Some 419 Insurance Welfare Benefit Plans Continue To Get Accountants Into Trouble

Popular so-called "419 Insurance Welfare Benefit Plans," sold by most insurance professionals, are getting accountants and their clients into more and more trouble. A CPA who is approached by a client about one of the abusive arrangements and/or situations to be described and discussed in this article must exercise the utmost degree of caution, not only on behalf of the client, but for his/her own good as well. The penalties noted in this article can also be applied to practitioners who prepare and/or sign returns that fail to properly disclose listed transactions, including those discussed herein.

On October 17, 2007, the IRS issued Notice 2007-83, Notice 2007-84, and Revenue Ruling 2007-65. Notice 2007-83 essentially lists the characteristics of welfare benefit plans that the Service regards as listed transactions. Put simply, to be a listed transaction, a plan cannot rely on the union exception set forth in IRC Section 419A(f)(5), there must be cash value life insurance within the plan and excessive tax deductions for life insurance, in excess of what may be permitted by Sections 419 and 419A, must have been claimed.

In Notice 2007-84, the Service expressed concern with plans that provide all or a substantial portion of benefits to owners and/or key and highly compensated employees. The notice identified numerous specific concerns, among them:

1. The granting of loans to participants
2. Providing deferred compensation
3. Plan terminations that result in the distribution of assets rather than being used post-
retirement, as originally established.
4. Permitting the transfer of life insurance policies to participants.

Alternative tax treatment may well be in the offing for such arrangements, as the IRS intends to re-characterize such arrangements as dividends, non-qualified deferred compensation (under IRC Section 404(a)(5) or Section 409A), split-dollar life insurance arrangements, or disqualified benefits pursuant to Section 4976. Taxpayers participating in these listed transactions should have, in most cases, already disclosed such participation to the Service. Those who have not should do so at the earliest possible moment. Failure to disclose can result in severe penalties – up to $100,000 for
individuals and $200,000 for corporations.

Finally, Revenue Ruling 2007-65 focused on 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), 419A (f)(6), and 419 plans. Life insurance premiums are not inherently tax deductible and authority must be found in Section 79 to justify such a deduction. Section 264(a), in fact, specifically disallows tax deductions for life insurance, at least in some cases. And moreover, the Service declared, interposition of a trust does not change the nature of the transaction.

LANCEWALLACHEXPERTWITNESS.INFO

IRS Offshore Voluntary Disclosure Program Reopens

Published in Offshore International Today By Lance Wallach, CLU, CHFC
Today, the Internal Revenue Service reopened the offshore voluntary disclosure program to help people hiding offshore accounts get current with their taxes.  Additionally, the IRS revealed the collection of more than $4.4 billion so far from the two previous international programs.

The Offshore Voluntary Disclosure Program (OVDP) was reopened following continued strong interest from taxpayers and tax practitioners after the closure of the 2011 and 2009 programs. The third offshore program comes as the IRS continues working on a wide range of international tax issues and follows ongoing efforts with the Justice Department to pursue criminal prosecution of international tax evasion.  This program will remain open indefinitely until otherwise announced.

Lance Wallach and his associates have received thousands of phone calls from concerned clients with questions about the prior programs. Some of Lance’s associates are still very busy helping people with the last program. Not a single person has been audited and most are pleased with the results and are now able to sleep easily without worrying about the IRS.  According to Lance, it requires years of experience to obtain a good result from the program.
He suggests using a CPA-certified, ex-IRS agent with lots of international tax experience. While this is not a requirement to file under the program, Lance has heard many horror stories from people who have tried to file by themselves or who have used inexperienced accountants.

“Our focus on offshore tax evasion continues to produce strong, substantial results for the nation’s taxpayers,” said IRS Commissioner Doug Shulman. “We have billions of dollars in hand from our previous efforts, and we have more people wanting to come in and get right with the government. This new program makes good sense for taxpayers still hiding assets overseas and for the nation’s tax system.”

