The Case Of Ernie Ryder And When Tax Shelter Promoters Drink Their Personal Koolaid

Ernie Ryder’s Tax Shelters Worked About As Well For Him As They Did For His Clients

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In Ernest S. Ryder & Assoc., Inc. v. CIR, the U.S. Tax Court ruled against a well-known San Diego area promoter of aggressive tax strategies, Ernie Ryder, in relation to questionable deductions that he and his wife took for many years. However, his wife was held not to be liable for the penalties and some of the penalties sought by the IRS were lost because the Service occasionally bumbled the procedures.

The opinion of the Court runs for 191 pages and you can read it here. Suffice it to say that Judge Holmes writes this opinion in an interesting and readable fashion, and it is well worth the time for tax professionals to digest.

Judge Holmes recites the allegations of the IRS that Ernie Ryder set up a business called Ryder & Associates, Inc., APLC (“R&A”), which marketed six aggressive tax strategies from 2003 to 2011, and thereby generated $31 million in revenue ― and yet paid no income taxes. Instead, the revenue flowed into a labyrinth of some 560 bank accounts, other Ryder-related entities, an amazing 1,100 ESOPs, and into Ryder’s ranches in Arizona and New Mexico. Ernie and Patricia Ryder ultimately received more than $15 million in distributions, “but paid only $31,000 in income tax during the years at issue.”

Ryder marketed six tax strategies, the first being a disability income policy sold through an alleged captive insurance company in the Turks & Caicos called American Specialty Insurance Group, Ltd. (“ASIG”), and which had a Las Vegas post office box that forwarded mail to Ryder. A person using this strategy sent in a premium for the DI policy, of which 2% was an annual policy fee and the rest went into a Charles Schwab account. The idea was that the DI policy would be deductible on the front end, but the participant could take the money out tax-free at a later time if they became disabled, or merely turned 60. The IRS challenged at least one of these policies in the case of Estate of Barnhorst v. Commissioner, T.C. Memo. 2016-177, and basically found the arrangement to really be just a deferred-compensation arrangement (where the money coming out of the policy was indeed taxable), “despite its stated title”. Nonetheless, for the years 2003 to 2011, the sale of these policies generated a little over $1.28 million in revenue for Ryder.

The second Ryder tax strategy was known as the “group factoring” strategy, and which also saw at least one of Ryder’s clients blow up in using the strategy in Pacific Management Group v. Commissioner, T.C. Memo. 2018-131. That strategy appeared to be a legitimate factoring arrangement, but the funds actually circled back to Ryder’s clients who participated in the deal, “with some leading out to R&A itself”. As Judge Holmes summarized it: “Instead of factors that paid for these accounts and then collected them, the clients themselves continued to bill and collect these accounts as if they’d never sold them. The factors were straw men who received no meaningful economic benefit in return for the money they paid out to the clients.” The IRS alleged that Ryder’s fees for this deal were a little less than $1.85 million.

Moving on to the third Ryder tax strategy, Judge Holmes described an employee leasing arrangement whereby Ryder’s clients basically terminated their employees and had them immediately re-hired by an employee leasing company which leased them back to Ryder’s clients and then skimmed the profits for the benefit of the clients (and Ryder) thereafter. The gross receipts to R&A for this deal was just short of $5.17 million.

The fourth Ryder tax strategy was known as the “staffing product”, and it was similar to Ryder’s employee leasing deal but tied an ESOP to the arrangement so that Ryder’s clients could attempt to avoid even more taxes. This deal was even more lucrative for Ryder, at least according to the IRS, as it raked in more than $6.69 million in gross receipts paid to Ryder-affiliated entities.

We now come to the fifth Ryder strategy, known as the “General Counsel Office”, which Judge Holmes described as “unusually creative”, and further that:

“He created hundreds of new corporations, none of which had any existence except on paper, with the plan to draft them into a reserve army awaiting deployment in his clients’ battle against taxation. He came up with a uniform pattern ― he had each S corporation’s board (of which he himself was the sole director) appoint him as vice president/general counsel, and R&A employee DeAun Castro as vice president/ESOP administration. Ryder then filed 2001federal income tax returns as of December 31, 2001 for the corporations not yet assigned to a client. Every return reported gross receipts of $100 and expenses of $97. None reported owing any tax on the resulting $3 in taxable income.”

Basically, a Ryder client had to buy into this arrangement and only then was granted access to one of R&A’s shelf companies and related ESOPs that Ryder kept in inventory, plus pay a $25,000 “documentation fee” to yet another Ryder-affiliated entity. Apparently, the idea here was that these pre-formed shelf companies and ESOPs would be available either for past-years’ filings or they would be grandfathered-in to the older, more favorable rules should the ESOP rules change. But as Judge Holmes’ noted: “This product was fairly short lived because the IRS learned about such deals and made them a listed transaction.” Ryder then made modifications to the deals, but at any rate the IRS alleged that they generated another $3.5 million in fees to Ryder.

