Courts and Value Billing

Canal Corporation and Subsidiaries v. Commissioner, 135 T.C. No. 9
KELLER, ET AL. v. U.S., Cite as 106 AFTR 2d 2010-6343, 09/15/2010

This was originally published on PAOO on November 3rd, 2010.

My father was fond of saying you need three things in life – a good doctor, a forgiving priest, and a clever accountant


I have these little stories I use to keep perspective. They are a combination of fact and speculation. The proportions vary. I sometimes hear that being a CPA is very stressful. I can get into that, but then I have my perspective story. Sometime, during the early part of the second Gulf War, my daughter's eighth grade class wrote encouraging letters to our service people abroad. I wasn't surprised that she got a reply, but the person replying was a bit of a surprise. He was a major, the executive officer of a helicopter battalion. I tried to imagine what his job must be like. It involves seeing that machines that don't look like they should fly keep flying. And that's just the tip of the iceberg. My speculation was that he received a stack of letters and that faced with the challenge of making sure that his collection of extremely stressed young people appropriately answered the schoolchildren in a way that reflected credit on the Army, he answered them all himself. Regardless it was a nice letter and I hope that he is now full colonel at a nice post in pleasant circumstance or perhaps even better collecting a well earned lieutenant colonel's pension. And when ever I think I have stress I think about him.

I believe that the biggest hazard CPA's face is not stress, but envy. It is in the nature of things that most CPA's who do well have client's who do even better, much better. In a free capitalist society, the most highly compensated people will be the successful entrepreneurs. That does not mean that entrepreneurial activity is over rewarded. Unsuccessful entrepreneurship garners fairly heavy penalties. In the process of failure, they may generate some complicated accounting work, but not the revenue to pay for it. A practice where those clients predominate, unless it is that of some sort of workout specialist, will not last. So a prosperous CPA sitting down to eat with a collection of his most prosperous clients will often be the least prosperous person at the table. Ironically, the more prosperous the CPA is, the more likely that he or she will be the least prosperous person at that particular table.

The concept of value billing has some very sound reasoning behind it, but I also think that the envy factor is the source of some of its attraction. I couldn't help but notice it in the banter between professionals that was such a rich part of Fidelity International Currency, the epic tale of EMC founder Richard Egan's doomed tax shelters

On May 26, 2000, Denby sent Reiss an e-mail regarding the previous day's meeting and her discussions with Helios after the meeting concerning fees:


... after the meeting I discussed with Helios the fees. The fees are based on a 3% rate. If KPMG were not involved Helios would just pocket a larger percentage. Since our connection came from KPMG, Helios would pay them a referral fee anyway. I think at the same rate. So [their] involvement does not cost more but just results in reallocation of the base fee. I know from other situations this reallocation occurs simply from [our] getting the name [from] KPMG. We are in the wrong business!

The writer was an attorney and the recipient a CPA, who was CFO of a family office. She was expressing the same frustration that led the CPA's at KPMG into a new and interesting way to do business. She or her firm was apparently getting paid by the hour to find a brilliant maneuver to save Mr. Egan's tax dollars. KPMG had already invested some hours in designing a brilliant scheme. They would not get paid for the additional hours they spent applying these principles to Mr. Egan's situation. They would get paid a percentage of the tax savings while incurring a relatively small marginal cost.

The outcome of the whole enterprise was not pretty for KPMG or many of their clients. KPMG found itself fortunate to be in any business. They were even pressured by the federal government to stop paying defense costs for some of their partners, a tactic which back fired on the government on constitutional grounds, but you should go to the federal tax crimes blog if you want to read about that type of thing. More to the point of this post, none of the opinions that the Egans paid for protected them from the imposition of penalties. They were viewed as part of the package and tainted by a lack of independence.

The disdain for professional imprimaturs unsupported by work has moved beyond the Son of Boss unbalanced entries to a deal that tax professionals felt deserved a bit more respect. Canal Corporation and Subsidiaries was a deferral deal. Instead of selling a subsidiary the taxpayer contributed it to a partnership and took a large distribution. The debt that funded the distribution was allocated to the contributing partner, which avoids the disguised sale rules. Of course, they didn't really want a liability, so the guarantee that supported the allocation was pretty tenuous.

Not to worry, they got a "should" opinion, the highest assurance possible from none other than PWC. If you can't rely on the people who count the votes for the academy awards, who can you rely on ? Turns out the client should have been a little more diligent than just cutting a check and asking for the envelope, please :

Chesapeake paid PWC an $800,000 flat fee for the opinion, not based on time devoted to preparing the opinion. Mr. Miller testified that he and his team spent hours on the opinion. We find this testimony inconsistent with the opinion that was admitted into evidence. The Court questions how much time could have been devoted to the draft opinion because it is littered with typographical errors, disorganized and incomplete. Moreover, Mr. Miller failed to recognize several parts of the opinion. The Court doubts that any firm would have had such a cavalier approach if the firm was being compensated solely for time devoted to rendering the opinion.
We are also nonplused by Mr. Miller's failure to give an understandable response when asked at trial how PWC could issue a “should” opinion if no authority on point existed. He demurred that it was what Chesapeake requested. The only explanation that makes sense to the Court is that no lesser level of comfort would have commanded the $800,000 fixed fee that Chesapeake paid for the opinion


Chesapeake did not act with reasonable cause or in good faith as it relied on Mr. Miller's advice. Chesapeake argues that it had every reason to trust PWC's judgment because of its long-term relationship with the firm. PWC crossed over the line from trusted adviser for prior accounting purposes to advocate for a position with no authority that was based on an opinion with a high price tag—$800,000.

The Keller opinion sheds a different light on the subject. It is a follow up to the Keller case which I mentioned briefly at the dawn of this blog noting that the role of the accountant bordered on the heroic. There was a family limited partnership all set to go with assets identified, etc., etc. Then the matriarch dies before she can sign anything. Don't you hate when that happens ? So her estate tax of 147,000,000 or so was computed with no valuation discount. Then one of the family's accountants got the notion that maybe they had gone far enough. So they sued for refund and in August of 2009, they won. The case came up again to determine deductible fees. Although the court was very deferential to the executor/accountant, they decided that a $2,400,000 "bonus" for future worker was not ordinary and necessary. They also disallowed a $9,470,606 contingency fee to attorneys (presumably the ones who handled the litigation on the valuation discounts).

Pricing on Purpose is a really good book and it offers some valuable perspectives on approaches for billing for professional services. I think, though, that these decisions raise some issues on the value of tax services that are detached from the amount of work that is involved. It is almost as if when you try to bill based on the value, the value disappears.

My final reflection is advice for the financial professionals who have those twinges of envy when they see the big checks is to try three techniques. The first is to go to the kitchen and get a glass of water from the tap and drink it. While you do that reflect on how few people in world historical terms have had such easy access to reasonably potable water. The second is that the next time somebody in the street asks your for money, engage with them. Ask them when they have last eaten and then sit down and have lunch with them. (If they are professional pan handlers, they will find this rather frustrating). If all else fails do a google search on "KPMG Tax Shelter Prison". It may well be that Attorney Denby was in the wrong business, but that didn't mean KPMG was in the right business.

I'm not giving up on the quote identifying contest. The one at the top is from a film and at the risk of making it too easy I will say the real hero of the film was an accountant (although he is not the "hero" of the film). Also Xavier graduates and old people probably don't have an edge on this one.