Posts Tagged ‘A. Blair Stover’

Tax Roundup, 1/8/15: Tax shelter turned upside down: S Corp – ESOP structure produces pretend income. And: you are the 1%!

Thursday, January 8th, 2015 by Joe Kristan

tack shelterFlaky tax shelters are supposed to generate pretend losses. You know a shelter has gone very bad when it generates pretend income instead. Yet that’s how it worked out for an “S corporation ESOP management company” plan considered by the Tax Court yesterday.

The plan involved a partnership, a C corporation, an S corporation, and an Employee Stock Ownership Plan. The ESOP owned 100% of the S corporation. S corporation income is taxed to its owners. As a tax-exempt entity receiving special treatment from the tax law, ESOP-owned S corporations can achieve Tax Fairy-like results. The ESOP’s can earn non-taxed business income passing through from the S corporation (though this gets very tricky and dangerous when there are few ESOP beneficiaries).

The plan was hatched by A. Blair Stover, who has shown up in these pixels before. Mr. Stover started his tax career with a national firm in Nebraska, moving on from there to Kansas City and then to California, leaving questionable tax shelters in his wake. He was barred from promoting shelters like the one in this case in an injunction affirmed by the Eighth Circuit in 2011.

This plan involved the payment of “management fees” and other purported expenses by a partnership owned by the taxpayer and his spouse that ended up in his ESOP-owned S corporation. The partnership appears to have had no other purpose than to gin up deductions by paying pretend management fees and other expenses. The taxpayers deducted the “expenses” on their 1040, with the idea that they would avoid tax because they flowed through the S corporation to the ESOP.

tax fairyWhen the IRS went after Mr. Stover’s shelters, his clients received unpleasant IRS attention. In yesterday’s Tax Court case, the taxpayers signed a settlement agreeing to include in income on their 1040 the purported management fees paid to the ESOP.

So far, so good. But the agreement didn’t address the other side of the deal – the deduction for the payment of the purported fees by the partnership. The taxpayers claimed that if they had to pick up the pretend fees in income, they should get to deduct them too. Fair’s fair.

But if you want fairness, the tax law might not be the place to seek it.  The court held that while they agreed to pick up the extra income, their settlement said nothing about a deduction, and they were stuck with the results (my emphasis, citations omitted):

Generally, recognition of income does not inexorably prove a corresponding deductible expense. For example, payments to a promoter in furtherance of a tax avoidance scheme constitute income to the promoter, but they are not deductible under section 162 by the payor.  Furthermore, that petitioners might otherwise be obliged to recognize phantom income does not relieve them of their obligation to identify some legal authority for the deduction, nor does it permit the Court to manufacture such authority from whole cloth.

Petitioners’ phantom income argument amounts, in essence, to a plea for fairness. This Court strives to avoid unjust results, but “we are not a court of equity and cannot ignore the law to achieve an equitable end.” Moreover, the parties’ recent stipulation assuages our fairness concerns. In our order of July 1, 2014, we directed the parties to stipulate if possible, or to otherwise brief, the source of and factual and/or legal basis for the income inclusions required by the SOSI. The parties stipulated that the required income inclusions represent “the amount of taxable income petitioners avoided reporting” for tax years 2001 through 2003 because of their use of the management S corporation/ESOP structure. Taxable income is a term that is defined in the Code. Section 63 generally defines taxable income as gross income less allowable deductions. The parties’ chosen language thus implies that the $84,837 of income petitioners must include for 2003 pursuant to the SOSI represents not “phantom income” but bona fide, net taxable income that petitioners received and should have reported. So interpreted, the stipulation is difficult, if not impossible, to reconcile with petitioners’ theory for deducting the administration fee.

The result: a reverse tax shelter, generating only phantom income.

I’m not sure this too-bad-to-be-true result would hold up on appeal, but it does serve a warning. The Tax Fairy is a fickle sprite, and she can magically generate income for those seeking magical deductions. And if you agree to include phantom income when the IRS comes after you, make sure they allow the offsetting phantom deduction in writing.

Cite: Wakefield, T.C. Memo 2015-4.


IMG_0598Leslie Book, Bank of America on Hot Seat For Issuing Allegedly Incorrect 1099C to Disabled Veteran (Procedurally Taxing)

Robert D Flach explains WHAT’S NEW FOR THE 2014 FORM 1040?

