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KPMG Official Faces Skeptical Senators at Tax Shelter Hearing

Nov 19, 2003 | Washington Post

Current and former officials of accounting giant KPMG LLP told a skeptical Senate subcommittee yesterday that the tax shelters they sold to wealthy clients in the late 1990s could be defended on technical grounds and had real business or charitable purposes.

They characterized internal e-mails and memoranda, in which some of the firm's own tax experts expressed doubts including one assessment of a shelter: "the whole thing stinks" as reflecting a vigorous internal review process that ensured the strategies complied with tax laws.

Sen. Carl M. Levin (D-Mich.) pressed KPMG Tax Services head Richard H. Smith Jr. on whether his firm sold its strategies specifically as tax shelters. In a back-and-forth that lasted several minutes, Smith gave only indirect answers to Levin's increasingly pointed questions. The parrying provoked laughter in the hearing room at one point, when Levin asked Smith if the firm had encouraged its professionals to market shelters and Smith replied: "We have encouraged our professionals to advise their clients."

"You're asking us to believe you've changed your ways," Levin said. "Frankly, I'm skeptical, and one of the reasons I'm skeptical is I can't get a straight answer."

Smith said afterward that Levin had been asking his question "in a setting where he's not intent on getting anything but yes or no and I think that the answer required context."

Representatives of two other large accounting firms, PricewaterhouseCoopers LLP and Ernst & Young LLP, said they have gotten out of the tax shelter business and wish they had never gotten in. "We made a regrettable mistake being in this business," said Richard Berry Jr. of PricewaterhouseCoopers.

KPMG's Smith, while defending the firm's actions, said it has "substantially changed [its] tax services and offerings," and "we no longer present or implement aggressive tax strategies specifically designed to be sold to multiple clients." He also said the firm has tightened up its review of all its tax strategies.

Levin, who had investigated the use of tax shelters by bankrupt Enron Corp., thinks penalties are too lax to deter the aggressive promotion of shelters. A key recommendation that has emerged from the probe is for higher penalties for tax shelter promoters. Currently, taxpayers are subject to severe penalties, but for promoters the limit is $1,000.

In fact, in a 1999 internal analysis of a shelter, KPMG figured that the maximum penalty for the firm "would be no greater than $14,000 per $100,000 in KPMG fees." Further, it said, in that shelter, "our average deal would result in KPMG fees of $360,000 with a maximum penalty exposure of only $31,000."

A report released yesterday by the Senate Governmental Affairs Committee's permanent subcommittee on investigations, which held yesterday's hearing, said the tax shelter industry underwent "fundamental changes" in the late 1990s.

The panel's investigation found extremely sophisticated shelters depend on the cooperation of a number of players, including banks, investment firms, lawyers and accountants.

The devices, which could often be sold to dozens of clients, produced lucrative fees for shelter designers and others involved. No aggregate figures are available, but internal e-mails indicated that KPMG's shelter business had annual revenue targets of $20 million to $50 million. Tax savings could be so large that the taxpayer could pay such fees and still come out ahead.

For example, in one KPMG shelter, known as BLIPS, a taxpayer who needed to shelter, say $20 million in income, could do so at a cost of $1.4 million. The shelter, when reduced to its essentials, consisted of little more than having the client borrow $50 million from a cooperating bank, also borrow $20 million in interest, keep the entire $70 million on deposit at the bank for a couple of months, then repay the bank and deduct the $20 million in interest.

Some KPMG partners expressed doubt internally that the deals had any real business purpose, but firm officials would not concede that yesterday. Only after extensive and increasingly heated questioning from Levin did Smith concede that BLIPS was marketed primarily as a tax shelter.

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