Showing posts with label 6707A. Show all posts
Showing posts with label 6707A. Show all posts
Lance Wallach: Big problems need big experts to resolve
Lance Wallach: Big problems need big experts to resolve: The Lance Wallach team of experts handles issues regariding 419 and 419i plans, listed reportable transactions, 6707A, abusive tax shelters, captive insurance, expert witness testimony, litigation support, section 79, and retirement plan lawsuits,Insurance fraud
Accountants Get Fined By IRS And Sued By Their Clients
Accountants Get Fined By IRS And Sued By Their Clients
By Lance Wallach, CLU, CHFC Abusive Tax Shelter, Listed
Transaction, Reportable Transaction
Expert Witness
Form 8886 is required to be filed by any
taxpayer who is participating, or in some cases has participated, in a listed
or reportable transaction.
New BISK CPEasy™ CPE
Self-Study Course
CPA’s Guide to Life Insurance
Author/Moderator: Lance Wallach
Below is an exert from one of Lance Wallach’s new books.
CPA’s Guide to Life Insurance
Author/Moderator: Lance Wallach
Below is an exert from one of Lance Wallach’s new books.
Lance Wallach
What attracted the most attention with respect to it, until very recently, were the penalties for failure to file, which were $100,000 annually for individuals and $200,000 annually for corporations. Recent legislation has reduced those penalties in most cases. However, there is still a minimum penalty of $5,000 annually for an individual and $10,000 annually for a corporation for failure to file. And those are the MINIMUM penalties. If the minimum penalties do not apply, the annual penalty becomes 75 percent of whatever tax benefit was derived from participation in the listed transaction, and the penalty is applied both to the business and to the individual business owners. Since the form must be filed for every year of participation in the transaction, the penalties can be cumulative; i.e., applied in more than one year. For example, a corporation that participated in five consecutive years could find itself, depending on the amount of claimed tax deductions, looking at several hundred thousand dollars in fines, even under the recently enacted legislation, before even thinking about back taxes, penalties, interest, etc., that could result from an audit. Even the minimum fine would be $15,000 per year, again in addition to all other applicable taxes and penalties, etc. So even the minimum fines could mount up fast.
The penalties can also be imposed for incomplete, inaccurate, and/or misleading filings. And the Service itself has not provided totally clear, unequivocal guidance to those hoping to avoid errors and penalties. To illustrate this point, Lance Wallach, a leading authority in this area who has received hundreds of calls and whose associates have literally aided dozens of taxpayers in completing these forms, reports that his associates, on numerous occasions, have sought the opinions and assistance of Service personnel, usually from the Office of Chief Counsel, with respect to questions arising while assisting taxpayers in completing and filing the form. The answers are often somewhat vague, and tend to be accompanied by a disclaimer advising not to rely on them.
One popular type of listed transaction is the so-called welfare benefit plan, which once relied in IRC Section 419A(F)(6) for its authority to claim tax deductions, but now more commonly relies on Section 419(e). The 419A(F)(6) plans used to claim that that section completely exempted business owners from all limitations on how much tax could be deducted. In other words, it was claimed, tax deductions were unlimited. These plans featured large amounts of life insurance and accompanying large commissions, and were thus aggressively pushed by insurance agents, financial planners, and sometimes even accountants and attorneys. Not to mention the insurance companies themselves, who put millions of dollars in premiums on the books and, when confronted with questions about the outlandish tax claims made in marketing these plans, claimed to be only selling product, not giving opinions on tax questions.
In the summer of 2003, the Service issued guidance that had the effect of severely curtailing those plans, and they began to largely, though not completely, disappear from the landscape. Most welfare benefit plans now claim Section 419(e) as the authority to claim a corporate tax deduction, though the promoters of these plans no longer claim that tax deductions are unlimited. Instead, they acknowledge that the amount of possible tax deductions is limited by the limitations of Section 419A, which Code section is a limitation on tax deductions that are authorized by other sections.
With respect to Section 419(e) welfare benefit plans, and of particular importance in this listed transaction/penalties arena, were the events of October 17, 2007, which over time have had roughly the same effect on Section 419(e) welfare benefit plans as the aforementioned 2003 developments had on Section 419A(F)(6) plans. On that date, the Service issued Notice 2007-83, which identified certain trust arrangements involving cash value life insurance policies, and substantially similar arrangements, as listed transactions. Translation: Section 419(e) welfare benefit plans that are funded by cash value life insurance contracts are listed transactions, at least if a tax deduction is taken for the amount of premiums paid for such policies. On that same day, the Service also issued Notice 2007-84 and Revenue Ruling 2007-65. The combined effect of these three IRS pronouncements was that not only was the use of cash value life insurance in welfare benefit plans, if combined with claiming tax deductions for the premiums paid, sufficient to cause IRS treatment of these plans as listed transactions, but that discrimination as between owners and rank and file employees in these plans was also being targeted.
To illustrate, in many of these promoted arrangements, these Section 419(e) welfare benefit plans, cash value life insurance policies are purchased on the lives of the owners of the business, and sometimes on key employees, while term insurance is purchased on the lives of the rank and file employees. The plans in question tend to anticipate that the plan will be terminated within five years or so, at which time the cash value policies will be distributed to the owners, and possibly key employees, with very little distributed to rank and file employees. In general, the Internal Revenue Code will not countenance the claiming of a tax deduction in connection with a welfare benefit plan where such blatant unequal treatment (discrimination) is exhibited. Nevertheless, plan promoters claim that insurance premiums are currently deductible by the business, and that the insurance policies, when distributed to the owners, can be done so virtually tax-free. And this also despite the fact that an employer’s deductions for contributions to an arrangement that is properly characterized as a welfare benefit fund are subject to the limitations and requirements of the rules in IRC sections 419 and 419A, including the use of reasonable actuarial assumptions and the satisfaction of nondiscrimination requirements.
With respect to the preparation and filing of Form 8886, incidentally, it should not surprise that welfare benefit promoters have been active in this area. This would include both the promoters of plans that have been listed transactions for years as well as those that became listed transactions, at least arguably, by virtue of the previously discussed October 2007 IRS activities. Some promoters take the position that their plans are completely compliant and that, therefore, there is no need to file Form 8886. Others take a more precautionary approach. While never admitting to being a listed transaction, they do urge clients to file on a protective basis. At least one went so far as to offer plan participants complete guidance and instructions about precisely how to file protectively. Many, if not most, plan promoters have, at the very least, forwarded completed sample forms to plan participants for guidance and use in completing Form 8886. It is certainly possible to file protectively. Any remotely good faith belief that the transaction is not a listed one justifies the protective filing. In fact and practice, the Service is actually treating protective filings in the same manner as other filings.
But while many plan promoters have recognized the filing obligation and recommended filing, this has led to another problem. As previously noted, they have been instructing taxpayers on how to complete and file the form, and the problem is that their guidance, in many cases, has not been particularly helpful and sometimes dangerous. In some cases, though this is difficult if not impossible to ascertain, the suggestions of the plan promoters seem designed more to protect the promoters than to assist the taxpayer. While this is a difficult call to make, it is absolutely clear, Wallach says, that more than one promoter, whether carelessly or otherwise, has sent taxpayers outdated forms to complete and file. Wallach, who you may recall has, between himself and his associates, aided dozens of taxpayers in completing and filing Form 8886, notes that his associates have frequently reported this problem. They also report never having seen a Form 8886 prepared completely correctly, especially where a promoter’s instructions were relied on. So, because the fines may be imposed for incomplete, misleading, or incorrect filings, the danger to plan participants can be clearly seen. And the taxpayer who discovers errors subsequent to filing must decide whether to amend the filing or not, which some plan participants are reluctant to do.
Burdens On Professionals With Clients In Welfare Benefit Plans And Other Listed Transactions
Form 8918 must be filed with the Internal Revenue Service by all “material advisors” to clients who are participating in listed transactions. Exactly who, then, is a material advisor? You are a material advisor if three requirements are satisfied. First, the client must actually be participating in the listed transaction. Second, you must have given the client tax advice with respect to the transaction. This does not necessarily mean that you recommended participation. For example, signing off on a tax return claiming a tax deduction for participation in the listed transaction surely qualifies as having given tax advice with respect to the transaction. In fact, even if you recommended against participation, you would satisfy this threshold so long as you rendered tax advice, be it positive, negative, or neutral.
The third threshold is that you must have received $10,000 or more in compensation (yourself and/or a related entity). This is not quite as simple as it sounds. The money need not all be received as a commission (as might be the case with a CPA who is insurance licensed), or even in a lump sum for accounting services rendered in connection with the client’s participation. The money could be received periodically over time. It is even possible that, so long as $10,000 in fees has been received from the client for whatever reason over whatever period of time, the threshold is met. Lance Wallach, previously referred to in the discussion about Form 8886 and whose associates are also expert in assisting CPAs and others in the preparation and filing of Form 8918, reports that one of his associates put this question directly to an attorney in the Office of the Chief Counsel who actually wrote published IRS guidance with respect to Form 8918. While the gentleman from the IRS was very courteous and professional, trying his best to be of assistance, a clear, unqualified, unequivocal answer that could be “taken to the bank” proved impossible to elicit.
Like Form 8886, however, Form 8918 can be filed protectively. Failure to file or incomplete, misleading, or inaccurate filings can lead to the penalties that used to apply to Form 8886, to wit: $100,000.00 for individuals and $200,000.00 for corporations. For this purpose, it is CRITICAL to note that the recent legislation reducing penalties applied ONLY to Form 8886. The penalties for failure to file Form 8918, or for filing it incorrectly, remain the same as they were, to wit: $100,000 for individuals and $200,000 for corporations.
A good faith belief that either you did not receive $10,000 in income or that the transaction in question is not a listed one enables you to file on a protective basis. And, in fact, as with the 8886 form, the IRS is, in fact, treating all filings identically in any event.
When the CPA files this form (it need only be filed once, not on an annual basis, as Form 8886 must be), the CPA is assigned a number by the IRS. The CPA or other professional then gives this number to all of his affected clients, who are required to report it on the 8886 forms that they must file. Also, as a perusal of Form 8918 makes clear, there is also a section where the material advisor is to give all pertinent information with respect to other material advisors who participated in and/or advised the client with respect to the transaction in question.
