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Abusive Insurance, Welfare Benefit, and Retirement Plans

The A2Z Directory March 2011

Lance Wallach

The IRS has various task forces auditing all section 419, section 412(i), and other plans that tend to be abusive. Most insurance agents sell these plans. The IRS is looking to raise money and is not looking to correct plans or help taxpayers. The IRS calls accountants, attorneys, and insurance agents “material advisors” and also fines them the same amount, again unless the client’s participation in the transaction is reported. An accountant is amaterial advisor if he signs the return or gives advice and gets paid. More details can be found on www.irs.gov and vebaplan.org.

Bruce Hink, who has given me written permission to use his name and circumstances, is a perfect example of what the IRS is doing to unsuspecting business owners. What follows is a story about how the IRS fines him each year for being in what they called a listed transaction. Listed transactions can be found at www.irs.gov. Also involved are what the IRS calls abusive plans or what it refers to as substantially similar. Substantially similar to is very difficult to understand, but the IRS seems to be saying, “If it looks like some other listed transaction, the fines apply.” Also, I believe that the accountant who signed the tax return and the insurance agent who sold the retirement plan will each be fined as material advisors. We have received many calls for help from accountants, attorneys, business owners, and insurance agents in similar situations. Don’t think this will happen to you? It is happening to a lot of accountants and business owners, because most of theses so-called listed, abusive, or insurance agents are selling substantially similar plans. Recently I came across the case of Hink, a small business owner who is facing thousands in IRS penalties for 2004 and 2005 because of his participation in a section 412(i) plan. (The penalties were assessed under section 6707A.)

In 2002 an insurance agent representing a 100-year-old, well-established insurance company suggested the owner start a pension plan. The owner was given a portfolio of information from the insurance company, which was given to the company’s outside CPA to review and give an opinion on. The CPA gave the plan the green light and the plan was started. Contributions were made in 2003. The plan administrator came out with amendments to the plan, based on new IRS guidelines, in October 2004. The business owner’s insurance agent disappeared in May 2005, before implementing the new guidelines from the administrator with the insurance company. The business owner was left with a refund check from the insurance company, a deduction claim on his 2004 tax return that had not been applied, and no agent.

It took six months of making calls to the insurance company to get a new insurance agent assigned. By then, the IRS had started an examination of the pension plan. Asking advice from the CPA and a local attorney (who had no previous experience in these cases) made matters worse, with a “big name” law firm being recommended and over ,000 in additional legal fees being billed in three months. To make a long story short, the audit stretched on for over 2 ½ years to examine a 2-year-old pension with four participants and the 8,000 in contributions. During the audit, no funds went to the insurance company, which was awaiting formal IRS approval on restructuring the plan as a traditional defined benefit plan, which the administrator had suggested and the IRS had indicated would be acceptable.In March 2008 the business owner received a private e-mail apology from the IRS agent who headed the examination, saying that her hands were tied and that she used to believe she was correcting problems and helping taxpayers and not hurting people.

Could you or one of your clients be next?

To this point, I have focused, generally, on the horrors of running afoul of the IRS by participating in a listed transaction, which includes various types of transactions and the various fines that can be imposed on business owners and their advisors who participate in, sell, or advice on these transactions. I happened to use, as an example, someone in a section 412(i) plan, which was deemed to be a listed transaction, pointing out the truly doleful consequences the person has suffered. Others who fall into this trap, even unwittingly, can suffer the same fate.

Now let’s go into more detail about section 412(i) plans. This is important because these defined benefit plans are popular and because few people think of retirement plans as tax shelters or listed transactions. People therefore may get into serious trouble in this area unwittingly, out of ignorance of the law, and, for the same reason, many fail to take necessary and appropriate precautions. The IRS has warned against the section 412(i) defined benefit pension plans, named for the former code section governing them. It warned against trust arrangements it deems abusive, some of which may be regarded as listed transactions. Falling into that category can result in taxpayers having to disclose the participation under pain of penalties. Targets also include some retirement plans.

One reason for the harsh treatment of some 412(i) plans is their discrimination in favor of owners and key, highly compensated employees. Also, the IRS does not consider the promised tax relief proportionate to the economic realities of the transactions. In general, IRS auditors divide audited plan into those they consider noncompliant and other they consider abusive. While the alternatives available to the sponsor of noncompliant plan are problematic, it is frequently an option to keep the plan alive in some form while simultaneously hoping to minimize the financial fallout from penalties.

The sponsor of an abusive plan can expect to be treated more harshly than participants. Although in some situation something can be salvaged, the possibility is definitely on the table of having to treat the plan as if it never existed, which of course triggers the full extent of back taxes, penalties, and interest on all contributions that were made – not to mention leaving behind no retirement plan whatsoever. Another plan the IRS is auditing is the section 419 plan. A few listed transactions concern relatively common employee benefit plans the IRS has deemed tax avoidance schemes or otherwise abusive. Perhaps some of the most likely to crop up, especially in small-business returns, are the arrangements purporting to allow the deductibility of premiums paid for life insurance under a welfare benefit plan or section 419 plan. These plans have been sold by most insurance agents and insurance companies.

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, wallachinc@gmail.com or visit www.taxadvisorexperts.com

The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.

Lance Wallach, CLU, ChFC, and National Society of Accountants Speaker of the Year, offers his insights and expertise here about VEBAs, life insurance, and “retirement plans”. He writes extensively about “419 plans”, “412(i) plans”,“welfare benefits plans”, “tax shelters”, and “IRS audits”, for more than fifty national publications and speaks at more than seventy conventions annually. The links below will take you to articles containing the most reputable information available from this expert. For more information and additional articles on these subjects, call 516-938-5007.

