IRS probing use of Roth IRAs to shelter large sums illegally

Investigation focusing on big accounting firm

November 11, 2003|By NEW YORK TIMES NEWS SERVICE

In 1997, Congress gave retirement savers an attractive deal: Put after-tax dollars into a Roth IRA, and withdraw all future investment gains and contributions without ever paying another penny of tax.

For some people, that is apparently not enough. They have sought to put in money on which they have never paid taxes, vastly exceed the annual contribution limit of up to $3,500 and reap much greater wealth.

The Internal Revenue Service, as part of a crackdown on abusive tax shelters, has been pressing an action against one of the country's biggest accounting firms, Grant Thornton, to force it to disclose the names of clients it advised to shelter millions of taxable dollars in Roth IRAs through shell corporations. How such a shelter worked and how it was promoted is vividly detailed in a lawsuit brought by a former Silicon Valley executive against Grant Thornton over the shelter he was sold.

The lawsuit - and the stepped-up activity by the IRS - indicate how tax shelters are no longer only for huge corporations and the super-rich. Financial arrangements that might have once been structured to shelter tens of millions of dollars in taxes are now being used for the mere millions of the simply wealthy, like those who enjoyed windfalls in salaries, stock and options during the Silicon Valley technology boom of the late 1990s. Such a democratization of the use of tax shelters threatens to strain the resources of tax enforcers and add to the burden of taxpayers

Grant Thornton declined to comment on the lawsuit or on the tax shelters.

But, according to documents filed with the lawsuit, Grant Thornton called its corporation-owned Roth IRA shelter strategy GIFT, or "Generating Income Free of Tax," and promoted the shelter in marketing brochures marked "confidential."

One brochure, full of descriptive arrows, described the shelter this way: Set up a shell company and a Roth IRA, then make the Roth IRA the effective owner of the new company by transferring shares of, and tax-free dividends from, the shell company to the Roth IRA. Next, have the shell company pay tax-free dividends, of any amount and from apparently any source, into the IRA. One benefit of GIFT, according to the brochure: "savings for higher education."

One shelter client was William C. Ross, a software sales manager. Ross filed a lawsuit against Grant Thornton and a smaller accounting firm, Raymond Creal, in June 2002 in a California court, accusing the two firms of selling him a bogus Roth IRA shelter that violated federal and state tax laws, of accounting malpractice and of breach of fiduciary duty.

According to his lawsuit, Ross first learned of Grant Thornton's shelter in the months after November 1999, when Red Hat Inc., a software company based in Raleigh, N.C., acquired Cygnus Solutions, a competitor in Sunnyvale, Calif., where Ross was then a vice president. Ross received approximately 35,000 Red Hat shares and options as part of the acquisition, and wanted to sell his stock quickly, his complaint states.

In early January 2000, a friend referred Ross to Robert Mather, an accountant at Raymond Creal in Fountain Valley, Calif. Mather put him in touch with A. Blair Stover, a senior tax manager at Grant Thornton in Kansas City, Mo. The two men told Ross he could sell his Red Hat - and any other - stock tax-free by setting up a small investment company in Nevada, where there is no income tax, and a Roth IRA that would buy the investment company.

Stock and options normally carry both capital gains taxes and income taxes when sold.

By Jan. 26, 2000, Grant Thornton had established Ross' Nevada-based shell company, Ticor Acquisition and Investment Co., and his Roth IRA. Ross contributed $2,000 in cash to the Roth IRA, then the legal yearly limit. He then transferred all his Red Hat shares, worth more than $1 million at the time, to the shell Nevada company, which then transferred them to the Roth IRA, according to court papers. The Roth IRA holds the shares, but does not count them as a contribution.

The total cost for the shelter for Ross was $135,000. The fee, Grant Thornton said, was tax-deductible.

IRS regulations prohibit self-dealing with Roth IRA plans.

Grant Thornton, in an unsigned letter to Ross dated Jan. 26, 2000, while not explicitly declaring the shelter legal, said that "the proposed structure does not violate the self-dealing rules."

An IRS representative did not return a request yesterday for comment.

Ross did not return repeated calls to his home requesting comment.

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