually performed in the U.S. and so have a high degree of being found out; and (2) these tax attorneys and CPAs tell you (falsely) that these strategies are either legal or will probably withstand IRS scrutiny, if the IRS ever figures out. So, at least with Marc you knew or should have known what you were getting in to. With these U.S. professionals, you THINK that what you are doing is right, but it isn't, and is in fact so illegal that you would probably have had a better risk/return ratio is you had put a mask over your head and robbed a bank.

Definition -- UFOs

UFO is an acronym we came up with to describe the mythical Uncontrolled Foreign Organization, which is an offshore corporation which is controlled in reality by the client, but which is not considered a Controlled Foreign Corporation ("CFC") by the IRS -- in other words it will be a "controlled non-controlled corporation".

These entities are every bit as sought after as the first documented contact with space aliens, because if you had such an corporation you could legally move assets to it and control those assets without declaring the entity to IRS or having to pay taxes on it. The world would then be your oyster, as you could do business worldwide without paying a cent of taxes, legally. Unfortunately, by their very definition they do not exist. If you exercise control over a foreign corporation, it is a controlled corporation. You simply can't have a controlled non-controlled corporation, any more than you could have a red non-red car, or a full not-full can of beer.

Usually, these theories will point to IRC Section 957 which states that a corporation will be considered to be owned and controlled by a U.S. citizen if more than 10% of the stock is owned or controlled by a U.S. citizen, or more than 50% of the aggregate of all the corporation's stock is owned or controlled by U.S. citizens. Unfortunately, these theories all ignore the next section, IRC Section 958, which essentially states that if you control it, you will be treated as owning it for purposes of tax reporting and remittance. These theories also over many other "attibution" rules of ownership and control.

There are at least dozens, and perhaps hundreds of tax attorneys and CPAs which spend a great deal of energy looking for UFOs -- doubtless more time and energy is spent looking for the offshore UFO than NASA spends looking for the deep space variety. And, not surprisingly, more offshore UFO sightings occur in flakey California than anywhere else in the U.S., where a number of Hollywood tax attorneys have (falsely) announced that they can create a UFO that will stand up to IRS scrutiny. Notably, despite research memos the size of the Los Angeles Yellow Pages and structures which usually end up with a Manx hybrid corporation or other little-understood entity, these attorneys consistently refuse to approach any of the Big-5 accounting firms for an opinion letter to validate their findings. 'Nuff said.

There are basically four types of encounters with UFOs:

• Close Encounters of the First Kind ("We sighted something but we don't know what"): We have a lot of these. About once a month, some tax attorney will call us and announce that he can form controlled non-controlled corporations for our clients for some grandiose fee. The tax attorney tells us that the corporation can trade stocks offshore without reporting investment income, and that we can all get rich pitching his structure. We yawn and say "Wow! That sounds great!" and ask for the tax attorney's supporting documentation. At this point, the attorney either attempts to charge us an enormous fee for the information (a flat $250,000 was what the last one wanted), or simply refuses to provide it. End of sighting.

• Close Encounters of the Second Kind ("Sighting of something which is obviously unknown"): We have a few of these a year. The tax attorney will send us supporting documentation, which we look at under a confidentiality agreement thicker than a Methodist hymnal. The theories which these attorneys come up with are nothing short of bizarre. They usually utilizing offbeat Civil Law structures or weird trust laws combined with a couple of Private Letter Rulings (which do not have precedential value). To-date every review of this type of information by us has lead to very serious questions as to whether substantial authority exists -- or even which planet the tax attorney is living on -- so we suggest to the tax attorney that they get one of the Big-5 accounting firms behind them, but they never do. End of sighting.

• Close Encounters of the Third Kind ("First Contact"): Every once in a while, we will be approached by a person who has either been approached by a tax attorney to enter into one of these transactions, or have recently entered into the transaction but it hasn't yet fully funded and they are having second thoughts. Here, we review the transaction and, having determined that the authority is not up to our (or, really, any) standard, assist the client in backing out of the transaction.

• Close Encounters of the Fourth Kind ("Abduction"): This is the worst case scenario. Here, we are approached by a client who has gone through with this transaction and is either being chased by the IRS for tax evasion, can't get his money back, or is now being extorted by someone who knows he is committing tax evasion -- but usually by some combination of all of these. Unfortunately for such persons, as with the extraterrestial UFOs these also have their own version of the dreaded probe.