Abusive Insurance and Retirement Plans - Single-Employer Section 419 "Welfare Benefit Plans" are the Latest Incarnation in Insurance Deductions the IRS Deems Abusive. Topics Include:

Promoters and Their Best-Laid Plans

Higher Risks for Practitioners Under New Penalties

Need for Caution

"Defined Benefit" "412(i) Plans" Under Fire

EXECUTIVE SUMMARY

AICPA RESOURCES

Laws, Rulings, and Guidance

Retirement Plans Being Audited by IRS in 2008. The "Internal Revenue Service" has recently been conducting a campaign by way of auditing Section 412(i) "defined benefit" "pension plans"

Small Business Tax News - Strategic Advice on the Tax Implications of Business Planning and Update on IRS Crackdown on Abusive 412(i) Plans

IRS says most 419 plans are "Abusive Tax Shelters" (PDF)

Tax Matters and Briefs – "Abusive Insurance Plans" Get Red Flag -

Sid Kess’ Practical Alternatives to Commonly Misused and Abused Small Business "Tax Strategies": Insuring Your Client’s Future

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Journal of Accountancy
September 2008

"Abusive Insurance" and "Retirement Plans"

Single-Employer "Section 419" "Welfare Benefit Plans" are the Latest
Incarnation in Insurance Deductions the IRS Deems Abusive.

By "Lance Wallach"

Parts of this article are from the AICPA CPE self-study course Avoiding"Circular 230" Malpractice Traps and Common Abusive Small Business Hot Spots, by Sid Kess, authored by "Lance Wallach".

Many of the "listed transactions" that can get your clients into trouble with the IRS are exotic "tax shelters" that relatively few practitioners ever encounter. When was the last time you saw someone file a return as a Guamanian trust (Notice 2000-61)? On the other hand, a few "listed transactions" concern relatively common "employee benefit plans" the IRS has deemed tax-avoidance schemes or otherwise "abusive tax shelters". Perhaps some of the most likely to crop up, especially in small business returns, are arrangements purporting to allow deductibles on premiums paid for "life insurance"under a "welfare benefit plan".

Some of these "abusive employee benefit plans" are represented as satisfying "Section 419" of the Code, which sets limits on purposes and balances of “qualified asset accounts” for such benefits, but purport to offer deductibles on contributions without any corresponding income. Others attempt to take advantage of exceptions to qualified asset account limits, such as sham union plans that try to exploit the exception for separate "welfare benefit" funds under collective-bargaining agreements provided by IRC § 419A(f)(5). Others try to take advantage of exceptions for plans serving 10 or more employers, once popular under Section 419A(f)(6). More recently, one may encounter plans relying on Section 419(e) and, perhaps, "defined benefit pension plans" established pursuant to the former Section 412(i) (still so-called, even though the subsection has since been re-designated section 412(e)(3). See sidebar “Defined Benefit" 412(i) "Plans Under Fire”).

Promoters and Their Best-Laid Plans

Sections 419 and 419A were added to the Code in 1984 by the "Deficit Reduction Act" of 1984 in an attempt to end employers’ acceleration of deductions for plan contributions. But it wasn’t long before plan promoters found an end run around the new Code sections. An industry developed in what came to be known as “10 or more employer plans.” The promoters of these plans, in conjunction with "life insurance" companies who just wanted premiums on the books, would sell people on the idea of tax-deductible "life insurance" and other benefits, and especially large "tax deductions". It was almost, “How much can I deduct?” with the reply, “How much do you want to?” Adverse court decisions (there were a few) and other law to the contrary were either glossed over or explained away.

The IRS steadily added these abusive plans to its designations of "listed transactions". With "Revenue Ruling" 90-105, it warned against deducting certain plan contributions attributable to compensation earned by plan participants after the end of the taxable year. Purported exceptions to limits of Sections 419 and 419A claimed by 10 or more multiple-employer benefit funds were likewise proscribed in "Notice 95-34". Both positions were designated "listed transactions" in 2000.

At that point, where did all those promoters go? Evidence indicates many are now promoting plans purporting to comply with Section 419(e). They are calling a life insurance plan a "welfare benefit plan" (or fund), somewhat as they once did, and promoting the plan as a vehicle to obtain large tax deductions. The only substantial difference is that these are now single-employer plans. And again, the IRS has tried to rein them in, reminding that "listed transactions" include those substantially similar to any that are specifically described and so designated.

On Oct. 17, 2007, the IRS issued notices 2007-83 and 2007-84. In the former, the IRS identified certain trust arrangements involving cash-value life insurance policies, and substantially similar arrangements, as "listed transactions". The latter similarly warned against certain post-retirement medical and life insurance benefit arrangements, saying they might be subject to “alternative tax treatment.” The IRS at the same time issued related Revenue Ruling 2007-65 to address situations where an arrangement is considered a "welfare benefit fund" but the employer’s deduction for its contributions to the fund is denied in whole or part for premiums paid by the trust on cash-value life insurance policies. It states that a welfare benefit fund’s qualified direct cost under section 419 does not include premium amounts paid by the fund for cash-value life insurance policies if the fund is directly or indirectly a beneficiary under the policy, as determined under section 264(a).

Notice 2007-83 is aimed at promoted arrangements under which the fund trustee purchases cash-value insurance policies on the lives of a business’s employee/owners, and sometimes key employees, while purchasing term insurance policies on the lives of other employees covered under the plan. These plans anticipate being terminated and that the cash-value policies will be distributed to the owners or key employees, with very little distributed to other employees. The promoters claim that the insurance premiums are currently deductible by the business, and that the distributed insurance policies are virtually tax-free to the owners. The ruling makes it clear that, going forward, a business under most circumstances cannot deduct the cost of premiums paid through a "welfare benefit plan" for cash-value life insurance on the lives of its employees. The IRS may challenge the claimed tax benefits of these arrangements for various reasons:

Some or all of the benefits or distributions provided to or for the benefit of owner-employees or key employees may be disqualified benefits for purposes of the 100% excise tax under section 4976.

Whenever the property distributed from a trust has not been properly valued by the taxpayer, the IRS said in Notice 2007-84 that it intends to challenge the value of the distributed property, including life insurance policies.

