Showing posts with label 419 Plans. Show all posts
Showing posts with label 419 Plans. Show all posts
Understanding IRC Sections 419(e) and 419A(f)(6) Plans
IRC Sections 419(e) and 419A(f)(6) Plans
For years life insurance agents and others have been selling ways to deduct life insurance in welfare benefit plans. For years the IRS has been disallowing most of these plans on audit.
In Notice 2007-83, the IRS identified certain trust arrangements involving cash value life insurance policies, and substantially similar arrangements, as listed transactions. The IRS also issued related Revenue Ruling 2007-65 to address situations where an arrangement is considered a welfare benefit fund but the employer's deduction for its contributions to the fund is denied in whole or in part for premiums paid by the trust on cash value life insurance policies.
More Problems for 419 Plans
For years, life insurance companies and agents have tried to find ways of making life insurance premiums paid by business owners tax deductible. This would allow them to sell policies at a "discount."
The problem became acute a few years ago with outlandish claims about how §§419A(f)(5) and (6) of the Internal Revenue Code (IRC) exempted employers from any tax deduction limitations. Other inaccurate assertions were made as well, until the Internal Revenue Service (IRS) finally put a stop to such egregious misrepresentations in 2002 by issuing regulations and naming such plans as "potentially abusive tax shelters" (or "listed transactions") that needed to be registered and disclosed to the IRS.This appeared to put an end to the scourge of scurrilous promoters, as many such plans disappeared from the landscape.
And what happened to the providers that were peddling §§419A(f)(5) and (6) life insurance plans a few years ago? We recently found the answer: Most of them found a new life as promoters of so-called "419(e)" welfare benefit plans.
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Benefit Plans Under Sections 412(i), 419 and 501(c)(9): Uses and Abuses
By Lance Wallach, CLU, ChFC, CIMC
While many taxpayers adopt legitimate Voluntary Employee Beneficiary Association (“VEBA”) Plans, Welfare Benefit Plans (“419(e) Plans”) and Fully-Insured Defined Benefit Pensions (“412(i) Plans”), all of the foregoing plans are also sold as a way for owners to obtain huge tax deductions, with the ability to take money out of a corporation tax-free, protect assets from creditors, tax-deduct life, health, disability and long-term care insurance premiums and pass wealth tax free to the next generation. This article will explore those claims.
We have worked with each of these benefit plans for years without problems for ourselves or for our clients. Yet a review of recent Internal Revenue Service (“IRS”) rulings and court cases instituted both by the IRS as well as the Department of Labor (“DOL”) shows that some taxpayers adopting 419 Plans or 412(i) Plans have had tax deductions disallowed, been the subject of lawsuits, or even worse. Many plans have been determined by IRS to be “listed transactions” (or potentially abusive tax shelters) requiring notification of the Services and potentially triggering heavy penalties.
When the various plans are sold and operated properly, they can provide excellent advantages. However, rather than brave the regulatory minefield, many accountants and advisors would rather simply just say “no”. How can a non-specialist differentiate between a legitimate plan and one that IRS or DOL may attack?
In addition to the additional caution begin exercised by accountants and advisors, some insurance companies have stopped allowing their products to be sold in connection some or all of the above-named benefit plans, while others require that their legal department do an extensive review of the plan and that the client sign a disclosure acknowledgement form that exonerates the insurance company. This is as a direct result of a number of lawsuits against insurance companies in connection with such benefit plans, usually after IRS has closed down a plan or disallowed tax deductions. In such situations, the insurance company is portrayed as the “deep pockets” which should have done a better job of investigating the integrity and history of the plan administrator. [Interestingly, other insurance companies see their role as issuing and underwriting insurance and annuity contracts and don’t opine on the purported tax benefits.]
VEBAs and 419(e) Plans
VEBAs potentially provide a triple-tax benefit: (i) Contributions to a legitimate VEBA or other welfare benefit plan may be tax-deductible within the limitations of Sections 419 and 419A of the Internal Revenue Code (“IRC”), as actuarially-determined. (ii) Investment income may accumulate tax-deferred inside a VEBA. And (iii) benefits paid from the VEBA can be distributed income tax free, either as death proceeds of life insurance (IRC Section 101(a) or for health reimbursement arrangement benefits under IRC Section 105(h). Welfare benefit plans are similar except that they do not provide tax-free investment income inside the plan.
If properly designed and established, the benefits inside a VEBA/419 plan are protected from creditors and the death benefits may be excluded from the participant’s estate for estate tax purposes.
A few months ago when the author addressed the annual convention of the National Network of Estate Planning Attorneys, the attorneys were surprised to learn about using VEBAs and welfare benefit plans to tax-deduct life insurance premiums while still excluding the death proceeds from the insured’s estate. This makes for an ideal package: Instead of buying life insurance with after-tax dollars inside an irrevocable life insurance trust (“ILIT”) to pay estate taxes, it may be possible to make a tax-deductible contribution to the VEBA, let the VEBA buy the life insurance with pretax dollars and name the ILIT as the irrevocable beneficiary.
