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(Bloomberg) — Former billionaire entrepreneur Samuel Wyly’s “difference of opinion” with the Internal Revenue Service could turn an offshore fortune into an onshore fraud if the agency gets its way.

Wyly, 81, and the estate of his late brother Charlesjoined forces for a trial Wednesday against the IRS in Dallas, seeking to wipe out the agency’s $3 billion claim for back taxes in their Chapter 11 bankruptcy cases.

The Wyly brothers, who developed companies including arts and crafts retailer Michaels Stores Inc., hid stock offshore and made illegal trades for 13 years, taking in $550 million in illegal profit, a federal jury in Manhattan found in 2014. That case, a victory for the U.S. Securities and Exchange Commission, triggered demands for years worth of back taxes and penalties by the IRS and forced Wyly and his brother’s widow, Caroline “Dee” Wyly, into bankruptcy.

The dispute in the latest trial hinges on the validity of trusts set up on the Isle of Man by the Wylys starting in 1992. Lawyers for Sam Wyly and his sister-in-law claim the trusts were legitimate, while the IRS argues they were used to avoid taxes and finance lavish lifestyles for family members from Texas to Colorado.

“It’s not fraud,” the Wylys’ lawyer, Donald Lan, said in his opening statement at the trial. “We think there’s an honest difference of opinion over the law.”

IRS lawyer Cynthia Messersmith said the case was about lies and “deception” surrounding one of the biggest tax frauds in U.S. history.

Evade Taxes?

The offshore structure was specifically designed to evade taxes, Messersmith said in her opening statement. The profits were repatriated to the U.S. through a variety of schemes, she said, including the trusts’ purchasing of jewelry, art, furnishings and other luxury items for use by the Wylys. The trusts also financed loans to family members and gifts to the brothers’ children worth millions of dollars, Messersmith said.

Sam Wyly testified for about 20 minutes before being excused for the day, due to what his lawyers said was a combination of his age and health. During that time, Wyly described his childhood growing up in small-town Louisiana, where he had a paper route, played high school football and became an Eagle Scout. At his lawyer’s prompting, Wyly recited the Boy Scout oath and also the Boy Scout law.

“A scout is trustworthy, loyal, helpful, friendly, courteous, kind, obedient, cheerful, thrifty, brave, clean and reverent,” Wyly said. His testimony will resume Thursday.

Lawyers for Caroline Wyly, who is also in her early 80s, have said the IRS lacks evidence that she systematically deceived the agency for 22 years. She was married to Charles Wyly for 56 years before his death in a 2011 car crash in western Colorado. She has said her husband’s death left her insolvent.

Caroline Wyly also testified that she and her husband never discussed taxes, trusts or any sort of business or financial matters. She said she knew nothing about how items for herself and her children were paid for, and that she didn’t know until three months ago that some of the art and jewelry in her possession was owned by an offshore trust.
During cross-examination, IRS lawyer John Blacker showed her a document she had signed related to the offshore trusts and annuity payments and asked Wyly whether she asked questions before signing it.

“I never asked a single question — never,” she said. “I trusted my husband.”
The case is In re Samuel E. Wyly, 14-bk-35043, U.S. Bankruptcy Court, Northern District of Texas (Dallas).

To contact the reporters on this story: Erik Larson in New York at elarson4@bloomberg.net; Tom Korosec in at tkorosec@texaswordworks.com To contact the editors responsible for this story: Michael Hytha at mhytha@bloomberg.net; Andrew Dunn at adunn8@bloomberg.net; David Glovin at dglovin@bloomberg.net Jeffrey Taylor