Can a CPA Bury his Client by Trying to Save Him ?

Originally Published on forbes.com on September 25th,2011

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The story related in US v Ellefsen, an eighth circuit criminal appeal highlights a knotty problem that a tax preparer can run into.  When someone sells your client some snake oil and the client asks you to pour it out and take a sip by signing the return, what do you do ?  This is the problem that CPA L. Michael Stelmacki faced.  He was in a thankless postition with no really good answers.  Mr. Stelmacki’s client was Southwest Missouri Bone & Joint Inc. (SMBJ) The company was owned by Brian Keith Ellefsen, an orthopodic surgeon.  His brother Mark was the corporation’s business manager.  Dr. Ellefsen searched out ways  to save taxes and he thought he found something really good, which he ran by Mr. Stelmacki, who thought it was maybe not so good.

In 1997, the Ellefsens attended a presentation by James Quay about the Aegis Business Trust System, which used domestic and foreign trusts to shelter assets from taxes. Quay explained that the Aegis system was “an asset protection device with tax deferral,” through which professionals could send their income offshore and defer paying taxes on it until they “[r]epatriate[d] the funds back to the United States.” . Participants in the system could access the funds with a credit card. Following the presentation, the Ellefsens sought advice from Stelmacki, who thereafter spoke to Quay about the Aegis system. Stelmacki concluded that Quay “was a person to avoid” and urged Brian to consult an independent tax attorney—one not associated with Aegis.  Brian failed do so. In July 1997, the Ellefsens enrolled in the Aegis system.

 One of the more challenging things about being a CPA is that we have to give advice to people who are generally smarter than we are.  Generally it works out, because they recognize that we apply our limited intelligence to a particular body of material that they could master if they chose, but their superior intellects are better spent on matters more profitable and in some instances, such as would be the case with an orthopedic surgeon, of more benefit to humanity.  When they start being stupid, though, it does not work out that well.  Mr. Stelmacki did not give up:

On July 21, 1997, Stelmacki faxed an article to Mark, with a note that read, “Mark, please read this article. I hope that it’s not too late for Brian to reconsider.” The article addressed the IRS’s crackdown on abusive trust schemes.

Mr. Stelmacki wrote to Brian on August 26, 1997, saying:

I noticed in your July disbursements an expense to Mr. Jim Quay for $15,000 for professional fees. I am also aware that you have decided to go ahead with the Aegis Company’s program to use offshore entities to shield you from Federal and State income taxes. I am writing to you because I am concerned for you and the risks you may inadvertently be taking…. While I share your interest in reducing your tax burden, I feel that you have the opportunity to build sizable wealth without incurring high risks. 

It seems to me that the promoters are relying on an elaborate chain of complex entities to conceal taxable income. They have concocted a series of transactions to cloak earned taxable income from rendering patient services in Carthage, Missouri into non-reported foreign source income and then arranging to lend or gift the money back to you. I am especially suspicious when I learned that they will provide you with a Visa card to access the money. They have also represented that you will have apower of attorney that will allow you to transfer funds at will. You will beearning the income by performing services and you will be enjoying the benefits of the income. Therefore it is reasonable that the I.R.S. could potentially look through this masquerade and say that it is taxable income to you regardless of the structure 

I am asking that you consider the worst case scenario in which the I.R.S. takes the position that you are committing tax evasion. They have the power to assess huge penalties and interest, to prosecute you, to ruin your career, and seize your property. Is the risk worth it?

 Mr. Stelmacki apparently thought that he had talked his clients out of the trust transaction.  Apparently, though, they just decided to stop talking to him about it.  If you don’t like the taste of the Kool-Aid, you might not get invited to the parties anymore.  They kept him on as their preparer though so they had to put up with his negativity towards this great plan again:

In 2000, SMBJ, Inc. transferred $650,000 to the Aegis-created entities and deducted the transfers as management fees on its 2000 corporate tax return. On his personal tax returns, Brian again declared that he had no interest or authority over any foreign accounts. As Stelmacki was preparing SMBJ, Inc.’s corporate tax return, he expressed concern regarding the deduction of $650,000 in management fees and requested that Brian represent in writing that the fees were legitimate. Stelmacki testified that he sent a representation letter because he wanted to be certain that Brian actually acknowledged that the payment was “an ordinary and necessary expense of business.”  Stelmacki discussed the representation letter and his concerns over the fees with Mark, and Brian thereafter signed and returned the letter.

In 2001, SMBJ, Inc. recorded an additional $460,000 in management fees. In February 2002, while preparing the 2001 corporate tax return for SMBJ, Inc. Stelmacki sent another letter to Brian, in which he stated: 

Again we noted that Southwest Missouri Bone & Joint, Inc. incurred substantial management fees amounting to $460,000. Last year, we asked that you provide us with a representation letter as to the deductibility of those management fees which you provided to us. We are concerned that these expenses will not meet the I.R.S. test as to being ordinary and necessary expenses of the business. It is our understanding that your financial consultants have attorneys and tax specialists that have advised you that these expenses are properly deductible. However, the I.R.S. says that tax preparers should suspect that a taxpayer may be involved in a tax shelter that the I.R.S. considers abusive if certain factors exist.

 We believe this important matter should command your immediate attention. Regarding the Corporation’s 2001 tax returns, we are unable to proceed in completing the tax returns unless we have an opinion from a tax attorney who is not associated with promoting or administering the management company or related entities indicating that he has reviewed the transactions and concluded they are legitimate and deductible. We will also require a representation letter from you similar to last year. 

Stelmacki enclosed numerous articles regarding abusive trust schemes and the possible criminal ramifications.

All that negative thinking, the clients are going to finally get fed up with you.  That’s what happened to Mr. Stelmacki.

In a phone conversation that September, Mark informed Stelmacki that they had hired someone else to prepare their 2001 return and that Brian would not provide further information or seek an outside opinion. SMBJ, Inc.’s 2001 corporate tax return was ultimately prepared by an accountant associated with Aegis and deducted $460,000 in management fees.

Mr. Stelmacki did not give up:

In February 2003, Stelmacki sent an IRS press release by facsimile to the Ellefsens. The release listed the “dirty dozen tax scams.” The first scam listed was entitled OFFSHORE TRANSACTIONS: “Some people use offshore transactions to avoid paying United States income tax. Use of an offshore credit card, trust or other arrangement to hide or underreport income or to claim false deductions on a federal tax return is illegal.” The release mentioned that the IRS was “offering people with improper offshore financial arrangements a chance to make things right.” Through April 15, 2003, eligible taxpayers would not face civil fraud and information return penalties. The release warned that a taxpayer “who does not come forward now, however, will be subject to payment of taxes, interest, penalties and potential criminal prosecution.”

As I noted, this is an appeal of a criminal case.The Ellefesen brothers, surgeon and office manager, have been convicted and their conviction was upheld.  The plan that they were sold doesn’t even make good nonsense, so it is really not worthy of discussion.  What fascinates me is the role that Mr. Stelmacki played, which as is often the case with CPAs is something of a bit part.  I think that if this had been a Greek tragedy, Mr. Stelmacki’s part would be played by the chorus.  He kept raising the decibel level hoping that his clients would get it.  They never did until it was too late.  The most tragic and troubling part of it to me is the possiblity that his warnings helped the government build its criminal case.  CPAs have very high standards with respect to client confidentiality, but we are not priests or attorneys so our advice is not priveleged.  A word to the wise is sufficient.  If after your word, the client is still going to drink the Kool-Aid, maybe the better course is to just fire him yourself.