In re Wyly, CASE NO. 14-35043-BJH

• Decision Date: 10 May 2016
• Docket Number: CASE NO. 14-35043-BJH
• Parties: IN RE: SAMUEL EVANS WYLY, et al., DEBTORS.
• Court: U.S. Bankruptcy Court — Northern District of Texas

IN RE: SAMUEL EVANS WYLY, et al., DEBTORS.

CASE NO. 14-35043-BJH

UNITED STATES BANKRUPTCY COURT FOR THE NORTHERN DISTRICT OF TEXAS DALLAS DIVISION

May 10, 2016

(Chapter 11)

JOINTLY ADMINISTERED

Related to ECF Nos. 4, 75, 516, 923, & 938

MEMORANDUM OPINION

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I. JURISDICTION, AUTHORITY, AND VENUE ............................................................... 2

II. PRELIMINARY MATTERS .............................................................................................. 2

A. Factual and Computation Stipulations of the Parties ....................................................... 2

B. Facts Found Due to this Court's Application of Collateral Estoppel ............................... 3

C. United States' Motion to Exclude the Expert Report, Opinions, and Testimony of Joshua S. Rubenstein ....................................................................................................... 6

D. Dee's Motion for Partial Summary Judgment ................................................................ 17

III. FACTUAL AND PROCEDURAL HISTORY ................................................................ 17

IV. LEGAL ANALYSIS ......................................................................................................... 30

A. Burden of Proof .............................................................................................................. 30

1. Bankruptcy Law Burden of Proof - In General ............................................... 30

a) Prima Facie Validity under Bankruptcy Rule 3001(f) ................................... 31
b) Have the Debtors Raised Evidence of a Probative Force Equal to that of the Proofs of Claim? ................................................................................. 36

2. Tax Law Burden of Proof—In General ............................................................ 38

a) Gift Tax Deficiencies and the Presumption of Correctness ........................... 39

(1) Is the IRS' Determination "Arbitrary and Erroneous?" .......................... 40
(2) Burden Shifting under 26 U.S.C. § 7491 .................................................. 43

b) Fraud Penalties for Income Tax and Gift Tax Underpayments ..................... 47
c) International Failure to File Penalties ............................................................ 49

3. The Debtors' Defenses ..................................................................................... 49

a) Reasonable Cause Defenses ........................................................................... 49
b) Dee's Innocent Spouse Defense ..................................................................... 50

B. Was the Debtors' Underpayment of Income Taxes Due to Fraudulent Intent? ............. 52

1. Relevant Statutes and Badges of Fraud ............................................................ 55

a) The Complexity of the Offshore System ....................................................... 59
b) The Wylys' Willingness to Commit Securities Fraud to Preserve the Secret Offshore System and to Maintain its Tax Advantages ...................... 78
c) The Failure to Take Action to Resolve the Conflicting Advice Sam and Charles Received Regarding the 1992 IOM Trusts ....................................... 84
d) The Creation of False Documents to Support the Settling of IOM Trusts in 1994 and 1995 to Attempt to Obtain Favorable Tax Benefits for the Wylys ............................................................................................................. 87

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e) The Treatment of the Offshore System as the Wyly Family Piggy Bank .... 98
f) The Planned Insolvency of Various IOM Corporations that Owed Annuity Obligations .................................................................................... 110
g) Understatement of Income ........................................................................... 126
h) Concealment of Income or Assets ............................................................... 133
i) Offering False or Incredible Testimony ....................................................... 133
j) Offering Implausible or Inconsistent Explanations of Behavior ................. 137
k) Filing False Documents ............................................................................... 142
l) Failure to Cooperate with Taxing Authorities ............................................. 153

C. Was Dee Willfully Blind? ............................................................................................ 155

D. Is Dee Entitled to the Benefits of the Innocent Spouse Defense? ................................ 159

E. Did Sam Establish his Reasonable Cause Defense to the Imposition of Fraud Penalties for His Income Tax Underpayments? ........................................................... 177

1. The Defense in General .................................................................................. 177
2. The 1992 Private Annuity Transactions ......................................................... 185
3. The Settlement of the Bessie IOM Trust and the La Fourche IOM Trust and their Proper Characterization ................................................................... 203
4. The 1996 Private Annuity Transactions ......................................................... 208
5. Alleged Reliance on French ........................................................................... 216

F. Were Gifts Made to the Wylys' Children? ................................................................... 230

1. The Relevant Standards .................................................................................. 230

a) Defining a Gift ............................................................................................. 230
b) Determining the Underlying Substance of the Transaction ......................... 232

(1) The Economic Substance Doctrine ......................................................... 233
(2) The Substance Over Form Doctrine ....................................................... 234
(3) The Step Transaction Doctrine ............................................................... 234

2. Understanding the Transactions Alleged to be Gifts by Sam to His Children .......................................................................................................... 235

a) Formation and Funding of the Cayman LLCs ............................................. 235
b) The Real Estate Holdings ............................................................................. 239
c) Liquidation of the Cayman LLCs ................................................................ 245

3. Analysis of Alleged Gifts Made by Sam ........................................................ 246

a) Cash Used to Purchase, Improve, and Maintain the Cottonwood Ventures I and II Properties ......................................................................... 247

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b) Cash and Other Assets that were Transferred Into the Cayman LLCs ....... 258

(1) The Interests in IOM Real Estate Companies ........................................ 258
(2) Cash and Other Financial Assets Transferred to the Cayman LLCs ..... 262

4. Understanding the Transactions Alleged to be Gifts by Dee to Her Children .......................................................................................................... 265

c) Stargate Horse Farm .................................................................................... 265
d) Little Woody (LL Ranch) ............................................................................ 267

5. Analysis of the Alleged Gifts Made by Dee ................................................... 269

a) Cash Used for the Purchase, Maintenance, Improvement, and Upkeep of the Stargate Horse Farm and Little Woody (LL Ranch) Real Estate Properties ..................................................................................................... 269
b) The Promissory Note Due to Dee from the Caroline D. Wyly Irrevocable Trust ............................................................................................................. 274

(1) Overview of the Transaction .................................................................. 274
(2) Analysis of the Alleged Gift Made by Dee ............................................ 279
(3) Is Dee Liable for Fraud Penalties on her Gift? ....................................... 284

G. Are Penalties Owing for the Failure to File Forms 3520, 3520-A, and 5471? ............ 286

1. Introduction .................................................................................................... 286
2. Statutory Overview ......................................................................................... 287

a) § 6038 and Failures to File Form 5471 ........................................................ 290
b) § 6048(b) and Failures to File Form 3520-A ............................................... 295
c) § 6048(c) and Failures to File Form 3520 ................................................... 296

(1) In General ............................................................................................... 296
(2) Annuity Payments .................................................................................. 298
(3) Real Estate Transactions ......................................................................... 314
(4) Security Capital Loans ............................................................................ 316
(5) Sales of Options to IOM Corporations ................................................... 323

H. Did the Debtors Establish Their Reasonable Cause Defenses to the Imposition of International Penalties? ................................................................................................ 324

1. Introduction .................................................................................................... 324

a) Review of Provisions of § 6038 ................................................................... 325
b) Review of Provisions of §§ 6048(b) and

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