Captive Insurance Plans
Avoid Paying nondeductible fines or penalties
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Showing posts with label captive insurance plans. Show all posts
Showing posts with label captive insurance plans. Show all posts
Using Captive Insurance Companies for Savings
Small companies have been copying a method to control insurance costs and reduce taxes that used to be the domain of large businesses: setting up their own insurance companies to provide coverage when they think that outside insurers are charging too much.
Often, they are starting what is called a "captive insurance company" - an insurer founded to write coverage for the company, companies or founders.
Here's how captive insurers work.
The parent business (your company) creates a captive so that it has a self-funded option for buying insurance, whereby the parent provides the reserves to back the policies. The captive then either retains that risk or pays reinsures to take it. The price for coverage is set by the parent business; reinsurance costs, if any, are a factor.
Here's how captive insurers work.
The parent business (your company) creates a captive so that it has a self-funded option for buying insurance, whereby the parent provides the reserves to back the policies. The captive then either retains that risk or pays reinsures to take it. The price for coverage is set by the parent business; reinsurance costs, if any, are a factor.
http://www.hg.org/article.asp?id=35592
IRS Attacks Business Owners in 419, 412, Section 79 and Captive Insurance Plans Under Section 6707A
Taxpayers who previously adopted 419, 412i, captive
insurance or Section 79 plans are in big trouble.
In recent years, the IRS has identified many of these arrangements as abusive devices to funnel tax deductible dollars to shareholders and classified these arrangements as listed transactions." These plans were sold by insurance agents, financial planners, accountants and attorneys seeking large life insurance commissions. In general, taxpayers who engage in a “listed transaction” must report such transaction to the IRS on Form 8886 every year that they “participate” in the transaction, and you do not necessarily have to make a contribution or claim a tax deduction to participate. Section 6707A of the Code imposes severe penalties for failure to file Form 8886 with respect to a listed transaction. But you are also in trouble if you file incorrectly. I have received numerous phone calls from business owners who filed and still got fined. Not only do you have to file Form 8886, but it also has to be prepared correctly. I only know of two people in the U.S. who have filed these forms properly for clients. They tell me that was after hundreds of hours of research and over 50 phones calls to various IRS personnel. The filing instructions for Form 8886 presume a timely filling. Most people file late and follow the directions for currently preparing the forms. Then the IRS fines the business owner. The tax court does not have jurisdiction to abate or lower such penalties imposed by the IRS.
"Many taxpayers who are no longer taking current tax deductions for these plans continue to enjoy the benefit of previous tax deductions by continuing the deferral of income from contributions and deductions taken in prior years."
Many business owners adopted 412i, 419, captive insurance and Section 79 plans based upon representations provided by insurance professionals that the plans were legitimate plans and were not informed that they were engaging in a listed transaction. Upon audit, these taxpayers were shocked when the IRS asserted penalties under Section 6707A of the Code in the hundreds of thousands of dollars. Numerous complaints from these taxpayers caused Congress to impose a moratorium on assessment of Section 6707A penalties.
The moratorium on IRS fines expired on June 1, 2010. The IRS immediately started sending out notices proposing the imposition of Section 6707A penalties along with requests for lengthy extensions of the Statute of Limitations for the purpose of assessing tax. Many of these taxpayers stopped taking deductions for contributions to these plans years ago, and are confused and upset by the IRS’s inquiry, especially when the taxpayer had previously reached a monetary settlement with the IRS regarding its deductions. Logic and common sense dictate that a penalty should not apply if the taxpayer no longer benefits from the arrangement. Treas. Reg. Sec. 1.6011-4(c)(3)(i) provides that a taxpayer has participated in a listed transaction if the taxpayer’s tax return reflects tax consequences or a tax strategy described in the published guidance identifying the transaction as a listed transaction or a transaction that is the same or substantially similar to a listed transaction.
Clearly, the primary benefit in the participation of these plans is the large tax deduction generated by such participation. Many taxpayers who are no longer taking current tax deductions for these plans continue to enjoy the benefit of previous tax deductions by continuing the deferral of income from contributions and deductions taken in prior years. While the regulations do not expand on what constitutes “reflecting the tax consequences of the strategy,” it could be argued that continued benefit from a tax deferral for a previous tax deduction is within the contemplation of a “tax consequence” of the plan strategy. Also, many taxpayers who no longer make contributions or claim tax deductions continue to pay administrative fees. Sometimes, money is taken from the plan to pay premiums to keep life insurance policies in force. In these ways, it could be argued that these taxpayers are still “contributing,” and thus still must file Form 8886.
It is clear that the extent to which a taxpayer benefits from the transaction depends on the purpose of a particular transaction as described in the published guidance that caused such transaction to be a listed transaction. Revenue Ruling 2004-20, which classifies 419(e) transactions, appears to be concerned with the employer’s contribution/deduction amount rather than the continued deferral of the income in previous years. Another important issue is that the IRS has called CPAs material advisors if they signed tax returns containing the plan, and got paid a certain amount of money for tax advice on the plan. The fine is $100,000 for the CPA, or $200,000 if the CPA is incorporated. To avoid the fine, the CPA has to properly file Form 8918.
Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals, Wallach is a frequent speaker on retirement plans, financial and estate planning, and abusive tax shelters. He is also a featured writer and has been interviewed on television and financial talk shows including NBC, National Pubic Radio’s All Things Considered and others. Lance authored 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 AICPA best-selling books including Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots.
Contact him at:
516.938.5007,
wallachinc@gmail.com, or
www.taxadvisorexperts.org, or
www.taxlibrary.us.
Help with Common IRS Problems: IRS Audits 419, 412i, Captive Insurance Plans With Life Insurance, and Section 79 Scams
IRS Audits 419, 412i, Captive Insurance Plans With Life
Insurance, and Section 79 Scams
By Lance Wallach
June 2011
The IRS started auditing 419 plans in the ‘90s, and then
continued going after 412i and other plans that they considered abusive,
listed, or reportable transactions, or substantially similar to such
transactions.
