Two tax attorneys and a life insurance agent have been convicted by a jury of conspiring to commit tax fraud through a fraudulent scheme they called the Gain Elimination Plan. This was the subject of an interesting press release from the U.S. Department of Justice, Tax Attorneys and Insurance Agent Convicted in Tax Shelter Scheme (DOJ Press Release, April 25, 2024). Because the press release is a little short on details, the Bill of Indictment, W.D.N.C. Case No. 22-CV-60 (Nov. 16, 2022), which gives a more full description of the charges leading to the convictions will be summarized below.
The defendants in the case were Michael Elliot Kohn, Catherine Elizabeth Chollet and David Shane Simmons. Kohn and Chollet were tax attorneys practicing law in St. Louis in The Kohn Partnership, LLP, referred to as “TKP”. Simmons was a life insurance agent who was a resident of Jefferson, North Carolina. Apparently, Kohn had plead guilty in 2002 to a previous tax offense and had been barred from practicing before the IRS and never reinstate (but there is no citation in the Indictment to that previous offense).
The way the Gain Elimination Plan worked was that Kohn and Chollet would first create at least one limited partnership for each client. Kohn and Chollet would then direct the clients to donate most of the limited partnership into a charity favored by Kohn and Chollet. The clients would retain 1% or 2% of the limited partnership.
Once this was in place, Kohn and Chollet dummied up fictitious royalty or management fees that were then paid by their clients’ other operating businesses to their limited partnerships. The clients’ operating businesses would take a deduction for the payments. However, because the limited partnerships were 98% or 99% owned by the charity, nearly all the tax on that income for the partnerships was then attributed to the charity. The limited partnerships, however, kept the actual cash and the clients were in control of that cash through the limited partnerships. Voila! Now the clients had manufactured sizeable deductions for their businesses, but without any corresponding tax, albeit through these bogus transactions which left them in control of the money.
Next, Simmon, working with Kohn and Chollet, would sell life insurance to each limited partnership with the death benefit supposedly going to the charity in an amount roughly equal to to how much each client desired to shelter in taxes. The idea was that this would be a ten-year plan, after which period of time a client could cancel the life insurance (presumably taking out the cash that had built up inside the policy, which was tax-free of course) and then using that money to buy back the limited partnership interest held by the charity. Simmons earned huge commissions on the sale of these life insurance policies, of course.
Working together, Kohn, Chollet and Simmons either prepared or assisted in the preparation of each client’s tax returns, which falsely took into account these deductions. Kohn and Chollet also promised their clients that they would receive opinion letters validating the transactions, but some clients never received these opinion letters while others received opinion letters that were for different transactions or sometimes even for different clients.
For his part, Kohn misrepresented his educational background, fudged the facts about his 2002 guilty plea, criticized his client’s previous accountants as saying that they did not understand the Gain Elimination Plan, and also told them that Simmons was the only insurance agent who could obtain the right insurance products for the Plan, although that was untrue (Chollet apparently worked with a different insurance agent on some of her own deals).
To bust this scheme, the IRS set up a sting where it sent a couple of undercover agents to meet first with Simmons, and then with Kohn, Chollet and Simmons at the TDK St. Louis office. The first undercover agent posed as a financial planner and the second undercover agent posed as the a client who owned a number of nail salons in Texas. Kohn pitched the scheme to the two undercover agents telling then that a purchase of life insurance was necessary in case the client died before the new limited partnership could be purchased back from the charity. Meanwhile, Chollet told the two undercover agents that she personally used the Gain Elimination Plan to reduce $50,000 of her own income each year. When the agents asked Kohn about whether they needed to meet with the charity, Kohn replied: “No, we’re basically just borrowing their exemption.”
On April 15, 2019, Kohn provided amended returns for tax years 2015, 2016 and 2017 to the undercover agent posing as the client, which claimed more than $100,000 in fraudulent tax returns. Kohn drafted these amended tax returns without even having a profit and loss statement from the undercover agent.
The evidence of the undercover agents was not the only proof of this tax fraud. E-Mails (“Evidence Mail”) between Kohn and Simmons demonstrated that Kohn was simply making up management fees for clients out of thin air for their other GEP clients. Bogus royalty agreements were similarly sent to clients on occasion after the years where the deductions for those royalty payments were claimed. Indeed, some GEP clients did not even open bank accounts for their limited partnerships to move money around, but Kohn saw to it that they got their deductions for royalty payments anyway. Finally, the paperwork by Kohn and Chollet was sometimes so sloppy that the interests in the limited partnerships never actually went to the charity, but of course the clients got their deductions anyway. Only years later in some cases would the involved charity belatedly discover that it was involved in some of these transactions.
