Abusive Tax Shelter

Abusive 412(i) Retirement Plans Can Get Accountants Fined $200,000

California Enrolled Agent

January 2

By Lance Wallach & Ira Kaplan

Most insurance agents sell 412(i) retirement plans. The large insurance commissions generate some of the enthusiasm. Unlike other retirement plans, the 412(i) plan must have insurance products as the funding mechanism. This seems to generate enthusiasm among insurance agents. The IRS has been auditing almost all participants in 412(i) plans for the last few years. At first, they thought all 412(i) plans were abusive. Many participants’ contributions were disallowed and there were additional fines of $200,000 per year for the participants. The accountants who signed the tax returns (who the IRS called “material advisors”) were also fined $200,000 with a referral to the Office of Professional Responsibility. For more articles and details, see www.vebaplan.com and www.irs.gov/.

On Friday February 13, 2004, the IRS issued proposed regulations concerning the valuation of insurance contracts in the context of qualified retirement plans.

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

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

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

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

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

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

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

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

The sponsor of an abusive plan can expect to be treated more harshly. Although in some situations something can be salvaged, the possibility is definitely on the table of having to treat the plan as if it never existed, which of course triggers the full extent of back taxes, penalties and interest on all contributions that were made, not to mention leaving behind no retirement plan whatsoever. In addition, if the participant did not file Form 8886 and the accountant did not file Form 8918 (to report themselves), they would be fined $200,000.

Lance Wallach, the National Society of Accountants Speaker of the Year, speaks and writes extensively about retirement plans, Circular 230 problems and tax reduction strategies. He speaks at more than 40 conventions annually, writes for over 50 publications and has written numerous best selling AICPA books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Business Hot Spots. Contact him at 516.938.5007 or visit www.vebaplan.com.

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

412iplan.wordpress.com

Important FBAR and International Tax Information For 2012

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By Lance Wallach

For individual tax returns (Forms 1040) due to be filed in 2012 (due this year by April 17, 2012, unless extended), the IRS has issued new Form 8938, "Statement of Specified Foreign Financial Assets," requiring the disclosure of certain foreign accounts and assets.

Whether an individual is required to file this form is complicated, but basically this applies to the following assets if owned in 2011:
Financial accounts in foreign financial institutions.
Any stock or securities issued by foreign corporations or entities, any interest in a foreign partnership, trust or estate, as well as any financial instrument or contract issued by a foreign person, and foreign pension plans and deferred compensation arrangements (but not foreign social security). You are not, however, required to report foreign assets (1) if the assets are held in a U.S. brokerage account; (2) if you are required to disclose the asset on certain other tax form such as Form 3520 or Form 5471; or (3) if such assets (other than stock) are used in your trade or business.

Whether you have to file Form 8938 depends on the total value of such foreign assets at year end as well as the highest value at any point in the year. For U.S. citizens and residents filing joint tax returns, you must file Form 8938 if the year-end value of the foreign assets is $100,000 or more or, if the value at any time during the year exceeded $150,000. On joint returns, all foreign-based assets owned by the spouses are considered in determining these thresholds. For married spouses filing separately and for unmarried persons, the thresholds are $50,000 (year end) and $75,000 (high value during the year).

There are different rules regarding certain persons who live abroad. There are also rules regarding valuation of certain assets. These are spelled out in greater detail in the Form 8938 instructions.

If required, Form 8938 is to be filed with your Federal Income Tax Return (Form 1040). Currently only individuals having filing requirements must fill out the Form 8938, but it is expected that this will be extended to corporations, partnerships and trusts in the future.

The IRS may impose penalties for failure to file Form 8938 if you lack reasonable cause or willfully neglected to file. In addition, if you underpay your tax as a result of a transaction involving an undisclosed foreign financial asset, the penalty for such failure may be 40 percent of the underpayment (instead of the normal 20 percent). In addition, the statute of limitations for assessing tax may be extended if you fail to file the form.

It is important to note that Form 8938 is in addition to the annual Foreign Bank Account Form or "FBAR," which has different filing requirements. The FBAR, generally is required if you have ownership or signature authority over one or more foreign bank accounts with a value of over $10,000 on any date in the prior year. The FBAR is not part of your income tax return, but is filed separately and must be received by the Department of Treasury in Detroit by June 30 (timely mailing does not apply to that form).

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.

412i Tax Shelter Fraud Litigation - How It Works

Lance Wallach

PARTIES:

Typically, these transactions will include an Insurance company, accountant, tax attorney, and a promoter (someone with an insurance background, perhaps an actuary, who knows how to structure the policy itself). These groups will use insurance brokerages and sub-agents (licensed in the various states) to sell the policies themselves.

INSURANCE COMPANIES

AMERICAN GENERAL LIFE INSURANCE COMPANY® INDIANAPOLIS LIFE INSURANCE COMPANY®

HARTFORD LIFE AND ANNUITY INSURANCE COMPANY® PACIFIC LIFE INSURANCE COMPANY®

BANKERS LIFE and OTHERS®?

