Showing posts with label 8886. Show all posts
Showing posts with label 8886. Show all posts
Captive Insurance: IRS Knocking
I.R.S. Is Looking Into Captive Insurance Shelters
The question is whether these small captives have gone too far. This year, the Internal Revenue Service placed them on its annual “Dirty Dozen list of tax scams.” Small captives now share space with phishing, identity theft and offshore tax avoidance.
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.
Abusive Trust Arrangements Utilizing Cash Value Life Insurance Policies Purportedly to Provide Welfare Benefits
Internal Revenue Bulletin: 2007-45
November 5, 2007
Notice 2007-83
Abusive Trust Arrangements Utilizing Cash Value Life Insurance Policies Purportedly to Provide Welfare Benefits
Concurrently with this notice, the IRS is publishing Rev. Rul. 2007-65 (concluding that for purposes of deductions allowable to an employer under § 419, a welfare benefit fund’s qualified direct cost does not include premium amounts for cash value life insurance policies paid by the fund, whenever the fund is directly or indirectly a beneficiary under the policy within the meaning of § 264(a)), and Notice 2007-84 (describing trust arrangements involving purported welfare benefit funds that, in form, provide post-retirement medical and life insurance benefits to employees on a nondiscriminatory basis but, in operation, result in the owner or owners receiving all or a substantial portion of the post-retirement and other benefits, and all or a substantial portion of any assets distributed from the trust).
BACKGROUND
1. Promoted Arrangements
Trust arrangements utilizing cash value life insurance policies and purporting to provide welfare benefits to active employees are being promoted to small businesses and other closely held businesses as a way to provide cash and other property to the owners of the business on a tax-favored basis. The arrangements are sometimes referred to by persons advocating their use as “single employer plans” and sometimes as “419(e) plans.” Those advocates claim that the employers’ contributions to the trust are deductible under §§ 419 and 419A as qualified cost, but that there is not a corresponding inclusion in the owner’s income.A promoted trust arrangement may be structured either as a taxable trust or a tax-exempt trust, i.e., a voluntary employees’ beneficiary association (VEBA) that has received a determination letter from the IRS that it is described in § 501(c)(9). The plan and the trust documents indicate that the plan provides benefits such as current death benefit protection, self-insured disability benefits, and/or self-insured severance benefits to covered employees (including those employees who are also owners of the business), and that the benefits are payable while the employee is actively employed by the employer. The employer’s contributions are often based on premiums charged for cash value life insurance policies. For example, contributions may be based on premiums that would be charged for whole life policies. As a result, the arrangements often require large employer contributions relative to the actual cost of the benefits currently provided under the plan.
Under these arrangements, the trustee uses the employer’s contributions to the trust to purchase life insurance policies. The trustee typically purchases cash value life insurance policies on the lives of the employees who are owners of the business (and sometimes other key employees), while purchasing term life insurance policies on the lives of the other employees covered under the plan.
It is anticipated that after a number of years the plan will be terminated and the cash value life insurance policies, cash, or other property held by the trust will be distributed to the employees who are plan participants at the time of the termination. While a small amount may be distributed to employees who are not owners of the business, the timing of the plan termination and the methods used to allocate the remaining assets are structured so that the business owners and other key employees will receive, directly or indirectly, all or a substantial portion of the assets held by the trust.
Those advocating the use of these plans often claim that the employer is allowed a deduction under § 419(c)(3) for its contributions when the trustee uses those contributions to pay premiums on the cash value life insurance policies, while at the same time claiming that nothing is includible in the owner’s gross income as a result of the contributions (or, if amounts are includible, they are significantly less than the premiums paid on the cash value life insurance policies). They may also claim that nothing is includible in the income of the business owner or other key employee as a result of the transfer of a cash value life insurance policy from the trust to the employee, asserting that the employee has purchased the policy when, in fact, any amounts the owner or other key employee paid for the policy may be significantly less than the fair market value of the policy. Some of the plans are structured so that the owner or other key employee is the named owner of the life insurance policy from the plan’s inception, with the employee assigning all or a portion of the death proceeds to the trust. Advocates of these arrangements may claim that no income inclusion is required because there is no transfer of the policy itself from the trust to the employees.