That now brings us to the six and last Ryder tax strategy, which was Ryder’s version of the infamous Son-Of-Boss tax shelter that basically used a stack of paper to generate losses culled from the fog that Ryder’s clients would then use to offset gains elsewhere. This deal generated a little short of $1.64 million in fees for Ryder-affiliated entities.

Ultimately, none of Ryder’s six tax strategies worked in the sense of technical tax law, other than perhaps for those of his clients who won the audit lottery because the IRS caught on to their shelters until too late. But these six tax deals not only describe the low-tax koolaid that Ryder was selling to his sucker clients, but they also describe in some part or another the very same koolaid that Ryder himself drank to try to avoid his taxes on the massive fees that he was receiving ― and it turned out that not only did Ryder’s tax deals not work for his clients, but they didn’t work for him and his wife either.

Ryder eventually purchased five ranches in Arizona and New Mexico, and then looked for ways to squirrel money (tax free, of course) to these ranches. To do this, Ryder used what he called “blocker entities” to try to disguise the true flow of cash and loans from his tax shelter businesses into the ranches. These were simply entities that were indirectly owned or controlled by Ryder, but which had the outward appearance of being independent third-parties. By a variety of transactions, moneys made their way from Ryder’s tax shelter businesses to the ranches, and he largely avoided paying taxes on any of it.

Then, in 2003, the IRS first showed up with an interest piqued because “someone noticed that the firm had applied to have ore than 800 ESOPs qualified at the same time.” This lead to more IRS investigations, and then to what Judge Holmes described as an “űberaudit”, and by the time Ryder was questioned by the IRS he pleaded his Fifth Amendment rights against self-incrimination. The California Franchise Tax Board then also became involved, and in 2010 executed a search warrant for R&A’s offices. Note: As far as I am aware, Ryder has not been criminally charged for anything.

Ultimately, the IRS denied many of the deductions taken by Ryder and his affiliated entities, and also assessed a variety of penalties against Ryder and his wife. Judge Holmes threw out the penalties against Ryder’s wife, and some of the penalties against Ryder himself, but by the end of the opinion Ryder was left with a healthy liability for taxes owed and penalties ― all for selling and then using for himself a bunch of junk tax strategies that didn’t work in the first place.

ANALYSIS

As I have described for well over 20 years now, there is in the United States what amounts to a tax shelter industry ― a finite segment of the economy devoted to doing nothing more than ginning up deductions and losses from whole cloth. This industry exists for three reasons, the first two of greed and stupidity relating to the users of these shelters, and the last being that the IRS audit rates are so low that some users do indeed get away with using them, at least for some tax years. The primary weapon that the U.S. has in dealing with the tax shelter industry is the promoter injunction lawsuit, but it is too infrequently used to be of any meaningful deterrent value. Thus, the U.S. Treasury loses a lot of revenue each and every year to tax shelters, simply because their audits, investigations, and ultimately enforcement actions and tax judgment enforcement, come years if not decades after the fact. Take this case as an example: Ryder was selling his junk as early as 2003, but we are now 18 years later before there is a determination that Ryder is responsible for just the tax on the fees that he made from it all. Thus, a tax shelter promoter like Ryder can generate tens-of-millions of dollars in fees but might die of old age before anything happens to him.

Very simply, Congress urgently needs to empower, fund, and mandate that the IRS and the U.S. Department of Justice (which brings the promoter injunction lawsuits), act much more quickly to identify and nip tax shelters in the bud before they blossom into huge fiscal losses to the government. The IRS Office of General Counsel also needs to pick up speed in identifying and listing transactions as abusive shelters ― and not with some amorphous “transaction of interest” designation as they did with certain 831(b) captive insurance companies.

For taxpayers who might otherwise get sucked into these deals, the solution is that same as it has been since there was a U.S. income tax: Get a truly independent second opinion from a qualified tax professional. Probably no putative client of Ryder’s that went and got an independent second opinion on Ryder’s junk would have gone forward with any of his transactions, but greed got the best of all his clients and they were happy to cut checks to Ryder to help them avoid the reach of Uncle Sam into their wallets. To the extent that they were caught and had to pay their back taxes and penalties, they got what they deserved. But that could easily have been avoided by allowing somebody not associated with Ryder to put a second set of eyeballs on his proposals.

Anyway, and as mentioned, the opinion in this case is very long but it is a good read, and probably a necessary one for tax professionals. Pay attention to Judge Holmes’ discussion about “economic substance” ― that means something.

CITE AS

Ernest S. Ryder & Assoc., Inc. v. CIR, T.C. Memo 2021-88 (July 14, 2021).