Thousands of wealthy Americans are paying dearly for questionable tax-avoidance schemes, and blaming the experts who proposed them.

"I was assured the transaction was low-risk and safe," recalled Peevey, now the president of the state's Public Utilities Commission.

A few years later, he and his wife, Assemblywoman Carol Liu (D-La Cañada Flintridge), heard from the Internal Revenue Service. By the agency's accounting, the couple owed Uncle Sam $2.36 million. The state would soon be demanding $1.1 million on top of that.

Peevey is now suing his accounting firm, Arthur Andersen, for $30 million. The firm, Peevey said, "let me down, and I think they took advantage of our long-standing relationship."

Tax evaders or victims, the La Cañada Flintridge couple have landed in the middle of a national uproar over questionable tax shelters. Peevey and Liu are among thousands of wealthy Americans who used the sophisticated strategies to avoid paying billions of dollars in taxes. Ordinary taxpayers are the ones harmed by this, says a former head of the Internal Revenue Service. "Everybody is paying 15% more than they should be to cover these free riders," said Charles Rossotti, who ran the IRS for five years until 2002.

Investigators say they are only now learning just how widespread the abuses are.

In California, state officials began to crack down last year, figuring they could collect an additional $90 million in back taxes. Regulators were stunned when they collected $1.3 billion from 1,200 taxpayers.

And now, California tax officials have put 40 more auditors on shelter investigations to see just how far the trail leads.

Federal agents, meanwhile, are sharing leads with investigators in California and other states on more than 28,000 taxpayers known to have used tax-avoidance schemes. One particular shelter that was mass-marketed to millionaires is believed to have cost the federal treasury $6 billion.

Michael Peevey's tax turmoil began in the summer of 1999 at a meeting in downtown Los Angeles with several officials from Andersen.

The accountants told him he could pay next to nothing, he said. Their strategy was rooted in a tax law intended to promote gifts to charity.

The plan called for Peevey and Liu to set up a charitable trust in Georgia. Under the terms of the tax-free trust, the couple would swap Peevey's company shares for other stocks. Accomplishing it all added thousands of pages of documents to their return. Andersen's interpretation of the tax code suggested that this would ultimately erase the capital gains taxes owed by Peevey.

After two years, the trust would be dissolved, and profits from it would go to Berkeley. And the initial $10-million investment would go back to Peevey and Liu, tax-free.

Months later, trouble began: Alarmed by trusts like the couple's, the IRS issued retroactive regulations prohibiting them. Now, taxpayers caught in the web of IRS and state tax investigations are scurrying to shift blame onto the partnerships that created the shelters.

Peevey, 66, said they were blindsided by their accountants.

"Arthur Andersen was one of the largest accounting firms in the world," Peevey recalled. "It had an excellent reputation and had represented me in conservative tax planning for roughly 15 years. I felt safe and secure."

At the time, Andersen was also the accountant for energy giant Enron. Andersen has since collapsed in the wake of the accounting scandal that led Enron into bankruptcy. Andersen does little now but handle the mountain of lawsuits following the collapse.

Andersen spokesman Patrick Dorton calls Peevey's lawsuit "an ill-advised attempt to protect his own and his wife's political futures."

Peevey's lawsuit is one of several filed by wealthy taxpayers nationwide against well-known accounting, law and banking firms, claiming they were duped into believing it was OK to skim millions off their returns. Tax attorneys predict they are the front end of a wave of hundreds of lawsuits that will be filed as more taxpayers are caught and forced to settle up.

"People are now having to pay the government, and they are extremely angry," said David Deary, a Texas attorney who represents 300 plaintiffs who are paying millions in back taxes and interest as part of a settlement with the IRS. Deary's clients typically paid hundreds of thousands of dollars to buy into the shelter plans.

"They are learning their trusted advisors and accountants and lawyers sold them a bill of goods," he said. "They weren't told a lot of information they should have been told."

Peevey and Liu paid Andersen $225,000 for their tax plan.

