While many in the public may be familiar with tax lawyers, most people don’t usually associate accountants or their work with intense legal disputes. While following the letter of the law is crucially important in the accounting industry, and savvy accountants will have some familiarity with the complex American legal system, many accounting professionals today simply aren’t paying enough attention to certain cases that they can learn valuable lessons from.
One such case is Kornfeld vs Commissioner, an astonishing legal clash that’s as bizarre as it is interesting. Here are the facts behind the Kornfeld vs Commissioner case, and why accountants should read up on this dispute for their own good.
Julian Kornfeld’s gambit
Our story begins with a clever tax attorney who took a risky gambit in hopes that he could game the system’s shaky regulations in order to seriously cash out with the help of tax benefits. Julian Kornfeld, the attorney in question, realized that the way the IRS regulates bonds could be exploited with relative ease. That’s because bonds purchased by taxpayers aren’t depreciable for federal income tax purposes – if bonds were depreciable, they would be serious windfalls for whoever was clever enough to scoop them up. Kornfeld, however, discovered that he could essentially manufacture a depreciable bond by enlisting the help of his co-conspirators, his two daughters.
And thus, one of the most interesting and creative incidents of tax scheming in American history was born. According to the facts of the case, Kornfeld realized that he could actually transfer the ownership of the bonds in question to his two daughters by setting up a revocable trust, which he used to enter into an agreement with the two of them. The terms of the deal were simple; Kornfeld himself would purchase a life estate interest in a bond, and his two daughters would simply scoop up the remainder interested. Kornfeld sent his own daughters checks to facilitate the payments through his trust, and made clever use of the actuarial tables used by the IRS to figure out the value of his life estate interest.
The results were impressive – by making use of information derived from the actuarial tables and having their father send them checks in the appropriate amount, Kornfeld’s daughters were capable of paying their father’s revocable trust the amount owed in remainder interest. This is a pretty staggering level of tax trickery – it’s indisputable that Kornfeld’s creative genius gave the IRS a run for its money.
All schemes must come to an end
As always, however, all tax schemes must inevitably come to an end, and the IRS ultimately bested Kornfeld in the ensuing legal dispute that followed his bond scheme. The court ultimately determined that Kornfeld made a fatal flaw by relying on the help of his two daughters as his business plan writer team; by using his daughters to purchase the remainder interest, he had essentially acquired the entire ownership interest of the bonds in question. As a result of his, Kornfeld was found liable for income tax deficiencies, the very type of thing he had been trying to avoid with his clever plan.
What does this lesson teach accountants? First and foremost, it’s a stellar reminder to never go up against the IRS unless you’re 100 percent certain of your math. Kornfeld was essentially taking a risky gamble, and had to bank on nobody noticing or caring about his bond scheme in order to truly succeed. The IRS, however, was having none of it, and Kornfeld’s 100 percent ownership of the bonds in question acted as the final nail in his legal coffin.
As long as accountants exist, they’ll be applying their creative talents to the tax system in hopes of winning themselves, their firms, or their clients a better deal from Uncle Sam. Nonetheless, the Kornfeld vs Commissioner case reminds us that mere technical ingenuity and financial creativity alone isn’t enough – the rules of the law will virtually always overcome any clever scheming. The government has since acted to close some of the loopholes Kornfeld was hoping to exploit, too, meaning accountants should also take this as a lesson that they can’t follow directly in the footsteps of previous schemers.
Above all else, however, Kornfeld vs Commissioner reminds us that the legal and financial worlds are constantly intertwining. It’s impossible to be a good accountant without a clear understanding of the law, nor can even the most seasoned tax attorneys expect to prevail over Uncle Sam if they don’t have the letter of the law on their side. It’s probably too late for Kornfeld to read up on classic cases of accounting fraud, but savvy accountants who want to avoid similar legal disputes with the IRS in the future should brush up on the rule of law while they still can.
Gary Eastwood is a CPA licensed senior accountant from Seattle, Washington. He received his CPA license from the Washington State Board of Accountancy in 2001 before relocating to Onawa, Iowa in 2008. Over more than 15 years of accounting experience, Gary has worked with multinational health service providers and independent CPA firms. He has a proven ability in dealing with business clients from a variety of backgrounds as well as leading companies to greater efficiency and profitability. He is familiar with both US GAAP and China GAAP.