2. Intent to Challenge Transactions
The IRS intends to challenge the claimed tax benefits for the above-described transactions for various reasons. Depending on the facts and circumstances of a particular arrangement, contributions to a purported welfare benefit fund on behalf of an employee who is a shareholder may properly be characterized as dividend income to the owner, the value of which is includible in the owner’s gross income, and for which amounts are not deductible by the corporation. See Neonatology Associates v. Commissioner, 299 F.3d 221 (3d Cir. 2002). Depending on the facts and circumstances of a particular arrangement, the arrangement may properly be characterized as a plan deferring the receipt of compensation for purposes of § 404(a)(5), resulting in the application of the rules under § 404(a)(5) governing the timing of any otherwise available deductions. See Wellons v. Commissioner, 31 F.3d 569 (7th Cir. 1994). In addition, an arrangement may properly be characterized as a nonqualified deferred compensation plan for purposes of § 409A. Application of § 409A may result in immediate inclusion of income and additional taxes to the employee, as well as income tax withholding liabilities to the employer. The facts and circumstances of a particular arrangement may result in it coming within the definition of a split-dollar life insurance arrangement, so that the tax consequences to the employer and the employees are subject to the rules governing those types of arrangements, including potentially § 409A. Under the economic benefit regime of the split-dollar life insurance arrangement rules set forth in § 1.61-22, the employee must include in income the full value of the economic benefits provided to the employee under the arrangement for the taxable year without a corresponding employer deduction.If, based on the facts and circumstances, an arrangement described above is properly characterized as a welfare benefit fund for purposes of §§ 419 and 419A (rather than a dividend arrangement, a plan deferring the receipt of compensation, or a split-dollar life insurance arrangement), an employer is allowed a deduction for contributions to the trust or other welfare benefit fund only to the extent allowed under §§ 419 and 419A. Under §§ 419 and 419A, no deduction is allowed with respect to premiums paid for life insurance coverage provided to current employees if the welfare benefit fund or the employer is directly or indirectly a beneficiary under the life insurance policy within the meaning of § 264(a). In the promoted arrangements discussed above, the trust typically retains rights in the life insurance policies and is directly or indirectly a beneficiary under the policies, so that no deduction is allowed with respect to the life insurance premiums. See Situation 1 in Rev. Rul. 2007-65. Further, any deduction with respect to uninsured benefits (for example, uninsured medical, disability, or severance benefits) is not based on the premiums paid on the life insurance policies, but is generally limited to claims incurred and paid during the year.[1] See Situation 2 in Rev. Rul. 2007-65. Thus, contrary to the claims made by persons advocating the use of the arrangements discussed above, premiums on cash value life insurance policies paid through the trust are not a justification for claiming a deduction under §§ 419 and 419A.
Moreover, in appropriate cases, the IRS intends to challenge the value claimed by the taxpayer for property distributed from the trust, including cash value life insurance policies.
The above conclusions apply whether the trust used to provide the plan benefits is a taxable trust or a VEBA. While the trust may have received a determination letter stating the trust is exempt under § 501(c)(9), a letter of this type does not address the tax deductibility of contributions to the trust with respect to the employer nor the income inclusion with respect to the employees.
The IRS has previously identified certain other transactions that claim to be welfare benefit funds as listed transactions, concluding that the tax benefits claimed to be generated by these transactions are not allowable for federal income tax purposes. Notice 2003-24, 2003-1 C.B. 853, describes certain transactions purporting to meet the exception under § 419A(f)(5) for collectively bargained plans and identifies those and substantially similar transactions as listed transactions, and Notice 95-34, 1995-1 C.B. 309, describes transactions that purport to meet the 10-or-more employer plan exception under § 419A(f)(6). The transactions described in Notice 95-34 and substantially similar transactions have also been identified as listed transactions. See Notice 2004-67, 2004-2 C.B. 600.
LISTED TRANSACTIONS
1. Transactions Identified As Listed Transactions
Any transaction that has all of the following elements, and any transaction that is substantially similar to such a transaction, are identified as “listed transactions” for purposes of § 1.6011-4(b)(2) and §§ 6111 and 6112, effective October 17, 2007, the date this notice is released to the public.(1) The transaction involves a trust or other fund described in § 419(e)(3) that is purportedly a welfare benefit fund.
(2) For determining the portion of its contributions to the trust or other fund that are currently deductible the employer does not rely on the exception in § 419A(f)(5)(A) (regarding collectively bargained plans).
(3) The trust or other fund pays premiums (or amounts that are purported to be premiums) on one or more life insurance policies and, with respect to at least one of the policies, value is accumulated either:
(a) within the policy (for example, a cash value life insurance policy); or
(b) outside the policy (for example, in a side fund or through an agreement outside the policy allowing the policy to be converted to or exchanged for a policy which will, at some point in time, have accumulated value based on the purported premiums paid on the original policy).
(4) The employer has taken a deduction for any taxable year for its contributions to the fund with respect to benefits provided under the plan (other than post-retirement medical benefits, post-retirement life insurance benefits, and child care facilities) that is greater than the sum of the following amounts:
(a) With respect to any uninsured benefits provided under the plan,
(i) an amount equal to claims that were both incurred and paid during the taxable year; plus
(ii) the limited reserves allowable under § 419A(c)(1) or (c)(3), as applicable; plus
(iii) amounts paid during the taxable year to satisfy claims incurred in a prior taxable year (but only to the extent that no deduction was taken for such amounts in a prior year); plus
(iv) amounts paid during the taxable year or a prior taxable year for administrative expenses with respect to uninsured benefits and that are properly allocable to the taxable year (but only to the extent that no deduction was taken for such amounts in a prior year).
