Frontline: Tax Me If You Can
Hedrick Smith
Producer/Correspondent
Friday, February 20, 2004; 11:00 a.m. ET
The tax shelter was one of corporate Americašs biggest hidden profit centers in recent years. Shelters have become so lucrative that some experts estimate as much as $50 billion is lost to the U.S. Treasury each year. And ordinary taxpayers wind up footing the bill. Frontline correspondent Hedrick Smith provides an inside look at how big corporations and wealthy individuals cut their taxes with intricate, hidden, and abusive tax shelters and investigates the role of blue chip accounting firms in these secret deals.
Smith will be online Friday, Feb. 20 at 11 a.m. ET, to discuss his report.
Submit your questions and comments before or during the discussion.
"Tax Me If You Can" airs Thursday, Feb. 19 at 9 p.m. ET (check local listings).
Editor's Note: washingtonpost.com moderators retain editorial control
over Live Online discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions.
washingtonpost.com:
Hedrick will be with us momentarily.
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Albany, N.Y.:
Have criminal charges been made against any of the promoters and/or taxpayers for use of these shelters?
What exactly was the claimed benefit to the U.S. for permiting these leasing transactions?
Where can I get a copy of the transcript of the congressional hearings regarding the accounting firms promoting these tranactions.
Thanks.
Hedrick Smith: I am not aware of any criminal charges yet being filed against users or promoters of shelters. However, yesterday, a few hours before our program aired, KPMG issued a statement saying that it was under investigation by a grand jury in New York State, which would indicate that a criminal investigate is under way and criminal charges may be filed.
To obtain Congressional hearing testimony, you should contact the appropriate Congressional COmmittee. In this case, the Senate Permanent Subcommittee on Investigations and the senate Finance Committee, both of which have held hearings and which have their own web sites. You can look them up on the internet and find the hearing transcripts.
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Pittsburgh, Pa.:
You seem to get upset that corporations avoid taxes using
transactions that exist only on paper, but don't
corporations themselves exist only on paper?
How can we express moral outrage at a non-entity?
In reality the taxes companies pay or don't pay get passed
along to shareholders, executives, employees, and
customers anyway. An examination on how these shelters
effect the ultimate distribution of the tax burden would
have been a more relevent, if less sexy, story.
Hedrick Smith: I think it would be hard to persuade the drivers of GM cars that GM is a corporation that exists only on paper. Certainly the employees and customers of corporations, as well as the suppliers, are going to see them as realities, as are the stockholders. SO the "paper" onoly argument seems a mirage.
As to the argument that it doesn't make any difference whether the corporaiton pays taxes or not because it merely passes on costs or gains to its shareholders or customers, the issue in any social system is one of responsibility for one's own actions and fairness and equity to others. If a corporation improperly reduces its tax burden, that burden shifts to other parties. In the case of corporations as a whole, as our program pointed out, there has been a steady decline in the corporate share ofr the tax burden over the past 50 years, especially in the past 20.
But the real issue here is everyone honestly paying their own taxes and not shifting the bvurden unfairly to someone else by illegitimate means.
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Arlington, Va.:
Over several decades, the Congress -- as a policy matter -- has encouraged leasing not only to taxable entities but to tax-exempt entities as well so that tax-exempts can have ready access to capital. Why should the Congress -- as a policy matter -- want to make it more difficult for tax-exempt entities to acquire productive assets by curtailing their ability to lease equipment?
Hedrick Smith: Congress has passed laws to encourage leasing in order to stimulate business activity. For example, if American Airlines wants to buy planes from Boeing and American Airlines does not have enough cash to do so, it can borrow money from a bank or banks, or it can float some equity and raise capital on the stock market. Leasing is another approach. A bank or banks can buy the planes and lease them to boeing and the bank or banks can claim the tax deduction on the depreciation of the aircraft. This is attractive to all parties because the airlines are not terribly profitable and do not have great need for tax shelters, whereas banks are very profitable and have great need for tax shelters, or so the experts tell us.
the net effect ot this type of transaciton is to stimulate economic activity and thus to create jobs and spurt economic growth.
