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— One misguided belief today is that if we lower tax rates of corporations and the rich, there will be less tax avoidance and evasion. Money stashed in offshore havens will float back to the U.S. Dubious tax-shelter deals will disappear. Bull. As tax rates go down, abusive tax shelters burgeon.

Now the Internal Revenue Service is cracking down. On November 4, federal court judge Thomas Whelan froze more than $500 million of assets belonging to thousands of doctors and dentists who bought allegedly abusive tax shelters from San Diego's Xelan, which boasts that beginning in 1971, it developed "an economic philosophy for doctors."

The Internal Revenue Service says it isn't philosophy: it's creation of fraudulent tax-avoidance schemes. The agency charges in a civil suit that 4000 health professionals who looked for loopholes through Xelan entities may owe as much as $420 million in taxes plus interest and penalties. It was one of the largest such actions ever, says the government. The New York Times put the story on its front page.

Also on November 4, the IRS raided Xelan's offices. Federal agencies are allegedly looking for evidence of criminal mail and wire fraud, as well as conspiracy against the government. Xelan, which has relationships with offshore tax havens such as Barbados and the British Virgin Islands, according to court records, was founded by the intense, fast-talking L. Donald Guess, a former San Diego dentist. Its tax-shelter products have been sold through a national network of related firms. With the IRS on their tails, some of the key entities filed for Chapter 11 bankruptcy in June.

As Xelan expanded over the years, so did Guess's exposure and ego. He featured himself in seminars, videotapes, and audiotapes. That strategy may have backfired. In February, a Pennsylvania federal judge, upholding the IRS's attempt to get certain Xelan-related records, ruled that Guess's own taped promotional words suggested that a "disability trust" he touted was more like a savings account than an insurance plan. On November 4, the IRS said the scheme was not insurance, but a deferred compensation plan that should be taxed.

The agency also focused on the Xelan Foundation, which was used by doctors to shelter income from taxes. However, they allegedly used the money for their children's college tuition or to reimburse themselves for volunteer work. That's like having your cake and eating it, too. Xelan's lawyers say the company's methods are legal.

Now, doctors and dentists who bought into Xelan's scheme are wondering what to do. "It may be better to consider cutting a deal early in exchange for immunity from prosecution than to wait until it is too late," counsels the xelanvictims.com website.

The IRS is now investigating more than 100 tax-shelter promoters, including those hawked by some of the largest banks and accounting firms. At the same time, people who paid big bucks to these firms to get the tax shelters, and then learned they didn't work, are getting a hair of the dog -- filing suits against the tax-shelter promoters. San Diegans Kevin Slatnick and John Sonnenberg are examples; they have sued several entities that provided them with tax shelters that didn't work. They want to recover the fees and tax penalties they paid.

The two engineers have been partners since 1994, when they started a wireless data band transceiver business, Sonik Technologies, in a garage. In 1999, they agreed to sell it to Vytek Wireless, Inc., then a privately held company. They would get cash and stock during 2000 and 2001. Therefore, they had a large cash windfall on which they would have to pay capital gains taxes. In financial magazines, they read about purportedly legitimate tax-shelter strategies that could offset those capital gains. The ads were placed by a Utah company, Cornerstone Strategic Advisers, and its principals, D. Michael Bishop and Roger Fuller. (The Department of Justice barred the now-defunct firm from promoting fraudulent tax schemes late last year.)

In early 2001, Slatnick and Sonnenberg each received $1.125 million in cash for their holdings in Sonik, according to the lawsuit filed by San Diego attorney Robert Scott Dreher. Cornerstone was aggressively courting the entrepreneurs, traveling to San Diego to stress the urgency of acting quickly, boasting of their experience and top-level connections. The Utah promoters said there would be an opinion letter from completely independent lawyers attesting to the tax shelter's legitimacy, according to the suit.

In December of 2001, Slatnick and Sonnenberg were told that a key player was Germany-based Deutsche Bank, which has more than a trillion dollars in assets. The so-called independent law firm that would give the opinion letter was Cantley & Sedacca, with offices in Georgia and Texas. But Slatnick and Sonnenberg had no idea that the law firm had been formed only nine months earlier "at Deutsche Bank's behest, specifically to help market the bogus tax-shelter packages," according to the suit. The law firm, said to have raked in $30 million to $40 million from the shelters, "produced canned, fill-in-the-blanks 'opinion' letters," according to the suit.

The key architect of the strategies was Clarion Capital of Westport, Connecticut, headed by Dan Brooks, a former employee of Deutsche Bank, according to the suit. On December 10, 2001, Slatnick and Sonnenberg each wired a $107,000 fee to Cornerstone. The same day, Brooks and a Deutsche Bank representative gave assurances that the tax shelter would work as advertised. Also that day, the San Diegans wired another $230,000 to the German bank for the creation of a partnership that was set up solely to generate losses in the trading of foreign-currency options. Those losses would, on paper, offset the capital gains from the sale of their business but would not actually be out-of-pocket expenses. Supposedly, the only cost would be fees for the tax-shelter service.

According to the suit, the shelter hawkers' strategy was "to incorporate the appearance of investment risk without actually exposing the client (or themselves) to any such risk, in order to generate predictable, large 'paper investment losses.' " However, Deutsche Bank was on all sides of the transaction. "The game was rigged," according to the suit. "Nothing actually traded, and it is unclear whether any transactions occurred at all." Deutsche Bank "had created a tax-shelter machine." But none of this was disclosed to Slatnick and Sonnenberg.

The Internal Revenue Service had said back in 1999 that losses from entities that were not formed for a legitimate business purpose, or deals that lacked "economic substance," would not pass muster. Any deal set up just to generate tax losses is not acceptable, declared the IRS back then, but Deutsche Bank and its minions kept trying new wrinkles to get around that decree, according to the suit.

Eventually, Slatnick and Sonnenberg learned that the shelter for which they had paid dearly would not work. "They voluntarily did the amnesty thing, said they would tell the IRS who did this," says Dreher. "They paid several hundred thousand to the IRS [for taxes owed], and now they are suing to get the money they paid, plus attorneys' fees." All told, they are asking for about $250,000 in the suit.

I called the defendants. Brooks refused comment. Deutsche Bank did not return calls. Says Bishop, who is no longer in financial planning, "The idea that somebody would go ahead with something, knowing it was banned by the IRS, is ridiculous. A tax protester might do that; it's the kind of thing a militia group would do, but it's a ridiculous idea that Deutsche Bank would say, 'Let's just go against the government.' "

Dallas attorney Steve Rasch, who represents the former law firm of Cantley & Sedacca, says, "The firm stands behind the opinions it gave and the legal work it did. As their lawyer, it is my view that everything they did was appropriate."

Deutsche Bank wants to move the case from court to arbitration. Snorts Dreher, " 'Arbitration' is a synonym for 'hide the documents, cover up the truth, avoid justice.' "

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