Last time I played the slots, I lost a small sum of money. But for several accountants and tax lawyers, playing with slots could have cost them significant fines and incarceration.

In their case, SLOTS was the acronym for Sale Leaseback of Tenant Improvements Strategy, which enabled a number of U.S. corporations to claim tax deductions totaling more than $240 million.

According to an indictment filed in 2009 in the U.S. District Court for the Southern District of Ohio, Western Division, the SLOTS shelter was designed by accountants at KPMG and marketed to the firm’s clients, including the retailer Kroger. TransCapital Corporation, a “tax-advantaged investments” company, marketed and implemented SLOTS transactions with partners of KPMG.

KPMG denied involvement in the case. “This proceeding was a personal matter with respect to the individuals involved,” said KPMG spokesman Manuel Goncalves in an email to Accounting Today.

At least eight SLOTS transactions were sold between 1996 and 2006. TransCapital would form a single-purpose entity with little or no assets, which would purchase leasehold improvements that it would lease back to the SLOTS client. Defendants named in the indictment arranged for appraisals of the leasehold improvements, and the SLOTS client would purportedly sell the improvement for this amount, which was always significantly less than the value of the improvement reflected on the SLOTS client’s books.

The difference between the purported market value and the book value of each client’s leasehold improvements comprised the loss that the SLOTS client claimed as a tax deduction.

The single-purpose entities purchased the improvements with funds from a financial institution involved in the transaction. In at least seven of the transactions, the single-purpose entity obtained these funds by selling to the financial institution the rights to the lease payments, creating significant income for the single-purpose entity.

Defendants named in the indictment designed a plan to eliminate the single-purpose entities’ income tax liability by having each entity resell its leasehold improvements to an unrelated third party at a loss, according to the prosecution. However, each SLOTS client retained an early buy-out option under the leases that gave it the right to buy back the leasehold improvement from the single-purpose entity at a specified price at a certain point in the lease term.

IRS auditors ultimately disallowed the tax deductions claimed by the corporations. In the course of a number of client audits, defendants participated in meetings with the IRS. The IRS alleged that they made misleading statements both to the IRS at these meetings and to their clients. An indictment was issued charging them with conspiracy to defraud the United States and the corrupt endeavor to obstruct and impede the Internal Revenue Laws.

“The whole thrust was about deception, misleading the IRS regarding the particular tax structures,” said Tom Zehnle, an attorney with Miller & Chevalier who successfully defended Jon Flask, one of the defendants.

“It was basically no different than any other sale and leaseback. It’s just that the assets were unique. That’s why the IRS said this was too much. It said they were hiding the fact that at the end of the day they were going to sell to another company and take their own loss.”

“Ultimately, you can’t talk about this in a vacuum,” Zehnle observed. “Even though the charge was tax evasion, these were sophisticated transactions, and you need jurors who are attentive enough to follow what is going on.”

“The trial lasted nearly a month,” he explained. “I was able to convince the jury that this was not something that was criminal. The CPAs and tax attorneys examined the 80,000 pages of law to determine how they could save their clients potential tax. They examined the law, the regs and the rulings, and thought it would work.”

“Criminal prosecutions tend to discourage people from thinking about minimization strategies,” Zehnle noted. “The jury decision in my case might be a sign that there is a real difficulty in prosecuting these sophisticated tax shelters. It may be that the government needs to rethink its strategy of charging accountants and tax lawyers as a deterrent.”

Zehnle’s client was acquitted on both counts of the indictment, while the co-defendant was acquitted on the first count. The second count resulted in a hung jury, and the court granted a motion to acquit on that count as well.