Under the tax benefit rule, some or all of an employer’s deductions in an earlier year may have to be included in income in a later year if an event occurs that is fundamentally inconsistent with the premise on which the deduction was based.

An employer’s deductions for contributions to an arrangement that is properly characterized as a "welfare benefit fund" are subject to the limitations and requirements of the rules in sections 419 and 419A, including reasonable actuarial assumptions and nondiscrimination. Further, a taxpayer cannot obtain a deduction for reserves for post-retirement medical or life benefits unless the employer intends to use the contributions for that purpose.

The arrangement may be subject to the rules for split-dollar arrangements, depending on the facts and circumstances.

Contributions on behalf of an owner-employee may be characterized as dividends or as non-qualified deferred compensation subject to section 404(a)(5), section 409A or both, depending on the facts and circumstances.

Higher Risks for Practitioners Under New Penalties

The updated Circular 230 regulations and the new law (IRC § 6694, preparer penalties) make it more important for CPAs to understand what their clients are deducting on tax returns. A CPA may not prepare a tax return unless he or she has a reasonable belief that the tax treatment of every position on the return would more likely than not be sustained on its merits. Proposed regulations issued in June 2008 spell out many new implications of these changes introduced by the Small Business and Work Opportunity Act of 2007.

The CPA should study all the facts and, based on that study, conclude that there is more than a 50% likelihood (“more likely than not”) that, if the IRS challenges the tax treatment, it will be upheld. As an alternative, there must be a reasonable basis for each position on the tax return, and each position needs to be adequately disclosed to the IRS. The reasonable-basis standard is not satisfied by an arguable claim. A CPA may not take into account the possibility that a return will not be "audited by the IRS", or that an issue will not be raised if there is an audit.

It is worth noting that "listed transactions" are subject to a regulatory scheme applicable only to them, entirely separate from Circular 230 requirements, regulations and sanctions. Participation in such a transaction must be disclosed on a tax return, and the penalties for failure to disclose are severe—up to $100,000 for individuals and $200,000 for corporations. The penalties apply to both taxpayers and practitioners. And the problem with disclosure, of course, is that it is apt to trigger an audit, in which case even if the "listed transaction"  were to pass muster, something else may not.

Need for Caution

Should a client approach you with one of these plans, be especially cautious, for both of you. Advise your client to check out the promoter very carefully. Make it clear that the government has the names of all former 419A(f)(6) promoters and therefore will be scrutinizing the promoter carefully if the promoter was once active in that area, as many current 419(e) (welfare benefit fund or plan) promoters were. This makes an audit of your client far riskier and more likely.
Defined-Benefit 412(i) Plans Under Fire

The IRS has warned against so-called section 412(i) "defined benefit pension plans", named for the former IRC section governing them. It warned against certain trust arrangements it deems abusive, some of which may be regarded as "listed transactions". Falling into that category can result in taxpayers having to disclose such participation under pain of penalties, potentially reaching $100,000 for individuals and $200,000 for other taxpayers. Targets also include some retirement plans.

One reason for the harsh treatment of 412(i) plans is their discrimination in favor of owners and key, highly compensated employees. Also, the IRS does not consider the promised tax relief proportionate to the economic realities of these transactions. In general, IRS auditors divide audited plans into those they consider non-compliant and others they consider abusive. While the alternatives available to the sponsor of a non-compliant plan are problematic, it is frequently an option to keep the plan alive in some form while simultaneously hoping to minimize the financial fallout from penalties.

The sponsor of an abusive plan can expect to be treated more harshly. Although in some situations something can be salvaged, the possibility is definitely on the table of having to treat the plan as if it never existed, which of course triggers, the full extent of back taxes, penalties and interest on all contributions that were made, not to mention leaving behind no retirement plan whatsoever.
EXECUTIVE SUMMARY

Some of the "listed transactions" CPA tax practitioners are most likely to encounter are "employee benefit insurance plans" that the IRS has deemed abusive. Many of these plans have been sold by promoters in conjunction with life insurance companies.

As long ago as 1984, with the addition of IRC §§ 419 and 419A, Congress and the IRS took aim at unduly accelerated deductions and other perceived abuses. More recently, with guidance and a ruling issued in fall 2007, the Service declared as abusive certain trust arrangements involving cash-value life insurance and providing post-retirement medical and life insurance benefits.

The new “more likely than not” penalty standard for tax preparers under IRC § 6694 raises the stakes for CPAs whose clients may have maintained or participated in such a plan. Failure to disclose a "listed transaction" carries particularly severe potential penalties.

Lance Wallach, CLU, ChFC, is the author of the AICPA’s The Team Approach to Tax, Financial and Estate Planning. He can be reached at wallachinc@gmail.comor on the Web at www.taxaudit419.com or at (516) 938-5007. The information in this article is not intended as accounting, legal, financial or any other type of advice for any specific individual or other entity. You should consult an appropriate professional for such advice.

AICPA RESOURCES:

Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots, by Sid Kess , a CPE self-study course (#733720)

Sid Kess’ Practical Alternatives to Commonly Misused and Abused Small Business Tax Strategies: Insuring Your Client’s Future, a CPE self-study course (#733730)

For more information or to place an order, go to www.cpa2biz.com or call the Institute at 888-777-7077.

AICPA PFP Center and PFS Credential:
The AICPA Personal Financial Planning (PFP) Center provides a range of valuable resources that CPAs need for professional and ethical financial planning. The center also contains information about the AICPA Personal Financial Specialist (PFS) credential and PFP section membership. For more information go tohttp://pfp.aicpa.org.