Similarly, at the National Convention of the American Association of Attorney–Certified Public Accountants which I also addressed, the attendees were interested to learn about using VEBAs as a way to attract high net worth clients. These are under-utilized, under-marketed and misunderstood plans.
419A(f)(5) and (6) Plans
Over the past few years, the Treasury and the IRS have acted forcefully to eliminate so-called “Section 419 plans”. In Notice 2000-15 and Notice 2001-51, the IRS included such plans as potentially abusive tax shelters or “listed transactions.” Treasury Decision 9000 extended the scope of those notices. The Section 419 Plans that are in disfavor with the IRS are those plans that claim to be exempt from the tax-deduction limitations imposed by Sections 419 and 419A of the IRC by virtue of supposed compliance with IRC Sections 419A(f)(5) or 419A(f)(6).
So-called Section 419A(f)(5) plans are marketed as “union” plans (sometimes called “VEBAs”). Some of these use convincing language to persuade employers that they are able to include only key employees and owner-employees in their “union,” and to provide such “union members” with an inviting array of benefits. There are variations on this scam, but no plan that offers benefits to doctors, executives or highly-compensated employees through such an arrangement is legitimate. Moreover, the IRS considers such arrangements to be listed transactions.
Section 419A(f)(6) plans, also called “10-or-more employer plans” are marketed as exempt from tax deduction limitations altogether. Some plans have even claim to be exempt from non-discrimination requirements. It now appears that IRS succeeded in eliminating most such plans by issuing Regulations under this Section of the IRC and classifying such arrangements as listed transactions.
The ramifications for clients who are involved in abusive tax shelters is substantial. Code section 6707A provides for a $100,000 penalty for an individual and a $200,000 penalty for all other taxpayers when the client does not disclose involvement with a “listed” tax transaction. The penalty cannot be waived by the IRS and cannot be reviewed or overturned by a court of law.
This is not a game, and the IRS has made that clear. Advisors (financial planners, CPAs, accountants, attorneys, EAs and others) are not outside of the reach of the IRS. See the following:
Act section 822(a)(1)(B) provides in part that:
“The Secretary may impose a monetary penalty on any representative …(which) shall not exceed the gross income derived from … the conduct giving rise to the penalty …”
An IRS press release (IR 2004-138) states that:
"The new 2004 Jobs Act strengthens our hand in the fight against abusive shelters," said IRS Commissioner Mark W. Everson. "Under the new law, attorneys, accountants and other tax advisers who fail to comply with these disclosure requirements will face significant monetary penalties.”
Many advisors are unaware of the fact that the IRS has a task force that does nothing but hunt down clients that are in abusive 419 Plans. If the IRS believes an advisor is invovled in any way in promoting abusive 419 Plans, a request for production of documents and for a client list will come in the mail to the advisor giving the advice. These inquiries are not fun and can cause significant grief for both the advisor and his/her unsuspecting clients.
The best course of action when dealing with advanced tax planning is to work with someone who has a track record of being reputable so as to prevent advisors and their clients from becoming “infamous.”
412(i) Fully Insured Defined Benefit Plans
412(i) plans continue to generate both interest and caution following recent Internal Revenue Service and Treasury Department actions to crack down on a number of abusive schemes that had cropped up in this marketplace.
Unlike 401(k) and other defined-contribution plans, defined benefit plans, including 412(i) Plans, are not subject to the $42,000 contribution limit ($46,000 with catch-up salary deferrals). Benefits are limited to 100% of pay, but employers may deduct the projected cost of funding the maximum benefit at the participant’s normal retirement date. Generally these contribution limitations are determined by the taxpayer’s actuary.
Section 412(i) Plans provide an alternative to using an independent actuary. If all plan contributions are invested in life insurance and annuity contracts of an insurance company, the contractually-guaranteed rates under those contracts may be used to determine the maximum tax-deductible contribution to the plan. This has the potential of increasing the taxpayer’s maximum tax deduction by 20%-40%.
Many accountants like S corporations for their clients. This allows the client to have large amounts of income without worrying about excess profits, accumulating retained earnings, dividends or double taxation of profits. However, since W-2 wages are subject to payroll taxes and passive dividend income is not, many S corporation owners limit their W-2 wages to a modest amounts and pass through the majority of the client’s income free of payroll tax. While this may make tax-planning sense, it may dramatically curtail the amount of retirement plan or welfare benefit plan contributions, which may only take W-2 wages into account.
