Although no household names from the United States showed up in the “Panama Papers,”[1] – a trove of leaked client correspondence from a Panamanian law firm that helped people set up offshore accounts – a Texas bankruptcy court recently elevated Dallas entrepreneurs Sam and Charles Wyly as the most high-profile offshore-account tax evaders ever caught.
Last month the court ordered Sam to pay $1.4 Billion and Charles’ estate to pay $800 million. Just today the bankruptcy court updated Sam’s amount owed as $1.1 Billion.
I have often wondered what the point of offshore accounts really is. I don’t have any offshore accounts – alas – so have not had the opportunity to learn from my personal experience. So I studied the Wyly case out of curiosity about how very wealthy people use offshore accounts, and why.
Why offshore accounts?
In their simplest form, offshore accounts are legal. You could choose to set one up with the same goals in mind that might lead you to form a regular LLC or corporation – namely, to clarify where and when to pay your taxes, and to reduce your potential liability or vulnerability to lawsuits or attacks on your net worth.
If you intend to dodge your taxes or to cheat securities law, however, offshore accounts offer at least four distinct advantages, as I learned from the Wylys. Here’s how.
Avoid Income Taxes
A primary function of the Wyly’s offshore trusts set up in 1992 was to take in valuable stock options they owned, swap them for special annuities that allowed them to not pay income tax on their stock options that year, and then indefinitely postpone receiving income from the annuities.
The less income you have this year, the less you pay in taxes!
I gather from the court record that this all could have been cool with US tax authorities if, when the annuities paid out, the Wylys reported the income and paid taxes then. Tax deferral like this is often fine, as long as you color within the lines, carefully disclose what you’re doing, and pay everything eventually – sort of like a 401K retirement account, but on a much bigger scale.
But then…it gets murkier. The brothers kept deferring when the annuities would pay out. And the ownership of their assets kept getting split up between various accounts in convoluted ways that don’t appear to make economic sense, but do make sense if your intention is for the government to lose track of your money, so they’ll never pin a tax bill on you. So it seems offshore accounts are useful if you’re trying to play hide-the-ball with the IRS.
Minimize Estate taxes
The brothers set up a series of Trusts and corporations offshore – specifically on the Isle of Man, a little financial offshore haven between the UK and Ireland.
One of the points of a trust is to set aside dedicated funds and to clarify certain charitable intentions that may reduce your estate taxes. The Wylys named charitable institutions, as well as their children, as beneficiaries.
Over two decades, the brothers declined to properly disclose to the IRS money flows into and out of their trusts and offshore corporations. The estate-planning function – which could have been done with offshore trusts legitimately – appears to have been more about obscuring the extent of their wealth, which in the long run could have saved them and their children tremendous amounts of money on their estates. Naturally, the less observable money you have in your estate when you die, the less the IRS would expect to receive from your estate.
Evade securities laws
Even after reading 400+ pages of court documents, I can’t tell if this was a nefarious intention of the Wylys from the beginning, or not.
Here’s what happened. They move a lot of shares in public companies – including one they’d founded called Sterling Software – to offshore accounts. US securities laws require owners to disclose how much of a company you own, especially if ownership hits certain triggers, like owning 5 percent of any one company at any given time.
But the Wylys didn’t want to show the federal government how much they owned, and by splitting up ownership into multiple anonymous-seeming accounts, they tried to keep any individual account below the 5 percent disclosure trigger. The SEC prosecuted the Wylys for trading illegally using these offshore anonymous accounts, but ultimately could not prove their case.
But just evading disclosure – splitting up ownership into various accounts to keep under the 5 percent ownership trigger – is fraud in and of itself. If your goal is to minimize taxes – not trade on inside information as the federal government unsuccessfully prosecuted them for – you may still end up breaking securities laws around mandatory disclosures. And the Wylys did.
Avoid gift taxes
The Wylys kindly purchased valuable real estate – homes, horse farms, and office buildings – for their children, using money in their offshore accounts. They also purchased art and collector-quality jewelry for personal use using offshore trust money.
Here’s a pro tip. You can’t give more than $14,000 per year to anyone, including your children, without triggering a gift tax. But let’s say an offshore corporation owned indirectly by you does the real estate buying, and it’s unclear to US government authorities who the buyer is? Then you might be able to get away with it. (Unless the government figures it out, convicts you, and you owe around $2 Billion in penalties. But hey, we’re all adults making our own choices here.)
The Wylys argued in court that their foreign trusts simply invested in valuable real estate in the United States, and that the purchases of homes, offices, and horse farms for their children’s exclusive and rent-free lifetime use weren’t gifts, but rather long-term investments by the trusts. This isn’t real tax advice but, c’mon really, you can’t just do that.
Obviously you should not be reading any of this as a how-to – unless securities fraud, tax evasion and bankruptcy seem like life goals.
Next week I’ll write about the Wylys from a psychological perspective. Like, hello? What the heck were they thinking?
A version of this post appeared in the San Antonio Express News
[1] An excellent New York Times piece highlighted a few US citizens outed by the Panama Papers – including a hedge fund businessman, a real estate investor, and an author – but nobody I’d heard of previously.
Please see related post
Sam Wyly – What Was He Thinking?
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