Accountants, insurance professionals and others need to be
careful that they don’t become what the IRS calls material advisors.
If they sell or give advice, or sign tax returns for
abusive, listed or similar plans; they risk a minimum $100,000 fine. They will
then probably be sued by their client, when the IRS finishes with their client
The McGehee Family Clinic enrolled in the 419 Plan in May
2001 and claimed deductions for contributions to it in 2002 and 2005. The
returns did not include a Form 8886, Reportable Transaction Disclosure
Statement, or similar disclosure. The IRS disallowed the latter deduction and
adjusted the 2004 return of shareholder Robert Prosser and his wife to include
the $50,000 payment to the plan.
The IRS assessed tax deficiencies and the enhanced 30
percent penalty under Section 6662A, totaling almost $21,000, against the
clinic and $21,000 against the Prossers. The court ruled that the Prossers
failed to prove a reasonable cause or good faith exception.
In rendering its decision, the court cited Curcio v.
Commissioner, in which the court also ruled in favor of the IRS. As noted in
Curcio, the insurance policies, which were overwhelmingly variable or universal
life policies, required large contributions relative to the cost of the amount
of term insurance that would be required to provide the death benefits under
the arrangement. The 419 Plan owned the insurance contracts. The excessive cost
of providing death benefits was a reason for the court’s finding in Curcio that
tax deductions had been properly disallowed.
As in Curcio, the McGehee court held that the contributions
to the 419 plan was not deductible under Section 162(a) because the
participants could receive the value reflected in the underlying insurance
policies purchased by insurance company—despite the payment of benefits by the
company seeming to be contingent upon an unanticipated event (the death of the
insured while employed). As long as plan participants were willing to abide by company’s
distribution policies, there was no reason ever to forfeit a policy to the
plan. In fact, in estimating life insurance rates, the taxpayers’ expert in
Curcio assumed that there would be no forfeitures, even though he admitted that
an insurance company would generally assume a reasonable rate of policy lapse.
Companies should carefully evaluate their proposed
investments in plans such as the 419 Plan. The claimed deductions will be
disallowed, and penalties will be assessed for lack of disclosure if the
investment is similar to the investments described in Notice 95-34, that is, if
the transaction is a listed transaction and Form 8886 is either not filed at
all or is not properly filed. The penalties, though perhaps not as severe, are
also imposed for reportable transactions, which are defined as transactions
having the potential for tax avoidance or evasion.
Insurance agents have been selling such abusive plans since
the 1990's. They started as 419A(F)(6) plans and abusive 412i plans. The IRS
went after them. They then evolved to single-employer 419(e) plans, which the
IRS also went after. The latest scams may be the so-called captive insurance
plan and the so called Section 79 plan.
While captive insurance plans are legitimate for large
corporations, they are usually not legitimate for small business owners as a
way to obtain a tax deduction. I have not yet seen a legitimate Section 79
plan. Recently, I have sent some of the plan promoters’ materials over to my
IRS contacts, who were very interested in receiving them. Some of my associates
are already trying to help defend some unsuspecting business owners who are
being audited by the IRS with respect to these plans.
Similar, though perhaps not as abusive, plans fail after the
IRS goes after them. Niche was one example. The company first marketed a
419A(F)(6) plan that the IRS audited. They then marketed a 419(e) plan that the
IRS audited. Niche, insurance companies, agents, and many accountants were then
sued after their clients lost their deductions, paid fines, interest, and
penalties, and then paid huge fines for failure to file properly under 6707A.
Niche then went out of business.
Millennium sold 419A(F)(6) plans and then 419(e) plans
through insurance companies. They stupidly filed for a private letter ruling to
the effect that they were not a listed transaction. They got exactly the
opposite: a private letter ruling saying that they were a listed transaction.
Then many participants were audited. The IRS disallowed the deductions, imposed
penalties and interest, and then assessed large fines for not filing properly
under Section 6707A. The result was lawsuits against agents, insurance
companies and accountants. Millennium sought bankruptcy protection after a lot
of lawsuits.
I have been an expert witness in a lot of the lawsuits in
these 419, 412i, etc., plans, and my side has never lost a case. I have
received thousands of phone calls over the years from business owners,
accountants, angry plan promoters, insurance agents, etc. In the 1990's, when I
started writing for the AICPA and other publications warning about these
abusive plans, most people laughed at me, especially the plan promoters.
In 2002, when I spoke at the annual national convention of
the American Society of Pension Actuaries in Washington, people took notice.
The IRS chief actuary Jim Holland also held a meeting, similar to mine on
abusive 412i plans. Many IRS agents attended my meeting. I was also invited to
IRS headquarters, at the request of the acting IRS commissioner, to meet with
high-level IRS officials and Treasury officials to discuss 419 issues in depth,
which I did after the meeting.
The IRS then set up task forces and started going after 419
and 412i plans. I have been warning accountants to properly file under 6707A to
avoid the large fines, but most do not. Even if they file, if they make a mistake on the forms the IRS fines.
Very few accountants have had experience filing the forms, and the IRS
instructions are difficult to follow. I only know of two people who have been
successful in properly filing the forms,
especially after the fact. If the forms are filled out wrong they should be
amended and corrected Most accountants call me a few years later when they and
their clients get the large fines, either after improperly filling out the
forms or not doing them at all, but then it is too late. If they don’t call me
then, then they call me when their clients sue them.
Lance Wallach, National Society of Accountants Speaker of
the Year and member of the AICPA faculty of teaching professionals, is a
frequent speaker on retirement plans, abusive tax shelters, financial,
international tax, and estate planning.
He writes about 412(i), 419, Section79, FBAR, and captive insurance
plans. He speaks at more than ten conventions annually, writes for over fifty
publications, is quoted regularly in the press and has been featured on
television and radio financial talk shows including NBC, National Pubic Radio’s
All Things Considered, and others. Lance has written numerous books including
Protecting Clients from Fraud, Incompetence and Scams published by John Wiley
and Sons, Bisk Education’s CPA’s Guide to Life Insurance and Federal Estate and
Gift Taxation, as well as the AICPA best-selling books, including Avoiding
Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots. He
does expert witness testimony and has never lost a case.
Contact him at 516.938.5007, lawallach@aol.com or visit
www.vebaplan.com.
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