You Can't Cheat an Honest Man - James Walsh [31]
Despite the carefully laid foundation, there were parts of Sherbondy’s story that should have raised warning signs for his investors.
Most pointedly, Sherbondy made no effort to appear low-key or conservative. He boasted about his wealth and international connections. He claimed to control a British bank and several mortgage companies in Texas. He talked vaguely about a millionaire father who ran a European investment trust. He said that the Teamsters pension fund had invested in his tax shelters. And, as his scheme was beginning to unravel, he insisted that the Gulf War had frozen assets he’d invested with the Emir of Kuwait.
But even the Emir couldn’t help Sherbondy avoid the inevitable.
By 1991, Sherbondy was desperate to raise money to keep the scheme going. He tried the usual tactics—increasing his promised returns to even more unlikely heights and offering existing investors finder’s fees for bringing in new money. But he needed more than he could raise, so dividend checks started bouncing.
In 1992, a group that included most of Sherbondy’s investors sued him in civil court for embezzlement and fraud. Tom Laube, the attorney handling the case, was able to produce a $4.5 million verdict in the group’s favor—but Laube was unable to enforce the award because Sherbondy didn’t have enough money to pay it.
When Laube tried to collect the judgment, he discovered that Sherbondy’s father was not a jet-set financier. The old man was a penniless former laborer living in a trailer on the outskirts of Las Vegas.
In late 1993, the U.S. Attorney in San Diego filed a 51-count indictment against Sherbondy for the various frauds he committed in the course of operating his scheme. The indictment also included charges of filing false tax returns—an ironic conclusion to a story that began with promises of besting the IRS.
The Outlaw Mentality
People who have a strong aversion to paying taxes often are attracted to investments shrouded in secrecy. These people have an outlaw mentality which plays into the Ponzi perp’s plans. As one attorney says, “People who feel the government is stealing their money are easy prey for swindlers. They’re predisposed to cloak-and-dagger antics.”
Despite the outlaw mentality and cloak-and-dagger approach, the basic parameters that apply to tax shelters are—relatively—straightforward.
In order to take a depreciation deduction with respect to an asset, the asset must be used in a trade or business or held for the production of income. Furthermore, the asset must be ordinary and necessary to carrying on a trade or business or producing income.
While a profit is not required (and, in many cases, not desired), a business must enter activities with the intent of making a profit. This rule applies to most Ponzi schemes, because they are not created with the intent of making a profit. They are, by definition, frauds created to steal money.
Another IRS rule that limits the effectiveness of Ponzi or pyramid schemes as tax shelters states that activities which serve no “purpose, substance or utility apart from their anticipated tax consequences” are disregarded for tax purposes. The tax code states, in relevant part:
In the case of an activity engaged in by an individual..., if such activity is not engaged in for profit, no deduction attributable to such activity shall be allowed.
So, even if a particular pyramid scheme is not illegal, it may have no purpose other than to be a tax dodge. If the Feds find this out—and they scrutinize pyramid schemes—they’ll deny any benefit.
The last tax rule to consider is the most general. Federal law prohibits anyone from claiming a deduction for personal, living or family expenses which are not incurred in the conduct of a trade or business or in the production of income.
So, aside from all the other problems a pyramid scheme poses, it isn’t as safe a place to hide expenses