In a recent Tax Court Case, Curcio v. Commissioner (TC Memo
2010-115), the Tax Court ruled that an investment in an employee welfare
benefit plan was a listed transaction in that the transaction in question was
substantially similar to the transaction described in IRS Notice 95-34. A
subsequent case, McGehee Family Clinic, largely followed Curcio, though it was
technically decided on other grounds. The parties stipulated to be bound by
Curcio on the issue of whether the amounts paid by McGehee in connection with
the 419 Plan and Trust were deductible. Curcio did not appear to have been
decided yet at the time McGehee was argued. The McGehee opinion (Case No.
10-102) (United States Tax Court, September 15, 2010) does contain an exhaustive
analysis and discussion of virtually all of the relevant issues.
Taxpayers and their representatives should be aware that the
Service has disallowed deductions for contributions to these arrangements. The
IRS is cracking down on small business owners who participate in tax reduction
insurance plans and the brokers who sold them. Some of these plans include
defined benefit retirement plans, IRAs, or even 401(k) plans with life
insurance.
In order to fully grasp the severity of the situation, one
must have an understanding of Notice 95-34, which was issued in response to
trust arrangements sold to companies that were designed to provide deductible
benefits such as life insurance, disability and severance pay benefits. The
promoters of these arrangements claimed that all employer contributions were
tax-deductible when paid, by relying on the 10-or-more-employer exemption from
the IRC § 419 limits. It was claimed that permissible tax deductions were
unlimited in amount.
In general, contributions to a welfare benefit fund are not
fully deductible when paid. Sections 419 and 419A impose strict limits on the
amount of tax-deductible prefunding permitted for contributions to a welfare
benefit fund. Section 419A(F)(6) provides an exemption from Section 419 and
Section 419A for certain “10-or-more employers” welfare benefit funds. In
general, for this exemption to apply, the fund must have more than one
contributing employer, of which no single employer can contribute more than 10%
of the total contributions, and the plan must not be experience-rated with
respect to individual employers.
According to the Notice, these arrangements typically
involve an investment in variable life or universal life insurance contracts on
the lives of the covered employees. The problem is that the employer
contributions are large relative to the cost of the amount of term insurance
that would be required to provide the death benefits under the arrangement, and
the trust administrator may obtain cash to pay benefits other than death
benefits, by such means as cashing in or withdrawing the cash value of the
insurance policies. The plans are also often designed so that a particular
employer’s contributions or its employees’ benefits may be determined in a way
that insulates the employer to a significant extent from the experience of
other subscribing employers. In general, the contributions and claimed tax
deductions tend to be disproportionate to the economic realities of the
arrangements.
The 419 plan advertised that enrollees should expect to
obtain the same type of tax benefits as listed in the transaction described in
Notice 95-34. The benefits of enrollment listed in its advertising packet
included:
Virtually unlimited deductions for the employer;
Contributions could vary from year to year;
Benefits could be provided to one or more key executives on
a selective basis;
No need to provide benefits to rank-and-file employees;
Contributions to the plan were not limited by qualified plan
rules and would not interfere with pension, profit sharing or 401(k) plans;
Funds inside the plan would accumulate tax-free;
Beneficiaries could receive death proceeds free of both
income tax and estate tax;
The program could be arranged for tax-free distribution at a
later date;
Funds in the plan were secure from the hands of creditors.
The Court said that the 419 Plan was factually similar to
the plans described in Notice 95-34 at all relevant times. In rendering its
decision the court heavily cited Curcio, in which the court also ruled in favor
of the IRS. As noted in Curcio, the insurance policies, 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 McGehee Family Clinic had 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 also assessed tax deficiencies and the enhanced
30% penalty 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.
More you should know:
In recent years, some section 412(i) plans have been funded
with life insurance using face amounts in excess of the maximum death benefit a
qualified plan is permitted to pay.
Ideally, the plan should limit the proceeds that can be paid as a death
benefit in the event of a participant’s death.
Excess amounts would revert to the plan.
Effective February 13, 2004, the purchase of excessive life insurance in
any plan is considered a listed transaction if the face amount of the insurance
exceeds the amount that can be issued by $100,000 or more and the employer has
deducted the premiums for the insurance.
A 412(i) plan in and of itself is not a listed transaction;
however, the IRS has a task force auditing 412i plans.
An employer has not engaged in a listed transaction simply because
it is a 412(i) plan.
Just because a 412(i) plan was audited and sanctioned for
certain items, does not necessarily mean the plan engaged in a listed
transaction. Some 412(i) plans have been audited and sanctioned for issues not
related to listed transactions.
Companies should carefully evaluate proposed investments in
plans such as the 419 Plan. The claimed deductions will not be available, and
penalties will be assessed for lack of disclosure if the investment is similar
to the investments described in Notice 95-34. In addition, under IRC 6707A, IRS
fines participants a large amount of money for not properly disclosing their
participation in listed, reportable or similar transactions; an issue that was
not before the Tax Court in either Curcio or McGehee. The disclosure needs to
be made for every year the participant is in a plan. The forms need to be
properly filed even for years that no contributions are made. I have received
numerous calls from participants who did disclose and still got fined because
the forms were not filled in properly. A plan administrator told me that he
assisted hundreds of his participants file forms, and they still all received
very large IRS fines for not properly filling in the forms.
IRS has been attacking all 419 welfare benefit plans, many
412i retirement plans, captive insurance plans with life insurance in them and
Section 79 plans.
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.