As with Form 8886, this area is replete with horror stories about advisors who, mostly innocently, have fallen into this trap. One that we know of was sold by one promoter on a questionable plan, recommended it to about fifteen clients, and now has been forced to file the 8918 form, help all those involved who have to file Form 8886, and expend a fair amount of his own funds, both to find people who can assist his clients with Form 8886 and in “rescuing” clients who want to get out of this plan. Another called about something else, and was horrified to discover that he had six clients in a plan that is a listed transaction. When he was apprised of his situation, he sank into a depression. These are only two of the dozens of sad, and worse, stories in this area that we have been privy to. The second person, for example, had no idea that anything was wrong. He initially called about something totally unrelated. There have even been instances of professional discipline being imposed in connection with this area, of CPAs being threatened with and perhaps even actually suffering loss of their licenses. Such is the terrain in which the CPA must now operate.
Another problem is possible, especially if you recommended that the client participate. Most practitioners are familiar with situations where, when things go wrong, clients often develop selective memory failure. This happens here, as it does elsewhere. At best, it can lead to you spending an inordinate amount of time, and perhaps money, on what is essentially a thankless exercise. At worst, if the situation worsens to the point where a lawsuit may be in the air, you could find yourself the subject of some sort of client complaint or, worse, a named defendant in a lawsuit, in which case your malpractice carrier would become involved, with all of the negative effects upon yourself and your practice that that could entail.
Section 6707A – Past, Present, and Future
Returning now to the Form 8886 aspect of Section 6707A, the disclosure requirement that applies to actual participants in listed transactions, it has been noted, and discussed, that Congress recently reduced the penalties under Section 6707A for many taxpayers. But it is still imperative to realize that this is only a partial solution to the continuing problem caused by the penalties imposed by that section. While the penalties have been reduced from the prior patently ridiculous, and probably illegal, level that until so recently prevailed, they are still sufficient, in many cases, to put business owners out of business, just as the prior penalties obviously were. And since the new legislation did not address or affect obligations and penalties with respect to Form 8918 at all, accountants, insurance professionals and other material advisors are as likely to be hurt as ever.
Whatever the underlying Congressional intent was in enacting the original Section 6707A in 2004, whatever Congress hoped to accomplish, the statute as it was written imposed clearly unconscionable burdens on taxpayers. Penalties of up to $300,000 annually could be imposed on taxpayers who had not underpaid tax and who had no knowledge that they had entered into transactions that the IRS deems “listed”.
Tax provisions are seldom found to violate the United States Constitution, but it is certainly arguable that the imposition of such a large penalty on a taxpayer who entered into a transaction that produced little or even no tax savings and without regard to the taxpayer’s knowledge or intent violates the Eighth Amendment prohibition on excessive fines, etc. In practice, the requirement that this penalty be imposed without regard to culpability often had the effect of bankrupting middle class families who had no intention of entering into a tax shelter – an outcome that dismayed even hardened IRS enforcement personnel.
The section previously imposed a penalty of $100,000 per individual and $200,000 per entity for each failure to make special disclosures with respect to a transaction that the Treasury Department characterizes as a “listed transaction” or “substantially similar” to a listed transaction. A listed transaction is one that is specifically identified as such by published IRS guidance. The question of what is “substantially similar” to such a transaction is increasingly troublesome, especially given the ever broadening IRS definition of the term, beginning with Treasury Decision 9,000, which declared, on June 18, 2002, that, from that date forward, the term “substantially similar” would be construed more broadly by the Service than it had up until that time. This started a trend that continues to this day.
It is important for the reader to understand that the only thing that was accomplished by the new, amended Section 6707A is a reduction in the penalties. The penalties are still severe, severe enough to seriously damage or even bankrupt most small businesses. And professional readers must understand that there has been no effect on their obligations at all, and that the same (in their case, even more severe) fines still apply.
For example, the following eleven statements are equally applicable to the new Section 6707A as they are to its predecessor:
1. The penalty applies without regard to whether the small business or the small business owners have knowledge that the transaction has been listed.
2. The penalty applies even if the small business and/or the small business owners derived no tax benefit from the transaction. Even under the new legislation, there are substantial minimum penalties that are applied even if there has been no tax benefit.
3. The penalty is applied at multiple levels, which is devastating to small businesses; the result is that the small business and its owners are hit with multiple penalties. The two most common problems are that fines are imposed on both the business entity and the owners as individuals, and also that fines are imposed each year, and thus are sometimes imposed for five years or more. In the case of a small business, the penalties can easily exceed the total earnings of the business and cause bankruptcy – totally out of proportion to any tax advantage that may or may not have been realized.
4. The penalty is final, must be imposed by the IRS (this is mandatory), and cannot be rescinded. There is no right of appeal, and there is no “good faith” exception, as business advocates had hoped would be a part of the new legislation.
5. Judicial review is expressly prohibited, which raises another Constitutional issue, this time a separation of powers argument, as it amounts to one branch of government prohibiting another from functioning.
6. The taxpayer’s disclosure must initially be made twice – once with the IRS Office of Tax Shelter Analysis and again with the tax return for the year in which the transaction is first required to be disclosed. Thereafter, for each year that the taxpayer “benefits” from the transaction, it must be reflected on the tax return. Aside: As a practical matter, the form should be filed with the tax return. The IRS directions assume a timely filing. There are no directions on how to file late, which most taxpayers must do, since few realized the need to disclose in this manner when they still could have timely filed. A few experts have figured out how to file late and simultaneously avoid penalties, after months of study and numerous conversations with IRS personnel. Those conversations were with IRS people that drafted the regulations, those that receive the forms, and others.
7. A taxpayer that discloses a transaction is subject to penalty if the Service deems the disclosure to be incomplete, incorrect, and/or misleading. I have had numerous conversations with people who filed the disclosure forms and got fined. They did not properly prepare and/or file the forms.
8. If a transaction is not “listed” at the time the taxpayer files a return but it subsequently becomes listed, the taxpayer becomes responsible for filing a disclosure statement and will be penalized for failing to do so. This is true even if the taxpayer has no knowledge that the transaction has been listed. This sort of thing is exactly why business interests, albeit unsuccessfully, pushed for a “good faith” exception in the new legislation.
9. The penalty is imposed on transactions that the IRS, in its sole discretion, determines are “substantially similar” to a listed transaction. Accordingly, taxpayers may never know or realize that they are in a listed transaction and, accordingly, the penalties compound annually because they never made any disclosure. At least, if a transaction is specifically identified, people can find out that it is a listed transaction. But how can anyone be sure that something is “substantially similar”, or not?
10. The taxpayer must disclose each year, which can result in compounding of already large penalties; and
11. The Statute of Limitations, usually three years, does not apply. IRC 6501(c)(10) tolls the statute until proper disclosure is made.
The Treasury Department usually announces on a somewhat ad hoc basis what is a listed transaction. There is no regulatory process or public comment period involved in determining what should be a listed transaction. Once that a transaction is deemed to be a listed transaction, the Draconian Section 6707A penalties are triggered. Section 6707A penalties not only apply to specifically listed transactions, but also to transactions that are deemed by Treasury to be “substantially similar” to any of the specifically listed transactions. Some have said that under Section 6707A, IRS and Treasury are the judge, jury and executioner. Be that as it may, once again Constitutional concerns need to be addressed, this time possible due process violations pursuant to the Fourteenth Amendment.
Some Examples
A business owner bought a type of life insurance policy featuring what is known as a “springing cash value” as an alternative to a pension plan. Two years later, this type of transaction was specifically identified as an abusive tax shelter, a listed transaction, meaning that the business owner was now obligated to file Form 8886. But the financial advisor, who years before had actually recommended this course of action, either willfully or out of ignorance failed to advise the business owner to disclose.
The IRS demanded back taxes and interest in the neighborhood of $60,000. It also assessed $600,000 of penalties under Section 6707A for failing to disclose participation in a listed transaction for two separate years.
Another taxpayer filed Form 8886 with his tax returns, but failed to file, in the first year, with the Office of Tax Shelter Analysis. The penalty was assessed for that failure, even though the IRS had the form, though perhaps in a different place. Again, this scenario cries out for the “good faith” exception that was not included in the new legislation.
Then there was the doctor who thought that he had settled his 419 welfare benefit plan issues with the Service. He entered into a closing agreement and paid all taxes due and owing. Later, he was assessed the penalty for failing to file Form 8886. Of course, this issue had been neither raised nor even discussed in the doctor’s prior communications, negotiations, etc. with the Service.
I could go on and on with these horror stories, but the reader probably gets my drift by now. I have been urging business owners to properly file Form 8886 for years. A surprising number of accountants have little or no knowledge in this area, even being unaware of the fines that can be imposed on “material advisors” which, as previously noted, have NOT changed as a result of the new legislation. And if a professional assumes that he has no clients in “listed transactions”, he should realize that there are numerous types of listed transactions. They are not restricted to welfare benefit plans. For example, they include the popular Section 412(i) defined benefit pension plan, and even some of the ubiquitous 401(k) plans. No business owner, and especially no financial, insurance or accounting professional should ever assume that he or she is immune from any or all of the possible repercussions outlined herein.
Summing up, the new legislation does reduce possible Section 6707A penalties for most taxpayers. That, in my view, is its only benefit. And the reduction is not as great as one might expect. Depending on surrounding circumstances, penalties of hundreds of thousands of dollars are still quite possible. Even the minimum penalties, which are applied in the event that there is no tax benefit, amount to $15,000 annually. Who can afford to just brush that aside? Over a period of years, and the fines in the 8886 area are still applied annually, the minimum fines all be themselves can add up to a considerable amount.
Both the 8886 and 8918 forms must still be filed properly. The fines and penalties for failure to do so remain substantial and unfair.
What attracted the most attention with respect to it, until very recently, were the penalties for failure to file, which were $100,000 annually for individuals and $200,000 annually for corporations. Recent legislation has reduced those penalties in most cases. However, there is still a minimum penalty of $5,000 annually for an individual and $10,000 annually for a corporation for failure to file. And those are the MINIMUM penalties. If the minimum penalties do not apply, the annual penalty becomes 75 percent of whatever tax benefit was derived from participation in the listed transaction, and the penalty is applied both to the business and to the individual business owners. Since the form must be filed for every year of participation in the transaction, the penalties can be cumulative; i.e., applied in more than one year. For example, a corporation that participated in five consecutive years could find itself, depending on the amount of claimed tax deductions, looking at several hundred thousand dollars in fines, even under the recently enacted legislation, before even thinking about back taxes, penalties, interest, etc., that could result from an audit. Even the minimum fine would be $15,000 per year, again in addition to all other applicable taxes and penalties, etc. So even the minimum fines could mount up fast.
