How the Super Rich Avoided Taxes; Despite Making Millions

May 30, 2007 — -- Four current and former partners at Ernst & Young, one of the world's largest accounting firms, were indicted Wednesday for allegedly orchestrating a scheme to create illegal tax shelters for the firm's richest clients.

The scam catered to clients who earned more than $10 million to $20 million a year, finding them ways to reduce their taxes, according to an indictment handed up in the federal court for New York's Southern District.

Ernst & Young took in more than $115.7 million in fees for setting up these shelters, charging clients between 1.25 percent and 2 percent for every dollar of tax deductions created, according to the indictment. The firm assisted more than 400 wealthy clients in reducing their taxes through such shelters.

According to ABC News' calculations, that could mean that Ernst & Young helped its clients create more than $7.56 billion in tax deductions.

One of these complicated tax shelters involved converting clients' ordinary income into capital gains.

The idea behind the alleged scheme is that the tax rate on capital gains is significantly lower than the regular income tax rate, especially for the rich.

The rich clients in question would normally be taxed at a rate of about 40 percent, according to court records. But the income allegedly filtered through the tax shelters and was taxed only at the long-term capital gains rate of about 20 percent.

Ernst & Young was not charged with any wrongdoing. In a statement, the firm said it has cooperated with the government from the beginning of its investigation and that none of the defendants were part of the firm's management.

Two of the partners have since left the firm and two were placed on leave in August of 2006, according to an Ernst & Young spokesman.

"They were part of a small group within the firm, disbanded years ago, that was responsible for developing the transactions in question," the firm said in a statement.

The government alleges the scheme was so good that its architects couldn't deny themselves a chance to reap the profits.

Three of the partners involved in the shelters allegedly decided to use the program to evade their own taxes and arranged for eight other partners in the firm to join in the shelters with them.

Those 11 Ernst & Young partners avoided paying about $3.7 million in taxes they owed, according to the indictment.

But the case doesn't end there.

Allegedly, several law firms and other companies co-conspired with Ernst & Young to carry out the tax shelters.

Several steps were taken to hide the true nature of these shelters from the Internal Revenue Service, according to the indictment.