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Court Says IRS Lawyers Cheated in Shelter Case

June 15, 1994 GMT

SAN FRANCISCO (AP) _ IRS lawyers cheated by reaching secret settlements with two airline pilots before they testified at a trial involving a collapsed tax shelter used by 1,300 other aviators, a federal court said Tuesday.

The ruling leaves the status of the tax shelters unsettled.

The 9th U.S. Circuit Court of Appeals ordered the U.S. Tax Court to hold a hearing ″to determine the full extent of the admitted wrong done by government trial lawyers.″ The case involves investment programs run in Hawaii by a man named Henry Kersting.

The court said his corporations lent money, primarily to airline pilots around the nation, to pay for stock in Kersting’s enterprises; covered their interest payments, which were used as tax deductions, and took the stock back at the end of the year as repayment of the loan.

After the IRS disallowed the tax deductions, about 1,300 investors sued in Tax Court, based in Washington, D.C. The two sides chose eight investors as test cases to resolve issues for all the investors.

The Tax Court ruled all eight investors’ deductions invalid in March 1992, finding that the interest-bearing debts were not genuine and that the programs were shams.

But three months later, the IRS commissioner sought to reopen the cases, saying settlements had been revealed with two of the supposed test-case investors.

The settlements forged with the IRS’ then-district counsel in Hawaii, William Sims, reduced both investors’ tax liabilities significantly - to no more than 10 percent of the amount originally sought by the IRS, according to Joe Izen, lawyer for the other six investors. The court said the difference was used to pay both investors’ legal fees.

In return, the two investors testified against their six fellow pilots at the trial. Izen said both testified that their deductions had been fraudulent and that they had agreed in advance with Kersting that the purported loans need not be repaid.

The Tax Court refused to hold a fact-finding hearing on the commissioner’s allegations and instead reaffirmed its conclusion that the deductions were invalid.

In its ruling on an appeal by the other six test-case investors, the appeals court did not decide whether the deductions were invalid, but said the Tax Court must determine the extent and effect of the government lawyers’ wrongdoing.

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″The commissioner presented a telling case of corruption of the process of the Tax Court and the rights of both the government and the taxpayers,″ the court said in a 3-0 ruling.

″The taxpayers, the government and the Tax Court have all been cheated by the conduct″ of the government’s lawyers, the court said.

A lawyer for six of the pilots said five of them faced tax liabilities of over $100,000 and would be forced into bankruptcy if the shelters were invalid. The Tax Court must decide whether a new trial is required after holding a fact-finding hearing, the appellate panel said.