The penalties can also be imposed for incomplete, inaccurate, and/or misleading filings. And the Service itself has not provided totally clear, unequivocal guidance to those hoping to avoid errors and penalties. To illustrate this point, Lance Wallach, a leading authority in this area who has received hundreds of calls and whose associates have literally aided dozens of taxpayers in completing these forms, reports that his associates, on numerous occasions, have sought the opinions and assistance of Service personnel, usually from the Office of Chief Counsel, with respect to questions arising while assisting taxpayers in completing and filing the form. The answers are often somewhat vague, and tend to be accompanied by a disclaimer advising not to rely on them.
One popular type of listed transaction is the so-called welfare benefit plan, which once relied in IRC Section 419A(F)(6) for its authority to claim tax deductions, but now more commonly relies on Section 419(e). The 419A(F)(6) plans used to claim that that section completely exempted business owners from all limitations on how much tax could be deducted. In other words, it was claimed, tax deductions were unlimited. These plans featured large amounts of life insurance and accompanying large commissions, and were thus aggressively pushed by insurance agents, financial planners, and sometimes even accountants and attorneys. Not to mention the insurance companies themselves, who put millions of dollars in premiums on the books and, when confronted with questions about the outlandish tax claims made in marketing these plans, claimed to be only selling product, not giving opinions on tax questions.
In the summer of 2003, the Service issued guidance that had the effect of severely curtailing those plans, and they began to largely, though not completely, disappear from the landscape. Most welfare benefit plans now claim Section 419(e) as the authority to claim a corporate tax deduction, though the promoters of these plans no longer claim that tax deductions are unlimited. Instead, they acknowledge that the amount of possible tax deductions is limited by the limitations of Section 419A, which Code section is a limitation on tax deductions that are authorized by other sections.
With respect to Section 419(e) welfare benefit plans, and of particular importance in this listed transaction/penalties arena, were the events of October 17, 2007, which over time have had roughly the same effect on Section 419(e) welfare benefit plans as the aforementioned 2003 developments had on Section 419A(F)(6) plans. On that date, the Service issued Notice 2007-83, which identified certain trust arrangements involving cash value life insurance policies, and substantially similar arrangements, as listed transactions. Translation: Section 419(e) welfare benefit plans that are funded by cash value life insurance contracts are listed transactions, at least if a tax deduction is taken for the amount of premiums paid for such policies. On that same day, the Service also issued Notice 2007-84 and Revenue Ruling 2007-65. The combined effect of these three IRS pronouncements was that not only was the use of cash value life insurance in welfare benefit plans, if combined with claiming tax deductions for the premiums paid, sufficient to cause IRS treatment of these plans as listed transactions, but that discrimination as between owners and rank and file employees in these plans was also being targeted.
To illustrate, in many of these promoted arrangements, these Section 419(e) welfare benefit plans, cash value life insurance policies are purchased on the lives of the owners of the business, and sometimes on key employees, while term insurance is purchased on the lives of the rank and file employees. The plans in question tend to anticipate that the plan will be terminated within five years or so, at which time the cash value policies will be distributed to the owners, and possibly key employees, with very little distributed to rank and file employees. In general, the Internal Revenue Code will not countenance the claiming of a tax deduction in connection with a welfare benefit plan where such blatant unequal treatment (discrimination) is exhibited. Nevertheless, plan promoters claim that insurance premiums are currently deductible by the business, and that the insurance policies, when distributed to the owners, can be done so virtually tax-free. And this also despite the fact that an employer’s deductions for contributions to an arrangement that is properly characterized as a welfare benefit fund are subject to the limitations and requirements of the rules in IRC sections 419 and 419A, including the use of reasonable actuarial assumptions and the satisfaction of nondiscrimination requirements.
With respect to the preparation and filing of Form 8886, incidentally, it should not surprise that welfare benefit promoters have been active in this area. This would include both the promoters of plans that have been listed transactions for years as well as those that became listed transactions, at least arguably, by virtue of the previously discussed October 2007 IRS activities. Some promoters take the position that their plans are completely compliant and that, therefore, there is no need to file Form 8886. Others take a more precautionary approach. While never admitting to being a listed transaction, they do urge clients to file on a protective basis. At least one went so far as to offer plan participants complete guidance and instructions about precisely how to file protectively. Many, if not most, plan promoters have, at the very least, forwarded completed sample forms to plan participants for guidance and use in completing Form 8886. It is certainly possible to file protectively. Any remotely good faith belief that the transaction is not a listed one justifies the protective filing. In fact and practice, the Service is actually treating protective filings in the same manner as other filings.
But while many plan promoters have recognized the filing obligation and recommended filing, this has led to another problem. As previously noted, they have been instructing taxpayers on how to complete and file the form, and the problem is that their guidance, in many cases, has not been particularly helpful and sometimes dangerous. In some cases, though this is difficult if not impossible to ascertain, the suggestions of the plan promoters seem designed more to protect the promoters than to assist the taxpayer. While this is a difficult call to make, it is absolutely clear, Wallach says, that more than one promoter, whether carelessly or otherwise, has sent taxpayers outdated forms to complete and file. Wallach, who you may recall has, between himself and his associates, aided dozens of taxpayers in completing and filing Form 8886, notes that his associates have frequently reported this problem. They also report never having seen a Form 8886 prepared completely correctly, especially where a promoter’s instructions were relied on. So, because the fines may be imposed for incomplete, misleading, or incorrect filings, the danger to plan participants can be clearly seen. And the taxpayer who discovers errors subsequent to filing must decide whether to amend the filing or not, which some plan participants are reluctant to do.
Burdens On Professionals With Clients In Welfare Benefit Plans And Other Listed Transactions
Form 8918 must be filed with the Internal Revenue Service by all “material advisors” to clients who are participating in listed transactions. Exactly who, then, is a material advisor? You are a material advisor if three requirements are satisfied. First, the client must actually be participating in the listed transaction. Second, you must have given the client tax advice with respect to the transaction. This does not necessarily mean that you recommended participation. For example, signing off on a tax return claiming a tax deduction for participation in the listed transaction surely qualifies as having given tax advice with respect to the transaction. In fact, even if you recommended against participation, you would satisfy this threshold so long as you rendered tax advice, be it positive, negative, or neutral.
The third threshold is that you must have received $10,000 or more in compensation (yourself and/or a related entity). This is not quite as simple as it sounds. The money need not all be received as a commission (as might be the case with a CPA who is insurance licensed), or even in a lump sum for accounting services rendered in connection with the client’s participation. The money could be received periodically over time. It is even possible that, so long as $10,000 in fees has been received from the client for whatever reason over whatever period of time, the threshold is met. Lance Wallach, previously referred to in the discussion about Form 8886 and whose associates are also expert in assisting CPAs and others in the preparation and filing of Form 8918, reports that one of his associates put this question directly to an attorney in the Office of the Chief Counsel who actually wrote published IRS guidance with respect to Form 8918. While the gentleman from the IRS was very courteous and professional, trying his best to be of assistance, a clear, unqualified, unequivocal answer that could be “taken to the bank” proved impossible to elicit.
Like Form 8886, however, Form 8918 can be filed protectively. Failure to file or incomplete, misleading, or inaccurate filings can lead to the penalties that used to apply to Form 8886, to wit: $100,000.00 for individuals and $200,000.00 for corporations. For this purpose, it is CRITICAL to note that the recent legislation reducing penalties applied ONLY to Form 8886. The penalties for failure to file Form 8918, or for filing it incorrectly, remain the same as they were, to wit: $100,000 for individuals and $200,000 for corporations.
A good faith belief that either you did not receive $10,000 in income or that the transaction in question is not a listed one enables you to file on a protective basis. And, in fact, as with the 8886 form, the IRS is, in fact, treating all filings identically in any event.
When the CPA files this form (it need only be filed once, not on an annual basis, as Form 8886 must be), the CPA is assigned a number by the IRS. The CPA or other professional then gives this number to all of his affected clients, who are required to report it on the 8886 forms that they must file. Also, as a perusal of Form 8918 makes clear, there is also a section where the material advisor is to give all pertinent information with respect to other material advisors who participated in and/or advised the client with respect to the transaction in question.
As with Form 8886, this area is replete with horror stories about advisors who, mostly innocently, have fallen into this trap. One that we know of was sold by one promoter on a questionable plan, recommended it to about fifteen clients, and now has been forced to file the 8918 form, help all those involved who have to file Form 8886, and expend a fair amount of his own funds, both to find people who can assist his clients with Form 8886 and in “rescuing” clients who want to get out of this plan. Another called about something else, and was horrified to discover that he had six clients in a plan that is a listed transaction. When he was apprised of his situation, he sank into a depression. These are only two of the dozens of sad, and worse, stories in this area that we have been privy to. The second person, for example, had no idea that anything was wrong. He initially called about something totally unrelated. There have even been instances of professional discipline being imposed in connection with this area, of CPAs being threatened with and perhaps even actually suffering loss of their licenses. Such is the terrain in which the CPA must now operate.
Another problem is possible, especially if you recommended that the client participate. Most practitioners are familiar with situations where, when things go wrong, clients often develop selective memory failure. This happens here, as it does elsewhere. At best, it can lead to you spending an inordinate amount of time, and perhaps money, on what is essentially a thankless exercise. At worst, if the situation worsens to the point where a lawsuit may be in the air, you could find yourself the subject of some sort of client complaint or, worse, a named defendant in a lawsuit, in which case your malpractice carrier would become involved, with all of the negative effects upon yourself and your practice that that could entail.
Section 6707A – Past, Present, and Future
Returning now to the Form 8886 aspect of Section 6707A, the disclosure requirement that applies to actual participants in listed transactions, it has been noted, and discussed, that Congress recently reduced the penalties under Section 6707A for many taxpayers. But it is still imperative to realize that this is only a partial solution to the continuing problem caused by the penalties imposed by that section. While the penalties have been reduced from the prior patently ridiculous, and probably illegal, level that until so recently prevailed, they are still sufficient, in many cases, to put business owners out of business, just as the prior penalties obviously were. And since the new legislation did not address or affect obligations and penalties with respect to Form 8918 at all, accountants, insurance professionals and other material advisors are as likely to be hurt as ever.