The Pitch

If you are so dumb as to actually pay to go to a seminar where Black Holes and UFOs are hawked (sort of like paying to go to a Used Car Dealership or to a Casino), you will probably hear one or both of the following pitches:

Variation #1:

"I have a Master of Law (LLM) degree from a major law school, and know tax law inside and out. [Blah, Blah, Blah]. Put your money into this offshore [(a) private annuity; (b) charitable foundation; (c) Manx hybrid company; or (d) other goofy entity] and it will sit there for a period of years and grow tax free. After a period of years, it will simply be forgotten, as if it fell into a black hole, but you will still control it and then it will forever be available to you and your kids offshore, and without any income taxes, capital gains taxes, or estate taxes."

Variation #2:

"I have a Master of Law (LLM) degree from a major law school, and the fact that I am giving this seminar and then charging you $25,000 for this transaction means that I know what I am doing. [Blah, Blah, Blah]. We will create a offshore foundation, which will be owned by a trust, which will be owned by a Manx hybrid company, and managed through a purpose trust (or some similar goofy structure), with the end result being that your money will eventually disappear (as if it fell into a black hole) into an entity which you control in reality -- you even get an offshore bank debit card! -- but is not controlled from the viewpoint of the IRS, and through this entity you and your kids will have a pot of money offshore which you can use which will be perpetually free from any income taxes, capital gains taxes, or estate taxes."

The Problems

The LLM initials behind the alleged expert's name notwithstanding, these schemes universally have the same serious defects.

• These schemes are criminally tax evasive. While all the ins-and-outs of these transactions may sound good at the seminar, the fact is that they are unsound, and that are not based on substantial authority -- or really any authority at all. What these strategies rely on is stealth; that is, the IRS never finding out about them. But that doesn't make them any more legal. Don't believe us? Ask the attorney to get a Big-5 opinion letter on the legality of the transaction. If the lawyer balks, you know everything you need to know. And if you haven't seen them yet, also request a copy of the Federal Sentencing Guidelines for tax evasion. They are based purely on dollar amounts, and you are guaranteed to get a much longer prison term if you have used "sophisticated" means, which has been interpreted to include any type of foreign structure or bank account.

• There are lots of ways the IRS can find out about these schemes. The old adage "loose lips sink ships" in this context means "divorced spouse gets everything when you go to Club Fed". Same goes for disgruntled secretaries, both of the client and of the lawyer. And assume that the Client A shares the same lawyer with Clients B, C, and D. Client C does something stupid, and now the lawyer's phone is tapped, and his office is raided, and information is found on undeclared accounts of Clients A, B, and D. Don't drop the soap! And the last couple of years we have seen more than one instance where the IRS put sufficient pressure on tax attorneys who were engaged in this type of conduct to reveal their clients' identities, who were then tried and convicted for tax evasion! So, just don't do it.

• You have now caused your kids to commit tax evasion. By creating a pool of money offshore for your kids to manage, you have now placed them in the position where they are committing felony tax evasion. And, unlike you, they can't come clean without revealing the source of the funds, which after penalties and then estate taxes are assessed, mean that they will have nothing at day's end (whereas if you had pursued legal methods, they would have had probably 85% of the same moneys and could sleep well at night).

• You can be scammed out of the money. Many of these schemes are premised on the notion that "The transaction occurred 15 years ago, no records of it are kept, and it has been forgotten about." The problem is that your kids can't prove that the transaction occurred either. This means that they can't prove ownership of the funds if the trustee or whoever decides to embezzle them. And the Catch-22 is that if you kids can prove that the transaction occurred, then that is proof-positive they too have committed tax evasion.

• You have set yourself up for extortion. The upshot of these transactions is that you have committed tax evasion and at least one person (the tax attorney) and probably several persons (your offshore trustee or banker) are also knowledgeable about the transaction. If for whatever reason they get tight for money (say their license is suspended or their cocaine habit gets worse), you and your offshore money are going to be at their top of their list of funds to tap -- and you can't say boo about it without revealing that you have committed tax evasion. And then after those funds are depleted, they will come to you for more, which you will gladly provide in lieu of Monday shower privileges.

See also Hiding Money Offshore, which independently is an incredibly bad idea but an integral part of these Black Hole and UFO schemes.

Terms

• Reinvoicing (a/k/a "Transfer Pricing")
  An offshore tax scheme involving the creation of a middleman entity or offshore wholesaler in a tax haven jurisdiction for purposes of skimming profits and thus decreasing the amount of U.S. income shown. The IRS has significant powers to combat such arrangements, some of which may amount to criminal tax evasion.