4121iHOW THESE PLANS WORK:

In the late 1990’s, the individuals and groups above devised a scheme to sell abusive tax shelters under the auspices of Section 412(i) of the tax code. A 412(i) is a defined benefit pension plan. It provides specific retirement benefits to participants once they reach retirement and must contain assets sufficient to pay those benefits. 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. To create a 412(i) plan, there must be a trust to hold the assets. The employer funds the plan by making cash contributions to the trust, and the Code allows the employer to take a tax deduction in the amount of the contributions, i.e. the entire amount.

The trust uses the contributed funds to purchase some combination of life insurance products (insurance or annuities) for the plan. As the plan participants retire, the trust will usually sell the policies for their present cash value and purchase annuities with the proceeds. The revenue stream from the annuities pays the specified retirement benefit to plan participants.

These defendants (with the aid and knowledge of the insurance companies) used the traditional structure and sold life insurance policies with excessively high premiums. The trust then uses the large cash contributions to pay high insurance premiums and the employer takes a deduction for the sum of those large contributions. As you might expect, these policies were designed with excessively high fees or “loads” which provided exorbitant commissions to the insurance companies and the agents who sold the products.

The policies that were sold were termed Springing Cash Value Policies. They had no cash value for the first 5-7 years, after which they had significant cash value. Under this scheme, after 5-7 years, and just before the cash value sprung, the participant purchases the policy from the trust for the policy’s surrender value. In theory, you have a tax free transaction.

The IRS does not recognize the tax benefit of such a plan and has repeatedly issued announcements indicating that such plans are contrary to federal tax laws and regulations.

I am not an attorney but I learned some of the above information from attorney’s Mr. Ford’s website.

Lawline Abusive Retirement Plans 412i

On Lawline regarding Abusive Retirement Plans 412i

Lance Wallach featured on Lawline speaking about Abusive Retirement Plan 412i, IRS 6706AFines and Abusive Insurance product. Here is the story of Bruce Hink purchasing a definet Benefit Retirement Plan & Abusive Tax Shelter from an Insurance Agent and well establish Insurance Company. Whats the problem?

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

Tax Resolution Sevices - Attorneys-USA.org Lance Wallach

Captive Insurance: IRS Knocking

I.R.S. Is Looking Into Captive Insurance Shelters The question is whether these small captives have gone too far. This year, the Internal Revenue Service placed them on its annual “Dirty Dozen list of tax scams.” Small captives now share space with phishing, identity theft and offshore tax avoidance.

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

Get Sued!

BY: Lance Wallach

The IRS is 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, I am always approached by many people who have questions about tax reduction plans that they have heard about. Below are the most common.
419 tax reduction insurance plans

These come in various versions, and most of them have or will get the participant audited and the salesman sued. They purportedly allow the business owner to make a large tax-deductible contribution, and some or all of the contribution pays for a life insurance product. The IRS has been disallowing most versions of these plans for years, yet they continue to be sold. After everyone gets into trouble and the insurance agents get sued, the promoters of the abusive versions sometimes change the name of their company and call the plan something else. The insurance companies whose policies are sold are legitimate companies. What usually is not legitimate is the way that most of the plans are operated. There can also be a $200,000 IRS fine facing the insurance agent who sold the plan if Form 8918 has not been properly filed. I've reviewed hundreds of these forms for agents and have yet to see one that was filled out correctly.

When the IRS audits a participant in one of these plans, the tax deductions are lost. There is also the interest and large penalties to consider. The business owner can also be facing a $200,000-a-year fine if he did not properly file Form 8886. Most of these forms have been filled out improperly. In my talks with the IRS, I was told that the IRS considers not filling out Form 8886 properly almost the same as not filing at all.

412(i) retirement plans

The IRS has been auditing participants in these types of retirement plans. While there is generally nothing wrong with many of the newer plans, the IRS considered most of the older abusive plans. Forms 8918 and 8886 are also required for abusive 412(i) plans.

I have been an expert witness in a lot 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. Don't let them learn on the job, with your career and money at stake.

Do not wait for IRS to come and get you, or for your client to sue you. Time is of the essence. Most insurance professionals need help to correct their improperly completed Form 8918 or to fill it out properly in the first place. If you have not previously filled out the form it is late, and therefore you should immediately seek assistance. There are plenty of legitimate tax reduction insurance plans out there. Just make sure that you know the history of the people with whom you conduct business.

Remember, if something looks too good to be true, it usually is. Be careful.