It is an entirely different matter when you have old assets in a foreign country that already exist, which are going to be leased out to the US bank and then instantly leased back to the foreign city, and used by the foreign city. The argument of the IRS, and many others in Congress and among the tax firms, is that there is no real business activity going on here. The money flows are circular. In fact, there is reason for the IRS to believe that in many instances, the money never actually moves, it just sits in the same banks tyhroughout the transaction. In other words, it all happens on paper - or nothing really changes at all.
That is a very different kind of transaction from the one that Congress envisaged when it sancitoned the leasing law. The gainers are the foreign city, which gets a fee, and the US bank which gets a tax deduction. But no other parties gain anything from this artificial transaction.
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Washington, D.C.:
What are the estimated revenue projections of closing these loopholes?
Hedrick Smith: Estimates on the benefits of shutting down illegitimate tax shelters vary widely, from about $15 billion to $50 billion a year. The General accounting Office estimated last fall that illegitimate tax shelters had cost the US treasury $85 billion over the previous several years - and those were only the shelters that the IRS knew about. So it would be enough to pay for a year of the Iraqi war, and some say, a lot more.
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Charlotte, N.C.:
Thank you for your excellent report on these egregious tax scams. How was it that you began this investigation? Was there any one event that triggered your effort?
Hedrick Smith: Thank you for your comment on our program. it means a lot that viewers feel that we have taken a very complicated subject and made it understandable and relevant to a general audience.
There was no single event that prompted us to take on this subject. In a previous PBS Frontline program, "Bigger Than Enron," we covered the collapse of Enron ans its use of off-book entites and the failure of accounting firms to informn investors how corporations were cooking their books. During our work on that project, we discovered that corporations could legally keep two sets of books - the optimistic book income report to Wall sTreet and the lowball tax income report to the IRS. That got us intrigued with how corporations hold down their tax payments.
In addition, there were press stories about hundreds of thousands of Americans ducking taxes by using offshore credit cards in places like the Cayman islands, as well as other stories of tax fraud.
SO we began to look into the issue of tax evasion in general and the trail led us to the major issues that we reported on in "Tax Me IF YOu can". Of course, we had time only to look at a few examples of illegitimate tax shelters. But there were many more, including some, as we said, where the IRS and the Justice department took major corporations to court and won cases against them.
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Arlington, Mass.:
What parallels can you draw between the
dubious ethical practices at KPMG and
what happened at Arthur Andersen?
Also, would you ever consider an
investigative report into the factions trying
to repeal the estate tax, from which 98 percent
of Americans are exempt ?
Hedrick Smith: I think that many tax and accounting professionals would see a connection between the failure of Arthur Andersen to sound the alarm on Enron and the tax shelter practices for which KPMG is now under investigation by a federal grand jury in New YOrk.
The comments that we heard over and over again from tax professionals, whether accountants or lawyers, as well as businessmen and government officials and members of Congress is that there has been a serious decline in ethics in the professionals. The explanation given by tax professionals is that in the 1980s and 1990s, especially the 90s, acocunting firms and law firms became more like businessess, driven by the bottom line rather than by professional ethics.
In the acocunting industry, we were told that the real money-making segments of the business were the new segments - consulting and selling tax advice or tax shelters. They became much more important in terms of earning power than the traditional function of auditing corporate books. This means that the partners in accounting firms, and in some law firms as well, make more money if the firm is aggressive in its consulting business and in its tax shelter business. Partners share in the partnership's wealth.
Several alwyers and others commented to us that accountants and lawyers saw investment bankers making enormous fees during the 1990s and they wanted to match those earnings. lPeople wcould become overnight millionaires many times over in that kind of an atmosphere. So the argument is that money corrupted the accounting professioln. Indeed that is one of the main concerns of the accounting oversight board now headed by William McDonough, the former chair of the New York federal reserve Board.