Whatever the underlying Congressional intent was in enacting the original Section 6707A in 2004, whatever Congress hoped to accomplish, the statute as it was written imposed clearly unconscionable burdens on taxpayers. Penalties of up to $300,000 annually could be imposed on taxpayers who had not underpaid tax and who had no knowledge that they had entered into transactions that the IRS deems “listed”.
Tax provisions are seldom found to violate the United States Constitution, but it is certainly arguable that the imposition of such a large penalty on a taxpayer who entered into a transaction that produced little or even no tax savings and without regard to the taxpayer’s knowledge or intent violates the Eighth Amendment prohibition on excessive fines, etc. In practice, the requirement that this penalty be imposed without regard to culpability often had the effect of bankrupting middle class families who had no intention of entering into a tax shelter – an outcome that dismayed even hardened IRS enforcement personnel.
The section previously imposed a penalty of $100,000 per individual and $200,000 per entity for each failure to make special disclosures with respect to a transaction that the Treasury Department characterizes as a “listed transaction” or “substantially similar” to a listed transaction. A listed transaction is one that is specifically identified as such by published IRS guidance. The question of what is “substantially similar” to such a transaction is increasingly troublesome, especially given the ever broadening IRS definition of the term, beginning with Treasury Decision 9,000, which declared, on June 18, 2002, that, from that date forward, the term “substantially similar” would be construed more broadly by the Service than it had up until that time. This started a trend that continues to this day.
It is important for the reader to understand that the only thing that was accomplished by the new, amended Section 6707A is a reduction in the penalties. The penalties are still severe, severe enough to seriously damage or even bankrupt most small businesses. And professional readers must understand that there has been no effect on their obligations at all, and that the same (in their case, even more severe) fines still apply.
For example, the following eleven statements are equally applicable to the new Section 6707A as they are to its predecessor:
1. The penalty applies without regard to whether the small business or the small business owners have knowledge that the transaction has been listed.
2. The penalty applies even if the small business and/or the small business owners derived no tax benefit from the transaction. Even under the new legislation, there are substantial minimum penalties that are applied even if there has been no tax benefit.
3. The penalty is applied at multiple levels, which is devastating to small businesses; the result is that the small business and its owners are hit with multiple penalties. The two most common problems are that fines are imposed on both the business entity and the owners as individuals, and also that fines are imposed each year, and thus are sometimes imposed for five years or more. In the case of a small business, the penalties can easily exceed the total earnings of the business and cause bankruptcy – totally out of proportion to any tax advantage that may or may not have been realized.
4. The penalty is final, must be imposed by the IRS (this is mandatory), and cannot be rescinded. There is no right of appeal, and there is no “good faith” exception, as business advocates had hoped would be a part of the new legislation.
5. Judicial review is expressly prohibited, which raises another Constitutional issue, this time a separation of powers argument, as it amounts to one branch of government prohibiting another from functioning.
6. The taxpayer’s disclosure must initially be made twice – once with the IRS Office of Tax Shelter Analysis and again with the tax return for the year in which the transaction is first required to be disclosed. Thereafter, for each year that the taxpayer “benefits” from the transaction, it must be reflected on the tax return. Aside: As a practical matter, the form should be filed with the tax return. The IRS directions assume a timely filing. There are no directions on how to file late, which most taxpayers must do, since few realized the need to disclose in this manner when they still could have timely filed. A few experts have figured out how to file late and simultaneously avoid penalties, after months of study and numerous conversations with IRS personnel. Those conversations were with IRS people that drafted the regulations, those that receive the forms, and others.
7. A taxpayer that discloses a transaction is subject to penalty if the Service deems the disclosure to be incomplete, incorrect, and/or misleading. I have had numerous conversations with people who filed the disclosure forms and got fined. They did not properly prepare and/or file the forms.
8. If a transaction is not “listed” at the time the taxpayer files a return but it subsequently becomes listed, the taxpayer becomes responsible for filing a disclosure statement and will be penalized for failing to do so. This is true even if the taxpayer has no knowledge that the transaction has been listed. This sort of thing is exactly why business interests, albeit unsuccessfully, pushed for a “good faith” exception in the new legislation.
9. The penalty is imposed on transactions that the IRS, in its sole discretion, determines are “substantially similar” to a listed transaction. Accordingly, taxpayers may never know or realize that they are in a listed transaction and, accordingly, the penalties compound annually because they never made any disclosure. At least, if a transaction is specifically identified, people can find out that it is a listed transaction. But how can anyone be sure that something is “substantially similar”, or not?
10. The taxpayer must disclose each year, which can result in compounding of already large penalties; and
11. The Statute of Limitations, usually three years, does not apply. IRC 6501(c)(10) tolls the statute until proper disclosure is made.
The Treasury Department usually announces on a somewhat ad hoc basis what is a listed transaction. There is no regulatory process or public comment period involved in determining what should be a listed transaction. Once that a transaction is deemed to be a listed transaction, the Draconian Section 6707A penalties are triggered. Section 6707A penalties not only apply to specifically listed transactions, but also to transactions that are deemed by Treasury to be “substantially similar” to any of the specifically listed transactions. Some have said that under Section 6707A, IRS and Treasury are the judge, jury and executioner. Be that as it may, once again Constitutional concerns need to be addressed, this time possible due process violations pursuant to the Fourteenth Amendment.
Some Examples
A business owner bought a type of life insurance policy featuring what is known as a “springing cash value” as an alternative to a pension plan. Two years later, this type of transaction was specifically identified as an abusive tax shelter, a listed transaction, meaning that the business owner was now obligated to file Form 8886. But the financial advisor, who years before had actually recommended this course of action, either willfully or out of ignorance failed to advise the business owner to disclose.
The IRS demanded back taxes and interest in the neighborhood of $60,000. It also assessed $600,000 of penalties under Section 6707A for failing to disclose participation in a listed transaction for two separate years.
Another taxpayer filed Form 8886 with his tax returns, but failed to file, in the first year, with the Office of Tax Shelter Analysis. The penalty was assessed for that failure, even though the IRS had the form, though perhaps in a different place. Again, this scenario cries out for the “good faith” exception that was not included in the new legislation.
Then there was the doctor who thought that he had settled his 419 welfare benefit plan issues with the Service. He entered into a closing agreement and paid all taxes due and owing. Later, he was assessed the penalty for failing to file Form 8886. Of course, this issue had been neither raised nor even discussed in the doctor’s prior communications, negotiations, etc. with the Service.
I could go on and on with these horror stories, but the reader probably gets my drift by now. I have been urging business owners to properly file Form 8886 for years. A surprising number of accountants have little or no knowledge in this area, even being unaware of the fines that can be imposed on “material advisors” which, as previously noted, have NOT changed as a result of the new legislation. And if a professional assumes that he has no clients in “listed transactions”, he should realize that there are numerous types of listed transactions. They are not restricted to welfare benefit plans. For example, they include the popular Section 412(i) defined benefit pension plan, and even some of the ubiquitous 401(k) plans. No business owner, and especially no financial, insurance or accounting professional should ever assume that he or she is immune from any or all of the possible repercussions outlined herein.
Summing up, the new legislation does reduce possible Section 6707A penalties for most taxpayers. That, in my view, is its only benefit. And the reduction is not as great as one might expect. Depending on surrounding circumstances, penalties of hundreds of thousands of dollars are still quite possible. Even the minimum penalties, which are applied in the event that there is no tax benefit, amount to $15,000 annually. Who can afford to just brush that aside? Over a period of years, and the fines in the 8886 area are still applied annually, the minimum fines all be themselves can add up to a considerable amount.
Both the 8886 and 8918 forms must still be filed properly. The fines and penalties for failure to do so remain substantial and unfair.
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.
ABOUT THE AUTHOR: Lance Wallach
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 more than 50 publications and is quoted regularly in the press. He does expert witness testimony and has never lost a case. Contact him at 516.938.5007, or visit www.taxadvisorexpert.com.
ABOUT THE AUTHOR: Lance Wallach
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 more than 50 publications and is quoted regularly in the press. He does expert witness testimony and has never lost a case. Contact him at 516.938.5007, or visit www.taxadvisorexpert.com.
Lines from Lance
NEW
JERSEY ASSOCIATION OF PUBLIC ACCOUNTANTS
Lines
from Lance - Newsletter - updated
If you were or are in a 412(i), 419, Captive
Insurance, or section 79 plan you are probably in big trouble. If you signed a
tax return for a client in one of these plans, you are probably what the IRS
calls a material advisor and subject to a maximum $200,000 fine. If you are an
Insurance Professional that sold or advised on one of these plans, the same
holds true for you. Business Owners and Material Advisors needed to properly
file under section 6707A, or face large IRS fines. My office has received
thousands of phone calls, many after the business owner has received the fine.
In many cases, the accountant files the appropriate forms, but the IRS still
levied the fine because the Accountant made a mistake on the form. My office
has reviewed many forms for Accountants, Tax Attorneys and others. We have not
yet seen a form that was filled out properly. The improper preparation of these
forms usually results in the client being fined more quickly then if the form
were not filed at all. I have been an expert witness in law suites on point.
None of my clients have ever lost where I was their Expert Witness.
The IRS will be soon attacking section 79 scams
I am told. My early articles by AICPA and others in the 90s predicted attacks
on 419s, which came true. My 412(i) article predictions came true. The section
79 scams soon will be attacked. Everyone in them should file protectively.
Anyone that has not filed protectively in a 419 or older 412(i) had better get
some good advise from someone who knows what is going on, and has extensive
experience filing protectively. IRS still has their task forces auditing these
plans. Then they will move on to 79 scams etc. including many of the illegal
captives pushed by the insurance companies and agents. Not all captives are
illegal. I am an expert witness in a lot of cases involving the 412(i) and 419.
It does not go well for the agents, accountants, plan promoters, insurance companies
etc. The insurance companies settle first leaving the agents hanging out there.
Then in many cases they fire the agents. I was just in a case as an expert
witness where a large well know New England mutual based insurance company did
just that.