The new program is similar to the 2011 program in many ways, but it has a few key differences. Unlike last year, there is no set deadline for people to apply.  However, the terms of the program could change at any time going forward.  For example, the IRS may increase penalties in the program for all or some taxpayers or defined classes of taxpayers – or decide to end the program entirely at any point.

“As we've said all along, people need to come in and get right with us before we find you,” Shulman said. “We are following more leads and the risk for people who do not come in continues to increase.”

The third offshore effort accompanies another announcement that Shulman made today, that the IRS has collected $3.4 billion so far from people who participated in the 2009 offshore program.  That figure reflects closures of about 95 percent of the cases from the 2009 program. On top of that, the IRS has collected an additional $1 billion from up front payments required under the 2011 program.  That number will grow as the IRS processes the 2011 cases.

In all, the IRS has seen 33,000 voluntary disclosures from the 2009 and 2011 offshore initiatives. Since the 2011 program closed last September, hundreds of taxpayers have come forward to make voluntary disclosures.  Those who come in after the closing of the 2011 program will be able to be treated under the provisions of the new OVDP program.

The overall penalty structure for the new program is the same for 2011, except for taxpayers in the highest penalty category.

The new program’s penalty framework requires individuals to pay a penalty of 27.5 percent of the highest aggregate balance in foreign bank accounts/entities or the value of foreign assets during the eight full tax years prior to the disclosure. That is up from 25 percent in the 2011 program. Some taxpayers will be eligible for 5 or 12.5 percent penalties; these remain the same in the new program as in 2011.

Participants must file all original and amended tax returns and include payment for back-taxes and interest for up to eight years as well as paying accuracy-related and/or delinquency penalties.

Participants face a 27.5 percent penalty, but taxpayers in limited situations can qualify for a 5 percent penalty. Smaller offshore accounts will face a 12.5 percent penalty. People whose offshore accounts or assets did not surpass $75,000 in any calendar year covered by the new OVDP will qualify for this lower rate. As under the prior programs, taxpayers who feel that the penalty is disproportionate may opt instead to be examined.

The IRS recognizes that its success in offshore enforcement and in the disclosure programs has raised awareness related to tax filing obligations.  This includes awareness by dual citizens and others who may be delinquent in filing, but owe no U.S. tax. 


FBAR-OVDI.COM



Lance Wallach National Society of Accountants Speaker of The Year





Help With Common IRS Problems



Published in Coatings Pro Magazine
 Lance Wallach
It is tax time. There are many problems you can run into with the IRS. This article is a generalized overview of some of these confusing issues:

•    IRS Penalties
•    Unfiled Tax Returns 
•    IRS Liens
•    IRS Audits
•    Payroll Tax Problems
•    IRS Levies
•    Wage Garnishments
•    IRS Seizures

When dealing with the IRS, it can seem like they have all the power. That is not always true. As a small business owner--and a taxpayer--it is vital that you know your options and your rights.

 IRS Penalties

The IRS penalizes millions of taxpayers each year. In fact, they have so many penalties that it can be hard to understand which penalty they are hitting you with.

The most common penalties are Failure to File and Failure to Pay. Both of these penalties can substantially increase the amount you owe the IRS in a very short period of time.

To make matters worse, the IRS charges interest on penalties. Many taxpayers often find out about IRS problems many years after they have occurred. As a result, the amount owed the IRS is substantially greater due to penalties and the accumulated interest on those penalties. Some IRS penalties can be as high as 75% to 100% of the original taxes owed. Often taxpayers can afford to pay the taxes owed, but the extra penalties make it impossible to pay off the entire balance.

The original goal of the IRS imposing penalties was to punish taxpayers in order to keep them in line. Unfortunately, the penalties have turned into additional sources of income for the IRS. So they are happy to add whatever penalties they can and to pile interest on top of those penalties. Your loss is their gain.
It is important to know that under certain circumstances the IRS does abate, or forgive, penalties. Therefore before you pay the IRS any penalty amounts, you may want to consider requesting that the IRS abate your penalties.

