It has been over ten years since the IRS declared the FOCUS tax shelter to be “an abusive partnership straddle tax shelter.” That decision was followed by a Congressional investigation, criminal convictions, the bankruptcy of the hedge fund that was at the center of the tax shelter and innumerable IRS proceedings that resulted in back taxes, interest and penalties being imposed against unfortunate taxpayers who fell for this scheme.
Some taxpayers are just now reaching the end of their IRS ordeal and finally learning how much they will owe as a result of having been snared by this sophisticated and complex tax scam back in 2001 and 2002. Even now, more ten years after these tax shelters were first sold to taxpayers, it may not be too late to try to recover some of the losses.
What was FOCUS? FOCUS was known by other names and/or was often lumped together with other, similar tax shelters: OPIS, BLIPs, COBRA and Son of Boss.
FOCUS is an acronym for "Family Options Customize,” but it had nothing to do with families, other than creating tax liabilities for family members who were taken in by the scheme. In essence, FOCUS used a tax loss that had already been sustained by shell companies before the taxpayer even entered into the transaction. The taxpayer bought interests in the shell companies and then reported the companies' tax loss on his own federal income tax return. The tax scheme masqueraded as a legitimate investment, but its primary purpose was to create a tax loss, not an investment gain.
FOCUS was marketed to customers of First Union/Wachovia Bank (now Wells Fargo) who were identified by the banking staff as having capital gains in the form of proceeds from the sale of a business or of real estate. This wasn’t the Bank’s idea; FOCUS was designed by the accounting firm KPMG. But then First Union/Wachovia Bank partnered with KPMG to identify its own customers who could be targeted for FOCUS sales.
These Bank customers were told that by claiming the shell companies’ losses on their own tax returns, the Bank’s customers would reduce taxes owed on those capital gains. However, similar tax shelters had already been rejected by the IRS by the time FOCUS was being sold and the tax courts found that there was ample notice that these kinds of transactions would not withstand scrutiny before FOCUS was offered to taxpayers.
Case Study. Vernon Litigation Group represented a taxpayer who was one of the early FOCUS victims who was audited by the IRS. He had sold his manufacturing business and shared the proceeds from the sale with his adult children. As a result, he and his children all faced capital gains taxes.
Although our client was a very successful businessman, he was neither a sophisticated investor nor a tax expert. He relied on his bankers with whom he had a long business relationship and they assured him that he and his children could reduce their taxes using the FOCUS tax shelter.
Instead, after the IRS disallowed the “phantom losses” from the FOCUS tax shelter, his IRS bill topped $10 million, including penalties and interest. Because his tax liability was established early, our client was able to recover a portion of his losses as a creditor in the hedge fund bankruptcy (his was the largest investor claim paid by the bankruptcy trustee), as well as recovering from other participants in the tax scheme. However, his results may not be typical. In fact, due to the passage of time, some of the remedies that were available to him are no longer available today.
What Can Be Done Now? The bankruptcy case is closed, so it is too late to file a creditor claim against the hedge fund. But if you have recently received your final decision from the IRS you still may have time to seek recovery from others who profited from the FOCUS tax shelter scheme.
The key is to act quickly. Recovery may be subject to one or more statutes of limitations, which means that your ability to recover could be lost if you delay.