If you are an insurance professional do not
count on your insurance company to back you up. More likely they will stab you
in the back, based on what I have seen. One of the agents was with the company
over 25 years and was a leading producer with lots of company awards. Be
careful. If you sold, gave tax advice, or signed a tax return and got paid a
certain amount of money you may be a material advisor. Under the newest
proposed regulations you had to file with the IRS to avoid the $200,000
$100,000 fines. You had to fill out the forms properly. You had to advise those
that you advised about the plans or sold the plan to. You had to send them a
note, or call them, giving them the number that the IRS had assigned to you as
a Material Advisor. This is the number that you obtain after you file the
appropriate forms for yourself. Even though you obtain a number you still may
have filed your forms improperly or completed them wrong. Many accountants have
called me after their clients were fined $800,000 or more by IRS for improperly
filing, or not filing under 6707A. A plan administrator called me after a lot
of his clients were fined millions. He told their accountants to file 8886, and
most of them did. All of the clients were fined shortly thereafter. The forms need
to be filled in exactly correct. In our numerous talks with IRS we were told if
filed out wrong the fine is still imposed. BE CAREFUL please be advised we have
not seen a form that has been filed out properly. Many accountants, tax
attorneys, etc., send us their forms to be reviewed, most after they file for
one client who then gets fined about one million dollars under the regulations.
I DO NOT do the forms. A former IRS agent of 37 years, CPA, tax professor does
them, as does another person that I know.
_______________________________________________________________
The moratorium on collection has been extended for
two additional months until March 1st.
_____________________________________________________________________
If
you are a small business owner, accountant or insurance professional you may be
in big trouble and not know it. IRS has
been fining people like you $200,000.
Most people that have received the fines were not aware that they had
done anything wrong. What is even worse
is that the fines are not appeal-able.
This is not an isolated situation.
This has been happening to a lot of people.
Currently,
the Internal Revenue Service (“IRS”) has the discretion to assess hundreds of
thousands of dollars in penalties under §6707A of the Internal Revenue Code
(“Code”) in an attempt to curb tax avoidance shelters. This discretion can be
applied regardless of the innocence of the taxpayer and was granted by
Congress. It works so that if the IRS
determines you have engaged in a listed transaction and failed to properly
disclose it, you will be subject to a potentially draconian penalty regardless
of any other facts and circumstances concerning the transaction. For some, this
penalty has been assessed at almost a million dollars and for many it is the
beginning of a long nightmare.
The
following is an example: Pursuant to a
settlement with the IRS, the 412(i) plan was converted into a traditional
defined benefit plan. All of the
contributions to the 412(i) plan would have been allowable if they had
initially adopted a traditional defined benefit plan. Based on negotiations with the IRS agent, the audit of the plan
resulted in no income and minimal excise taxes due. This is because as a traditional defined benefit plan, the
taxpayers could have contributed and deducted the same amount as a 412(i) plan.
Towards
the end of the audit the business owner received a notice from the IRS. The IRS assessed the client penalties under
the §6707A of the Code in the amount of $900,000.00. This penalty was assessed because the client allegedly
participated in a listed transaction and allegedly failed to file the form 8886
in a timely manner.
The IRS may call you a material advisor and fine you $200,000.00. The
IRS may fine your clients over a million dollars for being in a retirement
plan, 419 plan, etc. As you read this article, hundreds of unfortunate people
are having their lives ruined by these fines. You may need to take action
immediately. The Internal Revenue Service said it would extend until the end of
March 1, 2010 a grace period granted to small business owners for collection of
certain tax-shelter penalties.
"Clearly,
a number of taxpayers have been caught in a penalty regime that the legislation
did not intend," wrote Shulman. "I understand that Congress is still
considering this issue, and that a bipartisan, bicameral, bill may be in the
works." The issue relates to
penalties for so-called listed transactions, the kinds of tax shelters the IRS has
designated most egregious. A number of small business owners that bought
employee retirement plans so called 419 and 412(i) plans and others, that were
listed by the IRS, and who are now facing hundreds and thousands in penalties,
contend that the penalty amounts are unfair.
Leaders
of tax-writing committees in the House and Senate have said they intend to pass
legislation revising the penalty structure.
The
IRS has suspended collection efforts in cases where the tax benefit derived
from the listed transaction was less than $100,000 for individuals, or less
than $200,000 for firms. They are still however sending out notices that they
intend to fine.
Senator
Ben Nelson (D-Nebraska) has sponsored legislation (S.765) to curtail the IRS
and its nearly unlimited authority and power under Code Section 6707A. The bill
seeks to scale back the scope of the Section 6707A reportable/listed
transaction nondisclosure penalty to a more reasonable level. The current law
provides for penalties that are Draconian by nature and offer no flexibility to
the IRS to reduce or abate the imposition of the 6707A penalty. This has served
as a weapon of mass destruction for the IRS and has hit many small businesses
and their owners with unconscionable results.
Internal Revenue Code 6707A was enacted as
part of the American Jobs Creation Act on October 22, 2004. It imposes a strict
liability penalty for any person that failed to disclose either a listed
transaction or reportable transaction per each occurrence. Reportable
transactions usually fall within certain general types of transactions (e.g.
confidential transactions, transactions with tax protection, certain loss
generating transaction and transactions of interest arbitrarily so designated
as by the IRS) that have the potential for tax avoidance. Listed transactions are
specified transactions, which have been publicly designated by the IRS,
including anything that is substantially similar to such a transaction (a
phrase which is given very liberal construction by the IRS). There are
currently 34 listed transactions, including certain retirement plans under Code
section 412(i) and certain employee welfare benefit plans funded in part with
life insurance under Code sections 419A(f)(5), 419(f)(6) and 419(e). Many of
these plans were implemented by small business seeking to provide retirement
income or health benefits to their employees.
Strict liability requires the IRS to impose
the 6707A penalty regardless of innocence of a person (i.e. whether the person
knew that the transaction needed to be reported or not or whether the person
made a good faith effort to report) or the level of the person’s reliance on
professional advisors. A Section 6707A penalty is imposed when the transaction
becomes a reportable/listed transaction. Therefore, a person has the burden to
keep up to date on all transactions requiring disclosure by the IRS into
perpetuity for transactions entered into the past.
Additionally,
the 6707A penalty strictly penalizes nondisclosure irrespective of taxes owed.
Accordingly, the penalty will be assessed even in legitimate tax planning
situations when no additional tax is due but an IRS required filing was not
properly and timely filed. It is worth noting that a failure to disclose in the
view of the IRS encompasses both a failure to file the proper form as well as a
failure to include sufficient information as to the nature and facts concerning
the transaction. Hence, people may find themselves subject to the 6707A penalty
if the IRS determines that a filing did not contain enough information on the
transaction. A penalty is also imposed when a person does not file the required
duplicate copy with a separate IRS office in addition to filing the required
copy with the tax return. Lance Wallach Commentary. In our numerous talks with
IRS, we were also told that improperly filling out the forms could almost be as
bad as not filing the forms. We have reviewed hundreds of forms for
accountants, business owners and others. We have not yet seen a form that was
properly filled in. We have been retained to correct many of these forms.
For
more information see www.vebaplan.com, www.lawyer4audits.com, or e-mail us at
lawallach@aol.com
The imposition of a 6707A penalty is not
subject to judicial review regardless of whether the penalty is imposed for a
listed or reportable transaction. Accordingly, the IRS’s determination is
conclusive, binding and final. The next step from the IRS is sending your file
to collection, where your assets may be forcibly taken, publicly recorded liens
may be placed against your property, and/or garnishment of your wages or
business profits may occur, amongst other measures.
The
6707A penalty amount for each listed transaction is generally $200,000 per year
per each person that is not an individual and $100,000 per year per individual
who failed to properly disclose each listed transaction. The 6707A penalty
amount for each reportable transaction is generally $50,000 per year for each
person that is not an individual and $10,000 per year per each individual who
failed to properly disclose each reportable transaction. The IRS is obligated
to impose the listed transaction penalty by law and cannot remove the penalty
by law. The IRS is obligated to impose the reportable transaction penalty by
law, as well, but may remove the penalty when the IRS determines that removal
of the penalty would promote compliance and support effective tax
administration.
The
6707A penalty is particularly harmful in the small business context, where many
business owners operate through an S corporation or limited liability company
in order to provide liability protection to the owner/operators. Numerous cases
are coming to light where the IRS is imposing a $200,000 penalty at the entity
level and them imposing a $100,000 penalty per individual shareholder or member
per year.
The
individuals are generally left with one of two options:
- Declare Bankruptcy
- Face a $300,000 penalty per year.
Keep
in mind, taxes do not need to be due nor does the transaction have to be proven
illegal or illegitimate for this penalty to apply. The only proof required by
the IRS is that the person did not properly and timely disclose a transaction
that the IRS believes the person should have disclosed. It is important to note
in this context that for non-disclosed listed transactions, the Statue of
Limitations does not begin until a proper disclosure is filed with the IRS.
Many
practitioners believe the scope and authority given to the IRS under 6707A,
which allows the IRS to act as judge, jury and executioner, is
unconstitutional. Numerous real life stories abound illustrating the punitive
nature of the 6707A penalty and its application to small businesses and their
owners. In one case, the IRS demanded that the business and its owner pay a
6707A total of $600,000 for his and his business’ participation in a Code
section 412(i) plan. The actual taxes and interest on the transaction, assuming
the IRS was correct in its determination that the tax benefits were not
allowable, was $60,000. Regardless of the IRS’s ultimate determination as to
the legality of the underlying 412(i) transaction, the $600,000 was due as the
IRS’s determination was final and absolute with respect to the 6707A penalty.
Another case involved a taxpayer who was a dentist and his wife whom the IRS
determined had engaged in a listed transaction with respect to a limited
liability company. The IRS determined that the couple owed taxes on the
transaction of $6,812, since the tax benefits of the transactions were not
allowable. In addition, the IRS determined that the taxpayers owed a $1,200,000
section 6707A penalty for both their individual nondisclosure of the
transaction along with the nondisclosure by the limited liability company.
Even
the IRS personnel continue to question both the legality and the fairness of
the IRS’s imposition of 6707A penalties. An IRS appeals officer in an email to
a senior attorney within the IRS wrote that “…I am both an attorney and CPA and
in my 29 years with the IRS I have never {before} worked a case or issue that
left me questioning whether in good conscience I could uphold the Government’s
position even though it is supported by the language of the law.” The Taxpayers
Advocate, an office within the IRS, even went so far as to publicly assert that
the 6707A should be modified as it “raises significant Constitutional concerns,
including possible violations of the Eighth Amendment’s prohibition against
excessive government fines, and due process protection.”
