The U.S. Treasury building in Washington, D.C., U.S. Image: Al Drago/Bloomberg via Getty Images
‘A revolving-door influence’
For years, watchdogs and lawmakers have expressed concern about the potentially corrupting effects of individuals from the private tax industry ending up in high ranks of the IRS and its parent agency, the Treasury Department. Prominent tax attorneys from Big Four accounting firms or corporate law firms sometimes help implement favorable policies for their former clients. These officials often rejoin the private firms with rapid promotions.
Earlier this year, ICIJ reporting showed that top executives in LB&I commonly switch hats from regulating the wealthiest taxpayers to working for them. A review of LB&I executive lists from the past 13 years shows that out of 114 top executives named, at least a quarter either had worked for a major accounting firm, a tax consulting firm or a major tax law firm shortly before joining the IRS, or left the IRS for such private sector roles.
The IRS’s watchdog, the Treasury Inspector General for Tax Administration (TIGTA), warned last year that the movement of employees between the IRS and accounting firms and big companies raised “impartiality concerns.”
As the IRS embarks on a major hiring spree with its new billions, the questions around guarding against industry influence have gained new urgency.
“People from the private sector provide important viewpoints and unique expertise needed to help the IRS run the tax system,” IRS spokesperson Robyn Walker told ICIJ in a statement for a previous story. “This takes on even more importance as the agency works to build compliance work in high-risk corporate and high-wealth areas.”
The agency also told ICIJ that safeguards are in place to prevent conflicts of interest. These rules forbid officials from working on matters too closely related to their work for a former employer in the private sector. Yet these safeguards generally rely on these officials to proactively identify and declare such conflicts to the agency.
In January 2022, TIGTA received an eight-page complaint from an agent alleging that Maloy’s directive had been influenced by the private sector. The complaint alleged that “we at the IRS are not enforcing our tax laws on multinational taxpayers using tax structures lacking economic substance.”
The complaint emphasized that the 66-page letter urging LB&I to restrict the new law was co-authored by attorneys at Skadden, Maloy’s former employer, and alleged that the government was not enforcing its own rules around conflicts of interest.
“There’s clearly a revolving door influence in play within the IRS,” the complaint stated.
“Private sector attorneys from numerous firms known to be involved in promoting, opining, and defending abusive tax structures seized the opportunity to use revolving door colleagues in the executive ranks of the IRS to request, influence and craft guidance,” the complaint also said. The complaint urged the inspector general to assist the IRS in reviewing and revoking the directive.
One of the world’s largest corporate law firms, Skadden has a tax practice that employs a former IRS commissioner and a former executive of LB&I. One of the authors of the 66-page letter, Brendan O’Dell, left Skadden in 2016 to spend six years in high-ranking positions within LB&I and Treasury before becoming the director of tax controversy for Amazon. Another of the letter’s authors, Cary Douglas Pugh, left Skadden in 2014 to become a judge in federal tax court in Washington, D.C., making her among the most powerful people in tax law.
The IRS agent’s complaint to TIGTA has not been previously reported. Michael Welu, a former IRS agent who has been outspoken on the issues he saw within LB&I during his more than three decades at the IRS, provided a copy of the complaint to ICIJ. The complaint’s author, Brian Visalli, is a special agent in the Criminal Investigation Division.
“While I’ll confirm I’m a government whistleblower, I will not confirm or deny any specific complaints or documents I’ve provided to TIGTA,” Visalli told ICIJ in a LinkedIn message. Visalli added that, due to concerns over retaliation, he would not comment further.
In 2015, after almost six years of running LB&I, Maloy left the IRS to become the US Tax Controversy Leader at the Big Four accounting firm EY. EY’s website from that time lists Maloy as a contact in relation to its services around a highly technical practice known as “transfer pricing” that is at the heart of some of the largest tax avoidance schemes.
After five years at EY, Maloy returned to the IRS as a top executive in charge of the entire agency’s compliance efforts. The heads of LB&I, Criminal Investigation and other major compliance divisions now report to her.