(b) With respect to any insured benefits provided under the plan,
(i) insurance premiums paid during the taxable year that are properly allocable to the taxable year (other than premiums paid with respect to a policy described in (3)(a) or (b) above); plus
(ii) insurance premiums paid in prior taxable years that are properly allocable to the taxable year (other than premiums paid with respect to a policy described in (3)(a) or (b) above); plus
(iii) amounts paid during the taxable year or a prior taxable year for administrative expenses with respect to insured benefits and that are properly allocable to the taxable year (but only to the extent that no deduction was taken for such amounts in a prior year).
(c) For taxable years ending prior to November 5, 2007, with respect to life insurance benefits provided through policies described in (3)(a) and (b) above, the greater of the following amounts:[2]
(i) in the case of an employer with a taxable year that is the calendar year, the aggregate amounts reported by the employer as the cost of insurance with respect to such policies on the employees’ Forms W-2 (or Forms 1099) for that year, plus an amount equal to the amounts that would have been reportable on the employees’ Forms W-2 for that year, but for the exclusion under section 79 (relating to the cost of up to $50,000 of coverage); or, in the case of an employer with a taxable year other than the calendar year, the portions of the aggregate amounts reported by the employer on the Forms W-2 (or Forms 1099) as described in (i), above, (or that would have been reported absent the exclusion under § 79) that are properly allocable to the employer’s taxable year; and
(ii) with respect to each employee insured under a cash value life insurance policy, the aggregate cost of insurance charged under the policy or policies with respect to the amount of current life insurance coverage provided to the employee under the plan (but limited to the product of the current life insurance coverage under the plan multiplied by the current year’s mortality rate provided in the higher of the 1980 or 2001 CSO Table).
(d) The additional reserve, if any, under § 419A(c)(6) (relating to medical benefits provided through a plan maintained by a bona fide association), but only to the extent amounts are not already included above in this paragraph (4), and only to the extent that no deduction was taken for such amounts in a prior taxable year.
2. Participation in the Listed Transactions
Whether a taxpayer has participated in the listed transaction described in this notice will be determined under § 1.6011-4(c)(3)(i)(A). However, an individual who is not the employer will be treated as a participant for a taxable year if, and only if the individual owns, directly or indirectly, 20 percent or more of an entity, other than a C corporation, that is a participant in the listed transaction for the taxable year. For this purpose, indirect ownership is determined under rules similar to the rules of § 318 but without regard to the family attribution rules of § 318(a)(1).3. Disclosure, List Maintenance, and Registration Requirements; Penalties; Other Considerations
In general, if a taxpayer has participated in a listed transaction, the rules of § 1.6011-4(e) determine when a disclosure statement must be filed by the taxpayer. However, if, under § 1.6011-4(e), a taxpayer is required to file a disclosure statement with respect to the listed transaction described in this notice after October 17, 2007, and prior to January 15, 2008, that disclosure statement will be considered to be timely filed if the taxpayer alternatively files the disclosure statement with the Office of Tax Shelter Analysis (OTSA) by January 15, 2008.Some transactions described in Notice 95-34 and substantially similar transactions may be identified as a listed transaction in this notice also. It should be noted that, independent of their classification as “listed transactions” for purposes of § 1.6011-4(b)(2) and §§ 6111 and 6112, transactions that are the same as, or substantially similar to, the transaction identified in this notice may already be subject to the requirements of §§ 6011, 6111, 6112, or the regulations thereunder. Persons required to disclose these transactions under § 1.6011-4 and who fail to do so may be subject to the penalty under § 6707A.[3] Persons required to disclose or register these transactions under § 6111 who have failed to do so may be subject to the penalty under § 6707(a). Persons required to maintain lists of investors under § 6112 who fail to do so (or who fail to provide such lists when requested by the IRS) may be subject to the penalty under § 6708(a).
In addition, the IRS may impose other penalties on persons involved in this transaction or substantially similar transactions (including the accuracy-related penalty under § 6662 or 6662A) and, as applicable, on persons who participate in the promotion or reporting of this transaction or substantially similar transactions (including the return preparer penalty under § 6694, the promoter penalty under § 6700, and the aiding and abetting penalty under § 6701).
Further, under § 6501(c)(10), the period of limitations on assessment may be extended beyond the general three-year period of limitations for persons required to disclose transactions under § 1.6011-4 who fail to do so. See Rev. Proc. 2005-26, 2005-1 C.B. 965.
The IRS and the Treasury Department recognize that some taxpayers may have filed tax returns taking the position that they were entitled to the purported tax benefits of the types of transactions described in this notice. These taxpayers should consult with a tax advisor to ensure that their transactions are disclosed properly and to take appropriate corrective action.
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.
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