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Charlotte, N.C.:
Excellent piece. I was more familiar with the Charlotte KPMG practice than I wanted to be and left there in disgust in early 1997. The problem was two fold. First, the tax shelters for both corporate entities and individuals were extremely aggressive and secondly the profitability of the accounting firm's tax practice and the compensation of its partners depended on selling the shelters. It remains extremely troubling that even after much of this has come to light, even after Enron etc., even after the drafting of anti-tax shelter legislation Congress has refused to act. In both 2001 and 2003 anti-tax shelter legislation died in committee. Do you plan a follow up on this?
Hedrick Smith: We need to connect your comment to the question from the previous viewer/chat participant.
It is heartwarming for me as a reporter to hear that someone from the inside saw the same kind of picture we discovered, with great effort, on the outside.
The first follow-up that I can mention is that "Tax Me If You can" will be repeated by PBS Frontline on APril 15 - which seems veyr appropriate timing. SO I hope you will tell your friends who missed the program that they can still catch it - on APril 15.
We are now researching some other topics for our next program. if you ahve suggestions you can e-mail me at hsmith prod@aol.com or write Hedrick Smith, hedrick Smith Productions, 6935 Wisconsin Ave., Ch,evy Chase, Md., 20815.
Many thanks
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Richmond, Va.:
Wouldn't you agree that the growth of the tax shelter business is simply the result of the cradle to grave welfare policies of government, both federal and state, that makes it increasingly expensive for corporations and individuals to exist in this country? The news reports are full of people losing their jobs. Perhaps if the government would get out of the way of production, and let people keep more of what they earned, we wouldn't have this problem.
Hedrick Smith: I don't think any government expense justrifies dishonesty.
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Silver Spring, Md.:
I watched the Frontline on 2/19/04 on this subject. After being a contractor for IBM at the IRS, I am convinced the way the government collects and levies taxes is inherently unfair and is irretrievably broken. They are horribly understaffed, demoralized, and underfunded. Do you believe it is time for the government to go to a strictly consumption-based tax revenue system, like a national sales tax where there are no exemptions or excluded? Similar to the concept put forth by Lester Thurow in his book "Zero Sum Society"?
Hedrick Smith: I don't have a single answer to the problem of tax colleciton in America, but one thing is clear - the tax code is impossibly complex, and it made complex by the pvery parties that want to exploit loopholes. The acocunting rules in America are incrediblyk complex and they are made complex by the accounting profession, which then exploits the complexity.
That is not to say there are not people who are working very hard to try to make the tax laws and the accounting regulations more sensible. But it is vby and large the private sector, with its allies in Congress, that keeps making the laws more and more complex, and as soon as someone like Charles Rossotti or Chuck Grassley says let's pass a simple law that bans illegitimate shelters that have no business purpose, the tax trade protests.
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McLean, Va.:
In the program it was implied that Treasury or the IRS do not have an economic substance test for transactions. I thought that they did and that there have been many court decisions on economic substance as well. Isn't this true?
Hedrick Smith: There have been court decisions that do use economic substance as a test. But there have also been other decisions which conflict or overlap, and therefore the court history is replete with inconsistencies, at least that is what the experts told us. SO that the economic substance doctrine as interpreted by the courts cannot be understood as a general rule but only on a case by case basis.
Hence the argument by advocates of an economic substance law on Capitol Hill that there needs to be a general rule that can be understood by taxpayers. At the moment, the court record is a labyring=th. The reformers call for clarity so that taxpayers, corporate or individual, can ebtter know the ground rules that they are required to paly by.
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Nashville, Tenn.:
Why did you focus so much attention on First Union/Wachovia? I'm sure they are not the only corporations in America do implement such tax strategies.
Hedrick Smith: You are certainly correct that First Union and Wachovia are not the only companies to engage in questionable tax strategies. We used them by way of example. the example cropped up in our reporting. when we began looking into the leasing deals, we had no idea who the US investor was. In fact, there could have been other banks and big corporate investors as well.
SO your point is well taken, there are many others involved in this game. In fact, the IRS had audited and challenged 300 leasing transactions by 30-40 banks and corporate investors. By law, they are not allowed to reveal the names of those banks, so we cannot name them without independent evidence of our own.First Union and wachovia were the examples that we were able to obtain the necessary documentation and evidence. So we used those cases.