Senate
bill 765, the bill sponsored by Senator Nelson, seeks to alleviate some of
above cited concerns. Specifically, the bill makes three major changes to the
current version of Code section 6707A. The bill would allow an IRS imposed
6707A penalty for nondisclosure of a listed transaction to be rescinded if a
taxpayer’s failure to file was due to reasonable cause and not willful neglect.
The bill would make a 6707A penalty proportional to an understatement of any
tax due.
Accordingly,
non-tax paying entities such as S corporations and limited liability companies
would not be subject to a 6707A penalty (individuals, C corporations and
certain trusts and estates would remain subject to the 6707A penalty).
There
are a number of interesting points to note about this action:
1. In the letter, the IRS acknowledges that,
in certain cases, the penalty imposed by section 6707A for failure to report
participation in a “listed transaction” is disproportionate to the tax benefits
obtained by the transaction.
2. In the letter, the IRS says that it is
taking this action because Congress has indicated its intention to amend the
Code to modify the penalty provision, so that the penalty for failure to
disclose will be more in line with the tax benefits resulting from a listed
transaction.
3. The IRS will not suspend audits or
collection efforts in appropriate cases.
It cannot suspend imposition of the penalty, because, at least with
respect to listed transactions, it does not have the discretion to not impose
the penalty. It is simply suspending
collection efforts in cases where the tax benefits are below the penalty
threshold in order to give Congress time to amend the penalty provision, as
Congress has indicated to the IRS it intends to do.
4. The legislation does not change the
penalty provisions for material advisors.
This is taken directly from the
IRS website:
“Congress
has enacted a series of income tax laws designed to halt the growth of abusive
tax avoidance transactions. These provisions include the disclosure of
reportable transactions. Each taxpayer that has participated in a
reportable transaction and that is required to file a tax return must disclose
information for each reportable transaction in which the taxpayer participates.
Use Form 8886 to disclose information for each reportable transaction in which
participation has occurred. Generally, Form 8886 must be attached to the tax
return for each tax year in which participation in a reportable transaction has
occurred. If a transaction is identified as a listed transaction or transaction
of interest after the filing of a tax return (including amended returns), the
transaction must be disclosed either within 90 days of the transaction being
identified as a listed transaction or a transaction of interest or with the
next filed return, depending on which version of the regulations is applicable.”
January
15, 2010: Brand New Update: The new proposed regulations specify a requirement
that reporting forms filed under 6707A filed late must have additional
attachments. Where in is described many additional details not covered in the
original regulations. In addition, various parties must sign a statement on the
attachments under penalty of perjury. The proposed regulations also specify
that the late filing must be done in a specific manner. If this filing is not done according to
these rules, the one-year period for statute of limitations will not commence,
etc. In addition, the form should include a statement at the top in the manner
the IRS suggests. If a tax payer fails to include, on any
return or statement, for any taxable year, any information with respect to a
listed transaction as defined in CODE SECTION 6707A, which is required to be
included with such return or statement the time for assessment of any tax
imposed by this title with respect to such transaction shall not expire before
the date, which is one year after the earlier of; the date on which the
secretary is furnished the information so required, or the date that a material
advisor meets the requirements relating to such transaction with respect to
such tax payer. As you know, Congress
has armed the IRS with many weapons for enforcement. Usually there is
three-year statute of limitations granted to all taxpayers. In the situation
above there will be no statute of limitations, unless the forms are filed in
correctly with no errors at all. In
addition, the forms must be sent to the proper IRS authorities at their various
locations. Lance Wallach’s commentary: It seems to me and to the only two
people that I know who have been filing these forms correctly that that the IRS
has purposely made it almost impossible for accountants and tax attorneys to
properly fill out these forms and to comply with regulations under SECTION
6707A. The result is that a business owner in one of these plans asks his
accountant or attorney to file the disclosures. The Business Owner then gets
fined, on average, ABOUT A MILLION DOLLARS. Or the Business Owner does not file
the forms and gets the same fine. The same goes for the Material Advisor. The
two people that have been filing these forms properly to my knowledge have
repeatedly had discussions with the authors of these regulations and various
other IRS personnel, including the Office of Tax Shelter Analysis. Based on those many conversations with IRS
personnel, repeatedly re-reading the various regulations and experience in
filing many of the form under these code sections, these two people have
developed their expertise. I only have their word that no one has been fined
that they have helped. One of these individuals has been preparing the forms after
the fact, late, for the last few years. I am not endorsing using anyone in
particular for these forms. I am just writing about my experience in this area.
Lance Wallach, CLU, ChFC, speaks
and writes about benefit plans, tax reductions strategies, and financial plans.
He has authored numerous books for the AICPA books, Bisk Total tapes, Wiley and
others.
Lance Wallach, the National
Society of Accountants Speaker of the Year also writes about retirement plans,
412(1) and 419 and Captive plans. He speaks at more than ten conventions
annually, writes for over fifty publications, is quotes regularly in the press
and has written numerous best-selling AICPA books including Common Abusive
Business Hot Spots. He does Expert Witness work and has never lost a case.
Contact him at 516.938.5007, lawallach@aol.com or visit www.vebaplan.com or
www.taxlibrary.us.
The information provided herein
is not intended as legal, accounting, financial or any other type of advice for
any specific individual or other entity. You should contact an appropriate professional for any such
advice.
The dangers of being "listed"
WebCPA
Accounting Today: October 25
By: Lance Wallach
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
($200,000 for a business and $100,000 for an individual) 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 has to be prepared correctly. I only know of two people in the United States who have filed these forms properly for clients. They tell me that was after hundreds of hours of research and over fifty phones calls to various IRS personnel.
The filing instructions for Form 8886 presume a timely filing. 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 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. It
follows that taxpayers who no longer enjoy the benefit of those large deductions are no longer "participating ' in the listed transaction. But that is not the end of the story. 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. This language may provide the taxpayer with a solid argument in the event of an audit.
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 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 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 or www.taxlibrary.us.
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.
LANCEWALLACHEXPERTWITNESS.COM
A warning for 419, 412i, Sec.79 and captive insurance
Accounting Today: October 25
By: Lance Wallach
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
($200,000 for a business and $100,000 for an individual) 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 has to be prepared correctly. I only know of two people in the United States who have filed these forms properly for clients. They tell me that was after hundreds of hours of research and over fifty phones calls to various IRS personnel.
The filing instructions for Form 8886 presume a timely filing. 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 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. It
follows that taxpayers who no longer enjoy the benefit of those large deductions are no longer "participating ' in the listed transaction. But that is not the end of the story. 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. This language may provide the taxpayer with a solid argument in the event of an audit.
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 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 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 or www.taxlibrary.us.
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.
LANCEWALLACHEXPERTWITNESS.COM
The New Law Guarantees A Substantial Fine
by Robert Sherman
8886 Form Expert Preparer
The bill reducing fines for improperly or not filing under "6707A passed. That sigh of relief you heard last week might have
come from people participating in the plans named above, or
anything seeking tax relief that is similar to them – what the IRS
calls a listed transaction People think that Congress bailed them out of
trouble for participation in such transactions, and that the excessive
fines that were being imposed are now a thing of the past. While the
situation is certainly better than it was for some people, and
while I do not want to rain on anyone’s parade, you are still in
Disasterville, and the next to last bus out just left.
Consider this: The new legislation buried in the Jobs Act of 2010 calls for MINIMUM penalties of $5,000 per person per year, and $10,000 for a business. That is $15,000 per year if you are incorporated. So, if you have been in a plan since, say, 2003, you are looking at fines in excess of $100,000 before you even start to talk about how much of a tax benefit there has been.
Further fines would be seventy-five percent of the tax benefit derived from participation in the transaction. These are also applied each year. The point is that you are looking at fines, in all likelihood, to some degree in the six-figure range.
You can possibly still avoid all this by properly filing "form 8886" IMMEDIATELY with the IRS. Time is especially of the essence now. You MUST file before you are assessed the penalty. For months the Service has been holding off on actually collecting from people that they assessed because they did not know what Congress was going to come up with. But now they do know, so they are going to move aggressively to collection with people they have already
assessed. There is no reason not to now. This is especially true because the new legislation still does not provide for a right of appeal or judicial review. The Service is still judge, jury, and executioner. Its word is absolute as far as determining what is a listed transaction.
So you have to file form "8886" FAST; like NOW. But you also have to file it RIGHT. The Service treats forms that are incorrectly filed as if they were never filed. You get this fine for filing incorrectly or for not filing at all. The Statute of Limitations does not begin unless you properly file.
That means IRS can come back to get you any time in the future unless you file properly.
You must take care as to WHO prepares the form. Most accountants have no idea how to file these forms late. They will simply follow the filing instructions, which presume a timely filing. If you did not file in a timely manner, you need someone who knows how to file the forms late without incurring the penalty. This is an art. We have on board probably the only two people who have filed dozens of forms late, or more, without anyone being penalized. They learned how to
do it by dozens of conversations with IRS personnel.
I am sure by this point in the article that you agree that you may still be in trouble. If you thought that you were not, I am sorry if I brought you bad news. The good news is better because you can still get out of it. All you have to do is call 516 935-7346 NOW!
LANCEWALLACHEXPERTWITNESS.COM
Consider this: The new legislation buried in the Jobs Act of 2010 calls for MINIMUM penalties of $5,000 per person per year, and $10,000 for a business. That is $15,000 per year if you are incorporated. So, if you have been in a plan since, say, 2003, you are looking at fines in excess of $100,000 before you even start to talk about how much of a tax benefit there has been.
Further fines would be seventy-five percent of the tax benefit derived from participation in the transaction. These are also applied each year. The point is that you are looking at fines, in all likelihood, to some degree in the six-figure range.
You can possibly still avoid all this by properly filing "form 8886" IMMEDIATELY with the IRS. Time is especially of the essence now. You MUST file before you are assessed the penalty. For months the Service has been holding off on actually collecting from people that they assessed because they did not know what Congress was going to come up with. But now they do know, so they are going to move aggressively to collection with people they have already
assessed. There is no reason not to now. This is especially true because the new legislation still does not provide for a right of appeal or judicial review. The Service is still judge, jury, and executioner. Its word is absolute as far as determining what is a listed transaction.
