In 1999, Mr. Webber created a grantor Alaska Trust (Alaska has no income tax) to purchase two private placement insurance policies for about $700,000. Private placement insurance allows a taxpayer to invest the premiums into hedge funds and privately owned companies, but requires several rules to be followed to prevent the income of the policy to be included in income by the taxpayer.
As you can probably guess, Mr. Webber did not follow all of the rules (according to the IRS). For example, a primary rule is that the owner of the policy cannot fully direct the investments that the policy will make. The owner can advise, but the insurance company has the final say in the matter.
In the Webber case, there was an "independent" investment manager (paid only $2,500 per year) that was required to do full due diligence and determine the final investments. The attorney that helped set up the plan for Mr. Webber made sure that Mr. Webber did not directly deal with the investment manager, but the more than 70,000 emails between Mr. Webber, his attorney and accounting assistant certainly indicated that he was fully in charge of the investment decisions.
The IRS has issued several Revenue Rulings over the years dealing with these types of investments and the Tax Court gave deference to these rulings and therefore, ruled in favor of the IRS and held that Mr. Webber should have reported all income from the two policies. All told, by investing $700,000 in 1999, Mr. Webber was able to generate about 12.3 million of wealth by the end of 2007. This is the primary reason the IRS audited Mr. Webber, in my opinion. If the insurance had decreased in value, there would be no audit.
The bottom line is that sophisticated estate plans require taxpayers to follow the rules and as indicated by the Webber case, most of them fail at this and sometimes it can cost a lot of money (in Mr. Webber's case the cost was close to $1 million).