Unfiled Tax Returns

Many taxpayers fail to file required tax returns for a variety of reasons. What you must understand is that failure to file tax returns may be construed as a criminal act by the IRS--a criminal act punishable by up to one year in jail for each year not filed. Needless to say, its one thing to owe the IRS money but another thing to potentially lose your freedom for failure to file a tax return.

The IRS may file “SFR” (Substitute For Return) Tax Returns on your behalf. This is the IRS’s version of an unfiled tax return. Because SFR Tax Returns are filed in the best interest of the government, the only deductions you’ll see are standard deductions and one personal exemption. You will not get credit for deductions to which you may be entitled, such as exemptions for a spouse or children, interest on your home mortgage and property taxes, cost of any stock or real estate sales, business expenses, etc.

Remember that regardless of what you have heard, you have the right to file your original tax return, no matter how late it is filed.

IRS Liens

The IRS can make your life miserable by filing Federal Tax Liens on your business or property. Federal Tax Liens are public records indicating that you owe the IRS various taxes. They are filed with the County Clerk in the county from which you or your business operates.

Because they are public records, they will show up on your credit report. This often makes it difficult to obtain financing on an automobile or a home. Federal Tax Liens can also tie up your personal property, meaning that you cannot sell or transfer that property without a clear title.

Often taxpayers find themselves in a Catch-22 in which they have property that they would like to borrow against, but because of the Federal Tax Lien, they cannot get a loan. Should a Federal Tax Lien be filed against you, a CPA can help get it lifted.

IRS Audits 

The IRS conducts multiple types of audits. They can audit you by mail, in their offices, in your office or home. The location of the audit is a good indication of the severity.

Typically, Correspondence Audits are conducted to locate missing documents in your tax return that have been flagged by IRS computers. These documents usually include W-2s and 1099 income items or interest expense items. This type of audit can typically be handled through the mail with the correct documentation.

The IRS Office Audit--held in IRS offices--is usually conducted by a Tax Examiner who will request numerous documents and explanations of various deductions. During this type of audit you may be required to produce all bank records for a period of time so that the IRS can check for unreported income.

The IRS Home or Office Audit--held in your home or office--should be taken very seriously as these are conducted by IRS Revenue Agents. Revenue Agents receive more training and learn more auditing techniques than typical Tax Examiners.
Of course, all IRS audits should be taken seriously as they often lead to examinations of other tax years and other tax problems not stated in the original audit letter.

Payroll Tax Problems

The IRS is very aggressive in their collection attempts for past-due payroll taxes. The penalties assessed on delinquent payroll tax deposits or filings can dramatically increase the total amount you owe in just a matter of months.

I believe that it is critical for business owners to have an attorney present in these situations. Your answers to the first five IRS questions may determine whether you stay in business or are liquidated by the IRS. We always advise clients to avoid meeting with any IRS representatives regarding payroll taxes until you have met with a professional to discuss your options.

IRS Levies--Bank and Wage 

An IRS Levy is an action taken by the IRS to collect taxes. For example, the IRS can issue a Bank Levy to obtain the cash in your savings and checking accounts. Or, the IRS can levy your wages or accounts receivable. The person, company, or institution that is served with the levy must comply or face its own IRS problems.

When the IRS levies a bank account, the levy can only be honored on the particular day on which the bank receives the levy. The bank is required to remove whatever amount of money is in your account on that day (up to the amount of the IRS Levy) and send it to the IRS within 21 days unless otherwise notified by the IRS. This type of levy does not affect any future deposits made into your bank account unless the IRS issues another Bank Levy.

An IRS Wage Levy is different. Wage Levies are filed with your employer and remain in effect until the IRS notifies the employer that the Wage Levy has been released. Most Wage Levies take so much money from the taxpayer’s paycheck that the taxpayer doesn’t even have enough money remaining to meet basic needs.
Both Bank and Wage Levies create difficult situations and should be avoided if possible.

