A recent court decision ruled that a CPA’s failure to file and pay his taxes couldn’t be used against him in an unrelated tax shelter case.
The CPA in question, Robert Nagy, was originally tried in a district court for his participation in a tax shelter scheme, and found liable for $2.6 million in penalties. During the course of trial, evidence was admitted that Nagy had not timely filed and paid his taxes. On review, the Fourth Circuit decided that that was inadmissible character evidence, and overturned the penalties.
“Nothing in the record connects Nagy’s failure to timely file or pay his personal taxes to any knowing act of fraud or fraudulent intent …,” the court wrote. “Moreover, for Rule 403 purposes, the admission of Nagy’s personal tax information was highly prejudicial and quite likely to influence the jury against him.”
The original case
Nagy advised Charles Cathcart and his various Derivium companies in the development and marketing of an investment scheme termed the “90 percent loan program.” As part of this scheme, customers of Derivium would transfer appreciated securities to Derivium as “collateral” and receive in return a “loan” equal to 90 percent of the value of the securities. Derivium represented to its customers that it would cause hedging transactions to be undertaken to protect against market fluctuations, and that the 90 percent loan payments would be made by a separate offshore entity or entities that would also engage in the hedging transactions.
In reality, Derivium would not hold the securities received as collateral, but would immediately sell the customer’s securities, thus funding the loan payments out of the sales proceeds. There was no offshore entity.
Nagy’s role was to give Derivium his opinion, as a CPA, that the 90 percent loans were bona fide loans and not sales of securities, which would have been subject to federal and state income tax at the time of the sales. Derivium used Nagy’s tax advice in its marketing to customers.
The IRS assessed penalties under Section 6700 against Nagy and others who participated in the scheme. Nagy paid 15 percent of the penalties and filed a refund claim in the District Court of South Carolina.
At trial, the district court ruled that the transactions were sales, and the jury found Nagy liable for $2.6 million for the Section 6700 penalty for promotion of an abusive tax shelter. However, the district court permitted information regarding Nagy’s failure to timely file and pay his taxes to come before the jury. This was reversible error, the Fourth Circuit concluded, and so vacated the liability and penalty verdicts.