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.

A Shelter for Their Own Taxes

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.Various law firms were hired -- at $50,000 for each client -- to write "opinion letters" that claimed the tax shelter losses or deductions would "more likely than not" survive IRS challenge, or "should" survive IRS challenge.

The U.S. Attorney's office said that the defendants knew those opinions were based on false statements and omitted material facts.

It is unclear if the government will now pursue charges against any of these law firms or the banks and other financial institutions that executed the transactions.

A spokeswoman for Michael J. Garcia, U.S. attorney for the Southern District of New York, declined comment.

Ernst & Young set up various funds, partnerships and other transactions allegedly to make it appear to the IRS that these transactions were part of legitimate investments instead of tax-motivated moves.

For example, the indictment said, one defendant drafted a letter to be signed by clients who wanted to exit these partnerships after obtaining the tax benefits.

In one such letter, the clients falsely attributed their decision to discontinue their trading activities to the Sept. 11, 2001, terrorist attacks, and to "possible economic repercussions resulting from such attacks," the indictment said.

In April 2002, the IRS began investigating whether Ernst & Young had violated tax shelter laws. In June and August of that year, all four defendants appeared before the IRS and answered questions under oath. According to the indictment, they "sought to obstruct and impede the IRS by providing false and misleading testimony concerning the origin, design, marketing and implementation" of the tax shelters.

The Ernst & Young partners charged are:

Robert Coplan, 54, of Plano, Texas, a lawyer with a master's degree in tax law and a partner in Ernst & Young's Washington, D.C., office. Before his employment at the firm, Coplan worked for the IRS as a branch chief in the Legislation and Regulations Division. He is no longer employed by Ernst & Young.

Martin Nissenbaum, 51, of Brooklyn, N.Y., a lawyer with a master's degree in tax law and a partner in Ernst & Young's New York office. He is currently on administrative leave from Ernst & Young but is still employed by the company.

Richard Shapiro, 58, of Rye Brook, N.Y., a lawyer with a master's degree in tax law and a partner in Ernst & Young's New York office. He is currently on administrative leave from Ernst & Young, but he is still employed by the company.

Brian Vaughn, 39, of Calhoun, La., who had a college degree in accounting, is a certified public accountant and a certified financial planner. He is no longer employed by Ernst & Young.