Apr 1st 2013
By Teresa Ambord
As a former defensive player, Bill Romanowski should've seen this latest round of trouble coming, but he didn't. Having been a linebacker for several teams over his career – the 49ers, the Eagles, the Broncos, and the Raiders – he's seen his share of controversy. He broke the jaw of a quarterback, spit in the face of an opposing wide receiver, and ended the career of a teammate with a punch to the eye at training camp. He's made news for all the wrong reasons. Now a decade after retiring, he's back in the headlines. In a scrimmage with the IRS, Romanowski and his wife, Julie, ended up owing $4.6 million in federal taxes after the tax agency denied over $13 million in business losses they claimed on their 2003 tax return.
Here's what happened
Following his retirement from football in October 2003, Romanowski and his wife contacted an attorney about finding a way to shelter some of their income for the previous five years, 1998-2002. Their attorney, Rodney Atherton, recommended ClassicStar, a horse-breeding company based in Kentucky. ClassicStar owned mares that were leased out for breeding to thoroughbreds. The agreement was that foals produced from the breeding would belong to the investors.
As part of the sales pitch, an accountant for ClassicStar provided the Romanowskis with an "NOL illustration," which detailed the exact amount of loss they would need to show from horse breeding to offset their income from the five years in question. That amount was $13,092,732. With that information, the couple invested that exact amount, forming Romanowski Thoroughbreds, LLC.
ClassicStar encouraged would-be investors, including the Romanowskis, to borrow the funds to invest from National Equine Lending Co. (NELC), which was actually a shell funded entirely by ClassicStar. Later, court records would show that when a loan was requested, ClassicStar would transfer the money into NELC, which would lend the money to an investor and then give it right back to ClassicStar, often within a day. To make their investment, the Romanowskis borrowed $11.8 million from NELC.
Soon after their investment was made, things started to go wrong. With little knowledge of horse breeding, the couple relied on ClassicStar to handle the details. They were promised sixty-eight pairings with thoroughbred horses. But as Forbes magazine put it, the horse daddies were more like Mr. Ed than Secretariat. Also, only about 10 percent of the foals were delivered as scheduled. Still, the Romanowskis stayed in the deal, based on oral agreements from ClassicStar that it would perform better.
The tax return
ClassicStar later provided the Romanowskis with a statement showing no income, but expenses of $13,092,732 for 2003. That gave them a carryback for the five previous years, wiping out all the income for those years and resulting in federal refunds of more than $4 million. Most of that refund was used to pay back part of the loan from NELC.
It took awhile, but in 2010 when IRS agents took a closer look at the Romanowskis' tax return, they fully denied the loss. An analysis by the tax court concluded there was little evidence the Romanowskis had entered the horse breeding business for profit. A few of the points the tax court made included:
- The taxpayers kept no records, relying fully on ClassicStar to do that.
- They didn't consult industry experts on how to make a profit from the venture.
- When they discovered that ClassicStar didn't deliver according to the agreement, the taxpayers did little to rectify the situation.
The court said there were clear indications that the couple hadn't acted in a businesslike manner. But the most telling evidence was that subsequently, the Romanowskis used the loss to overturn their tax liabilities from the previous five years and produce a refund. When the court weighed the case against nine factors used to differentiate between a business loss and a hobby loss (see sidebar), the decision was easy.
The court said: "We believe petitioners' participation in the program was almost entirely motivated by tax benefits available to them through such participation. . . . we find that petitioners' horse-breeding activities were not engaged in for-profit, and the related expenses are therefore not deductible under Section 162 or 212 for the years at issue."
The Romanowskis challenged the court ruling. In 2013, Judge Joseph Goeke issued the opinion that the taxpayers were liable for the taxes because they failed to meet most of the requirements for claiming related expenses. However, because they relied on the advice of Atherton and another independent attorney, the Romanowskis wouldn't be charged penalties.
"We recognize that tax planning is often a consideration when deciding whether to enter a business," Goeke wrote. "However, this case does not represent a normal instance of tax planning. Rather, we believe [the Romanowskis'] participation in the program was almost entirely motivated by tax benefits available to them through such participation."
What happened to ClassicStar?
One equine attorney – Joel Turner of Louisville Kentucky – said of ClassicStar, "They were selling these horse-breeding investments as tax shelters in such a brazen way. This Machiavellian scheme created a bunch of taxpayer victims, and they are now dealing with the fallout."
According to the Paulick Report (a publication for thoroughbred news), the principals behind ClassicStar all pled guilty to committing tax fraud totaling $200 million. They included ClassicStar's former marketing director David Plummer and his son Spencer, John Parrott, and accountant Terry Green. In 2011, US District Judge Joseph M. Hood awarded $65 million in damages to a group of ClassicStar investors, stating:
"Plaintiffs have set forth a compelling and well-supported account of how defendants misrepresented the reality of the mare-lease programs offered through ClassicStar and how, acting together, they took plaintiffs' money to use for their own ends, then worked to prevent the discovery of the ruse and to perpetuate the cycle of investment."
While that conclusion was good news for those investors, the Romanowski case shows that just because taxpayers get scammed by such a fraud, it doesn't let them off of the hook with the IRS for their participation.