Kay Bell, Daily Tax Tip #2: A tax quiz!

Robert Wood, The 1031 Exchange That Ate New York City. A lesson on the scalability of swaps.

TaxProf, The IRS Scandal, Day 609. The Worst Commissioner Ever comes out the other side of the revolving door.


The EITC as a poverty trap: phaseouts of the benefit impose stiff marginal tax rates on the working poor.

The EITC as a poverty trap: phaseouts of the benefit impose stiff marginal tax rates on the working poor.

Scott Sumner on low-income use of untraceable cash at Econlog:

College professors who advocate the elimination of currency are often unaware of how important currency is for those with low incomes, many of who lack bank accounts. For instance, consider someone getting government benefits that are conditional on income (food stamps, EITC, disability, welfare, Medicaid, etc.) This group often faces relatively high implicit marginal tax rates. However currency allows them to supplement their meager benefits with additional earned income, perhaps doing home repair for neighbors, or working as a nanny. Lots of those jobs are paid in cash. If we eliminate physical cash then all transactions will be easily traceable by the government… That’s bad for two reasons; low-income people would see reduced incomes (increasing inequality), and the rest of us will be denied the services that they might have produced in the underground economy. Economists who advocate the elimination of currency need to consider those side effects.

This highlights one of the dangers of the earned income tax credit: its phase-outs serve as a hidden high tax rate on low incomes, resulting in a poverty trap on those earning their way out of poverty.



Russ Fox, The Tax Court Looks for $1,410 in Dividends. Sometimes you can fight a small injustice and win.


We are the 1% Admit It: You’re Rich (Megan McArdle):

The cutoff for the global 1 percent starts quite a bit lower than the parochial American version preferred by pundits. I’m on it. So is David Sirota. And if your personal income is higher than $32,500, so are you.  

It’s all a matter of perspective.



Tax Roundup, 10/2/2012: Des Moines has to repay $40 million in illegally-collected taxes. Also: Kansas City tax shelter figure arrested.

Tuesday, October 2nd, 2012 by Joe Kristan

The City of Des Moines will finally do the right thing, having exhausted all venues to do otherwise.  The Supreme Court yesterday ruled that the city must repay $40 million of an illegally-imposed franchise fee on utility bills.  The Des Moines Register reports:

The high court’s ruling centers on franchise fees that are added to customers’ gas and electricity bills. A lower court ruled that the city charged excessive fees for a period of years, in essence an illegal tax. The high court declined to review the lower court’s order requiring the city to repay roughly $40 million to residents who paid the illegal tax.

Mayor Cownie predicts disaster and famine:

City lawyers have fought the case for years by arguing, in part, that any refunds would lead inevitably to higher property taxes — in essence taking money out of one pocket of city residents to place cash in another.

Cownie said the city would pursue options fairest to citizens while balancing the long-term realities of a beleaguered city budget. Any franchise fee repayment from the city would likely come from a mixture of property tax increases and cuts to city services, he said.

“We’re not just cutting away fat. We’re cutting away muscle and bone and tendons,” he said.

It’s useful to imagine how much sympathy the city would offer a taxpayer who had illegally collected money from the city.  “I’m not just cutting away fat.  I’m cutting away essential services for myself and my family, like my house and my car.”  Of course, the city has compounded its own problems by litigating all the way to the U.S. Supreme Court, piling up legal fees and interest on top of the refunds.

The city now has to pay up, though the Register story makes it look like the city isn’t exactly racing to cut the refund checks.

The Moral?  Next time, don’t collect an illegal tax, and if you do, repay it. 


Supreme Court declines to review West Des Moines S corporation compensation case.  In addition to denying Des Moines’ franchise tax appeal, the Supreme Court yesterday denied a hearing in an important case involving the so-called “John Edwards Shelter,” named after the former vice-presidential nominee and model husband who ran his law practice in an S corporation.

A U.S. district court held that an area CPA who reported $24,000 of wage income and around $200,000 of K-1 income from his S corporation had to report as compensation around $90,000 of the income; the Eighth Circuit upheld the ruling in February (David E. Watson, P.C. v. U.S).   The tax law imposes payroll taxes on compensation, but not S corporation K-1 income, so the taxpayer must pay payroll taxes on the additional compensation.    The denial is reported on page 50 here.