OTHER RESOURCES

Law, rulings and guidance

Internal Revenue Code §§ 264, 419, 419A, 6111 and 6112

News Releases IR 2007-170 and IR 2004-21

Revenue Ruling 2007-65

Notices 2007-83 and 2007-84

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New Jersey Association of Public Accountants Newsletter

Retirement Plans being audited by IRS in 2008

Retirement Plans being audited by IRS in 2008.  The Internal Revenue Service has recently been conducting a campaign by way of auditing Section "412(i) defined benefit pension plans". They are seeking substantial taxes and penalties from plans that they conclude are "abusive", although they are not approaching each plan with that mindset. But some of those that have been deemed abusive have also been regarded as "listed transactions", and falling into that category leads to the disastrous result that taxpayers participating in them must disclose such participation under pain of penalties for nondisclosure potentially reaching as high as $100,000 for individuals and $200,000 for other taxpayers.

There is also increased audit activity in the general area of retirement plans, aiming to catch those companies cheating their workers or the Government.  Targets include traditional pensions, 401(k) plans, and profit sharing plans. Part of the reason for the harsh treatment of 412(i) plans is discrimination in favor of owners and/or key, highly compensated employees, as well as the general feeling that the promised tax relief is not proportionate to the economic realities of these transactions. In general, IRS auditors divide the audited plans into non-compliant plans and abusive plans. While the alternatives available to the plan sponsor of a non-compliant plan are problematical, keeping the plan alive in some form, while simultaneously hoping to minimize the financial fallout from penalties, etc., is frequently an option.

The plan sponsor of an abusive plan can expect to be treated more harshly. Although it may not be the rule in all cases, there possibly being situations where something can be salvaged, the possibility is definitely on the table of having to treat the plan as if it never existed, which of course triggers, to the fullest extent possible, back taxes, penalties and interest on all contributions that were made, not to mention leaving behind no retirement plan whatsoever.

Perhaps the largest issue in making sure that a qualified plan satisfies nondiscrimination testing and remains compliant is the inclusion of all “related employers” as joint sponsors of the plan. That’s because many small business owners may indeed own or control more than one enterprise. It is tempting to adopt a 412(i) plan to benefit one group of employees, and not cover all the related employees, but this may not be possible under current pension law as a plan must meet specific coverage and participation rules. [IRC §410(b) and §401(a)(26)] Generally, all the employees of businesses under common control are aggregated for nondiscrimination testing vesting and top-heavy rules. Also the 415(a) contribution and 415(b) benefit limits will aggregate as if all the employees worked in one single employer. [IRC §414(b)] Presented here are definitions of the “controlled” and “affiliated” service groups that the professional adviser must consider before recommending adoption of any qualified retirement plan.

The Pension Protection Act, which became law in August of 2006, has altered the landscape in some ways. There is the favorable treatment accorded cash balance plans; this encouragement has made them almost ubiquitous. There is also a provision requiring that all defined benefit plans, except for 412(i) plans, be fully funded. This means that one hundred percent of the present value of the future promised liability must be funded. As for the consequences of failing to fully fund, if funding is below sixty (60) percent, the Pension Benefit Guaranty Corporation is legally authorized to simply terminate the plan. Other plans that are not as seriously under funded are considered "at risk", and are subject to a wide range of sanctions.

The traditional 401(k) defined contribution plan has also become somewhat of an audit target recently. Government auditors are trained to look for failure to adhere to the terms of the plan document as well as the improper exclusion of employees, both of which could lead to the disqualification of the plan.

To avoid such a disaster, the Service recommends that employers work in conjunction with plan administrators so that both parties are knowledgeable with respect to the particulars of the plan, and that plan administrators be timely provided with the necessary information to properly determine whether each employee should be included or excluded. All parties should also be mindful of the limitations imposed by Section 415. This section limits the amount of contributions that a participant can receive in a defined contribution plan as well as the amount of benefits that a participant can accrue in a defined benefit plan. Failure to adhere to Section 415 limitations most frequently occurs in situations where the employer or third party administrator does not monitor the amount of contributions allocated or the amount of benefits that are accrued by participants.
Lance Wallach is a frequent speaker at national conventions and writes for more than 50 publications. He was the National Society of Accountants Speaker of the Year. Lance welcomes your contact. Email - lawallach@aol.com or call 516-938-5007 for more info.

The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.(Scroll back to top of page to choose more articles)

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Small Business Tax News

Strategic Advice on the Tax Implications of Business Planning

(March 2004)

UPDATE ON IRS CRACKDOWN ON ABUSIVE 412(i) PLANS

By Lance Wallach & Ira Kaplan

On Friday, February 3, 2004, the IRS issued proposed regulations concerning the valuation of insurance contracts in the context of qualified retirement plans.

The IRS says that it is no longer reasonable to use the cash surrender value or the interpolated terminal reserve as the accurate value of a life insurance contract for income tax purposes.  The IRS issued proposed regulations stating that the value of a life insurance contract in the context of qualified retirement plans should be the contract’s fair market value.

The Service acknowledged in the regulations (and in a revenue procedure issued simultaneously) that the fair market value standard could create some confusion among taxpayers.  They addressed this possibility by describing a safe harbor position.

When I addressed the American Society of Pension Actuaries Annual National Convention, the IRS chief actuary also spoke about attacking abusive 412(i) pensions.

A “Section 412(i) plan” is a tax-qualified retirement plan that is funded entirely by a life insurance contract or an annuity.  The employer claims tax deductions for contributions that are used by the plan to pay premiums on an insurance contract covering an employee.  The plan may hold the contract until the employee dies, or it may distribute or sell the contract to the employee at a specific point, such as when the employee retires.

“The guidance targets specific abuses occurring with Section 412(i) plans”, stated Assistant Secretary for Tax Policy Pam Olson.  “There are many legitimate Section 412(i) plans, but some push the envelope, claiming tax results for employees and employers that do not reflect the underlying economics of the arrangements.”  Or, to put it another way, tax deductions are being claimed, in some cases, that the Service does not feel are reasonable given the taxpayer’s facts and circumstances.

“Again and again, we’ve uncovered abusive tax avoidance transactions that game the system to the detriment of those who play by the rules,” said IRS Commissioner Mark W. Everson.