419 Plan
419 Plan
| Our team of experienced consulting "tax attorneys", CPAs, and "insurance experts" specializing in 412i" and "419 "IRS audits" that resulted from plans you sold to your clients, mainly "419 plans", "412i plans", "captive insurance" plans and "Section 79" plans as well as other similar "employee benefit plans" or "welfare benefit plans" that the IRS is targeting as "abusive tax shelters". Our firm has been successful in "defending life insurance agents" and "material advisors" who have participated in the sale of these "benefit plans". If you signed a return or participated in the sale of these "welfare benefit plans", you are probably a "material advisor" and subject to huge "IRS penalties and interest". No "Form 8886" or "Form 8918" that we have reviewed for new clients has been properly prepared, which leaves the "material advisor" subject to the $200,000 "IRS penalty". We fight for our clients to defend against the $200,000 IRS "6707A penalty" by providing "expert witness testimony". Lance's side has never lost a case! |
Did you Participate in a 419 or 412i Benefit Plan?: IRS Attacks Business Owners in 419, 412, Section 7...
Did you Participate in a 419 or 412i Benefit Plan?: IRS Attacks Business Owners in 419, 412, Section 7...: Massachusetts Society of Certified Public Accountants, Inc. Winter 2010 By Lance Wallach Taxpayers who previously adopted 419, 412i, c...
As an expert witness, Lance Wallach has never lost a case.
Lance Wallach; Expert Witness:
To read more about me, click here!
Sometimes the IRS might disagree with planning you did with other advisors and you need to find help to ensure that your rights are protected, the facts are interpreted accurately and the law applied correctly. Lance Wallach is among the few in this country who fully understand the mechanics and legal issues surrounding what has become known as “419 Plans,” often welfare benefit plans for small companies funded with life insurance. For that reason taxpayers throughout the country seek his services of his ex IRS agents and tax attorney CPAs in dealing with the Internal Revenue Service in audits, appeals and in the Tax Court.
Frankly, not everybody does it right. Whether through ignorance or ill-intent, some folks sell insurance based programs with tax benefits, such as 419 Plans and 412(i) Plans, captive insurance, section 79 scams, or promote premium financing or STOLI programs to unsuspecting consumers leaving the consumer to be eaten alive, either by the IRS or by a turn in the economy, when all goes wrong. But the opposite is also true. One 419 Plan and some 412(i) Plans are very well designed and flawlessly implemented but the IRS just shoots first and aims second. Some legitimate premium financing might miscue. Building off of Lances knowledge of life insurance and the many ways life insurance has been and can be used in tax and wealth planning, lawyers for both plaintiffs and defendants throughout the US seek Lances services as an expert witness in cases between consumers and those who sold them these programs that develop after the IRS, right or wrong, initiates an audit or the investment goes under water. In looking for an expert witness examine the past. As an expert Lance Wallach’s side has never lost a case. Who else can say that?
- 419 Plans
- 412i Plans
- Captive Insurance Plans
- Welfare Benefit Plans
- 419 Plan Problems
- Section 79 Plan
- and more!
To read more about me, click here!
Sometimes the IRS might disagree with planning you did with other advisors and you need to find help to ensure that your rights are protected, the facts are interpreted accurately and the law applied correctly. Lance Wallach is among the few in this country who fully understand the mechanics and legal issues surrounding what has become known as “419 Plans,” often welfare benefit plans for small companies funded with life insurance. For that reason taxpayers throughout the country seek his services of his ex IRS agents and tax attorney CPAs in dealing with the Internal Revenue Service in audits, appeals and in the Tax Court.
Frankly, not everybody does it right. Whether through ignorance or ill-intent, some folks sell insurance based programs with tax benefits, such as 419 Plans and 412(i) Plans, captive insurance, section 79 scams, or promote premium financing or STOLI programs to unsuspecting consumers leaving the consumer to be eaten alive, either by the IRS or by a turn in the economy, when all goes wrong. But the opposite is also true. One 419 Plan and some 412(i) Plans are very well designed and flawlessly implemented but the IRS just shoots first and aims second. Some legitimate premium financing might miscue. Building off of Lances knowledge of life insurance and the many ways life insurance has been and can be used in tax and wealth planning, lawyers for both plaintiffs and defendants throughout the US seek Lances services as an expert witness in cases between consumers and those who sold them these programs that develop after the IRS, right or wrong, initiates an audit or the investment goes under water. In looking for an expert witness examine the past. As an expert Lance Wallach’s side has never lost a case. Who else can say that?
Captive Insurance & 419 Plans Litigation: September 2013
Captive Insurance & 419 Plans Litigation: September 2013
hursday, May 29, 2014
419 Welfare Benefit Plans
A view from a former IRS Agent, CPA, College Professor - Sam Susser - Welfare Benefit Plans (WBP), also known as Welfare Benefit Trusts and Welfare Benefit Funds are vehicles by which employers may offer their employees and retirees with certain types of insurance coverage (e.g., life insurance, health insurance, disability insurance, and long-term care), as well as other benefits such as severance payments and educational funding.
If properly designed and in compliance with IRC sections 419 and 419A, WBPs offer employers with a valid tax deduction. However, as is the case with many plans that offer opportunities for deductibility, some WBPs fail to comply with Code standards, invite abuse, and otherwise are used inappropriately as a basis to reduce taxable income.
It is, therefore, not surprising that the Internal Revenue Service (IRS) has targeted WBP, designating many such plans as “listed transactions.” The IRS’ attack arsenal includes, but is not limited to: Notice 2007-83 (where the IRS intends to challenge claimed tax benefits meeting the definition of a “listed transaction”); Notice 2007-84 (where the IRS may challenge trust arrangements purporting to provide non-discriminatory medical and life insurance benefits, if such plans are, in substance, discriminatory); Revenue Ruling 2007-65 (where the IRS will not disallow deductions for such arrangements for prior year tax years, except to the extent that deductions have exceeded the amount of insurance included on the participant’s Form W-2 for a particular year), and IR-2007-170 (the IRS’ guidance position on WBPs). Accordingly, taxpayers who have claimed deductions pursuant to Internal Revenue Code (Code) Section 419 are receiving letters from the IRS inviting them to an audit.