A defined benefit plan, especially a 412(i) Plan, may provide relief for such shareholder-employees. Maximum contributions to a defined benefit plan may be achieved with as little as 3 years of W-2 wages of $70,000 per year. And the plan contribution may far exceed 100% of compensation. (We have seen cases where tax-deductible contributions in excess of $200,000 per year for a single lone participant were available.) For example, a W-2 wage of $50,000 would permit a maximum SEP-IRA contribution of $12,000 for a 50-year-old, but will allow a 412(i) contribution of over $75,000!
Defined benefit plans (including 412(i) Plans) have tremendous appeal for small, closely held businesses that are successful and have few, if any, employees. The initial tax-deductible contributions and projected benefits are unparalleled for participants age 40 and older. But care must be exercised to assure that a 412(i) or defined-benefit plan is properly designed and funded.
I recently addressed the National Convention of the American Society of Pensions Actuaries. At that meeting, Jim Holland, the IRS’ chief actuary, spoke about their concerns about abusive 412(i) Plans. Since then, officials from the IRS have publicly and privately expressed concerns about abuses in the 412(i) arena. As early as the 2003 Los Angles Benefits Conference, concerns were expressed primarily about some perceived abuses:
(i) Utilization of life insurance contracts rather than annuities as the primary or exclusive funding vehicle for 412(i) plans;
(ii) Use of life insurance products designed to minimize cash values upon early plan termination, and
(iii) Funding for benefits that that exceed Code Section 415(b) limitations.
I recently heard of a 412(i) Plan described as “two retirement plans in one: one for the participant and one for the insurance agent.” However, such criticism does not apply to all 412(i) Plans; only to abusive plans with some or all of the features described above.
Properly structured 412(i) plans are viable when avoiding the pitfalls described above and can provide the maximum tax deduction and retirement benefit.
Maximum Tax Deductions
We recommend consulting with knowledgeable tax counsel and benefit providers to develop an individualized approach for each client.
_________________
Lance Wallach, National Society of Accountants Speaker of the Year and member of the American Institute of CPAs faculty of teaching professionals, is a frequent speaker on retirement plans, financial and estate planning, and abusive tax shelters. He speaks at more than ten conventions annually and writes for over fifty publications. 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. Mr. Wallach may be reached at 516/938.5007, wallachinc@gmail.com, or at www.taxaudit419.com or www.lancewallach.com.
The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
Abusive Insurance Plans Get Red Flag
Tax Briefs - The IRS in Notice 2007-83 identified as listed transactions certain trust arrangements involving cash value life insurance policies. Revenue Ruling 2007-65, issued simultaneously, addressed situations where the tax deduction has been disallowed, in part or in whole, for premiums paid on such cash-value life insurance policies.
Also simultaneously issued was Notice 2007-84, which disallows tax deductions and imposes severe penalties for welfare benefit plans that primarily and impermissibly benefit shareholders and highly compensated employees.
Taxpayers participating in these listed transactions must disclose such participation to the Service by January 15. Failure to disclose can result in severe penalties--- up to $100,000 for individuals and $200,000 for corporations.
Ruling 2007-65 aims at situations where cash-value life insurance is purchased on owner/employees and other key employees, while only term insurance is offered to the rank and file. These are sold as 419(e), 419(f) (6), and 419 plans. Other arrangements described by the ruling may also be listed transactions. A business in such an arrangement cannot deduct premiums paid for cash-value life insurance.
A CPA who is approached by a client about one of these arrangements must exercise the utmost degree of caution, and not only on behalf of the client. The severe penalties noted above can also be applied to the preparers of returns that fail to properly disclose listed transactions.
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.
Taxpayers participating in these listed transactions must disclose such participation to the Service by January 15. Failure to disclose can result in severe penalties--- up to $100,000 for individuals and $200,000 for corporations.
Ruling 2007-65 aims at situations where cash-value life insurance is purchased on owner/employees and other key employees, while only term insurance is offered to the rank and file. These are sold as 419(e), 419(f) (6), and 419 plans. Other arrangements described by the ruling may also be listed transactions. A business in such an arrangement cannot deduct premiums paid for cash-value life insurance.
A CPA who is approached by a client about one of these arrangements must exercise the utmost degree of caution, and not only on behalf of the client. The severe penalties noted above can also be applied to the preparers of returns that fail to properly disclose listed transactions.
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.
As an expert witness Lance Wallach's side has never lost a case. People need to be careful of 419 Welfare Benefit Plans, 412i plans, Section 79 plans and Captive Insurance Plans. Most of these plans are sold by insurance agents. If you are in an abusive, listed or similar transaction plan you need to file under IRS 6707a. The participant files form 8886, and the salesmen or accountant who signs the tax returns files form 8918 if they got paid over $10,000. They are called Material Advisors and face a minimum $100,000 fine. Some plans are offshore which could involve FBAR or OVDI filings. If you have money overseas you probably need to file for IRS tax amnesty. If you want to reduce the tax we suggest that you first file and then opt out. For more information Google Lance Wallach.