I have been published by the AICPA and others for years about these and similar abuses. Finally, the IRS is doing something.  If someone is in an abusive 412(i) plan, they had better seek counsel quickly.

Editor's note: The author and publisher are not rendering professional advice and assume no liability in connection with its use.  Consult your tax adviser and accountant before making any investment or tax-related decisions.

Lance Wallach is a member of Small Business Tax News’ Advisory Board.  He is a frequent speaker on tax-related subjects including VEBAs, pensions, and tax-oriented strategies.·
Ira Kaplan, Esq., CPA, MBA, is a national speaker and author.  For more information call Lance Wallach at (516)938-5007.(Scroll back to top of page to choose more articles)

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IRS Says Most 419 Plans
Are Abusive Tax Shelters

Click on link above to read this PDF article.
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TAX MATTERS

TAX BRIEFS: ABUSIVE INSURANCE PLANS GET RED FLAG

The IRS in Notice 2007-83 identified as listed transactions certain trust arrangements involving cash-value life insurance policies. Revenue Ruling 2007-65, issued simultaneously, addressed situations where the tax deduction has been disallowed, in part or in whole, for premiums paid on such cash-value life insurance policies. Also simultaneously issued was Notice 2007-84, which disallows tax deductions and imposes severe penalties for welfare benefit plans that primarily and impermissibly benefit shareholders and highly compensated employees.

Taxpayers participating in these listed transactions must disclose such participation to the Service by January 15. Failure to disclose can result in severe penalties--- up to $100,000 for individuals and $200,000 for corporations.

Ruling 2007-65 aims at situations where cash-value life insurance is purchased on owner/employees and other key employees, while only term insurance is offered to the rank and file. These are sold as 419(e), 419(f) (6), and 419 plans. Other arrangements described by the ruling may also be listed transactions. A business in such an arrangement cannot deduct premiums paid for cash-value life insurance.

A CPA who is approached by a client about one of these arrangements must exercise the utmost degree of caution, and not only on behalf of the client. The severe penalties noted above can also be applied to the preparers of returns that fail to properly disclose listed transactions.

Prepared by Lance Wallach, CLU, ChFC, of Plainview, N.Y.,

516-938-5007, a writer and speaker on voluntary employee’s beneficiary associations and other employee benefits:taxaudit419.com

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       Virginia Society of Certified Public Accountants
July 27, 2007

More Problems for 419 Plans

By Lance Wallach, CLU, ChFC, and

Ronald H. Snyder, JD, MAAA, EA

For years, life insurance companies and agents have tried to find ways of making life insurance premiums paid by business owners tax deductible. This would allow them to sell policies at a “discount.”

The problem became acute a few years ago with outlandish claims about how §§419A(f)(5) and (6) of the Internal Revenue Code (IRC) exempted employers from any tax deduction limitations. Other inaccurate assertions were made as well, until the Internal Revenue Service (IRS) finally put a stop to such egregious misrepresentations in 2002 by issuing regulations and naming such plans as “potentially abusive tax shelters” (or “listed transactions”) that needed to be registered and disclosed to the IRS.

This appeared to put an end to the scourge of scurrilous promoters, as many such plans disappeared from the landscape.

And what happened to the providers that were peddling §§419A(f)(5) and (6) life insurance plans a few years ago? We recently found the answer: Most of them found a new life as promoters of so-called “419(e)” welfare benefit plans.

What does IRC §419(e) provide?

IRC §419(e) provides a definition of the term “welfare benefit fund” and provides that it includes a trust or “organization described in paragraph (7), (9), (17), or (20) of section 501(c)” or any taxable trust that provides welfare benefits. Reference to IRC §419(e) is therefore meaningless.

So what are “§419(e) Plans”?

We recently reviewed several so-called §419(e) plans. Many of them are nothing more than recycled §§419A(f)(5) and (6) plans. Now many of the same promoters simply claim that a life insurance policy is a welfare benefit plan and therefore tax-deductible because it uses a single-employer trust rather than a "10-or-more-employer plan". Many plans incorrectly purport to be exempt from ERISA, from IRC §§414, 105, 505, 79, 4975, etc.

What are the problems with “§419(e) Plans”?

Vendors commonly claim that contributions to their plan are tax-deductible because they fall within the limitations imposed under IRC §419; however, §419 is simply a limitation on tax deductions. The deductions themselves must be claimed under enabling sections of the IRC. Many fail to do so. Others claim that the deductions are ordinary and necessary business expenses under §162, citing Regs. §1.162-10 in error: There is no mention in that section of life insurance or a death benefit as a welfare benefit.

Some plans claim to impute income for current protection under the PS 58 rules. However, PS 58 treatment is available only to qualified retirement plans and split-dollar plans. (None of the 419(e) plans claim to comply with the split-dollar regulations.) Income is imputed under Table I to participants under Group-Term Life Insurance plans that comply with §79. This issue is addressed in footnotes 17 and 18 of the Neonatology case. Most of the plans have various other flaws or mistakes.

The biggest problem that most promoters ignore

Following up on Congress’s lead, the IRS has fired another potentially fatal shot at spurious welfare benefit plans. On April 10, 2007, the IRS issued Final Regulations under §409A of the IRC.

If it wasn’t clear before, it is crystal clear now: Most of the so-called “419(e)” plans are in violation of the law and subject to hefty penalties because they provide deferred compensation without complying with §409A.

What does §409A do?

Code Section 409A was enacted into law on October 10, 2004, to provide some uniformity and to impose several requirements upon non-qualified deferred compensation plans and similar arrangements.

Among new rules imposed, it:

·         Requires a written plan agreement.

·         Limits payments to death, disability or retirement.

·         Requires a substantial risk of forfeiture to avoid immediate taxation to the employee.

·         Imposes timing limitations on benefit distributions.

What is deferred compensation?

Congress drafted §409A broadly to include any payment to an employee after the year in which it was earned or after termination of employment, unless the payment falls under one of the named exceptions. (Exceptions include payments within 75 days, COBRA benefits, de minimis cash outs paid in the year of termination of employment, etc.)