The Good:
Let’s start off with a proposition that may surprise many of you – the IRS is generally good. No, that’s not an oxymoron. The rest of this article is in the words of Sam Susser:
For over 35 years, I have had the privilege of representing the IRS and the US taxpayers on tax audits. Our goal was to always determine the correct tax –whether the outcome was a deficiency or a refund. The bottom line, which the IRS supported, was to “do the right thing.” Over these years, I have met and befriended many competent and exemplary agents. As with all industries, there are a few who simply go through the motions, and there are a few who are simply incompetent. Fortunately, the latter two groups are in the minority. Now that I represent clients who are being audited by IRS, my objectives have not changed. The right thing must still be done. I only hope to get a well-versed agent who knows the law and can make a determination based on facts and circumstances, and not by preconceived notions.
I have been resolving the WBP issue mostly at the Revenue Agent (RA) level. Most RAs are knowledgeable in the area of WBP, and it it a pleasure dealing with them. My clients became involved with both abusive plans as well as what I determined to be non-abusive plan. Because most clients have sought the opinions of an independent professional tax attorney, CPA, Enrolled Agent , or other independent professionals who the IRS deems to be knowledgeable and capable of rendering an opinion on a Plan, Prior to 2007 I had a good case for abating the penalty and any interest thereon due to the reasonable cause exception. The RAs accepted my briefs for penalty relief and I usually resolved the case agreed at the agent’s level. The right thing was being done by both sides. Since 2007 the bar has been raised in meeting the reasonable cause exception. Simply put, if taxpayers failed to file Forms 8886 with their tax returns, the penalty could no longer be abated due to reasonable cause. If we do not come to an agreement, the case would, at taxpayer’s additional expense, proceed to the Appeals Division. This would normally be a good strategy in nebulous circumstances. With rare exceptions this is not a good strategy under these circumstances as explained later.
Just as there are good and bad IRS agents, there are good and bad WBPs. The abusive plans that have been sold should not affect those plans that adhere to the spirit of the tax laws. Thus, of the many plans sold to taxpayers, some can be considered “good.” The “bad” WBPs should not taint the “good” ones.
IR-2007-170, Oct. 17, 2007, recognizes that “[t]here are many legitimate welfare benefit funds that provide benefits, such as health insurance and life insurance, to employees and retirees. However, the arrangements the IRS is cautioning employers about is primarily benefits the owner or other key employees of businesses, sometimes in the form of distributions of cash, loans, or life insurance policies.”
The Bad:
A persistent pattern that I see with WBPs is that the IRS appears to presumptively hold such plans as improper contrary to the statement in IR-2007-170. From what I have indirectly encountered, it appears that the IRS may interview the plan administrator, with the primary objective of securing the plan’s participants (and audit targets) rather than determining whether the limitations of a Code Section 419 deduction were satisfied. No determination is made as to whether the plan meets or fails to meet Code requirements. The plan participants then receive audit letters: one to the entity claiming the deduction, and the other to the owner(s) of such entity. These audit letters are generally accompanied by a lengthy “canned” Information Document Request (IDR) ostensibly written by IRS attorneys.
During my decades with the IRS, IDRs are usually focused documents seeking very specific documents and information to determine whether further action is required. However, my review of IDRs on the subject of WBPs shows them to be akin to document production demands in a civil litigation. The IRS basically wants everything associated with the WBP – there is no specific focus. Moreover, they have a very expansive definition of documents, and seek them whether they are in the taxpayer’s possession, or in the possession of the taxpayer’s “attorneys, accountants, affiliates, advisers, representatives, or other persons directly or indirectly employed by you, hired by you, or connected with you, or your representatives, and anyone else subject to your control.”
What was most disturbing about these IDRs that I have seen is the fact that the RAs also have, on a number of occasions, requested copies of the tax returns for the tax year(s) under audit. This indicated to me, especially since the name of the WBP is repeatedly mentioned in the IDR, that my client was selected from the list provided by the plan administrator to the IRS. This in itself is not necessarily bad since this is a useful tool for the IRS in obtaining names of participants of plans that might not meet the muster of the Code and IRS pronouncements. However, I would think that the “give me everything from everybody” approach should not be the first step in an IRS inquiry into the validity of a WBP.
Other clients received audit letters with a similar IDR requesting information including copies of the returns under examination. These clients, however, had stopped participating in the plan many years prior to the audit years. Nonetheless, since the client's name was still on the Plan’s list of participants, the client was going to be audited. The IRS takes the position that the cash surrender value of any life insurance policy in the plan is available to the client and is therefore income to that client for the year the IRS has decided to audit Accordingly, the RAs are proposing adjustments in years in which no deduction to the WBP have been taken.
The … ?
To rub salt into the wound, the RA has enclosed an explanation as to why the deduction is disallowed, and has proposed a statutory underpayment penalty. The tax law provides for a penalty to be imposed where a taxpayer makes a substantial understatement of their tax liability. For individual taxpayers, a substantial underpayment exists when the understatement for the year exceeds the greater of ten percent of the tax required to be shown on the return, or $5,000. This is a relatively low threshold and is easily met by most taxpayers. The penalty is twenty percent of the tax underpayment.
