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Fraud > Financial
Planning > Black
Holes & UFOs
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
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
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:
"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."
"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 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
See also Hiding
Money Offshore, which independently is an incredibly bad idea
but an integral part of these Black Hole and UFO schemes.
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
Have a question for Quatloos?
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presentation from the IRS regarding Tax Scams