Editor’s Note: Amalie L. Tuffin is a member of the Research Triangle Park law firm of Daniels Daniels & Verdonik, P.A. TechLaw is a regular feature in Local Tech Wire.
______________________________________________________________________________________The legal crackdown continues.

Last week I wrote about the success of the IRS’s recent clampdown on certain schemes designed to avoid taxes on the exercise of stock options in an article called “IRS Continues to Target Execs, Companies on Stock Options” (See: www.localtechwire.com/article.cfm?u=11963 )

The week before that, Jim Verdonik wrote about the excessive costs that are being imposed on businesses as they attempt to comply with Section 404 of the Sarbanes-Oxley Act of 2002 in an article called “Sarbanes-Oxley Turns 3, But It’s a Costly Birthday for Business” (See: www,localtechwire.com/article.cfm?u=11905 )

The common theme of these articles was that, for good or ill, the government continues to take a harsh look at corporations, the executives running them, and the professionals who aid them.

On the tax side, for example, the enforcement of tax cases has become a renewed priority for the IRS. Enforcement in recent years has been weakened by lack of personnel and lack of equipment. This is changing, as for the first time in a number of years Congress has fully funded the IRS’s budget requests, budget requests that were made with higher levels of enforcement in mind. The IRS Commissioner has publicly stated that tax law enforcement, especially including enforcement efforts aimed at tax return preparers, tax accountants, tax lawyers and other professionals, is a key component of his plans for the Service. In the last year the IRS has referred over 3,000 tax cases to the Justice Department for enforcement actions, which is a significant increase from prior years.

Former KPMG Partners a Target of Current Probes

One of the current targets of the government’s harsh looks is the accounting firm KPMG LLP and its members. Certain tax shelter sales by KPMG have been under investigation for several years. These tax shelters were devised around methods aimed at helping taxpayers create large “paper” losses which, for tax purposes, offset large capital gains generated from the sale of family businesses and other similar transactions. A number of the (then) “Big 6” accounting firms and others profited greatly from selling such tax shelters in the late 1990s. It is estimated that the tax shelters sold by KPMG and others reduced federal tax revenue by close to $1.5 billion dollars. Published reports indicate that KPMG earned around $124 million in fees from selling such shelters between 1997 and 2001.

Why is KPMG the primary target of these tax shelter probes if it was only one of many participants?

When the investigations began, its rivals, such as Ernst & Young LLP and PricewaterhouseCoopers LLP quickly settled with the government, paid large fines and have moved on. KPMG, on the other hand, chose to defend itself and its clients vigorously. For example, it initially refused to turn over documents related to the tax shelters and its clients who utilized the shelters to the IRS. KPMG’s resistance to the probe made regulators eye the firm even more closely.

By June of this year, there were public reports that KPMG faced possible criminal charges in the probe. In response, the firm became cooperative, issuing an unprecedented public statement apologizing for “unlawful” activity by former partners. KPMG then pledged to cooperate with investigators, which has led to it turning over documents to the government and the resignation or termination of dozens of its tax partners. For example, in late July a number of partners left the KPMG, including the firm’s associate general counsel and tax partners from its Los Angeles, San Francisco and New York offices. A number of those leaving had worked in KPMG’s personal financial planning group, the group within the firm which sold the suspect tax shelters).

Talks Continue

Settlement negotiations between KPMG and the government continue, and its recent spirit of cooperativeness seems to have saved the firm itself from being indicted…at least for now. (In addition to the government probes, KPMG also faces both class-action and individual lawsuits from former clients who were sold the tax shelters.)

Polite pressure from European accounting regulators and others, who fear the anti-competitive consequences if yet another major auditing form goes down in flames à la Arthur Andersen, has also helped keep the Justice Department from indicting KPMG. However, that does not mean that KPMG’s former partners who were actively involved in selling the tax shelters are safe. Recent news reports suggest that Federal prosecutors have informed up to 20 former KPMG partners that they face possible criminal charges.

This list is believed to include personnel who held high-ranking positions within KPMG, including a former deputy chairman of the firm, a former head of the firm’s tax services practice, and a former head of the firm’s national tax practice office. The threat of prosecution should not come as a surprise to these partners or others–after all, several of them had stated in internal memos (released as part of a 2003 Senate probe) that the firm should “roll the dice” on the suspect deals because the fees from selling the shelters would likely exceed any eventual government penalties. Given such attitudes, why would the government expect the possible imposition of penalties–rather than the threat of jail time–would deter unlawful tax avoidance?

Hopefully, any criminal charges brought against former KPMG partners will signal the beginning of the end of the current spate of corporate crackdowns. With any luck, needed lessons will have been learned by corporate executives and their advisors, so that we can all move on with the business of business–rather than the business of endless legal compliance efforts.
_______________________________________________________________________________________

Daniels Daniels & Verdonik, P.A. has been serving the legal needs of entrepreneurial and high technology clients for more than 20 years. Amalie L. Tuffin concentrates her practice in the representation of entrepreneurial and technology-based businesses, focusing on corporate, taxation and securities matters. Questions or comments can be sent to atuffin@d2vlaw.com