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Yesterday we covered the impending expiration of the VCI 2 program which is designed to protect taxpayers with tax shelters from prosecution. In addition to helping taxpayers avoid tax fraud charges, the VCI 2 is also designed to decrease the sometimes sizeable penalties associated with underreporting income or engaging in abusive tax avoidance practices.

One billionaire banker recently avoided penalties associated with a billion-dollar tax shelter. The Texas-based billionaire banker is accused of using “distressed asset debt” shelters multiple times to rack up as much as $4 billion in fake losses. A federal circuit court recently upheld the IRS’ disallowance of his losses from the DAD tax shelter but spared him of the penalties. The IRS believes that the so-called DAD tax shelter allows taxpayers to create false losses to shield otherwise taxable income. Taxpayers allegedly use DAD shelters to buy junk foreign assets for pennies on the dollar and then claim huge losses. The losses claimed are typically sustained by foreign lenders and the sole purpose of these transactions is to shield other taxable income.

So how was the banker able to avoid a penalty? The federal court held that the bank had “good cause” to believe that the DAD shelter would work and therefore wasn’t liable for penalties.

DAD shelters were a favorite of many wealthy taxpayers including a Broadcom co-founder who is currently involved in tax litigation with California and the IRS over losses claimed based on junk debt from China and Korea. The businessman allegedly attempted to claim $290 million in losses over a three year period based on a $6 million investment in the junk debt.

We will discuss further developments in the DAD shelter litigation next week.

Source: Forbes, “Appeals Court Nixes Billionaire Beal’s $1.1 Billion Tax Shelter,” Janet Novack, Oct. 2, 2011