Why does this apply to welfare benefit or life insurance plans?

§409A does NOT apply to welfare benefits. In fact, several forms of welfare benefits are specifically excluded under 409A. However, such excluded arrangements do not permit transfer of property to the participant except for death, disability and payments made upon retirement in accordance with the §409A rules.

Most of the existing §419(e) and §419A(f)(6) welfare benefit plans do not comply with the §409A rules relative to transfers of insurance policies or cash payments other than upon death.

What are the penalties for failure to comply?

Significant penalties apply for non-compliance with §409A. In addition to having compensation included in income, tax penalties equal to the IRS underpayment rate plus 1% from the time the compensation should have been included in income plus 20% of the compensation amount apply. Additional penalties may apply for failure to report the arrangement appropriately.

When are the new rules effective?

When §409A was added, employers and consultants scrambled to comply because the rules were effective for years beginning after 2004 for all arrangements entered into after October 3, 2004. Existing arrangements were given until the end of 2005 to comply. However, IRS granted an extension for compliance for employers who made a “good-faith” effort to comply with the rules. Under the final regulations, plans have untilDecember 31, 2007, to be in full compliance.

What does this mean to sponsors of 419 plans?

Sponsors of 419 plans have two choices: totally eliminate distributions from their plans (except death benefits and/or medical reimbursements), or comply with Code §409A and the regulations thereunder.

What does this mean to professionals who advise clients?

Under Circular 230 standards, a CPA or attorney who advises his or her client about participating in a non-compliant welfare benefit plan may be liable for fines and other sanctions. We expect that opinion letters relative to such welfare benefit plans have either been withdrawn or will be shortly. We admonish professionals carefully to review all communications with clients relative to such plans. The IRS has recently been successful in imposing huge fines on several law firms for blessing questionable transactions.

What does this mean to employers participating in 419 plans?

This means that employers have until December 31, 2007, to be in compliance. Employers who have adopted 419 plans must choose immediately whether to remain in their current 419 plan, cancel their participation in such arrangement and have their benefits distributed by December 31, or transfer to a plan that is fully compliant with the new rules.

Conclusion

Time is of the essence in making and implementing a decision as to what to do.

We have only seen one or two plans that may be in compliance. We therefore recommend that employers waste no time in contacting a tax professional to review their welfare benefit plan participation to verify compliance with the new law and regulations.(Scroll back to top of page to choose more articles)

Lance Wallach, CLU, ChFC,author of Bisk Education’s “CPA’s Guide to Life Insurance,” speaks and writes extensively about financial planning, retirement plans and tax reduction strategies. He speaks at more than 70 national conventions annually and writes for more than 50 national publications. For more information and additional articles on these subjects, visit www.vebaplan.com or call (516) 938-5007.

Ronald H. Snyder, JD, MAAA, EA, is an ERISA attorney and enrolled actuary specializing in employee benefit plans.

The information contained in this article was taken from an article previously published in the Enrolled Agents Journal and from another article published in The Trusted Professional, both of which articles were co-authored by Lance Wallach and Ron Snyder.

Note: Information contained in this article is not intended as legal, accounting, financial or any other type of advice for any specific individual or entity. You should contact an appropriate professional for appropriate guidance with respect to tax matters.

Reprinted with permission from the Virginia Society of CPAs.

___________________________________________________________

California Broker Magazine
January 2008

IRS says most 419 life insurance plans are now abusive tax shelters

By Lance Wallach, CLU, ChFC

On October 17, 2007, the IRS, in Notice 2007-83, identified as listed transactions certain trust arrangements involving cash value life insurance policies. Revenue Ruling 2007-65, issued simultaneously, addressed situations wherein the tax deduction has been disallowed, in whole or in part, for premiums paid on such cash value life insurance policies.  These arrangements claim to be welfare benefit plans.

Taxpayers participating in listed transactions must disclose such participation to the Internal Revenue Service. Failure to disclose can result in severe penalties, up to $100,000 for individuals and $200,000 for corporations.  Penalties can also be assessed against the insurance agent who sold the plan or the accountant who recommended it.  In Notice 2007-84 the IRS threatened to impose penalties under IRC Sections 6700 and 6701 against promoters and aiders and abetters (insurance agents) even if the plan is not a listed transaction.
Revenue Ruling 2007-65 describes situations where cash value life insurance is bought for owners and/or other employees.  These are sold as 419(e), 419A(f)(6), and 419 plans. The 419A(f)(6) plan was previously categorized as a listed transaction. Other arrangements described by the ruling may also be listed transactions.  All of the plans that we have studied except one are listed transactions. The IRS has threatened to impose significant penalties and alternative tax treatment on companies participating in such arrangements.

The CPA who is approached by a client about one of these arrangements must exercise utmost caution, and not only on behalf of his client. The severe penalties noted above can also be applied to accountants. Your client must do impeccable research on the promoter, who is likely to have once been in the 419A(f)(6) arena. If that is true, the IRS has his name and that, in turn, makes an audit far riskier and more likely.  Be skeptical of the plan promoter who says that all the other 419 plans are abusive, but that his is legal.  It appears that almost every so called “419 plan” is abusive.

Lance Wallach, CLU, ChFC, National Society of Accountants Speaker of the Year, speaks and writes extensively about VEBAs, life insurance, and retirement plans.   He speaks at more than seventy conventions a year and writes for over fifty national publications.  For more information and additional articles on these subjects, call 516-938-5007/935-7346.
(Scroll back to top of page to choose more articles)

The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity.  You should contact an appropriate professional for any such advice.
____________________________________________________

The Trusted Professional

The Newspaper of the New York State Society of Certified Public Accountants
July 15, 2007

IRS Clarifies Legality of 419(e) Plans
By Lance Wallach, CLU, ChFC,
and Ronald H. Snyder, JD, MAAA, EA

Following the U.S. Congress’ lead, on April 10 the IRS issued final regulations under Section 409A of the Internal Revenue Code. If  the rules seemed unclear before, they are crystal clear now: Most of the so-called “419(e)” plans as well as the remaining 419A(f)(6) plans are in violation of the law and subject to hefty penalties.