So you have to file form "8886" FAST; like NOW. But you also have to file it RIGHT. The Service treats forms that are incorrectly filed as if they were never filed. You get this fine for filing incorrectly or for not filing at all. The Statute of Limitations does not begin unless you properly file.
That means IRS can come back to get you any time in the future unless you file properly.
You must take care as to WHO prepares the form. Most accountants have no idea how to file these forms late. They will simply follow the filing instructions, which presume a timely filing. If you did not file in a timely manner, you need someone who knows how to file the forms late without incurring the penalty. This is an art. We have on board probably the only two people who have filed dozens of forms late, or more, without anyone being penalized. They learned how to
do it by dozens of conversations with IRS personnel.
I am sure by this point in the article that you agree that you may still be in trouble. If you thought that you were not, I am sorry if I brought you bad news. The good news is better because you can still get out of it. All you have to do is call 516 935-7346 NOW!
LANCEWALLACHEXPERTWITNESS.COM
Form 8886 is required to be filed by any taxpayer who is participating
Robert Sherman
Form 8886 is required to be filed by any taxpayer who is
participating, or in some cases has participated, in a listed or reportable
transaction. What attracted the most attention with respect to it, until very
recently, were the penalties for failure to file, which were $100,000 annually
for individuals and $200,000 annually for corporations. Recent legislation has
reduced those penalties in most cases. However, there is still a minimum
penalty of $5,000 annually for an individual and $10,000 annually for a
corporation for failure to file. And those are the MINIMUM penalties. If the
minimum penalties do not apply, the annual penalty becomes 75 percent of
whatever tax benefit was derived from participation in the listed transaction,
and the penalty is applied both to the business and to the individual business
owners. Since the form must be filed for every year of participation in the
transaction, the penalties can be cumulative; i.e., applied in more than one
year. For example, a corporation that participated in five consecutive years
could find itself, depending on the amount of claimed tax deductions, looking
at several hundred thousand dollars in fines, even under the recently enacted
legislation, before even thinking about back taxes, penalties, interest, etc.,
that could result from an audit. Even the minimum fine would be $15,000 per
year, again in addition to all other applicable taxes and penalties, etc. So
even the minimum fines could mount up fast.
The penalties can also be imposed for incomplete,
inaccurate, and/or misleading filings. And the Service itself has not provided
totally clear, unequivocal guidance to those hoping to avoid errors and
penalties. To illustrate this point, Lance Wallach, a leading authority in this
area who has received hundreds of calls and whose associates have literally
aided dozens of taxpayers in completing these forms, reports that his
associates, on numerous occasions, have sought the opinions and assistance of
Service personnel, usually from the Office of Chief Counsel, with respect to
questions arising while assisting taxpayers in completing and filing the form.
The answers are often somewhat vague, and tend to be accompanied by a
disclaimer advising not to rely on them.
One popular type of listed transaction is the so-called
welfare benefit plan, which once relied in IRC Section 419A(F)(6) for its
authority to claim tax deductions, but now more commonly relies on Section 419(e).
The 419A(F)(6) plans used to claim that that section completely exempted
business owners from all limitations on how much tax could be deducted. In
other words, it was claimed, tax deductions were unlimited. These plans
featured large amounts of life insurance and accompanying large commissions,
and were thus aggressively pushed by insurance agents, financial planners, and
sometimes even accountants and attorneys. Not to mention the insurance
companies themselves, who put millions of dollars in premiums on the books and,
when confronted with questions about the outlandish tax claims made in
marketing these plans, claimed to be only selling product, not giving opinions
on tax questions.
In the summer of 2003, the Service issued guidance that had
the effect of severely curtailing those plans, and they began to largely,
though not completely, disappear from the landscape. Most welfare benefit plans
now claim Section 419(e) as the authority to claim a corporate tax deduction,
though the promoters of these plans no longer claim that tax deductions are
unlimited. Instead, they acknowledge that the amount of possible tax deductions
is limited by the limitations of Section 419A, which Code section is a
limitation on tax deductions that are authorized by other sections.
With respect to Section 419(e) welfare benefit plans, and of
particular importance in this listed transaction/penalties arena, were the
events of October 17, 2007, which over time have had roughly the same effect on
Section 419(e) welfare benefit plans as the aforementioned 2003 developments
had on Section 419A(F)(6) plans. On that date, the Service issued Notice
2007-83, which identified certain trust arrangements involving cash value life
insurance policies, and substantially similar arrangements, as listed
transactions. Translation: Section 419(e) welfare benefit plans that are funded
by cash value life insurance contracts are listed transactions, at least if a
tax deduction is taken for the amount of
premiums paid for such policies. On that same day, the Service also
issued Notice 2007-84 and Revenue Ruling 2007-65. The combined effect of these
three IRS pronouncements was that not only was the use of cash value life
insurance in welfare benefit plans, if combined with claiming tax deductions for
the premiums paid, sufficient to cause IRS treatment of these plans as listed
transactions, but that discrimination as between owners and rank and file
employees in these plans was also being targeted.
To illustrate, in many of these promoted arrangements, these
Section 419(e) welfare benefit plans, cash value life insurance policies are
purchased on the lives of the owners of the business, and sometimes on key
employees, while term insurance is purchased on the lives of the rank and file
employees. The plans in question tend to anticipate that the plan will be
terminated within five years or so, at which time the cash value policies will
be distributed to the owners, and possibly key employees, with very little
distributed to rank and file employees. In general, the Internal Revenue Code
will not countenance the claiming of a tax deduction in connection with a
welfare benefit plan where such blatant unequal treatment (discrimination) is
exhibited. Nevertheless, plan promoters claim that insurance premiums are
currently deductible by the business, and that the insurance policies, when
distributed to the owners, can be done so virtually tax free. And this also
despite the fact that an employer’s deductions for contributions to an
arrangement that is properly characterized as a welfare benefit fund are
subject to the limitations and requirements of the rules in IRC sections 419
and 419A, including the use of reasonable actuarial assumptions and the
satisfaction of nondiscrimination requirements.
With respect to the preparation and filing of Form 8886,
incidentally, it should not surprise that welfare benefit promoters have been
active in this area. This would include both the promoters of plans that have
been listed transactions for years as well as those that became listed
transactions, at least arguably, by virtue of the previously discussed October
2007 IRS activities. Some promoters take the position that their plans are
completely compliant and that, therefore, there is no need to file Form 8886.
Others take a more precautionary approach. While never admitting to being a
listed transaction, they do urge clients to file on a protective basis. At
least one went so far as to offer plan participants complete guidance and
instructions about precisely how to file protectively. Many, if not most, plan
promoters have, at the very least, forwarded completed sample forms to plan
participants for guidance and use in completing Form 8886. It is certainly
possible to file protectively. Any remotely good faith belief that the
transaction is not a listed one justifies the protective filing. In fact and
practice, the Service is actually treating protective filings in the same
manner as other filings.
But while many plan promoters have recognized the filing
obligation and recommended filing, this has led to another problem. As
previously noted, they have been instructing taxpayers on how to complete and
file the form, and the problem is that their guidance, in many cases, has not
been particularly helpful and sometimes dangerous. In some cases, though this
is difficult if not impossible to ascertain, the suggestions of the plan
promoters seem designed more to protect the promoters than to assist the
taxpayer. While this is a difficult call to make, it is absolutely clear, Wallach
says, that more than one promoter, whether carelessly or otherwise, has sent
taxpayers outdated forms to complete and file. Wallach, who you may recall has,
between himself and his associates, aided dozens of taxpayers in completing and
filing Form 8886, notes that his associates have frequently reported this
problem. They also report never having seen a Form 8886 prepared completely
correctly, especially where a promoter’s instructions were relied on. So,
because the fines may be imposed for incomplete, misleading, or incorrect
filings, the danger to plan participants can be clearly seen. And the taxpayer
who discovers errors subsequent to filing must decide whether to amend the
filing or not, which some plan participants are reluctant to do.
Burdens On Professionals With Clients In Welfare Benefit
Plans And Other Listed Transactions
Form 8918 must be filed with the Internal Revenue Service by
all “material advisors” to clients who are participating in listed
transactions. Exactly who, then, is a material advisor? You are a material
advisor if three requirements are satisfied. First, the client must actually be
participating in the listed transaction. Second, you must have given the client
tax advice with respect to the transaction. This does not necessarily mean that
you recommended participation. For example, signing off on a tax return
claiming a tax deduction for participation in the listed transaction surely
qualifies as having given tax advice with respect to the transaction. In fact,
even if you recommended against participation, you would satisfy this threshold
so long as you rendered tax advice, be it positive, negative, or neutral.
The third threshold is that you must have received $10,000
or more in compensation (yourself and/or a related entity). This is not quite
as simple as it sounds. The money need not all be received as a commission (as
might be the case with a CPA who is insurance licensed), or even in a lump sum
for accounting services rendered in connection with the client’s participation.
The money could be received periodically over time. It is even possible that,
so long as $10,000 in fees have been received from the client for whatever
reason over whatever period of time, the threshold is met. Lance Wallach,
previously referred to in the discussion about Form 8886 and whose associates
are also expert in assisting CPAs and others in the preparation and filing of
Form 8918, reports that one of his associates put this question directly to an
attorney in the Office of the Chief Counsel who actually wrote published IRS
guidance with respect to Form 8918. While the gentleman from the IRS was very
courteous and professional, trying his best to be of assistance, a clear,
unqualified, unequivocal answer that could be “taken to the bank” proved
impossible to elicit.
Like Form 8886, however, Form 8918 can be filed
protectively. Failure to file or incomplete, misleading, or inaccurate filings
can lead to the penalties that used to apply to Form 8886, to wit: $100,000.00
for individuals and $200,000.00 for corporations. For this purpose, it is
CRITICAL to note that the recent legislation reducing penalties applied ONLY to
Form 8886. The penalties for failure to file Form 8918, or for filing it
incorrectly, remain the same as they were, to wit: $100,000 for individuals and
$200,000 for corporations.
A good faith belief that either you did not receive $10,000
in income or that the transaction in question is not a listed one enables you
to file on a protective basis. And, in fact, as with the 8886 form, the IRS is,
in fact, treating all filings identically in any event.