Wage Garnishments

The IRS Wage Garnishment is a very powerful tool used to collect taxes that you owe through your employer. Once a Wage Garnishment is filed with an employer, the employer is required to collect a large percentage of each paycheck. The funds that would have otherwise been paid to the employee will then be paid to the IRS.
The Wage Garnishment stays in effect until the IRS is fully paid or until the IRS agrees to release the garnishment. Having wages garnished can create other debt problems because the amount left over after the IRS takes its cut is often small, so you may have difficulty with bills and other financial obligations.

IRS Seizures

The IRS has extensive powers when it comes to seizures of assets. These powers allow them to seize personal and business assets to pay off outstanding tax liabilities. Seizures typically occur when taxpayers have been avoiding the IRS.

Similar to levies and garnishments, seizures are one of the IRS’s ultimate invasive collection tools. They can seize cars, television sets, jewelry, computers, collectibles, business equipment, or anything of value, which can be sold in order to acquire the money the IRS wants to pay off your tax debts. If you are facing a seizure, you have a serious problem.

Hopefully this tax season will begin and end without any of these IRS issues coming into play. But if they do, help is out there. CPAs and attorneys can help you negotiate your rights should it become necessary.

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, 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 Public 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.taxadvisorexpert.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.


irshelpblog.wordpress.com

IRS Audits 419, 412i, Captive Insurance Plans With Life Insurance and Section 79 Scams


     Published on hgexperts.com
         By: Lance Wallach
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. Listed designated as listed in published IRS material available to the general public or transactions that are substantially similar to the specific listed transactions. A reportable transaction is defined simply as one that has the potential for tax avoidance or evasion.
In a recent Tax Court Case, Curcio v. Commissioner (TC Memo 2010-15), the Tax Court ruled that an investment in an employee welfare benefit plan marketed under the name "Benistar" 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 Benistar 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.

Benistar 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 Benistar 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 Benistar Plan owned the insurance contracts.

Following Curcio, as the parties had stipulated, on the question of the amnesty paid by Mcghee in connection with benistar, the Court held that the contributions to Benistar were not deductible under section 162(a) because participants could receive the value reflected in the underlying insurance policies purchased by Benistar—despite the payment of benefits by Benistar seeming to be contingent upon an unanticipated event (the death of the insured while employed). As long as plan participants were willing to abide by Benistar’s distribution policies, there was no reason ever to forfeit a policy to the plan. In fact, in estimating life insurance rates, the taxpayers’ expert in Curcio assumed that there would be no forfeitures, even though he admitted that an insurance company would generally assume a reasonable rate of policy lapses.

The McGehee Family Clinic had enrolled in the Benistar 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 makes the plan 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 in a 412(i) plan.

Just because a 412(i) plan was audited and sanctioned for certain items, does not necessarily mean the plan is 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 Benistar 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 or 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 prepared 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, financial and estate planning, and abusive tax shelters.  He writes about 412(i), 419, 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 Public 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 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.taxaudit419.com and www.taxlibrary.us

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.

Protecting Clients from Fraud, Incompetence and Scams


Parts of this article are from the book published by John Wiley and Sons, Protecting Clients from Fraud, Incompetence and Scams, authored by Lance Wallach.

Every financial expert out there knows that bad faith and bad planning can take down even the biggest firms, wiping out millions of dollars of value in an instant. Whether it's internal fraud, a scammer, or an incompetent planner that takes your client's cash, the bottom line is: The money is gone and the loss should have been prevented.

Filled with authoritative advice from financial expert Lance Wallach, Protecting Clients from Fraud, Incompetence, and Scams equips you as an accountant, attorney, or financial planner with the weaponry you need to detect bad investments before they happen and protect your clients' wealth - as well as your own.