A 419(e) plan is a benefit plans that generally seeks to make the purchase of life insurance tax-deductible to employers.  While the concept is appealing, most of the existing arrangements have permitted the plans to transfer the insurance policies to the participants upon retirement.

The Purpose of 409A

Code Section 409A was enacted into law on Oct.10, 2004, to provide some uniformity and to impose several requirements upon non-qualified deferred compensation plans and similar arrangements.  The new rules imposed include a required written plan agreement;  a limit of  payments to death, disability, or retirement; a substantial risk of forfeiture to avoid immediate taxation to the employee; and timing limitations on benefit distributions.

Congress drafted Section 409A broadly to include any payment to an employee after the year for which it was paid or after termination of employment, unless the payment falls under one of the named exceptions. Exceptions include payments within 75 days, COBRA benefits, de minimis cash-outs paid in the year of termination of employment, etc.
409A Applicability to Welfare Benefits

Section 409A does not apply to welfare benefits.  In fact, several forms of welfare benefits are specifically excluded under 409A.  However, such excluded arrangements do not permit transfer of property to the participant except for death, disability, and payments made upon retirement in accordance with the 409A rules.

Most of the existing 419(e) and 419A(f)(6) welfare benefit plans do not comply with the 409A rules relative to transfers of insurance policies or cash payments other than upon death.

Compliance and Effective Dates

Significant penalties apply for noncompliance with section 409A. In addition to having compensation included in income, tax penalties equal to the IRS underpayment rate plus 1 percent from the time the compensation should have been included in income, plus 20 percent of the compensation amount, apply.  Additional penalties may apply for failure to report the arrangement appropriately.
When Section 409A was added, employers and consultants scrambled to comply because the rules were effective for years beginning after 2004 for all arrangements entered into after Oct. 3, 2004.  Existing arrangements were given until the end of 2005 to comply.  However, IRS granted an extension for compliance for employers who made a “good-faith” effort to comply with the rules.  Under the Final Regulations, plans have until Dec. 31, 2007 to be in full compliance.
Effect on CPAs, Plan Sponsors and Others
Under Circular 230 standards a CPA or attorney who advises his or her client about participating in a non-compliant welfare benefit plan may be liable for fines and other sanctions.  The authors expect that opinion letters relative to such welfare benefit plans have either been withdrawn or will be shortly, and we admonish professionals to review carefully all communications with clients relative to such plans. The IRS has recently been successful in imposing huge fines on several law firms for blessing questionable transactions.
Sponsors of 419 plans have two choices: totally eliminate distributions from their plans (except medical reimbursement or death benefits), or comply with Code Section 409A and the regulations thereunder.

Employers have until Dec. 31 to be in compliance.  Employers who have adopted 419 plans must choose immediately whether to remain in their current 419 plan, cancel their participation in such arrangement and have their benefits distributed by Dec. 31, or transfer to a plan that is fully compliant with the new rules.

(Scroll back to top of page to choose more articles)

Lance Wallach, CLU, ChFC, can be reached at 516-938-5007 orlawallach@aol.com.  Ron Snyder, JD, is an enrolled actuary.

___________________________________________________________

New Spring/Summer AICPA CPE Self-Study and On-Site Training Catalog is here!

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Sid Kess’ Practical Alternatives to Commonly Misused and Abused Small Business Tax Strategies: Insuring Your Client’s Future

Author/Moderator: Lance Wallach, CLU, CHFC,

Publisher: AICPA

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A perfect follow-up to "Avoiding Circular 230 Malpractice Traps this course was created by the renowned Sid Kess. Learn the best strategies for reducing taxes and building, conserving and passing wealth to the next generation while at the same time avoiding abusive strategies. Utilize retirement planning strategies under the Pension Protection Act and the latest health care financing methods. Advise your clients how to avoid being victims of IRS enforcement of aggressive insurance and retirement products.

Objectives:

Identify practical alternatives to abusive tax shelters

Understand how to integrate financial products as part of a retirement plan

Discover how to use innovative retirement and financial programs to improve business and personal financial wealth of your clients

Optimize your value in the planning process between your clients and their financial advisors

Prerequisite: None

A NASBA Field of Study: Taxes

Level: Intermediate

Recommended CPE Credit: 4

Accepted for CFP^® credit.

Overview

Course Objectives

Introduction

Organization

Chapter 1 - Planning for Business Owners

Learning Objectives

Introduction

Building the Perfect Retirement Plan

SEP IRA: The Good

SEP IRA: The Bad

SEP IRA: The Ugly

The K

The Double K

Defined Benefit Plans

Adding Survivor Benefits

412(i) Defined Benefit Plan

Cash Balance Plans

VEBAs and 419 Plans

Taxability of Trust Net Income

Taxability of Excess Benefits

Group-Term Life Insurance Plan

Post-Retirement Medical Benefit

Voluntary Employees Beneficiary Association (VEBA) - Commentary

New Development - Welfare Benefit Plans under Section 419(e)

Executive Carve Out Long-Term Care

What Is Long-Term Care?

How Much Does It Cost

Benefits of Long-Term Care Insurance to Employees

Benefits of Long-Term Care Insurance to Employers

Executive Carve Out Long-Term Care

Taxability

Long-Term Care Insurance Premium Deductibility

2007 Eligible Long-Term Care Insurance Premiums Age-Based Deduction Limits

Chapter 2 - Personal Financial Planning

Learning Objectives

Introduction

IRA Planning

RMDs

Stretch IRA

Stretch IRA Example

Stretch IRA Pitfalls

Other Beneficiary Pitfalls

Important Questions Your Client Should Ask Their IRA Custodian

When a Stretch IRA Might Not Make Sense

Taxable Estate

Company Stock

What Investments Should be In Your Client's IRA?