Following the RA’s review, the taxpayer can expect to receive a 20 – 40 page “boiler-plated” or “canned” write-up, which will wind up as the Revenue Agent Report (RAR). The RARs that I’ve seen appear obviously drafted by IRS attorneys. Sometimes the RAR is shortened as a result of “cut and paste” procedures assembled by the RA. The RARs also contain alternative positions for these proposed disallowances. Taxpayers and representatives can take little comfort when all indications lead to the conclusion that the IRS has made a determination prior to assessing all the facts and circumstances of any given case standing on its own merits. My concern is that the WBP that meet IRS requirements are swept together with those that do not, and are unjustly branded as “bad.” The participants of these “good” plans must now overcome the preconceived notions of the RA. This becomes a difficult task as RAs won't deviate from the “boiler-plated” positions, forcing the taxpayer to expend funds in seeking further relief . The Appeals Division has similarly received a directive to sustain the RA RAR thus effectively eliminating the appeals right the taxpayers normally have. The only "appeals" route a taxpayer can take is to petition the Courts for a hearing. The time, expense, and outcome in defending a WBP under this scenario are enigmatic (hence the “…?”), and well, simply put, can really become downright UGLY!
Conclusion:
The IRS needs to examine WBPs on a plan by plan basis, and make a determination based on the facts and circumstances of each plan. Specifically, they should be charged with independently evaluating whether a particular WBP generally adheres to the Code and the IRS’s issued pronouncements. The RA and those in charge of this project should be cognizant of the statement issued by Donald L. Korb (Chief Counsel for the IRS): “The guidance targets specific abuses involving a limited group of arrangements that claim to be welfare benefit funds.” (emphasis provided). He continues to state that: “[T]oday’s action sends a strong signal that these abusive schemes must stop.” (emphasis provided). For those plans that the IRS deems to be abusive, the IRS can concentrate its resources in auditing the plan participants. The IRS hierarchy needs to eliminate the UGLY, recognize the GOOD, and pursue the BAD.
It is, therefore, not surprising that the Internal Revenue Service (IRS) has targeted WBP, designating many such plans as “listed transactions.” The IRS’ attack arsenal includes, but is not limited to: Notice 2007-83 (where the IRS intends to challenge claimed tax benefits meeting the definition of a “listed transaction”); Notice 2007-84 (where the IRS may challenge trust arrangements purporting to provide non-discriminatory medical and life insurance benefits, if such plans are, in substance, discriminatory); Revenue Ruling 2007-65 (where the IRS will not disallow deductions for such arrangements for prior year tax years, except to the extent that deductions have exceeded the amount of insurance included on the participant’s Form W-2 for a particular year), and IR-2007-170 (the IRS’ guidance position on WBPs). Accordingly, taxpayers who have claimed deductions pursuant to Internal Revenue Code (Code) Section 419 are receiving letters from the IRS inviting them to an audit.
The Good:
Let’s start off with a proposition that may surprise many of you – the IRS is generally good. No, that’s not an oxymoron. The rest of this article is in the words of Sam Susser:
For over 35 years, I have had the privilege of representing the IRS and the US taxpayers on tax audits. Our goal was to always determine the correct tax –whether the outcome was a deficiency or a refund. The bottom line, which the IRS supported, was to “do the right thing.” Over these years, I have met and befriended many competent and exemplary agents. As with all industries, there are a few who simply go through the motions, and there are a few who are simply incompetent. Fortunately, the latter two groups are in the minority. Now that I represent clients who are being audited by IRS, my objectives have not changed. The right thing must still be done. I only hope to get a well-versed agent who knows the law and can make a determination based on facts and circumstances, and not by preconceived notions.
I have been resolving the WBP issue mostly at the Revenue Agent (RA) level. Most RAs are knowledgeable in the area of WBP, and it it a pleasure dealing with them. My clients became involved with both abusive plans as well as what I determined to be non-abusive plan. Because most clients have sought the opinions of an independent professional tax attorney, CPA, Enrolled Agent , or other independent professionals who the IRS deems to be knowledgeable and capable of rendering an opinion on a Plan, Prior to 2007 I had a good case for abating the penalty and any interest thereon due to the reasonable cause exception. The RAs accepted my briefs for penalty relief and I usually resolved the case agreed at the agent’s level. The right thing was being done by both sides. Since 2007 the bar has been raised in meeting the reasonable cause exception. Simply put, if taxpayers failed to file Forms 8886 with their tax returns, the penalty could no longer be abated due to reasonable cause. If we do not come to an agreement, the case would, at taxpayer’s additional expense, proceed to the Appeals Division. This would normally be a good strategy in nebulous circumstances. With rare exceptions this is not a good strategy under these circumstances as explained later.
Just as there are good and bad IRS agents, there are good and bad WBPs. The abusive plans that have been sold should not affect those plans that adhere to the spirit of the tax laws. Thus, of the many plans sold to taxpayers, some can be considered “good.” The “bad” WBPs should not taint the “good” ones.
IR-2007-170, Oct. 17, 2007, recognizes that “[t]here are many legitimate welfare benefit funds that provide benefits, such as health insurance and life insurance, to employees and retirees. However, the arrangements the IRS is cautioning employers about is primarily benefits the owner or other key employees of businesses, sometimes in the form of distributions of cash, loans, or life insurance policies.”
The Bad:
A persistent pattern that I see with WBPs is that the IRS appears to presumptively hold such plans as improper contrary to the statement in IR-2007-170. From what I have indirectly encountered, it appears that the IRS may interview the plan administrator, with the primary objective of securing the plan’s participants (and audit targets) rather than determining whether the limitations of a Code Section 419 deduction were satisfied. No determination is made as to whether the plan meets or fails to meet Code requirements. The plan participants then receive audit letters: one to the entity claiming the deduction, and the other to the owner(s) of such entity. These audit letters are generally accompanied by a lengthy “canned” Information Document Request (IDR) ostensibly written by IRS attorneys.
During my decades with the IRS, IDRs are usually focused documents seeking very specific documents and information to determine whether further action is required. However, my review of IDRs on the subject of WBPs shows them to be akin to document production demands in a civil litigation. The IRS basically wants everything associated with the WBP – there is no specific focus. Moreover, they have a very expansive definition of documents, and seek them whether they are in the taxpayer’s possession, or in the possession of the taxpayer’s “attorneys, accountants, affiliates, advisers, representatives, or other persons directly or indirectly employed by you, hired by you, or connected with you, or your representatives, and anyone else subject to your control.”