Sharp and savvy in its frank, often humorous, and authoritative examination of financial fraud and mismanagement, you'll learn about the dysfunctional sectors in the financial industry and:
  • Protecting your retirement assets
  • Asset protection basics
  • Shifting the risk equation: insurance maneuvers
  • Reevaluating existing insurance
  • What financial advisors and insurance agents "forget" to tell their clients
  • The truth about variable annuities
  • What you must know about life settlements
  • The smart way to approach college funding

The news for the past two years has been filled with gloom and dangers: Swindles, Bernie Madoff, rip-offs, and the collapse of Bear Stearns and Lehman Brothers. But the party's over, and with that era done, it's more important than ever for you to perform the due diligence on all financial maneuvers affecting the money you oversee and provide your clients with assurance in the form of practical solutions for risk and asset management.

A pragmatic blueprint for identifying trouble spots you can expect and immediately useful solutions, Protecting Clients from Fraud, Incompetence, and Scams equips you with the resources, strategies, and tools you need to effectively protect your clients from frauds and financial scammers.

Herewith is an excerpt from Lance Wallach's book, Protecting Clients from Fraud, Incompetence and Scams:

The IRS has been cracking down on what it considers to be abusive tax shelters. Many of them are being marketed to small business owners by insurance professionals, financial planners, and even accountants and attorneys. I speak at numerous conventions, for both business owners and accountants. And after I speak, many people who have questions about tax reduction plans that they have heard about always approach me.

I have been an expert witness in many of these 419 and 412(i) lawsuits and I have not lost one of them. If you sold one or more of these plans, get someone who really knows what they are doing to help you immediately. Many advisors will take your money and claim to be able to help you. Make sure they have experience helping agents that have sold these types of plans. Make sure they have experience helping accountants who signed the tax returns. IRS calls them material advisors and fines them $200,000 if they are incorporated or $100,000 if not. Do not let them learn on the job, with your career and money at stake.

LANCEWALLACHEXPERTWITNESS.COM



IRS Audits Focus on Captive Insurance Plans April 2011 Edition



April 2011 Edition By Lance Wallach

The IRS started auditing § 419 plans in the 1990s, and then continued going after § 412(i) and other plans that they considered abusive, listed, or reportable transactions, or substantially similar to such transactions. If an IRS audit disallows the § 419 plan or the § 412(i) plan, not only does the taxpayer lose the deduction and pay interest and penalties, but then the IRS comes back under IRC 6707A and imposes large fines for not properly filing.

Insurance agents, financial planners and even accountants sold many of these plans. The main motivations for buying into one were large tax deductions. The motivation for the sellers of the plans was the very large life insurance premiums generated. These plans, which were vetted by the insurance companies, put lots of insurance on the books. Some of these plans continue to be sold, even after IRS disallowances and lawsuits against insurance agents, plan promoters and insurance companies.

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 marketed under the name “Benistar” 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 Benistar 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 IRS 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 IRS 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 § 419 and § 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 percent 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.

Benistar 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 Benistar 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 Benistar Plan owned the insurance contracts.

Following Curcio, as the Court has stipulated, the Court held that the contributions to Benistar were not deductible under § 162(a) because participants could receive the value reflected in the underlying insurance policies purchased by Benistar—despite the payment of benefits by Benistar seeming to be contingent upon an unanticipated event (the death of the insured while employed). As long as plan participants were willing to abide by Benistar’s distribution policies, there was no reason ever to forfeit a policy to the plan. In fact, in estimating life insurance rates, the taxpayers’ expert in Curcio assumed that there would be no forfeitures, even though he admitted that an insurance company would generally assume a reasonable rate of policy lapses.

The McGehee Family Clinic had enrolled in the Benistar 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 percent 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.

Other important facts:
  • In recent years, some § 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 412(i) 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 Benistar 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 with filing forms, and they still all received very large IRS fines for not properly filling in the forms.

IRS has targeted all 419 welfare benefit plans, many 412(i) retirement plans, captive insurance plans with life insurance in them and Section 79 plans.

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