Big Four firms Ernst & Young and KPMG are being sued by clients for selling tax shelters that have been found by the Internal Revenue Service to be illegal tax evasion strategies.

In December we reported that four Indiana residents along with 45 other clients of E&Y sued the Big Four firm for $1 billion, alleging that the firm induced them into entering into what were known to be illegal tax shelters. In addition to paying $3 million in fees to E&Y, participants in the lawsuit paid $75,000 each for a letter from a law firm attesting to the propriety of the shelter.

KPMG has also experienced retaliation from clients in the form of lawsuits. Three North Carolina businessmen are suing the firm for advising them that the shelter they purchased need not be registered because it qualified as a "tax investment strategy" and was not a tax shelter. The IRS has called the investment a shelter and a scam.

This may be the beginning of a trend as the IRS continues to pursue action against high income taxpayers who use tax shelters to shield income. The New York Times reports that "tax experts and lawyers handling these cases said they expect a flood of similar cases" ("Wealthy Suing Accountants Over Rejected Tax Shelters," The New York Times, February 7, 2003). The accounting firms claim their clients were advised of a certain level of risk associated with the tax shelters.

In addition to paying hefty fees to the accounting firms, shelter participants in all cases paid a law firm for a letter giving credence to the shelter. In a New York Times article that appeared on Sunday, these opinion letters are described as a means of blessing the shelters and protection for shelter participants from possible penalties should the IRS rule the shelters are illegal ("Costly Questions Arise on Legal Opinions for Tax Shelters," The New York Times, Sunday, February 9, 2003).

The letters, which are often as long as 100 pages, offer assurances as to the validity of the shelter. Taxpayers rely on the letters as protection against penalties should the IRS rule unfavorably regarding the shelter. "The real value of opinion letters," according to the article, "is as a shield from government penalties for not paying taxes when they were due. Penalties are usually waived when a taxpayer relied on professional advice that the IRS regards as reasonable and given in good faith."

Since penalties for underpayment of taxes at the level represented by these shelters can be quite costly, the price of the opinion letter, which may be $50,000 or more, may seem like a bargain. "The opinion letter is essentially a get-out-of-jail-free card because penalties are waived," said U.S. Congressman Lloyd Doggett (D-TX). Representative Doggett has been an advocate of enabling the IRS to charge penalties in cases where taxpayers who invest in tax shelters use such opinion letters as a means of penalty avoidance.