The real money earned on this particular tax scheme — as it is with all such deals that involve life insurance — was through the huge commissions derived from the sales of those products. Simmons’ commission was approximately 95% of each policy’s first-year premium. Although Simmons represented in his annual life insurance agent compliance forms that he did not share premiums with anybody, he was of course sharing the premiums with Kohn and Chollet. The way this worked is that the life insurance company would pay Simmons his commissions on the sale, then Simmons would deposit these premiums into his account for the Simmons Family LP account in Jefferson, North Carolina. Next, Simmons would send 50% of his commissions to Kohn and Chollet and falsely designated those commissions as fees for professional services.
Besides the United States, the other victim of this scheme was the involved life insurance company, since Simmons submitted false information to that company so that the policy would be issued and did not advise the company that the policies were intended to lapse at the end of 10 years.
The indictment stated 23 counts. The first count was a criminal conspiracy by Kohn, Chollet and Simmons to defraud the United States. Counts 2-12 alleged the criminal aiding and assisting in the filing of the false tax returns. Counts 13-17 alleged the filing of false tax returns by Simmons. Counts 18-22 alleged criminal aiding and assisting in the filing of false tax returns by Kohn and Chollet. Finally, count 23 alleged wire fraud by Kohn and Simmons relating to the false information provided to the insurance company and in corresponding with the clients involved in the scheme by e-mail.
Back to the DOJ’s press release, it stated the tax loss to the IRS was $4 million and that:
“Simmons earned more than $2.3 million in commissions from selling the insurance policies, splitting the commissions with Kohn and Chollet. Kohn and Chollet received more than $1 million from Simmons. Simmons also filed false personal tax returns that underreported his business income and inflated his business expenses, resulting in a tax loss of more than $480,000.”
The press release also notes that these defendants have not yet been sentenced.
ANALYSIS
Whenever life insurance is pitched as part of a tax transaction, it creates a giant red flag that indicates that there might be something wrong. This is not because of any inherent flaws with life insurance. Rather, the issue that may arise is the one here: The life insurance commissions are being split with the tax planner such as there is a serious conflict of interest with the tax planner’s advice.
The reason for this is that the commissions paid to agents for life insurance are substantially larger than typical legal fees. As a rule-of-thumb, a top life insurance agent can receive 40% of the first-year premium for a universal life insurance policy, 80% of the first-year premium for a whole life policy, and 100% of the first-year premium for a term life policy. Thus, if a tax plan is created that will be funded with a whole life policy that contemplates five equal annual payments of $300,000 for a total premium of $1.5 million, the commission paid to the agent will be around $240,000. Compare this $240,000 commission against what the tax planner may charge for the tax plan — say $50,000 — and one can see that the commission is nearly five times larger than the fee.
Thus, what is commonplace is that the tax planner will offer some tax plan with seemingly reasonable attorneys fees as basically a loss-leader to draw in the client, but the tax attorney will next tell the client that the plan must be funded with a particular life insurance policy sold by a particular life insurance agent. The agent will then sell the policy and make a huge commission that is then split with the attorney. If the client wants to use their own insurance agent, the tax attorney will subtly steer the client away and to his buddy agent, because of course his buddy will share the commission, but the client’s own agent will not. This happens all the time.
Most states disallow life insurance agents from sharing commissions with persons who are not licensed as life agents, as Simmons did with Kohn in this case, and most life insurance companies disallow as well. Discovering these illegal arrangements is difficult, of course, since the agent will simply deny that it happened (as Simmons did here) while the tax attorney’s share of the commissions is laundered through other entities (as occurred here as well).
From the attorney’s viewpoint, an attorney is required to advise their clients whenever they receive compensation for their services from a third-party, such as Kohn did here from Simmons, but like the life insurance agents such attorneys will fail to make such disclosures as well. The bottom line is that the client ends up dealing with a dishonest attorney and a dishonest life insurance agent, and that is rarely going to work out well for the client.
As I have explained many times, and will now do so again, the best way for a client to avoid getting into a bad tax transaction is the simple expedient of taking the proposed strategy to another attorney (or not involved in the transaction or suggested by the promoter) and getting a second opinion. Generally, if a tax strategy works then everybody will see that it works. It is when there is disagreement about whether a tax strategy will end survive scrutiny that one should clamp their hand firmly on their wallet. A second opinion may also call into question whether life insurance is really needed to achieve the most efficient benefits ― it often is not.
Promoters of tax scams know this and the last thing they want is for their client to seek a second opinion. To avoid this, the promoter will (as Kohn did here) tell their clients something to the effect that their own tax advisors are not sophisticated enough to understand the transaction. This is almost always an outright lie. Even if it were true, a client’s other tax advisors would likely get the client to somebody who could understand the transaction and offer a second opinion.