ICIJ found that Maloy was not the only government official receiving policy requests from former private-sector colleagues related to the 2010 law. In January 2011, Lisa Zarlenga, then a tax partner at Steptoe & Johnson LLP — a corporate law firm that had opposed to the new law — was named as an author on the 66-page letter requesting restrictions on the IRS’s use of the doctrine. Two of Zarlenga’s colleagues at Steptoe, Mark Silverman and Amanda Varma, were also co-authors of the letter.
But a similar letter co-authored by Silverman and Varma and sent just 3½ months later listed Zarlenga as a recipient. This was because Zarlenga had switched hats to become a high-ranking tax policy official at Treasury.
In an interview with ICIJ, Zarlenga said she had nothing to do with Maloy’s directive. “Treasury would have had no involvement in that directive. I saw it when it was published in Tax Notes along with everyone else.”
In an interview after the the 2011 directive, Silverman — who had helped lead Steptoe’s opposition to the doctrine — called the directive ‘thoughtful’ and “extremely well done.”
Zarlenga, who now heads Steptoe’s Tax Policy Practice, said that it’s both common and important for the industry to weigh in on what the IRS is working on. “Government officials interact pretty regularly with practitioners,” she said. “It’s all part of the flow of information. Otherwise, the government attorneys are sort of sitting in an ivory tower and they don’t know what is going on.”
New life for an old law
Several months after TIGTA received the complaint in 2022, the IRS quietly rolled back the LB&I directive at issue, replacing it with a set of rules that stripped away a number of restrictions on agents’ use of the economic substance doctrine. This was more than a decade after Congress passed the doctrine into law.
The IRS did not respond to requests to comment on this story or answer questions about why it changed its rules around the doctrine in 2022.
Suddenly the industry that had once applauded the directive sounded the alarm once more. In the wake of the new guidance, EY told its clients that “taxpayers should focus on penalty protection” and should consult tax professionals “before entering into transactions with related parties” — a technical term that generally means shifting assets or liabilities between entities all owned by a single person or business.
In a post on its website, corporate law giant Baker McKenzie said the updated directive exemplifies what it called “the IRS’s increasingly offensive posture.”
The law firm was right. In August 2022, Biden signed the Inflation Reduction Act, which included the $80 billion for the IRS to help fulfill his promise to make the wealthiest people and corporations pay their fair share of taxes.
Despite its languid existence after being passed, the 2010 law has become a critical part of this effort. In June, the IRS announced an initiative to tackle tax abuse in the highly complex realm of investment partnerships, which have become a key means for the richest people on Earth to increase their wealth while minimizing the U.S. government’s slice of the pie. In announcing the move, U.S. Treasury Secretary Janet Yellen raised eyebrows by stating that “many of these transactions violate the codified economic substance doctrine” — a clear shot at the tax planners serving the ultrawealthy.
U.S. Treasury Secretary Janet Yellen. Image: Justin Tallis – WPA Pool/Getty Images
Following through on this tougher rhetoric may be difficult, though. Recent ICIJ reporting showed that LB&I often takes an accommodating approach toward the largest taxpayers. Over the past five years, the division flagged no more than 22 instances of possible tax crimes for criminal investigators to review further — out of trillions of dollars in annual income from large corporations and ultrawealthy people that the office oversees. The IRS office that covers small businesses and self-employed people flagged roughly 40 times more possible crimes.
In the agency’s own comments to ICIJ for earlier stories, the IRS suggested that large corporations break the law less often than other types of businesses, saying their checks and balances and their use of independent accountants “generally limit the opportunity for criminal activity.” ICIJ found that the agency treats these powerful taxpayers accordingly.
On Wednesday, TIGTA released an extensive report on the IRS’s challenges to stand up to tax evasion by multinational corporations and addressed frustrations of agents around the difficulty of using the economic substance doctrine. The report also said that the IRS’s 2022 change to the directive was “a result of gaining experience and a level of comfort in the application of the doctrine.” It added that “the IRS could not provide us with the number of cases where examination teams considered the Economic Substance Doctrine.”