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Nacogdoches, Tex.:
Based on involvement in abusive tax shelter promotion by CPAs, do you have any insight into the culture of accounting firms that led many to compromise their professional principles? I.e. is there a deeper problem within the profession?
Hedrick Smith: As mentioned in a previous answer, people in the tax trade told us that the culture of accounting firms has changed radically over the past 20 years, especially in the 1990s. They became much more market-driven, less managed by professional ethics, although there is evidence that KPMG's leadership is trying to get back to the old ethics. it has removed the leaders of its tax divisions which got it deeply involved in marketing aggressive shelters.
There was also some soul-searching in the accounting profession after the collapse of Arthuer Andersen in the wake of the enron scandal.
but it remains to be seen whether the leading accounting firms can restore their reputation for integrity and convince the public that they are in fact performing a public service. The problem is that the public service that we as investors and the general public count upon is honest auditing of corporate books, and that has become th least profitable part of the acocunting business.
There are some who believe that the natural step to take is to sever auditing from the private sector and to have corporate books examined by federal government examiners , the way that banks are now examined by a staff under Alan Greenspan at the Federal reserve Board.
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Los Angeles, Calif.:
Your report mentioned that legislation is currently bottled up in the House. Do you know the House resolution number? Is there a bias unique to either party against legislation?
Hedrick Smith: On the House Ways and Means Committee the most arden advocate of a broad rule government economic substance to block illegitimate tax shelters has been rep.Lloyd Doggett of Texas.
While Republicans in the senate, led by the Finance Committee chairman Chuck grassley, have voted strongly for the econoomic substance rule, the House Republican leadership has been against it. That has also been true of Bill Thomas, the Republican Chair of the House Ways and Means Committee.
There is currently some movement on piecemeal tax shelter reform in the Ways and Means Committee. Chairman Thomas has a bill of his own that would increase some penalties on shelter abusers and promoters. The treasury Department has also proposed closing some shelter loopholes, including very recently a proposal to shut down the leasing transactions that we portrayed in "Tax Me If You can." However, the fate of that legislation is unclear.
One thing is clear: It is unlikely that a broad economic substance rule will pass without some strong public pressure in favor of that, because industry lobbyists, from the financial industry, the leasing industry and others, strongly oppose such a change. So does the Bush administration.
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Washington, D.C.:
Mr. Smith,
I simply could not believe it, 7 percent in taxes is what the rich pay and the rest falls on the average Americans, which by the way pays 15 percent more than we have to pay because of this manipulation.
I bet you the average American doesn't even know this exists.
How sad, I actually went from laughing to actually feeling as if someone ripped my heart out. I can not believe the parties that be allow such a thing to happen in this country.
As I've sad to my colleagues, corruption is on all levels of society, from the street hustler to Oliver North or in this case KPMG.
Thank you.
Hedrick Smith: Thanks for your comments. Our program was intended to inform the public about a set of issues that are poorly understood or not even understood at all. SO it is good to know that you found it informative.
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Augusta, Ga.:
Doesn't the type of corporate tax shelter you exposed both result in higher taxes for the middle class and contribute to the export of jobs? By decreasing the need for foreign governments to increase their own taxes, businesses located in those foreign jurisdictions have lower costs. Consequently, the greed of Wachovia's management has resulted in a competitive pricing advantage for foreign companies over American based companies.
Hedrick Smith: My understanding is that you are certainly correct in saying that the illegitimate tax shelters used by some corporations and some wealthy individuals do increase the tax burden on the middle class. YOu hae the testimony from former IRS COmmissioener Charles Rossotti for that.
But as to whether that phenomenon also contributes to the US loss of jobs is hard to say. The overseas leasing that we saw and heard about was mostly with cities of quasi-public institutions, such as public works departments or the foreign equivalent of the TVA. SO whether that could translate into jobs, I don't know.