Being enjoined is bad.  Being indicted is worse.  An attorney who was enjoined from promoting some extremely aggressive tax shelters in the Kansas City area now has worse problems, as outlined in a press release from the California Franchise Tax Board:  Los Angeles Tax Professionals Arrested for Illegal Tax Schemes Costing State $7.6 Million:

A Cerritos CPA and Los Angeles attorney were  arrested today on felony charges of conspiracy and tax evasion, the Franchise  Tax Board announced.

Victor George Kawana, 53, and Blair Stover,  51, each own one-third of Kruse Mennillo, LLP. According to FTB special agents,  Kawana and Stover allegedly promoted an abusive tax avoidance transaction  (ATAT) to more than 100 clients during the years 2002-2005. The fraudulent  activity cost the state more than $7.6 million in tax liability.

They each face three felony counts of aiding  in the preparation of false state income tax returns and one felony count of conspiracy.  Each tax count carries a maximum sentence of three years in state prison.

The charges appear to arise from the same sorts of shelters Mr. Stover was enjoined from promoting:

They instructed their clients to utilize an  ATAT involving the creation of Nevada corporations and Roth IRA or Employee  Stock Option Plans (ESOP) as the sole shareholders. The ATAT was formed with a  series of related transactions with no valid business purpose other than tax  evasion.

Kawana and Stover were recently arrested and  both pleaded not guilty at their arraignments.

Mr. Stover got his start at national firm Coopers and Lybrand in St. Louis, later moving to their Kansas City office.  He joined the Grant Thornton office there before going to Kruse Menillo, LLP.

While a number of the tax shelters involved did poorly in court, that doesn’t make it a crime to promote them; the defendants are innocent until proven guilty.  Whatever the outcome of the trial, we can safely assume that the shelters relied on taxpayers’ eternal pursuit of the tax fairy, that mythical creature who can magically make income taxes go away without pain and without risk.  There is no tax fairy. 

Thanks to an alert reader for the tip.

Martin Sullivan,  Romney Advisor Advocates Tax Hikes ( “He proposes putting a cap on everyone’s tax benefits from deductions and credits equal to some percentage (perhaps 2 or 3 percent) of adjusted gross income and using the revenue gained for both rate cuts and deficit reduction”

Richard Morrison,  Chart of the Day: The Average Tax Rate for the Rich (Tax Policy Blog):


Patrick Temple-West,  Essential reading: Payroll tax cut is unlikely to survive into next year, and more

TaxGrrrl,  Comment for the Cure: Cancer, Comments, Cures and Yeah, Taxes

Trish McIntire,  Chicken or Egg Tax Cut

Jack Townsend has two more posts on the affirmation of sentences for figures in the “Aegis” tax shelter case:  Aegis Convictions Affirmed Installment #4 – the Conspiracy Conviction and  Aegis Convictions Affirmed Installment #5 – IRS Notices and Harmless Error

Kay Bell,  Tax moves to make in October 2012

William Perez,  Consider Accelerating Salary Income into 2012

Howard Gleckman,  If Congress Goes Over the Fiscal Cliff Your Taxes Will Likely Go Up (TaxVox):

If Congressional gridlock sends the U.S. government tumbling over the fiscal cliff later this year, Americans could face an average tax hike of almost $3,500 in 2013. Nearly 9 of every 10 households would pay higher taxes. Every income group would see their taxes rise by at least 3.5 percent, but high-income households would suffer the biggest hit by far, according to a new Tax Policy Center analysis.

TPC found that if the tax hikes last the entire year—a big ”if”–those in the top 0.1 percent would pay an average $633,000 more than if today’s tax rules were extended. However, even middle income households would take a hit: they’d pay an average of almost $2,000 more, and see their after-tax income fall by more than 4 percent. Such tax hikes would be “unprecedented,” said the paper’s authors, Bob Williams, Eric Toder, Donald Marron, and Hang Nguyen.

So, have a nice day!


Kaye A. Thomas, Roth Conversions Ahead of 2013 Tax Increases.

The Critical Question: What is this “Fiscal Cliff,” and why are we in this handbasket?  My new post at, the Des Moines Business Record blog for entrepreneurs.