Estate Planning

What Makes a Good Estate Plan?

Minimizing Taxes

Gift Taxes

Generation Skipping Tax (GST)

Estate Division

Insurance Trusts

Pay Estate Taxes at a Discount

Estate Planning Mistakes of the Rich and Famous

Unintended Heirs

Estate Tax Problems

Incapacity

Leaving Money Outright to Children

Pension Plan Beneficiary Problems

Premium Financing as a Tool to Pay Life Insurance Premiums

The Benefits of Premium Financing

Type of Premium Financing Arrangements

Collateral

Interest Rate Risk

General Account Universal Life

Variable Life Insurance

Single Index Life

Multiple Index Life

Premium Financing Components

Loan Options

Process

Repaying Premium Loans

Income Tax Considerations

Gift Tax Considerations

Estate Tax Considerations

Premium Finance Due Diligence

Life Settlements

Life Settlement History

The Life Settlement Market

Life Settlement Case Studies

The Insurance Swapout Process(TM)

Reasons for Using an ISP

Why You Would Not Want to Use an ISP

Important Considerations

Annuities

Types of Annuities

Non-Qualified Funds in a Tax Deferred Annuity

Surrender Charges

Tax Rules

Sales Abuses

Risks

Annuity Checklist

Chapter 3 - Advanced Planning

Learning Objectives

Introduction

Hedge Funds

Availability

Hedge Fund Risks and Disadvantages

Hedge Fund Advantages

Hedge Fund Investing Styles

Relative Value

Event Driven

Long/Short

Tactical Trading

Due Diligence

Returns

Risks

Diversification

Hedge Fund of Funds

Mutual Funds That Follow Hedge Fund Strategies

Tax Implications

Private Placement Variable Universal Life Insurance

Why High Net Worth Investors Use Hedge Funds

Taxation of Life Insurance

PPVUL

Prospect Profile

Practitioner Beware

Conclusion

International Mortgages

How it Works

Loan Features

Other Considerations

Costs

Risks

Frequently Asked Questions

Chapter 4 - Health Insurance Planning

Learning Objectives

Introduction

Health Insurance Basics

Health Savings Accounts

Health Reimbursement Arrangements

Other Health Insurance Arrangements

Self-Funded Plans and Stop-Loss

Limited Coverage and Supplemental Plans

Conclusion

Appendix A - Qualified Medical Expenses - Distributions from an HSA

Appendix B - Health Savings Accounts - Preventive Care, Safe Harbor

Appendix C - Sample Sections of an Actual Health Reimbursement Arrangement Summary Plan Document

Chapter 5 - Ethics Focus: Taxation

Ethics Overview

Recent Developments

Spotlight on Independence in Tax Services

Key Ethical Dilemmas and Judgment Calls

Addressing Ethical Dilemmas

Available Resources

Chapter 6 - Latest Development

Call   5 1 6 - 9 3 8 - 5 0 0 7 or email WallachInc@gmail.com
now for information about any topic here and to ensure a fast resolution to all of your tax issues.

Retirement Today Sept 2011

Participate in a 419 or 412i Plan or Other Abusive Tax Shelter You could be fined a large amount of Money

Lance Wallach

Did you get a letter from the IRS threatening to impose this fine? If you haven’t already, you still may. Consider yourself lucky if you have not because this means that you have more time to straighten this situation out. Do not wait for this letter to come from the IRS before you call an expert to help you. Even if you have been audited already, you could still get the letter and/or fine. One has nothing to do with the other, and once the fine has been imposed, it is not able to be appealed.

Many businesses that participated in a 412i retirement plan or the IRS is auditing a 419-welfare benefit plan. Many of these plans were not in compliance with the law and are considered abusive tax shelters. Many business owners are not even aware that the welfare benefit plan or retirement plan that they are participating in may be an abusive tax shelter and that they are in serious jeopardy of huge IRS penalties for each year that they have been in this type of plan.

Insurance companies, CPAs, sellers of these 419 welfare benefit plans or 412i retirement plans, as well as anyone that gave tax advice or recommended participation in one or more of these plans, also known as a material advisor, is in danger of being sued, fined by the IRS, or both.

There is help available if you think you may be involved with one of these 419 welfare benefit plans, 412i retirement plans, or any abusive tax shelter. IRS penalty abatement is an option if you act now. Feel free to contact me for more information.www.lancewallach.com

Avoid IRS Penalties

Investment News - Lance Wallach - 412i and 419 plan litigatation

Tax Matters and Briefs – "Abusive Insurance Plans" Get Red Flag -

More Problems for 419 Plans. This article answers the following questions:

* The Purpose of 409A

Sid Kess’ Practical Alternatives to Commonly Misused and Abused Small Business "Tax Strategies": Insuring Your Client’s Future

New Jersey Association of Public Accountants Newsletter

Retirement Plans being audited by IRS in 2008

(March 2004)

What does §409A do?

Conclusion

Sid Kess’ Practical Alternatives to Commonly Misused and Abused Small Business Tax Strategies: Insuring Your Client’s Future

Lance Wallach

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Post a Comment

Investment News - Lance Wallach - 412i and 419 plan litigatation

Tax Matters and Briefs – "Abusive Insurance Plans" Get Red Flag -

More Problems for 419 Plans. This article answers the following questions:

* The Purpose of 409A

Sid Kess’ Practical Alternatives to Commonly Misused and Abused Small Business "Tax Strategies": Insuring Your Client’s Future

New Jersey Association of Public Accountants Newsletter Retirement Plans being audited by IRS in 2008

(March 2004)

What does §409A do?

Conclusion

Sid Kess’ Practical Alternatives to Commonly Misused and Abused Small Business Tax Strategies: Insuring Your Client’s Future

Lance Wallach

No comments:

Post a Comment

New Jersey Association of Public Accountants Newsletter

Retirement Plans being audited by IRS in 2008