The report, which was premised on determining whether the IRS gives multinational corporations preferential treatment, said it found no instances of such treatment. It did, however, recommend that LB&I review its procedures around enforcement of multinational taxpayers, including around its use of the economic substance doctrine.
Experts say that the decade when the doctrine lay dormant may put the office at a disadvantage for a number of reasons. One is that the IRS’s agents and attorneys have little experience using it and could be forced into a trial-and-error approach. Some commentators say that, despite all of the commotion around the law, it may be vulnerable to legal challenges. The previous dearth of cases involving the new law also means that judges are just now getting the chance to issue significant rulings on it. The way judges interpret any tax law sends important signals to the IRS about how to pursue winning legal arguments in court — where they face tax attorneys for large corporations and the ultrawealthy known to spend massively to defeat the IRS.
“They haven’t had a lot of experience in actually applying it in real-world cases or seriously thinking about it,” Jackel, the tax attorney, said of the 2010 law. “It will be a slow process for them to get up to speed on it and be confident in their ability to assert the doctrine.”
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Engineering a $2.4 billion deduction
Some of the IRS’s cases using the 2010 law are beginning to make their way through the courts. Most significant of these is the agency’s attempt to invalidate a $2.4 billion tax deduction claimed by Liberty Global, the multinational telecommunications firm led by billionaire John C. Malone. With a net worth of roughly $9.8 billion, Malone is the largest voting shareholder in Liberty Global and is listed by Bloomberg as the second largest private landowner in the U.S., holding some 2 million acres across the country.
In 2020, Liberty Global asked the IRS for a $110 million refund for overpaying its 2018 taxes. The massive refund request was based on a complex series of maneuvers — involving shuffling assets between subsidiaries in places like Belgium, the Netherlands and Slovakia — that had been created by Liberty Global’s tax department with help from Deloitte. In challenging the refund request, Justice Department lawyers alleged that the entire point of the transactions was to improperly exploit a new loophole in federal tax law.
Billionaire John C. Malone is the largest shareholder in Liberty Global. In 2020, Liberty Global asked the IRS for a $110 million refund for overpaying its 2018 taxes. Image: David Paul Morris/Bloomberg via Getty Images
Liberty Global’s tactics did not emerge out of thin air. In one filing, the Justice Department noted that the “situation arises because tax litigators have been developing strategies” like Liberty Global’s. In emails contained in court records, Liberty Global’s tax department discussed paying Deloitte and another Big Four firm, KPMG, hundreds of thousands of dollars for their work on the complex international tax structures. The Justice Department attorneys noted that Skadden had publicly endorsed a refund tactic similar to that of Liberty Global.
Skadden did not respond to a request for comment.
In October 2023, the IRS won its case against Liberty Global, with a federal judge in Colorado ruling that the company’s use of a loophole was not permitted under the 2010 law.
That ruling was “the worst nightmare for tax planners who rely on ‘catching’ Congress in a glitch in the law,” wrote Jasper Cummings, the tax attorney at Alston & Bird. “This Liberty Global opinion is by far the scariest [economic substance doctrine] opinion of recent times and shows a Justice Department unleashed from the historic norms of the income tax.”
Liberty Global maintains that its tax reporting in connection with the case was correct. Although Liberty Global had acknowledged that the maneuvers did not have any true business purpose apart from avoiding taxes, according to court documents, it appealed the ruling in April on technical grounds around applying the doctrine. The firm’s lawyers said “the court fundamentally misunderstood” the case and asserted that the IRS “wrongly wields the economic substance doctrine to rewrite, rather than interpret, the law.”
If Liberty Global prevails in its appeal, it could create a precedent, perhaps as high as with the U.S. Supreme Court, that would weaken the IRS’s use of the doctrine moving forward.
The law firm representing Liberty Global in this quest: Skadden.
Delphine Reuter and Rick Sia contributed to reporting
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Publish date : 2024-08-29 04:11:00
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