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.
HAVE YOU BEEN THE VICTIM OF THE SALE OF ABUSIVE LIFE INSURANCE AND ANNUITY PRODUCTS SOLD AS PART OF A PENSION PLAN OR RETIREMENT PLAN?
Abusive Tax Shelters, Insurance and Annuity Product Fraud Lawsuit
RECOVER YOUR LOSSES FROM LIFE INSURANCE 412 (i) AND ANNUITY PRODUCTS SOLD AS PART OF A PENSION PLAN OR RETIREMENT PLAN
Insurance and Annuity Product Fraud Lawsuit
Life Insurance Companies and their Agents have been selling abusive life insurance and annuity products. Many pension plans have been promoted as legitimate retirement plans which contain various life insurance products and annuities. Unfortunately the Internal Revenue Service (“IRS”) has now attacked many of these pension and retirement plans and is conducting audits to demand payment for taxes, penalties and interest and attempting to disqualify many plans.
If you are an accountant, business owner, corporate officer, dentist, doctor, professional athlete, professional or corporation of high net worth, you were unscrupulously targeted by life insurance companies and their agents to purchase a 412i defined benefit pension plan. You were chosen to purchase a 412i plan because you have the net worth to pay for it.
Our investigation has disclosed that many life insurance companies, promoters, attorneys,
and accountants promoted and sold these plans, including but not limited to the following:
• American General Life Insurance Company
• Guardian Life Insurance Company
• Hartford Life and Annuity Insurance Company
• Indianapolis Life Insurance Company
• Pacific Life Insurance Company
• Pension Services, LLC
• Many Other Life Insurance Companies and Agents
• Guardian Life Insurance Company
• Hartford Life and Annuity Insurance Company
• Indianapolis Life Insurance Company
• Pacific Life Insurance Company
• Pension Services, LLC
• Many Other Life Insurance Companies and Agents
The individuals and groups above devised a scheme to sell abusive tax shelters under the auspices of Section 412(i) of the tax code. A 412(i) is a defined benefit pension plan. It provides specific retirement benefits to participants once they reach retirement and must contain assets sufficient to pay those benefits. A 412(i) plan differs from other defined benefit pension plans in that it must be funded exclusively by the purchase of individual life insurance products. To create a 412(i) plan, there must
be a trust to hold the assets. The employer funds the plan by making cash contributions to the trust, and the Code allows the employer to take a tax deduction in the amount of the contributions, i.e. the entire amount.
The trust uses the contributed funds to purchase some combination of life insurance products (insurance or annuities) for the plan. As the plan participants retire, the trust will usually sell the policies for their present cash value and purchase annuities with the proceeds. The revenue stream from the annuities pays the specified retirement benefit to plan participants.
These defendants (with the aid and knowledge of the insurance companies) used the traditional structure and sold life insurance policies with excessively high premiums. The trust then uses the large cash contributions to pay high insurance premiums and the employer takes a deduction for the sum of those large contributions. As you might expect, these policies were designed with excessively high fees or “loads” which provided exorbitant commissions to the insurance companies and the agents who sold the products.
The policies that were sold were termed Springing Cash Value Policies. They had little or no cash value for the first 5-7 years, after which they had significant cash value. Under this scheme, after 5-7 years, and just before the cash value sprung, the participant typically purchases the policy from the trust for the policy’s surrender value. In theory, you have a tax free transaction.
The IRS does not recognize the tax benefit of such a plan and has repeatedly issued announcements indicating that such plans are contrary to federal tax laws and regulations.
Have you received a letter from the IRS either (1) informing you of an upcoming audit of your plan or (2) demanding payment for substantial tax “penalties and interest”? The “tax free” benefit pension plan you purchased might be a scam, a fraud. Please allow us to speak with you and review your documentation to help you to determine your best course of action. Your communications will be treated with the strictest attorney-client confidence.
If you were a victim of such a sale of a 412i or 419 plan, we encourage you to contact us immediately . You may also receive a free initial consultation by telephone at 516 9357346 If you desire a free initial phone consultation please leave a specific time or time period within which to contact you.
Since you have already expanded a substantial amount of money in your pension plan and believed it was a legitimate retirement plan, you are obviously shocked to now learn that major life insurance companies and their agents may have sold you improper retirement plans simply to generate enormous commissions on life insurance and annuities. www.taxaudit419 and www.vebaplan.com have more information.
We also help with abusive tax shelters like 419 welfare benefit plans. In 2002 Lance Wallach wrote to Hartford and other insurance companies telling them that IRS will be increasing 419 audits and law firms would be suing them. What did Hartford do? They sent out some emails to others including their compliance department and continued to sell 419 plans. Give us a call if you want a copy of this.
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