When the CPA files this form ( it need only be filed once,
not on an annual basis, as Form 8886 must be), the CPA is assigned a number by
the IRS. The CPA or other professional then gives this number to all of his
affected clients, who are required to report it on the 8886 forms that they
must file. Also, as a perusal of Form 8918 makes clear, there is also a section
where the material advisor is to give all pertinent information with respect to
other material advisors who participated in and/or advised the client with
respect to the transaction in question.
As with Form 8886, this area is replete with horror stories
about advisors who, mostly innocently, have fallen into this trap. One that we
know of was sold by one promoter on a questionable plan, recommended it to
about fifteen clients, and now has been forced to file the 8918 form, help all
those involved who have to file Form 8886, and expend a fair amount of his own
funds, both to find people who can assist his clients with Form 8886 and in
“rescuing” clients who want to get out of this plan. Another called about
something else, and was horrified to discover that he had six clients in a plan
that is a listed transaction. When he was apprised of his situation, he sank
into a depression. These are only two of the dozens of sad, and worse, stories
in this area that we have been privy to. The second person, for example, had no
idea that anything was wrong. He initially called about something totally
unrelated. There have even been instances of professional discipline being
imposed in connection with this area, of CPAs being threatened with and perhaps
even actually suffering loss of their licenses. Such is the terrain in which
the CPA must now operate.
Another problem is possible, especially if you recommended
that the client participate. Most practitioners are familiar with situations
where, when things go wrong, clients often develop selective memory failure.
This happens here, as it does elsewhere. At best, it can lead to you spending
an inordinate amount of time, and perhaps money, on what is essentially a
thankless exercise. At worst, if the situation worsens to the point where a
lawsuit may be in the air, you could find yourself the subject of some sort of
client complaint or, worse, a named defendant in a lawsuit, in which case your
malpractice carrier would become involved, with all of the negative effects
upon yourself and your practice that that could entail.
Section 6707A – Past, Present, and Future
Returning now to the Form 8886 aspect of Section 6707A, the
disclosure requirement that applies to actual participants in listed
transactions, it has been noted, and discussed, that Congress recently reduced
the penalties under Section 6707A for many taxpayers. But it is still
imperative to realize that this is only a partial solution to the continuing
problem caused by the penalties imposed by that section. While the penalties
have been reduced from the prior patently ridiculous, and probably illegal,
level that until so recently prevailed, they are still sufficient, in many
cases, to put business owners out of business, just as the prior penalties
obviously were. And since the new legislation did not address or affect obligations
and penalties with respect to Form 8918 at all, accountants, insurance
professionals and other material advisors are as likely to be hurt as ever.
Whatever the underlying Congressional intent was in enacting
the original Section 6707A in 2004, whatever Congress hoped to accomplish, the
statute as it was written imposed clearly unconscionable burdens on taxpayers.
Penalties of up to $300,000 annually could be imposed on taxpayers who had not
underpaid tax and who had no knowledge that they had entered into transactions
that the IRS deems “listed”.
Tax provisions are seldom found to violate the United States
Constitution, but it is certainly arguable that the imposition of such a large
penalty on a taxpayer who entered into a transaction that produced little or
even no tax savings and without regard to the taxpayer’s knowledge or intent
violates the Eighth Amendment prohibition on excessive fines, etc. In practice,
the requirement that this penalty be imposed without regard to culpability
often had the effect of bankrupting middle class families who had no intention
of entering into a tax shelter – an outcome that dismayed even hardened IRS
enforcement personnel.
The section previously imposed a penalty of $100,000 per
individual and $200,000 per entity for each failure to make special disclosures
with respect to a transaction that the Treasury Department characterizes as a
“listed transaction” or “substantially similar” to a listed transaction. A
listed transaction is one that is specifically identified as such by published
IRS guidance. The question of what is “substantially similar” to such a
transaction is increasingly troublesome, especially given the ever broadening
IRS definition of the term, beginning with Treasury Decision 9,000, which
declared, on June 18, 2002, that, from that date forward, the term
“substantially similar” would be construed more broadly by the Service than it
had up until that time. This started a trend that continues to this day.
It is important for the reader to understand that the only
thing that was accomplished by the new, amended Section 6707A is a reduction in
the penalties. The penalties are still severe, severe enough to seriously
damage or even bankrupt most small businesses. And professional readers must
understand that there has been no effect on their obligations at all, and that
the same (in their case, even more severe) fines still apply.
For example, the following eleven statements are equally
applicable to the new Section 6707A as they are to its predecessor:
- The penalty applies without regard to whether the small business or the small business owners have knowledge that the transaction has been listed.
- The penalty applies even if the small business and/or the small business owners derived no tax benefit from the transaction. Even under the new legislation, there are substantial minimum penalties that are applied even if there has been no tax benefit.
- The penalty is applied at multiple levels, which is devastating to small businesses; the result is that the small business and its owners are hit with multiple penalties. The two most common problems are that fines are imposed on both the business entity and the owners as individuals, and also that fines are imposed each year, and thus are sometimes imposed for five years or more. In the case of a small business, the penalties can easily exceed the total earnings of the business and cause bankruptcy – totally out of proportion to any tax advantage that may or may not have been realized.
- The penalty is final, must be imposed by the IRS (this is mandatory), and cannot be rescinded. There is no right of appeal, and there is no “good faith” exception, as business advocates had hoped would be a part of the new legislation.
- Judicial review is expressly prohibited, which raises another Constitutional issue, this time a separation of powers argument, as it amounts to one branch of government prohibiting another from functioning.
- The taxpayer’s disclosure must initially be made twice – once with the IRS Office of Tax Shelter Analysis and again with the tax return for the year in which the transaction is first required to be disclosed. Thereafter, for each year that the taxpayer “benefits” from the transaction, it must be reflected on the tax return. Aside: As a practical matter, the form should be filed with the tax return. The IRS directions assume a timely filing. There are no directions on how to file late, which most taxpayers must do, since few realized the need to disclose in this manner when they still could have timely filed. A few experts have figured out how to file late and simultaneously avoid penalties, after months of study and numerous conversations with IRS personnel. Those conversations were with IRS people that drafted the regulations, those that receive the forms, and others.
- A taxpayer that discloses a transaction is subject to penalty if the Service deems the disclosure to be incomplete, incorrect, and/or misleading. I have had numerous conversations with people who filed the disclosure forms and got fined. They did not properly prepare and/or file the forms.
- If a transaction is not “listed” at the time the taxpayer files a return but it subsequently becomes listed, the taxpayer becomes responsible for filing a disclosure statement and will be penalized for failing to do so. This is true even if the taxpayer has no knowledge that the transaction has been listed. This sort of thing is exactly why business interests , albeit unsuccessfully, pushed for a “good faith” exception in the new legislation.
- The penalty is imposed on transactions that the IRS, in its sole discretion, determines are “substantially similar” to a listed transaction. Accordingly , taxpayers may never know or realize that they are in a listed transaction and, accordingly, the penalties compound annually because they never made any disclosure. At least, if a transaction is specifically identified, people can find out that it is a listed transaction. But how can anyone be sure that something is “substantially similar”, or not?
- The taxpayer must disclose each year, which can result in compounding of already large penalties; and
- The Statute of Limitations, usually three years, does not apply. IRC 6501(c)(10) tolls the statute until proper disclosure is made.
The Treasury Department usually
announces on a somewhat ad hoc basis what is a listed transaction. There is no
regulatory process or public comment period involved in determining what should
be a listed transaction. Once that a transaction is deemed to be a listed
transaction, the Draconian Section 6707A
penalties are triggered. Section 6707A penalties not only apply to
specifically listed transactions, but also to transactions that are deemed by
Treasury to be “substantially similar” to any of the specifically listed
transactions. Some have said that under Section 6707A, IRS and Treasury are the
judge, jury and executioner. Be that as it may, once again Constitutional
concerns need to be addressed, this time possible due process violations
pursuant to the Fourteenth Amendment.
Some Examples
A business owner bought a type of
life insurance policy featuring what is known as a “springing cash value” as an
alternative to a pension plan. Two years later, this type of transaction was
specifically identified as an abusive tax shelter, a listed transaction,
meaning that the business owner was now obligated to file Form 8886. But the
financial advisor, who years before had actually recommended this course of
action, either willfully or out of ignorance failed to advise the business owner
to disclose.
The IRS demanded back taxes and
interest in the neighborhood of $60,000. It also assessed $600,000 of penalties
under Section 6707A for failing to disclose participation in a listed
transaction for two separate years.
Another taxpayer filed Form 8886
with his tax returns, but failed to file, in the first year, with the Office of
Tax Shelter Analysis. The penalty was assessed for that failure, even though
the IRS had the form, though perhaps in a different place. Again, this scenario
cries out for the “good faith” exception that was not included in the new
legislation.
Then there was the doctor who
thought that he had settled his 419 welfare benefit plan issues with the
Service. He entered into a closing agreement and paid all taxes due and owing.
Later, he was assessed the penalty for failing to file Form 8886. Of course,
this issue had been neither raised nor even discussed in the doctor’s prior
communications, negotiations, etc. with the Service.
I could go on and on with these
horror stories, but the reader probably gets my drift by now. I have been
urging business owners to properly file Form 8886 for years. A surprising
number of accountants have little or no knowledge in this area, even being
unaware of the fines that can be imposed on “material advisors” which, as
previously noted, have NOT changed as a result of the new legislation. And if a
professional assumes that he has no clients in “listed transactions”, he should
realize that there are numerous types of listed transactions. They are not
restricted to welfare benefit plans. For example, they include the popular
Section 412(i) defined benefit pension plan, and even some of the ubiquitous
401(k) plans. No business owner, and especially no financial, insurance or
accounting professional should ever assume that he or she is immune from any or
all of the possible repercussions outlined herein.
Summing up, the new legislation
does reduce possible Section 6707A penalties for most taxpayers. That, in my
view, is its only benefit. And the reduction is not as great as one might
expect. Depending on surrounding circumstances, penalties of hundreds of
thousands of dollars are still quite possible. Even the minimum penalties,
which are applied in the event that there is no tax benefit, amount to $15,000
annually. Who can afford to just brush that aside? Over a period of years, and
the fines in the 8886 area are still applied annually, the minimum fines all be
themselves can add up to a considerable amount.
Both the 8886 and 8918 forms must
still be filed properly. The fines and penalties for failure to do so remain
substantial and unfair.
Subscribe to:
Posts (Atom)