© 2017 The Texas Lawbook.
By Mark Curriden
(May 18) – The bankruptcy and federal tax fraud case of Dallas entrepreneur and philanthropist Sam Wyly and his sister-in-law Dee Wyly officially moved to the U.S. Court of Appeals for the Fifth Circuit this week when lawyers for the family filed their opening brief seeking to reverse one of the largest tax judgments against individuals in U.S. history.
In two separately filed briefs, the Wylys claim that Bankruptcy Chief Judge Barbara Houser of Dallas committed numerous errors in her 459-page ruling in May 2016 that the offshore trusts created by the brothers Sam and Charles Wyly from 1992 to 2004 were shams designed to hide hundreds of millions of dollars from the IRS.
Lawyers for the Wylys claim that Judge Houser’s opinion is riddled with misapplications of federal tax and securities laws and misinterpretations of key facts in the case. And they argued that the penalties the judge imposed were so outrageously high that they violate the prohibition against excessive financial fines under the Eighth Amendment of the U.S. Constitution.
“A taxpayer does not commit tax fraud when he delegates the design, structure and implementation of his affairs to an ‘army of lawyers’ and they assure him repeatedly that the resulting structure is lawful,” Josiah Daniel and James Lee, who represent Sam Wyly, told the Fifth Circuit in the appellate petition.
“A taxpayer does not commit tax fraud because of information of which he is wholly unaware,” the brief states. “A taxpayer does not commit tax fraud when the basis for his tax liability is a change in the law that post-dates his actions by decades and contravenes 38 years of settled precedent.
“And a taxpayer does not commit tax fraud by voluntarily disclosing to the IRS potential issues promptly after he learns of them. This Court should reverse.”
The Wylys filed for protection under Chapter 11 of the U.S. Bankruptcy Code in 2014 after a New York judge hit Sam and Charles Wyly with a $299 million judgment for federal securities violations involving offshore trusts.
In April 2015, the IRS accused the Wylys of tax evasion and fraud related to the offshore trusts. The IRS sought $1.4 billion in back taxes, fees and penalties from Sam Wyly and $800 million from Dee Wyly. Charles Wyly died in a car crash in Colorado in 2011.
The IRS claims that the Wylys, who made billions of dollars growing and then selling Michaels Stores and Bonanza steakhouses, set up the series of offshore trusts in the Isle of Man in order to hide income from being taxed, while still using the money in the trusts to fund their lavish lifestyle.
The government claims that the trusts were sham operations that were used to purchase multimillion-dollar houses, $700,000 pieces of jewelry and artwork any time the Wyly family demanded it.
Lawyers for the Wylys claimed that they intended for the trusts to be legally proper and that they relied upon lawyers and tax professionals to make sure the trusts were operated lawfully. They point out that the Wylys paid tens of millions of dollars in taxes once they learned there were questions regarding the legitimacy of the offshore trusts.
But Judge Houser, who heard more than three weeks of testimony and reviewed thousands of pages of legal and tax documents, described the trusts as a “tax scheme implemented… in such a way as to attempt to shield the Wylys from this outcome is equally clear.”
In their separately filed appeals this week, the Wylys attacked Judge Houser’s findings by saying that she:
- Relied too heavily on a decision by a New York federal court in a separate but related case that concluded that the Wylys violated federal securities laws in their creation and management of the offshore trusts;
- rejected the Wylys reliance on their lawyers and outside investors that the offshore trusts were legal and proper;
- ruled that the offshore trusts were actually controlled by the Wylys, instead of independent trustees;
- declared that the Wylys intended to violate federal tax reporting laws;
- slapped the Wylys with hundreds of millions of fines and penalties in violation of the Eighth Amendment’s prohibition against excessive fines.
“A reader of the bankruptcy court’s 427-page opinion would be forgiven for believing this case is dizzyingly complex,” Sam Wyly’s brief states. “But in essence, it is actually quite straightforward. It turns on the tax status of several foreign trusts created for… Wyly in 1992, 1994, and 1995.
“Securities Sam owned were transferred to subsidiaries of foreign trusts in exchange for private annuities that would be paid to Sam years later, after his retirement,” the brief continues. “If those trusts were ‘grantor’ trusts, meaning that he remained the trusts assets’ owner for federal income tax purposes, he had to report trust/subsidiary income; if they were non-grantor trusts to Sam, meaning someone else owned the assets, Sam would have to report income only when he received annuity payments.”
Judge Houser ruled that Sam Wyly owed $135 million in unpaid taxes and nearly $1 billion in penalties and interest.
“None of Sam’s specialist tax advisors told him the trusts were grantor trusts to him.” Wyly told the Fifth Circuit. “It was not until 2003 that Sam learned that one advisor of many, Charles Lubar, had previously concluded there was a ‘significant risk’ that some of the trusts could be treated as grantor trusts to him. Sam significantly overpaid his taxes in 7 of the 22 years at issue — hardly the actions of someone seeking to defraud the IRS.”
Josiah Daniel, James Lee and Paul Heath of Vinson & Elkins in Dallas represent Sam Wyly.
Kathleen Sullivan of Quinn Emanuel, Stewart Thomas of Hallett & Perrin and David Coale of Lynn Pinker Cox & Hurst represent Dee Wyly.
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