LANCEWALLACHEXPERTWITNESS.INFO

Avoid the IRS 6707A Penalty, form 8886 for 419e 412i plans

Notice 2007–84 Notice to all that 419 plans are abusive

Division Counsel/Associate Chief
Counsel (Tax Exempt and Government
Entities). For further information regarding
this notice, contact Mr. Isaacs
at RetirementPlanQuestions@irs.gov

Ms. Clary. Trust Arrangements
Purporting to Provide
Nondiscriminatory
Post-Retirement Medical
and Life Insurance Benefits

Notice 2007–84

Sections 419 and 419A of the Internal
Revenue Code set forth rules under
which employers are permitted to make
currently deductible contributions to welfare
benefit funds in order to provide their
retirees with medical and life insurance
benefits. Businesses often maintain welfare
benefit funds that comport with the
intent of §§ 419 and 419A and do in fact
provide meaningful medical and life insurance
benefits to retirees on a nondiscriminatory
basis, and make substantial contributions
to those welfare benefit funds that
are fully deductible. Such welfare benefit
funds are outside the scope of this notice.
This notice addresses certain trust arrangements
that are being promoted to and
used by small businesses to avoid federal
income and employment taxes. The
arrangements described in this notice involve
purported welfare benefit funds that,
in form, provide post-retirement medical
and life insurance benefits to employees on
a nondiscriminatory basis, but that, in operation,
will primarily benefit the owners
or other key employees of the businesses.
This notice alerts taxpayers and their representatives
that the tax treatment of these
arrangements may vary from the claimed
tax treatment. The Internal Revenue Service
(IRS) may issue further guidance to
address these arrangements, and taxpayers
should not assume that the guidance will
be applied prospectively only.
Concurrentlywith this notice, the IRS is
publishing Notice 2007–83, this Bulletin,
which identifies as listed transactions certain
transactions involving purported welfare
benefit fund arrangements using cash
value life insurance policies. The fact that
an arrangement is described in this notice
does not preclude it from also being a listed
transaction under Notice 2007–83 where
the arrangement provides benefits to active
employees as well as to retired employees.
The IRS has previously identified certain
other transactions that claim to be
welfare benefit funds as listed transactions.
Notice 2003–24, 2003–1 C.B. 853,
describes certain transactions purporting
to meet the exception under § 419A(f)(5)
of the Internal Revenue Code for collectively
bargained plans. Notice 95–34,
1995–1 C.B. 309, describes transactions
that purport to meet the 10-or-more employer
plan exception under § 419A(f)(6).
Notice 2004–67, 2004–2 C.B. 600, includes
transactions described in Notice
2003–24 and Notice 95–34, as well as
substantially similar transactions, as listed
transactions.
BACKGROUND
Promoted trust arrangements claiming
to provide nondiscriminatory post-retirement
medical benefits and post-retirement
life insurance benefits have recently come
to the attention of the IRS. These arrangements,
among others, may be referred to
by persons advocating the use of the plans
as “single employer plans” or “419(e)
plans.” These purported welfare benefit
arrangements are usually sold to small
businesses and other closely held businesses
as a way to provide post-retirement
medical benefits, post-retirement life insurance,
and cash and other property to
the owners or other key employees of the
business on a tax-favored basis through
the use of a trust. Those advocating the
use of these plans usually assert that the
contributions are tax-deductible, but with
no corresponding inclusion by the owner
or other key employee. Some of these arrangements
involve plans that previously
had claimed to be 10-or-more employer
plans under § 419A(f)(6); some others
were established to receive policies transferred
from terminating plans that claimed
to be 10-or-more employer plans.
A promoted arrangement may involve
either a taxable trust or a tax-exempt trust,
i.e., a voluntary employees’ beneficiary association
(VEBA) that has received a determination
letter fromthe IRS that it is described
in § 501(c)(9). The trust frequently
uses the employer’s contributions to purchase
cash value life insurance policies on
the lives of employees who are owners of
the business and, sometimes, on the lives
of other key employees.
The amount of the employer’s deduction
for contributions to one of these plans
is often based on a calculation of a reserve
associated with each of the plan participants.
However, the calculation may be
based on an unreasonable assumption that
all of the covered employees will eventually
receive post-retirement benefits under
the plan, ormay be based on other actuarial
assumptions that either are not reasonable
or are not permitted to be reflected in the
reserve calculations for purposes of §§ 419
and 419A.
Under some arrangements, the plan
documents may indicate that post-retirement
benefits will be provided on a nondiscriminatory
basis when, in fact, only a few
employees (primarily the employees who
are also owners of the business) will ever
receive those benefits. To the extent a trust
holds excess assets not needed to pay the
original benefits, the owner will also receive
a substantial portion of those assets.
Under some arrangements, this will be
accomplished through the use of “loans”
to the owners. For some arrangements, the
plan will be amended to provide benefits
other than the plan’s original post-retirement
medical or life insurance benefits.
For others, the plan will be terminated
prior to the payment of the post-retirement
benefits and the timing of the termination
and the methods used to allocate the
remaining assets are structured so that
the owners and other key employees will
receive, directly or indirectly, all or a substantial
portion of the assets held by the
trust.
Persons advocating the use of these
plans claim that the employer’s contributions
for the post-retirement medical and
life benefits are deductible under §§ 419
and 419A as additions to a qualified asset
account. They may also claim that owners
or other key employees receive the
economic benefits from the contributions
with little or no income inclusion.
LAW
Sections 419 and 419A prescribe limits
on the amount of deductions for contributions
paid or accrued by an employer
November 5, 2007 963 2007–45 I.R.B.

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Lance Wallach

Notice 2007–84