In many cases, tax officials say, the firms created shelters they knew were abusive but sought to paper them over with various complicated accounting maneuvers.

"It was clear these firms were banking on us not finding these schemes," said Rossotti, the former IRS chief. "The logic was, the IRS will never find out about it, and if they do find out it will take years to litigate, and you will only have to pay part of the taxes back."

The accounting firms say the tax code is extremely complex and much of it is open to interpretation. The firms note that clients were told upfront that these strategies were merely an interpretation of the tax code, one that the IRS and state tax officials could ultimately reject.

Signs of trouble for Peevey didn't come until two years after the energy executive moved his money into the shelter in 1999. By then, federal regulators were investigating Anderson as part of the Enron scandal, and they came across the tax plan sold to Peevey and about a dozen other clients.

By spring of 2002, the plan Peevey had locked himself into began to fall apart. The IRS informed Peevey he was being audited.

The news came to him as he was diagnosed with lung cancer and he was undergoing a tough confirmation process for his appointment to the utilities commission. Consumer groups charged that his background as former president of Southern California Edison made him too cozy with industry.

And the couple had already pledged the $1 million to UC Berkeley.

"They had wanted to give to a worthy cause, especially because all this money came in" from the sale of Peevey's business, said Darren Enenstein, the couple's attorney. "It wasn't a situation where they had to give to some charity in order to save on taxes. They wanted to give, and this seemed like a good arrangement."

As chairwoman of the Assembly Higher Education Committee, Liu, 63, is one of the state's most influential voices on the public university system. She also sits on the Board of Trustees for the UC Berkeley Foundation, an organization that raises private money for university programs.

Liu and her husband are making good on their pledge to endow Berkeley professorships in their names, even as they confront a tax bill for more than three times the amount of their gift. The lawsuit has brought unwelcome attention to the couple < especially during Liu's recent reelection campaign < but the assemblywoman told the Associated Press that they filed it because "we believe we were victimized."

Enenstein says that Peevey didn't call Anderson and say, " 'I want to play on the edge and do whatever I can to not pay anything to the government.' S What he was planning to do was pay his taxes and cash out his stock. He called them to say this is what is going on. They said, 'Wait a sec, you need to come on in.' "

Others wonder whether it was greed, not naivete, that led Peevey down the path to trouble with the IRS.

"I can't imagine someone saying, 'I have a $10-million capital gain and I will avoid paying taxes totally legitimately because this is all on the up and up,' " said Lenny Goldberg, a Sacramento tax lobbyist and consumer advocate.

Yet Peevey is just one of thousands of people who say they were duped into believing they could get away with not paying taxes.

Another self-made millionaire, Indiana computer entrepreneur Henry Camferdam, told a congressional hearing in October 2003 about his accountant's convincing sales job.

"None of us understood the deal," said Camferdam, whose four-person partnership paid $3 million in fees to accountants Ernst & Young and to Jenkens & Gilchrist, a large Texas law firm, for a plan to shelter $70 million from taxes.

"I quickly signed voluminous documents, which included documents for formation of limited liability corporations," he recalled. "I viewed it as like closing a mortgage loan, where it was, 'Sign the documents or go to another lender,' except that in this case, Ernst & Young was the only party we knew of who could eliminate our taxes, in their words, 'legally and conservatively.' "

Joseph Bankman, a Stanford law professor and a top tax shelter expert, says it is entirely believable that lots of wealthy taxpayers were snookered.

"Even if you were a sophisticated businessperson," he said, "it is easy to be snowballed by a smooth-talking, high-powered professional connected with a top accounting firm with a reputation for honesty."

The firms had reputable lawyers provide letters attesting to the legality of the tax plans and even offered insurance on the plans. The accountants pitched the strategies to millionaires created by the stock market boom of the late 1990s. And with federal and state revenues flush with cash, tax officials did little to stop it.