What was most disturbing about these IDRs that I have seen is the fact that the RAs also have, on a number of occasions, requested copies of the tax returns for the tax year(s) under audit. This indicated to me, especially since the name of the WBP is repeatedly mentioned in the IDR, that my client was selected from the list provided by the plan administrator to the IRS. This in itself is not necessarily bad since this is a useful tool for the IRS in obtaining names of participants of plans that might not meet the muster of the Code and IRS pronouncements. However, I would think that the “give me everything from everybody” approach should not be the first step in an IRS inquiry into the validity of a WBP.
Other clients received audit letters with a similar IDR requesting information including copies of the returns under examination. These clients, however, had stopped participating in the plan many years prior to the audit years. Nonetheless, since the client's name was still on the Plan’s list of participants, the client was going to be audited. The IRS takes the position that the cash surrender value of any life insurance policy in the plan is available to the client and is therefore income to that client for the year the IRS has decided to audit Accordingly, the RAs are proposing adjustments in years in which no deduction to the WBP have been taken.
The … ?
To rub salt into the wound, the RA has enclosed an explanation as to why the deduction is disallowed, and has proposed a statutory underpayment penalty. The tax law provides for a penalty to be imposed where a taxpayer makes a substantial understatement of their tax liability. For individual taxpayers, a substantial underpayment exists when the understatement for the year exceeds the greater of ten percent of the tax required to be shown on the return, or $5,000. This is a relatively low threshold and is easily met by most taxpayers. The penalty is twenty percent of the tax underpayment.
Following the RA’s review, the taxpayer can expect to receive a 20 – 40 page “boiler-plated” or “canned” write-up, which will wind up as the Revenue Agent Report (RAR). The RARs that I’ve seen appear obviously drafted by IRS attorneys. Sometimes the RAR is shortened as a result of “cut and paste” procedures assembled by the RA. The RARs also contain alternative positions for these proposed disallowances. Taxpayers and representatives can take little comfort when all indications lead to the conclusion that the IRS has made a determination prior to assessing all the facts and circumstances of any given case standing on its own merits. My concern is that the WBP that meet IRS requirements are swept together with those that do not, and are unjustly branded as “bad.” The participants of these “good” plans must now overcome the preconceived notions of the RA. This becomes a difficult task as RAs won't deviate from the “boiler-plated” positions, forcing the taxpayer to expend funds in seeking further relief . The Appeals Division has similarly received a directive to sustain the RA RAR thus effectively eliminating the appeals right the taxpayers normally have. The only "appeals" route a taxpayer can take is to petition the Courts for a hearing. The time, expense, and outcome in defending a WBP under this scenario are enigmatic (hence the “…?”), and well, simply put, can really become downright UGLY!
Conclusion:
The IRS needs to examine WBPs on a plan by plan basis, and make a determination based on the facts and circumstances of each plan. Specifically, they should be charged with independently evaluating whether a particular WBP generally adheres to the Code and the IRS’s issued pronouncements. The RA and those in charge of this project should be cognizant of the statement issued by Donald L. Korb (Chief Counsel for the IRS): “The guidance targets specific abuses involving a limited group of arrangements that claim to be welfare benefit funds.” (emphasis provided). He continues to state that: “[T]oday’s action sends a strong signal that these abusive schemes must stop.” (emphasis provided). For those plans that the IRS deems to be abusive, the IRS can concentrate its resources in auditing the plan participants. The IRS hierarchy needs to eliminate the UGLY, recognize the GOOD, and pursue the BAD.
As an expert witness Lance Wallach's side has never lost a case. People need to be careful of 419 Welfare Benefit Plans, 412i plans, Section 79 plans and Captive Insurance Plans. Most of these plans are sold by insurance agents. If you are in an abusive, listed or similar transaction plan you need to file under IRS 6707a. The participant files form 8886, and the salesmen or accountant who signs the tax returns files form 8918 if they got paid over $10,000. They are called Material Advisors and face a minimum $100,000 fine. Some plans are offshore which could involve FBAR or OVDI filings. If you have money overseas you probably need to file for IRS tax amnesty. If you want to reduce the tax we suggest that you first file and then opt out. For more information Google Lance Wallach.
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.
412i Plans Attacked by IRS, Lawsuits
IRS has been attacking abusive 412i plans for years. Business men have been suing the insurance agents who sold the plans. The IRS has attacked 412i, 419 plans for years. As a result promoters are now promoting section 79 and captive insurance plans. They are just starting to be attacked by the IRS.
A 412(i) plan differs from other defined benefit pension plans in that it must be funded exclusively by the purchase of individual life insurance products.
In the late 1990's brokers and promoters such as Kenneth Hartstein, Dennis Cunning, and others began selling 412(i) plans designed with policies created and sold through agents of Pacific Life, Hartford, Indianapolis life, and American General. These plans were sold or administered through companies such as Economic Concepts, Inc., Pension Professionals of America, Pension Strategies, L.L.C. and others.
These plans were very lucrative for the brokers, promoters, agents, and insurance companies. In addition to the costs associated with administering the plans, the policies of insurance had high commissions. If they were cancelled within a few years of purchase the had very little cash value.
Attorney Richard Smith at the law firm of Bryan Cave issued tax opinion letters opinion which stated that the design of many of the plans met the requirements of section 412(i) of the tax code.
In the early 2000s, IRS officials began questioning the insurance representatives, brokers, promoters, and their attorneys and giving speeches at benefits conferences wherein they took the position that these plans were in violation of both the letter and spirit of the Internal Revenue Code. When I spoke at the annual national convention of the American Society of Pension Actuaries in 2002 I heard such a speech given by Jim Holland, IRS chief actuary.
