(December 19) – “Merrill Lynch saved AlliedSignal $180 million,” writes David Cay Johnston in today’s New York Times.

“A division in Merrill’s army of bankers, lawyers and accountants — known as the financial engineers — had invented a way for AlliedSignal to escape taxes it owed the federal government on the sale of an oil business.”

“The scheme worked this way: the company transferred the taxable profit on the sale to a newly created partnership with a foreign company, which turned around and returned the same amount to AlliedSignal in a way that made it no longer count as taxable profits.”

“For their efforts, Merrill and its associates got a cut of the savings — $25 million, or more than 13 cents on every dollar rescued from the government.”

“For decades, accountants and lawyers charged by the hour for advising corporations on how to arrange deals to legally avoid as much tax as possible. But the business has changed in two significant ways. First, Merrill and others decided they could create business deals that existed only on paper and could wipe out enormous tax bills. Second, they could demand a cut of the savings for devising the techniques that make the deal look real. The bigger the savings, the higher the fee.”

“As companies have discovered how much money these deals can save them, Wall Street bankers, lawyers and accountants have rushed in to serve them. All of the Big Five accounting firms — PricewaterhouseCoopers, Ernst & Young, Deloitte & Touche, KPMG and Arthur Andersen — now charge corporations a fee based on the savings from tax shelters they design and sell. So do big investment houses, notably Merrill Lynch, Goldman, Sachs and Bear, Stearns.”

“Some of their colleagues in these fields are appalled. They say that many of these tax shelters are illegal because they have no business purpose; they exist only to avoid taxes. They say that such shelters would be much less likely to be approved by advisers who are not compromised by the possibility of profiting handsomely from work that requires strikingly little time.”

“Indeed, the United States Tax Court ruled the AlliedSignal deal, struck in 1990, was a sham, and an appeals court upheld that decision earlier this year. AlliedSignal, now called Honeywell and planning to merge with General Electric, is appealing. Merrill Lynch sold a similar shelter to 10 other companies.”

“But few tax shelters are uncovered by an Internal Revenue Service whose resources have been significantly reduced in recent years. And even if one is discovered, penalties are rare. Criminal prosecution is almost unheard of. And, as in the AlliedSignal case, the Treasury is still without the money while appeals drag on for years.”

“In short, the money to be made can seem well worth the very small risk of being caught. That is why the tax shelter business is thriving to an extent that worries even some people in the field.”