Then the economy faltered, state and federal revenues began to dry up, and tax officials resolved to look harder for the billions lost to the shelters.

The IRS is auditing 200 firms believed to have sold precarious tax strategies. As the agency uncovers evidence of potential tax evasion, it will seek to force those firms to turn over their client lists. The clients will then be audited. But those who have been involved in the hunt say the agency's hands are tied by the reluctance of Congress to get tougher with wealthy taxpayers and corporations.

"It's an uneven battle," says Bankman. "There are no lobbyists for the average citizen in this fight."

There are, however, plenty of lawyers for the accounting firms and taxpayers who get caught using the tax shelters. And right now, many of them are at war with each other.

In Peevey's case, the Andersen spokesman calls it "a clear example of an individual attempting to shift blame to an advisor for his own personal and financial gain."

Peevey's lawyer responds: "If he knew it was risky, he never would have done it."

Neither side is likely to be vindicated soon.

"This case will never be tried in a year," said Los Angeles Superior Court Judge Helen I. Bendix, who is presiding over the Peevey lawsuit, which could ultimately involve dozens of witnesses and mountains of tax documents. "Hopefully, it will be tried in two years."

Innocent lambs or pulling wool?

Article Published: in Los Angeles Times, Wednesday, January 12, 2005

WE were pleased to endorse the recent re-election of Assemblywoman Carol Liu, D-Pasadena, but we're having second thoughts about her judgment and that of her husband, Michael Peevey, head of the powerful regulatory agency, the California Public Utilities Commission.

We reported on May 7 that the pair had sued the accounting firm Arthur Andersen over shaky tax-shelter advice that landed the power couple in hot water with the IRS after they sought to donate $1 million to Liu's alma mater, UC Berkeley, but otherwise avoid paying out after a financial windfall.

What we didn't know at the time was that the donation was to have been made possible from a charitable trust set up to avoid paying any taxes at all on about $10 million in capital gains earned from the sale of Peevey's private energy company. That's $10 million gained and nothing to federal or state coffers, fellow taxpayers.

Perhaps that's why Peevey never returned our reporter's phone calls last spring when we tried to get details on the reason a tax shelter was deemed necessary.

By some interpretations, the shelter was at least technically legal at the time, although the feds have decided retroactively that such shelters instead qualify as nothing more than evasionary schemes.

On the surface, an argument can be made that Liu and Peevey undertook the shelter in good faith. Indeed, most of us look for ways to pay as few taxes as possible. And a federal agency applying the rule of law retroactively is controversial at best.

But the idea that the already very well-off would seek to avoid paying one penny in taxes on what surely qualifies as a fortune, even in these inflationary times, turns the stomach of those of us who pay a bundle each year to the federal treasury.

Perhaps if this was some GOP oil baron, it might be seen as business as usual. But from an Assembly member from the state party that wants to raise taxes while times are tough --well, it's shocking.

Is the reasoning here that such taxes are intended to be levied on all those except already well-off politicians and their partners and pals?

If Liu and Peevey wanted to do the right thing, they would have agreed to pay their fair share of taxes to Washington and Sacramento. Even if the accounting advice was unsolicited, it would still raise a red flag. But the couple sought the advice, and paid $225,000 for the privilege of setting up a shelter in Georgia, of all places.

Why have Liu and Peevey not explained these actions to the public? Are they hoping this will all blow over? But their only response was to sue Arthur Andersen for $30 million, an attempt to shift blame and claim victim status.

If public trust hasn't been erased by these revelations, we don't know what will do it. Perhaps their suggestions that they were duped -- didn't understand the complexities of the shelter -- is their way of smoothing things over with people who actually do pay taxes.

If those excuses are to be believed from two highly educated people, we have some questions easily understood by the unwashed electorate. Do we really need someone so bereft of financial savvy running a public watchdog agency?

Do we want a limousine liberal advocating do-as-I-say, not-as-I-do tax policy?

If these two are innocent lambs, it was the people they were attempting to fleece.