Master Recordings: Shelter Draws Heavy Fire From IRS

Sometimes even an financial expert can make a bad investment.

Take Louis Rukeyser, for instance, the sophisticated host of “Wall Street Week” on public television to whom millions turn for economic sagacity.

He recently filed suit in tax court challenging an Internal Revenue Service claim that he and his wife owe nearly $500,000 in back taxes and penalties because the IRS disallowed losses from several tax shelter investments that he made in 1980 and 1982.

The alleged deficiency for 1980 grew out of the IRS’ refusal to allow the Rukeysers an investment tax credit on master recordings that he’d purchased, as well as a $36,000 loss claimed as a result of the investment in the recordings.

Rukeyser is currently on a lecture tour and could not be reached for comment, and a spokesman said that on the advice of his lawyers, Rukeyser is not answering any questions while the matter is in litigation.

With his investment in master recordings, Rukeyser joined thousands of others across the country who invested in what IRS Commissioner Roscoe L. Egger has called one of the most flagrantly abusive tax shelters in recent years.

Since 1979, when the marketing of master-recording tax shelters began mushrooming, the IRS and the Justice Department have come down hard on both shelter promoters and investors. The tax reform bill about to be enacted by Congress will effectively eliminate such investments as a means to reduce tax liability, but experts say it will be years before the effects of the most abusive shelters are ended.

Last January, a New York businessman pleaded guilty to charges that he conspired to defraud the IRS of about $9 million in tax revenue through the sale of 160 purported master recordings by such popular artists as Olivia Newton-John, The Who, Kenny Rogers, Barbara Mandrell and Billy Joel, among others.

In April, three men who allegedly masterminded the Koala Records tax shelter--often called the “granddaddy of them all”--were indicted in Los Angeles on charges of conspiring to defraud the government out of more than $28 million. Sold between 1979 and 1981, the Koala shelter involved 5,200 investors nationwide and 1,551 master recordings. The three men face possible prison terms of up to 227 years.

A master recording is the original, studio-produced multitrack tape from which commercial recordings are made. In cases uncovered by the IRS, however, the masters sold as tax shelters generally are older, obscure recordings, studio practice sessions called “outtakes” or non-professional recordings “bootlegged “ from radio programs.

Rarely do such “masters” have any real commercial value, according to the IRS.

Sold Out ‘Back Door’

In many cases the recordings have been acquired without proper title--they’ve been sold “out the back door” by recording studio or record company employees, record producers or even by the recording artist’s manager.

“The artist almost never knows this is occurring and is not getting paid royalties,” said Claire Fallon, a spokesman for the Justice Department in Washington. “I don’t believe we’ve had a case where an artist sold anything to anyone.” But it is often the allure of the artist’s name that attracts the investor.

“We had one woman who invested in a recording because she had always liked that particular artist and wanted to help him out,” Fallon said.

“The tragedy in this is that investing in a recording is something the average consumer can readily relate to--they can see their investment on a shelf,” said Walt Dunnigan, the public affairs officer for the IRS in Detroit. “There have been so many cases of people putting their life savings in these only to have it all disallowed two years later.”

According to the IRS, a typical master-recording tax shelter involves the overvaluation of a master recording through a series of sham transactions at the seller level rather than the investor level. The scheme usually operates in the following manner:

An entity that purchases a master recording for, say, $100, sells it to a production company for $2,500. The production company then obtains a rigged appraisal and sells the master to a tax shelter promoter for $250,000 (or 100 times the original cost). However, the promoter actually pays only 1% of that amount in cash (or the original $2,500 cost) and executes a “recourse note,” for the balance, to be paid in the future from the proceeds of the master-recording sales.

The promoter then leases the master to an individual investor or a limited partnership for $16,000. The promoter elects to pass through to the investor the investment tax credit, which is based on the $250,000 price ostensibly paid by the promoter for the master. The buyer thus can claim an immediate investment tax credit refund of $25,000 (10% of the $250,000), resulting in a first-year profit of $9,000.

Designed to Evade

In the Koala case, the IRS says the government paid out more than $60 million in fraudulent investment tax credit claims.

One creative financing aspect of the typical shelter is that the promoter often will lend the buyer the cash needed to invest in the shelter--at 20% interest--until the buyer gets his tax refund, which usually takes only 90 days. Thus, the government is in effect putting up the front money for the scheme.

The IRS contends that such shelters are abusive because they are “lacking in economic reality”--that the primary objective is to evade taxes rather than reap profits from the sale of records. In most cases, very few records are ever manufactured--anywhere from several hundred to a few thousand per master, as opposed to the hundreds of thousands or even millions that would need to be sold in order to return a profit.

“It doesn’t make any difference to the investor if nothing happens as far as sale of records from the master, because within a short period of time he has his money back and them some,” Dunnigan said.

In some cases, the purported master recordings don’t even contain music. In 1982, a Beverly Hills-based operation made an offering called Face-to-Face that involved the leasing of audio recordings of three-minute news interviews with Bob Hope, Henry Kissinger, Moshe Dayan and Menachem Begin. The same firm sold another shelter called One-on-One, which involved the leasing of religious interviews with professional athletes such as Los Angeles Lakers star Magic Johnson, Merlin Olsen, Roosevelt Grier and Elgin Baylor.

According to the IRS, 135 investors leased more than 400 masters in the two shelters, resulting in estimated lost tax revenue of $5.7 million.