IRS pursuing doctors who did business with Xelan

February 1, 2005

Certain rules apply to the income the owner receives from renting the home and the expenses they incur from maintaining the home.

Q. It appears that the financial service firm Xelan, with whom I've been doing business, is now in trouble with the IRS. Could I be personally liable also?

A. This is indeed a complicated legal issue. According to the IRS, San Diego-based Xelan, Inc. persuaded physicians and dentists to buy large amounts of supplemental insurance, which it incorrectly represented as fully deductible to corporations the doctors owned. Among the many issues in the Xelan case is whether the insurance issued by the company's disability trust was insurance at all, and if it was, whether it served a legitimate business purpose.

According to court documents, the IRS's preliminary conclusion is that what was offered was not insurance. Additionally, federal agents claim in sworn statements that they found evidence that the Xelan-owned Barbados insurance company transferred more than $30 million of the doctors' insurance premiums back to an account in the name of Xelan's general counsel. The money was then used for legal fees to fight the IRS investigation and to defend some of the doctors being audited.

Xelan was recently shut down by the U.S. Department of Justice. The IRS contends in a civil fraud complaint that Xelan sold fraudulent tax-reduction schemes to doctors, who now could personally owe as much as $420 million in taxes, penalties, and interest. Certain court papers filed in connection with the case mention that hundreds of doctors have already been audited. This appears to be a prime example of how the high-profile marketing of allegedly aggressive tax schemes can end up with clients actually being chased down by the IRS.

This is the case despite the fact that the Xelan plans were seemingly well designed and apparently fully compliant with the law. The Xelan plan consisted of a collection of highly sophisticated plans put together by top nationally known tax professionals. Even if the plan documents were perfectly drafted, they can be deemed worthless if, as the Department of Justice contends, Xelan's representatives were making contrary statements to their prospective physician clients to induce them into the Xelan plan. Because the scheme was utilized by almost 4,000 doctors and dentists, was mass marketed, and certain inopportune claims about the plan were made by Xelan representatives, the government went on the offensive.

Five Xelan-related companies are now in Chapter 11 bankruptcy proceedings and are also the subject of numerous lawsuits filed by dissatisfied clients. The court has frozen more than $500 million in various bank and investment accounts. Depending on what the courts do, the physician clients, in the best-case scenario, may have their deductions ultimately upheld.

On the other end of the spectrum, the courts may also find that the physicians were willing participants in a fraudulent tax scheme and thus potentially liable for back taxes and penalties. According to court papers filed in connection with the case, hundreds of doctors have already been personally audited. The documents also show that the IRS used undercover agents to tape-record conversations with Xelan officials, including a former IRS agent and a lawyer who were representing some Xelan clients in their federal audits.

To obtain additional information, please visit the web site, http://www.xelanvictims.com/.

Q. We are considering buying a second home to be used for vacations and to rent out when we are not using it. What tax issues should we consider?

A. You are not alone. According to the National Association of Realtors, last year saw 445,000 purchases of second homes in the United States, representing a 25% increase from the previous year, with the trend expected to continue.