Dimiter Hristov operated his medical practice thorough a wholly owned S corporation. Tired of handing over 45% of his income to the IRS each year, he began searching for tax saving alternatives. Because Hristov regular tax preparer was an enrolled agent who — admittedly — did not have the sophistication to conjure up such tax solutions, he eventually sought the help of a snake-oil salesman named William Alexander.
Alexander pitched pension plans and Section 419 plans for a living, and he pitched them hard. Fraudulently holding himself out as an enrolled agent, Alexander claimed to have “learned from 8-10 of the sharpest and most aggressive CPAs in the country” about how to take advantage of retirement plans and defend them on audit. To hear Alexander tell it, Hristov could lower his tax liability with large retirement contributions, yet still have access to the cash to make additional income-producing investments.
And if Hristov’s regular accountant didn’t agree, well…she just didn’t know any better:
What do most accountants and tax attorneys say about all of this? Most would never advise you to put these plans together and do what I do because they don’t understand and know about what I do. Why? By nature, it seems like U.S. accountants are conservative and backward people that are not creative. It’s really easier for them just to have you pay a lot of tax. You have a lady accountant now, who is conservative and backward, but if she does what I tell her to do, you can keep her; otherwise, use one of my accountants * * *.
Though skeptical at times, Hristov signed on, allowing Alexander to establish retirement plans for the S corporation. Each year from 2004 through 2006, Hristov would make a cash payment to the retirement account, Alexander would take his cut, and the rest would be “loaned” back to Hristov, never to be repaid; a rather large violation of the qualified plan rules. But that didn’t concern Alexander:
If I put $400K into the pension plans, you would have no tax, but obviously, you would have to borrow a lot of money from the pension plans, which my clients do as I promote this. Assets in the money purchase plan can be invested anywhere while I use fixed and variable annuities for the 419 plan, you really are not supposed to borrow money from the 419, but I’m aggressive so I have my clients do this * * *.
As if that weren’t egregious enough, Alexander encouraged Hristov to amend his 2002 return by reclassifying large expenses paid for assets to retirement plan contributions, resulting in a $100,000 refund request, from which Hristov took his 10% cut.
Throughout the process, Alexander continued to assuage Hristov’s fears with letters such as this:
“I also think this amendment will move through easily without IRS even asking for copies of the checks because we are amending a K-1, but if I am wrong, and IRS asks for checks, we can come up with check[s]…we are just asking for a refund so the worse thing that could happen is to be denied, but typically I get the refund although sometimes it takes a while”.
To be fair, with the smooth delivery and impeccable grammar evidenced in that communication, who wouldn’t have their nerves calmed?
The IRS, however, predictably began auditing Hristov, resulting in a full disallowance of all the pension plan contributions and leaving Hristov on the hook for over $400,000 in back taxes. And despite Alexander’s previous assurances to Hristov that he was an acclaimed audit negotiator, he cut and run, refusing to provide documentation to the IRS before eventually having an order of injunction filed against him, prohibiting him from promoting his pension plan scam.
But here’s the real lesson of the Hristov case: despite being rooked by Alexander, Hristov was not able to use the “reasonable cause” defense of I.R.C. § 6664 to avoid understatement penalties.
In general, the most common taxpayer appeal for reasonable cause comes in the form of “reliance upon the advice of a tax professional.” In determining whether a taxpayer’s reliance on a professional is reasonable, the courts tend to look at three factors:
1. Was the adviser a competent professional who had sufficient expertise to justify reliance?
2.Did the taxpayer provide necessary and accurate information to the adviser; and
3. Did the taxpayer actually rely in good faith on the adviser’s judgment?
Hristov, the Tax Court concluded, was not reasonable in relying on Alexander for two reasons: First, there was an obvious conflict of interest: Alexander only got paid to the extent Hristov made contributions to the retirement plan pitched and managed by Alexander. Furthermore, reliance on the professional advice of a tax shelter promoter is unreasonable when the advice would seem to a reasonable person to be “too good to be true.” Because Hristov was made aware by Alexander that he would both 1) get a tax deduction for the funds contributed to the retirement plans, and 2) have access to the cash, he should have sought independent confirmation from a reliable and disinterested adviser familiar with retirement plans.
Failure to do so cost him dearly.