Folks may be surprised to learn that there a consultants and financial planners out there who will also give a second opinion of life insurance and annuity products. For a large policy ― say, one with premiums in excess of $500,000 ― getting a second opinion on policy selection is usually a good idea. Let me tell you why.
There is an old saying: Life insurance is not bought, it is sold. The import of this statement is that most folks will not ordinarily seek to purchase life insurance, but rather the life insurance agent must talk them into it. Because the life insurance agent will receive such a large commission on the sale of big policies, there is an inherent conflict of interest with the agent as to how much premiums the client will be told to buy and what types of policies to buy. Simply put, if the life insurance agent can talk the client into paying more premiums, the agent will receive a correspondingly higher commission. Similarly, if the agent can steer the client into higher-commission products, the agent will come out better even if the client does not.
The best example of this is a life insurance agent who steers her client into a whole life insurance policy as opposed to a universal life insurance policy. What is the difference? For tax reasons related to the so-called Modified Endowment Contract (MEC) rules, a cash-value life insurance policy must be funded over so many years (as opposed to a single up-front payment) for the investment income building up within the cash-value of the policy to be tax free. A whole life policy is one that requires level funding, so something like $200,000 every year for five years for a total of $1 million dollars. If the purchaser is not able to make a payment in one year, say, their business really suffered in one year, the whole life policy will lapse and the insurance company will simply keep all the dough. By contrast, a universal life insurance policy allows for flexible funding, so for the same $1 million dollars it could be paid in something like $200,000 then $100,000 then $300,000 then two final payments of $150,000 ― all mostly chosen in those years by the purchaser.
While it is true that whole life policies can sometimes have slightly better performance than universal life policies, the lack of premium payment flexibility can be a real downer if the purchaser is hit with an unforeseen financial problem, such as happened to so many previously rich real estate developers during the 2008 crisis or many business owners during the pandemic. So why would anybody ever recommend a whole life policy with its potentially fatal inflexibility?
The answer is primarily commissions. Because whole life policies can and do lapse when payments are not made, and the insurance company can also more easily budget how to invest the premiums from such policies, the insurance companies make a lot more money from them and thus can pay much higher commissions. As in double the commissions for a universal life policy. A top-selling agent with good agency contracts can make around 80% of first-year premiums on the sale of a whole life policy. The same agent, however, will only get 40% for a universal life insurance policy. As an example, if the first-year premium for a policy is $200,000 then the agent will get around $160,000 in commissions for a whole life policy, but only $80,000 in commissions for a universal life policy. Therein lies the conflict of interest. Whenever you are pitched a whole life insurance policy, chances are that policy is being proposed primarily because the insurance agent will be doubling her commission over the policy that is truly best for you. Thus, as with tax strategies, getting a second opinion on the type of insurance policy offered by an agent is a good idea, particularly for very large policies.
There is also a second way to ferret out this conflict of interest: Ask that the life insurance agent to disclose the commissions to be received from the sale of the product. Note that every other financial professional (and also lawyers) are required to disclose in advance the amount of the compensation that they will be receiving on whatever service or product they are offering. Not so with life insurance agents, mostly due to the fact that life insurance is regulated by the states and the insurance companies have lobbied hard to prevent such mandatory disclosures because of the very real fear that sales of life insurance would be much more difficult if purchasers could see how much the agent will be making. However, there usually is no law preventing the purchaser from asking the agent to provide a compensation disclosure, and if the agent refuses to provide one then, well, you need to find another agent.
This is not to say that all life insurance and annuity agents are bad. There are some very good and conscientious agents out there who really do put their clients’ interests first and care less about what they are paid than doing a good job. Unfortunately, these seem to be a minority. Put a less than scrupulous agent together with a shady tax attorney and you get Simmons and Kohn here.
Finally, at the end of the day there is the saying that: If it is too good to be true, it probably is. This fits the Gain Elimination Plan like a glove. The GEP was clearly devoid of any economic substance, but rather deductions were (fraudulently) ginned up out of thin air. Anybody who got into the GEP should have known better ― and at least sought a second opinion ― but greed in saving taxes tends to blind such folks to the brightly waiving row of red flags.
The opinion in this case doesn’t tell us what happened to the participants in the Gain Elimination Plan, but we can easily surmise that their deductions were disallowed and they paid substantial penalties. They probably also paid quite a bit for their tax controversy counsel fees, in addition to the stress of wondering whether they themselves had tickets to Club Fed.
It is their reward for ignoring all the red waving flags.
Read the full article here