In February 2004, the IRS issued guidance on 412(i) and began the process of making plans "listed transactions." Taxpayers involved in listed transaction are required to report them to the IRS. These transactions are to be reported using a form 8886. The failure to file a form 8886 subjects individual to penalties of very large amounts, and failure of insurance agents, accountants and others to file 8918 results in a $100,000 fine.
In late 2005, the IRS began obtaining information from advisors and actively auditing plans and more recently, levying section 6707 penalties. First the IRS would audit the business owner and deny the deduction. The business owner would also owe interest and penalties. Then another unit of the IRS would assess large additional fines for failure to properly file, or failure to file 8886 forms. The directions for these forms is very complicated, especially if the forms are filed after the fact. Many business owners still got fined even if they filed the forms. If the forms were not filled in exactly right a fine was still assessed.
The IRS's response to these 412(i) plans was predictable. They made it clear that the IRS would not be gentle and even indicated that potential criminal liability existed. The IRS made speeches and people like me wrote articles about the problems.
Insurance company representatives attended these conferences and heard the IRS warnings. Many of them ignored them.
Neither the brokers, promoters, or Insurance companies relayed this information to their clients and insureds at this time. When I would speak about the problems of 412i and 419 plans I would be attacked by promoters and salesmen. When I testified against a springing cash value policy in my first court case I was challenged by the defendants attorney as not being an expert. The judge allowed the jury to hear whether I was indeed an expert. The result was a huge loss for the defense.
On February 13, 2004, the IRS issued a press release, two revenue rulings, and proposed regulations to shut down abusive transactions involving specifically designed life insurance policies in retirement plans, section 412(i) plans and 419 plans etc.
In October of 2005, the IRS invited those who sponsored 412(i) plans that were treated as listed transactions to enter a settlement program in which the taxpayer would rescind the plan and pay the income taxes it would have paid had it not engaged in the plan, plus interest and reduced penalties.
MDL stands for Multidistrict Litigation. It was created by Congress in 1968 – 28 U.S.C. §1407.
The act created an MDL Panel of judges to determine whether civil actions pending in different federal districts involve one or more common questions of fact such that the actions should be transferred to one federal district for coordinated or consolidated pretrial proceedings. In theory, the purposes of this transfer or “centralization” process are to avoid duplication of discovery, to prevent inconsistent pretrial rulings, and to conserve the resources of the parties, their counsel and the judiciary. Transferred actions which are not resolved in the MDL are remanded to their originating court or district by the Panel for trial. Lots of people who were audited sued the insurance companies, agents, accountants and others.
Then, Pacific Life, Hartford Life & Annuity moved for summary judgment in the MDL. The court granted the motions in part, and denied the motions in part. Specifically, the court dealt with the issue of the disclaimers contained within the policies and signed by various policyholders.
Applying California law in evaluating the disclosures and disclaimers, the Court ruled that the California Plaintiffs failed to raise issues of material fact that they reasonably relied on representations by Hartford and Pacific Life regarding the tax and legal issues related to their 412(i) plans.
Conversely, the court ruled that pursuant to Wisconsin law, the disclaimers were unenforceable. The court came to similar conclusion when applying Texas law to the Plaintiffs claims.
Plaintiffs have been more successful in suing 419 plan promoters, insurance companies, accountants, etc. I have been an expert witness and my side has never lost a case.
I have been speaking with my IRS contacts about the newest abusive tax shelter trends, captives and section 79 plans. They have started auditing participants in these plans. The IRS has not yet decided if the plans are listed, abusive or similar to. I think that captive insurance companies and section 79 plans may become the next 412 and 419 problem for unsuspecting companies. Designed under IRS Code 831(b), these captive insurance companies are designed to insure the risks of an individual business. In theory and if properly designed, the premiums are deducted when paid to a related company, and depending on claims, profits can be paid out as dividends and when liquidated, the proceeds are taxed at capital gains rates.
The problem with Captives is that they are expensive to set up and operate. Captives must be operating as a true risk assuming entity, not simply a tax avoidance vehicle. Some variations are to rent a cell captives that can work for a lot less money.
The IRS is looking into the sale of life insurance to fund Captives. They are also looking at most section 79 plans. This sounds very familiar.
National Society of Accountants Speaker of The Year
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.
As an expert witness Lance Wallach's side has never lost a case. People need to be careful of 419 Welfare Benefit Plans, 412i plans, Section 79 plans and Captive Insurance Plans. Most of these plans are sold by insurance agents. If you are in an abusive, listed or similar transaction plan you need to file under IRS 6707a. The participant files form 8886, and the salesmen or accountant who signs the tax returns files form 8918 if they got paid over $10,000. They are called Material Advisors and face a minimum $100,000 fine. Some plans are offshore which could involve FBAR or OVDI filings. If you have money overseas you probably need to file for IRS tax amnesty. If you want to reduce the tax we suggest that you first file and then opt out. For more information Google Lance Wallach.
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author. Lance Wallach
A 412(i) plan differs from other defined benefit pension plans in that it must be funded exclusively by the purchase of individual life insurance products.
In the late 1990's brokers and promoters such as Kenneth Hartstein, Dennis Cunning, and others began selling 412(i) plans designed with policies created and sold through agents of Pacific Life, Hartford, Indianapolis life, and American General. These plans were sold or administered through companies such as Economic Concepts, Inc., Pension Professionals of America, Pension Strategies, L.L.C. and others.
These plans were very lucrative for the brokers, promoters, agents, and insurance companies. In addition to the costs associated with administering the plans, the policies of insurance had high commissions. If they were cancelled within a few years of purchase the had very little cash value.
