The lure of distant shores
Time was, people who wanted to avoid taxes flew their ill- or well-gotten gains to a country that levied little or no tax, a so-called tax haven. Among the more popular destinations: the Bahamas, Bermuda, the Cayman Islands, the Isle of Man and Panama.
With the help of local lawyers and financiers, tax escapees established a trust or a corporation into which they deposited their assets. Doing that transferred ownership to a non-U.S. citizen not liable for taxes. And privacy laws kept the IRS from discovering what was going on.
That era is fading away. Congress has passed dozens of laws over the years to make sure that earnings even in far-off Dubai or Andorra are taxed. And the IRS has to some degree penetrated bank secrecy laws. Still, in the quest for zero taxes, plenty of people try to find ways around the laws (or within the gray areas). According to one estimate, the U.S. loses $40 billion to $70 billion a year to offshore tax havens.
A 2006 Senate subcommittee investigation into a vast tax shelter associated with brothers Charles Jr. and Sam Wyly, Dallas computer billionaires and owners of Michaels crafts stores, offers a rare chance to see how such arrangements can work.
Starting in 1992, the committee found, the brothers, both now in their seventies, moved $190 million in stock options and warrants into 58 corporations and trusts in the Caymans and the Isle of Man in exchange for annuity agreements. According to their adviser, the Wylys would owe no taxes until the annuity payments started a decade later. (Of course, they would trade low-tax capital gains for higher-tax annuity income - not the wisest move.)
The offshore entities exercised many of the options and earned millions over the years, but the Wylys' adviser maintained that the brothers had no control over them and therefore owed no taxes while the money was abroad.
But Senate investigators found that the Wylys brought the money back to the U.S. in the form of low-interest loans. With those tax-free dollars, according to the Senate report, the Wylys made extensive real estate purchases, including a $45 million, 244-acre ranch near Aspen, Colo. and a $12 million, 95-acre ranch outside Dallas.
They also showered their families with artwork and jewelry, including a $622,000 ruby and a $759,000 emerald necklace. To top it all off, they spent $721,000 on documents from the Lincoln presidency.
William A. Brewer, the Wylys' lawyer, says that the brothers didn't direct investments that were made; they merely made suggestions. He adds that they're repaying the loans and are now paying taxes on the annuity income.
Although several government investigations are under way, the Wylys have not paid any extra taxes, fines or penalties. Says Brewer: "They were just following the advice of their tax adviser."
Can You Do This? Very few overseas tax dodges meet the very technical requirements of U.S. law, according to Vernon Jacobs, a C.P.A. and co-author of Offshore Tax Strategies.
You could move to another country and earn less than $87,600 in 2008 - that's the foreign earned income exclusion. But unless you choose a no-tax jurisdiction, you will have to pay local taxes there (Hello, income-tax-free Bahrain and Mauritius).
You could also renounce your citizenship and leave the country. But there are catches. The U.S. will still tax your income for 10 years if you move only to avoid taxes. So if you bid farewell to the U.S. in 2007 and your net worth is more than $2 million or your annual tax bill exceeds $136,000, the IRS simply assumes that you have moved to Vanuatu not for the gentle breezes but for its lack of income taxes.
As for offshore tax shelters that let you remain on these shores, don't assume you'll walk as free as the Wyly brothers do. In 1999, John Mathewson, controlling shareholder in Guardian, a Cayman Islands bank, agreed to rat out depositors in exchange for a lower sentence on a cable piracy scam. They had deposited money in his bank and used credit cards to tap the untaxed cash. In 2004 the IRS settled 1,200 cases for a total of $3.7 billion in fines and back taxes. That's about $3.1 million for each zero-taxpayer wannabe.