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Washington, D.C.:
As a tax lawyer, I watched your show last night with great interest. While I wish that you could have provided a more nuanced description of just how egregious many of these transactions were, I understand that you were limited by constraints of time and medium in which you were working.
With the benefit of an insider's background on these matters, I was particularly struck by Ken Kies' participation in your program. I would have loved it if you had been able to include the fact that while an employee of PwC testifying before Congress, Mr. Kies denied any involvement by his firm in tax shelters even as the Committee had in its possession a PwC memo promoting the "BOSS shelter." It certainly would have given viewers a sense of his credibility.
I was wondering if you were aware of this background and chose not to run it, or if you had never heard the story before.
Hedrick Smith: Thank you for your comments.
We were aware of the testimony of Ken Kies before the House Ways and Means Committee on the subject of the PWC "Bopss" tax shelter deals.
Our need for television was to stick with one set of stories and one set of characters and not make the topic so confusing that a general audience could not follow it. One of those difficult decisions of editing.
There were other very good comments that we obtained from Former Treasury Secretary Larry Summers, from Pam Olson, the outgoing assistant Secretary of the Treasury in the Bush administration, from Mark Everson, the current IRS Commissioner, from Rep. Lloyd Doggett, which were excellent and which appear on the PBS Frontline web page. But unfortunately, the policy debate got very complex for the end of an hour-long program on shelters. SO we could not cover all that we wanted to.
we also wanted to include more of a seciton on the rise of banking Charlotte, NC, which is a major phenomenon in our financial industry. But alas, time also limited us on that score.
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Waltham, Mass.:
Have you considered doing a follow-up program focusing on similar abuses involving state taxes, like the recent reported case involving Worldcom?
Hedrick Smith: As part of our research for "Tax Me If You can," we did look at the lproblem of states losing their taxes because of shelter dodges, and specificlaly looked at the use of Delaware as a tax haven byu WorldCOm, which shifted much of its "trademark" type income to that state to avoid taxes in other states, such as california. But it was more than we could get into one program.
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Washington, D.C.:
Nice piece last night. Comprehensive look at issues that have been festering in the media for some time. My one question: Bob McIntyre was on camera saying Wachovia made $4 billion in profits in 2002 and paid no taxes -- in fact got a rebate. You then implied this had to do deductions generated by leasing. It's my understanding reading Wachovia's annual report this morning that their leasing portfolio has an extensive collection of rail cars leased to taxable entities. In other words, it's more akin to a leveraged airline lease, which carries with it a very real economic risk. Isn't it improper to link leasing deals with economic substance (and if you don't think airline leverage leases have economic substance, just ask yourself why so many planes are gathering dust in the desert) with the kinds of defeasance deals such as the sewer system, where no real money is at risk?
Hedrick Smith: Certainly Wachovia's leasing deals and leasing tax writeoffs must have included some Congreesisonally sanctioned leasing deals, though we did not find any breakdown in the annual reports from which we were working.
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Washington, D.C.:
What effect would closing these shelters have on financial markets? After all, wouldn't many of these businesses post lower profits, hurting their market valuation and possibly our economic recovery?
Hedrick Smith: The advantage of identifying and closing illegitimate shelters to the financial markets would be to have a more accurate evaluation of which corporations were relaly profitable and how profitable, rather than an artificial picture based on bogus deals. The danger of false or inaccurate financial reporting is that capital resources (in the form of stock price and debt offerings, etc.) flows to the wrong places. One major function of cpaital markets is to allocate capital efficiently. That requires openness, accuracy anhd honesty. Dishonesty and inaccuracy lead to inefficiency of the m,arkets. So an an investor you should want the playing field to be level, the players to play honestlhy, and the unmpires to be vigilent and active. In the Superbowl of finance, let the true winner win, not someone who using the corporate equivalent of steroids.
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washingtonpost.com:
Hedrick, thank you for joining us today.
Hedrick Smith: Thanks for having me...I hope you got the last answer about steroids, because in a lot of ways, this is as improper and dishonest a practice as athletes hoking their performances illegitimately. Let's make capitalism work honestly and fairly. It will be all the stronger for that.
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