Clients of bankrupt money manager Reed E. Slatkin want the Internal Revenue Service to forgo its $11.8-million claim for unpaid taxes in the case, saying the government's demand would unfairly dilute the few assets available to pay investors.
The IRS' claim against Slatkin would "doubly penalize" investors who for years paid capital gains and income taxes on what were likely phantom profits, said Richard Wynne, attorney for the bankruptcy court creditors' committee that represents investors.
IRS officials said they could not comment on the case.
Slatkin, who had operated a money management firm in Santa Barbara since the mid-1980s, filed for Chapter 11 bankruptcy May 1 after being sued by investors. He is under criminal investigation for investment fraud.
Bankruptcy Court officials say investor claims in the case could reach $600 million. Slatkin has less than $30 million in brokerage accounts, Wynne said. Investigators believe another $100 million was funneled into real estate and limited partnerships, although the value of those holdings has not yet been determined, Wynne said.
IRS claims typically have high priority in bankruptcy cases, and are frequently paid in full before remaining assets are divided among other creditors, bankruptcy experts said.
Slatkin's investors could make a case that they paid more in taxes on bogus returns than the U.S. Treasury would recoup, but that argument is unlikely to sway the IRS, said Los Angeles bankruptcy attorney J. Scott Bovitz.
"I've never seen it happen" that the IRS withdrew a bankruptcy claim, Bovitz said.
Slatkin's investors paid millions of dollars in taxes over the years on the gains Slatkin showed on their quarterly statements, said investor George V. Kriste, a radio station owner.
In the last few years, Slatkin began reporting more short-term gains on his investors' statements, increasing their tax burden, Kriste said. Short-term gains are taxed at higher rates than long-term gains.
Investors may be able to amend their tax returns for the last three or four years to claim refunds if criminal investigators prove that Slatkin was operating a Ponzi scheme, with some investors' money used to pay bogus returns to other investors, tax experts said.
But tax law won't allow Slatkin's investors to claim refunds for taxes paid in earlier years. Federal law requires refund claims be made within three years after a return's due date. California has a four-year limit for state tax purposes.
The Securities and Exchange Commission alleged that Slatkin conducted a fraudulent investment operation since he began taking in money from a group of fellow Scientologists in 1985. Slatkin's unregistered money management business eventually expanded to include Hollywood celebrities, Internet moguls and socialites from across the country. Slatkin also was a co-founder of Earthlink Inc., one of the three largest Internet service providers.
Slatkin settled with the SEC last month, agreeing not to violate securities laws in the future while neither admitting nor denying the allegations. The criminal investigation into his activities continues, however.
The FBI in May raided Slatkin's home and offices, as well as the home of an associate, Ronald L. Rakow.
Rakow, a former manager for the Grateful Dead, pleaded guilty to one felony count of mail fraud in 1987 and was sentenced to a year in prison for his role in an Irvine-based milk-culture investment scheme. More than 27,000 people nationwide spent $80 million to purchase culture-growing kits after being promised their cultures would be purchased to make women's cosmetics.
State regulators said the operation was actually a huge, illegal pyramid scheme in which the cultures that were purchased were recycled into new kits to be sold to investors.