These plans were often described as Pendulum Plans, or other similar names. In theory, the plans would work as follows. After the plan was set up, the plan would purchase a life insurance policy insuring the life of an individual. The plan would have very little (and high surrender charges) for 5 or more years. The Corporation would pay the premium on the policy and take a deduction for the entire amount. In year 5, when the policy had little or no cash value, the plan would transfer the policy to the individual, who would take it at a greatly reduced basis. Subsequently, the policy would spring up with cash value, thus the name springing cash value policy. The insured would have cash value which he could withdraw almost tax free .
Attorney Richard Smith at the law firm of Bryan Cave issued tax opinion letters opinion which stated that the design of many of the plans met the requirements of section 412(i) of the tax code.
In the early 2000s, IRS officials began questioning the insurance representatives, brokers, promoters, and their attorneys and giving speeches at benefits conferences wherein they took the position that these plans were in violation of both the letter and spirit of the Internal Revenue Code. When I spoke at the annual national convention of the American Society of Pension Actuaries in 2002 I heard such a speech given by Jim Holland, IRS chief actuary.
In February 2004, the IRS issued guidance on 412(i) and began the process of making plans "listed transactions." Taxpayers involved in listed transaction are required to report them to the IRS. These transactions are to be reported using a form 8886. The failure to file a form 8886 subjects individual to penalties of very large amounts, and failure of insurance agents, accountants and others to file 8918 results in a $100,000 fine.
In late 2005, the IRS began obtaining information from advisors and actively auditing plans and more recently, levying section 6707 penalties. First the IRS would audit the business owner and deny the deduction. The business owner would also owe interest and penalties. Then another unit of the IRS would assess large additional fines for failure to properly file, or failure to file 8886 forms. The directions for these forms is very complicated, especially if the forms are filed after the fact. Many business owners still got fined even if they filed the forms. If the forms were not filled in exactly right a fine was still assessed.
The IRS's response to these 412(i) plans was predictable. They made it clear that the IRS would not be gentle and even indicated that potential criminal liability existed. The IRS made speeches and people like me wrote articles about the problems.
Insurance company representatives attended these conferences and heard the IRS warnings. Many of them ignored them.
Neither the brokers, promoters, or Insurance companies relayed this information to their clients and insureds at this time. When I would speak about the problems of 412i and 419 plans I would be attacked by promoters and salesmen. When I testified against a springing cash value policy in my first court case I was challenged by the defendants attorney as not being an expert. The judge allowed the jury to hear whether I was indeed an expert. The result was a huge loss for the defense.
On February 13, 2004, the IRS issued a press release, two revenue rulings, and proposed regulations to shut down abusive transactions involving specifically designed life insurance policies in retirement plans, section 412(i) plans and 419 plans etc.
In October of 2005, the IRS invited those who sponsored 412(i) plans that were treated as listed transactions to enter a settlement program in which the taxpayer would rescind the plan and pay the income taxes it would have paid had it not engaged in the plan, plus interest and reduced penalties.
MDL stands for Multidistrict Litigation. It was created by Congress in 1968 – 28 U.S.C. §1407.
The act created an MDL Panel of judges to determine whether civil actions pending in different federal districts involve one or more common questions of fact such that the actions should be transferred to one federal district for coordinated or consolidated pretrial proceedings. In theory, the purposes of this transfer or “centralization” process are to avoid duplication of discovery, to prevent inconsistent pretrial rulings, and to conserve the resources of the parties, their counsel and the judiciary. Transferred actions which are not resolved in the MDL are remanded to their originating court or district by the Panel for trial. Lots of people who were audited sued the insurance companies, agents, accountants and others.
Then, Pacific Life, Hartford Life & Annuity moved for summary judgment in the MDL. The court granted the motions in part, and denied the motions in part. Specifically, the court dealt with the issue of the disclaimers contained within the policies and signed by various policyholders.
Applying California law in evaluating the disclosures and disclaimers, the Court ruled that the California Plaintiffs failed to raise issues of material fact that they reasonably relied on representations by Hartford and Pacific Life regarding the tax and legal issues related to their 412(i) plans.
Conversely, the court ruled that pursuant to Wisconsin law, the disclaimers were unenforceable. The court came to similar conclusion when applying Texas law to the Plaintiffs claims.
Plaintiffs have been more successful in suing 419 plan promoters, insurance companies, accountants, etc. I have been an expert witness and my side has never lost a case.
I have been speaking with my IRS contacts about the newest abusive tax shelter trends, captives and section 79 plans. They have started auditing participants in these plans. The IRS has not yet decided if the plans are listed, abusive or similar to. I think that captive insurance companies and section 79 plans may become the next 412 and 419 problem for unsuspecting companies. Designed under IRS Code 831(b), these captive insurance companies are designed to insure the risks of an individual business. In theory and if properly designed, the premiums are deducted when paid to a related company, and depending on claims, profits can be paid out as dividends and when liquidated, the proceeds are taxed at capital gains rates.
The problem with Captives is that they are expensive to set up and operate. Captives must be operating as a true risk assuming entity, not simply a tax avoidance vehicle. Some variations are to rent a cell captives that can work for a lot less money.
The IRS is looking into the sale of life insurance to fund Captives. They are also looking at most section 79 plans. This sounds very familiar.
National Society of Accountants Speaker of The Year
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.
As an expert witness Lance Wallach's side has never lost a case. People need to be careful of 419 Welfare Benefit Plans, 412i plans, Section 79 plans and Captive Insurance Plans. Most of these plans are sold by insurance agents. If you are in an abusive, listed or similar transaction plan you need to file under IRS 6707a. The participant files form 8886, and the salesmen or accountant who signs the tax returns files form 8918 if they got paid over $10,000. They are called Material Advisors and face a minimum $100,000 fine. Some plans are offshore which could involve FBAR or OVDI filings. If you have money overseas you probably need to file for IRS tax amnesty. If you want to reduce the tax we suggest that you first file and then opt out. For more information Google Lance Wallach.
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author. Lance Wallach
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