Showing posts with label IRS attacks. Show all posts
Showing posts with label IRS attacks. Show all posts
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.
Captive Insurance and Other Tax Reduction Strategies – The Good, Bad, and Ugly
Every accountant knows that increased cash flow and cost savings are critical for businesses . What is uncertain is the best path to recommend garnering these benefits.
Over the past decade business owners have been overwhelmed by a plethora of choices designed to reduce the cost of providing employee benefits while increasing their own retirement savings. The solutions ranged from traditional pension and profit sharing plans to more advanced strategies.
Some strategies, such as IRS section 419 and 412(i) plans, used life insurance as vehicles to bring about benefits. Unfortunately, the high life insurance commissions (often 90% of the contribution, or more) fostered an environment that led to aggressive and noncompliant plans.
The result has been thousands of audits and an IRS task force seeking out tax shelter promotion. For unknowing clients, the tax consequences are enormous. For their accountant advisors, the liability may be equally extreme.
Recently, there has been an explosion in the marketing of a financial product called Captive Insurance. These so called “Captives” are typically small insurance companies designed to insure the risks of an individual business under IRS code section 831(b). When properly designed, a business can make tax-deductible premium payments to a related-party insurance company. Depending on circumstances, underwriting profits, if any, can be paid out to the owners as dividends, and profits from liquidation of the company may be taxed as capital gains.
While captives can be a great cost saving tool, they also are expensive to build and manage. Also, captives are allowed to garner tax benefits because they operate as real insurance companies. Advisors and business owners who misuse captives or market them as estate planning tools, asset protection vehicles, tax deferral or other benefits not related to the true business purpose of an insurance company face grave regulatory and tax consequences.
A recent concern is the integration of small captives with life insurance policies. Small captives under section 831(b) have no statutory authority to deduct life premiums. Also, if a small captive uses life insurance as an investment, the cash value of the life policy can be taxable at corporate rates, and then will be taxable again when distributed. The consequence of this double taxation is to devastate the efficacy of the life insurance, and it extends serious liability to any accountant who recommends the plan or even signs the tax return of the business that pays premiums to the captive.
The IRS is aware that several large insurance companies are promoting their life insurance policies as investments with small captives. The outcome looks eerily like that of the 419 and 412(i) plans mentioned above.
Remember, if something looks too good to be true, it usually is. There are safe and conservative ways to use captive insurance structures to lower costs and obtain benefits for businesses. And, some types of captive insurance products do have statutory protection for deducting life insurance premiums (although not 831(b) captives). Learning what works and is safe is the first step an accountant should take in helping his or her clients use these powerful, but highly technical insurance tools.
Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals, is a frequent speaker on retirement plans, abusive tax shelters, financial, international tax, and estate planning. He writes about 412(i), 419, Section79, FBAR, and captive insurance plans. He speaks at more than ten conventions annually, writes for over fifty publications, is quoted regularly in the press and has been featured on television and radio financial talk shows including NBC, National Public Radio’s All Things Considered, and others. Lance has written numerous books including Protecting Clients from Fraud, Incompetence and Scams published by John Wiley and Sons, Bisk Education’s CPA’s Guide to Life Insurance and Federal Estate and Gift Taxation, as well as the AICPA best-selling books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots.
He does expert witness testimony and has never lost a case. Contact him at 516.938.5007, lawallach@aol.com or visit www.vebaplan.com.
The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
Over the past decade business owners have been overwhelmed by a plethora of choices designed to reduce the cost of providing employee benefits while increasing their own retirement savings. The solutions ranged from traditional pension and profit sharing plans to more advanced strategies.
Some strategies, such as IRS section 419 and 412(i) plans, used life insurance as vehicles to bring about benefits. Unfortunately, the high life insurance commissions (often 90% of the contribution, or more) fostered an environment that led to aggressive and noncompliant plans.
The result has been thousands of audits and an IRS task force seeking out tax shelter promotion. For unknowing clients, the tax consequences are enormous. For their accountant advisors, the liability may be equally extreme.
Recently, there has been an explosion in the marketing of a financial product called Captive Insurance. These so called “Captives” are typically small insurance companies designed to insure the risks of an individual business under IRS code section 831(b). When properly designed, a business can make tax-deductible premium payments to a related-party insurance company. Depending on circumstances, underwriting profits, if any, can be paid out to the owners as dividends, and profits from liquidation of the company may be taxed as capital gains.
While captives can be a great cost saving tool, they also are expensive to build and manage. Also, captives are allowed to garner tax benefits because they operate as real insurance companies. Advisors and business owners who misuse captives or market them as estate planning tools, asset protection vehicles, tax deferral or other benefits not related to the true business purpose of an insurance company face grave regulatory and tax consequences.
A recent concern is the integration of small captives with life insurance policies. Small captives under section 831(b) have no statutory authority to deduct life premiums. Also, if a small captive uses life insurance as an investment, the cash value of the life policy can be taxable at corporate rates, and then will be taxable again when distributed. The consequence of this double taxation is to devastate the efficacy of the life insurance, and it extends serious liability to any accountant who recommends the plan or even signs the tax return of the business that pays premiums to the captive.
The IRS is aware that several large insurance companies are promoting their life insurance policies as investments with small captives. The outcome looks eerily like that of the 419 and 412(i) plans mentioned above.
Remember, if something looks too good to be true, it usually is. There are safe and conservative ways to use captive insurance structures to lower costs and obtain benefits for businesses. And, some types of captive insurance products do have statutory protection for deducting life insurance premiums (although not 831(b) captives). Learning what works and is safe is the first step an accountant should take in helping his or her clients use these powerful, but highly technical insurance tools.
Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals, is a frequent speaker on retirement plans, abusive tax shelters, financial, international tax, and estate planning. He writes about 412(i), 419, Section79, FBAR, and captive insurance plans. He speaks at more than ten conventions annually, writes for over fifty publications, is quoted regularly in the press and has been featured on television and radio financial talk shows including NBC, National Public Radio’s All Things Considered, and others. Lance has written numerous books including Protecting Clients from Fraud, Incompetence and Scams published by John Wiley and Sons, Bisk Education’s CPA’s Guide to Life Insurance and Federal Estate and Gift Taxation, as well as the AICPA best-selling books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots.
He does expert witness testimony and has never lost a case. Contact him at 516.938.5007, lawallach@aol.com or visit www.vebaplan.com.
The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
Tax Reduction
Every business owner thinks he pays too much in taxes, and in reality, most actually do. These days your accountant has to "play it safe". This is not reducing your tax bill.
Many times a tax preparer's work on a typical return is subject to 'interpretations' of the tax code. New legislation may force preparers who hope to lower a client's tax bill to be less aggressive with respect to these interpretations, or else they may risk substantially increased penalties.
Furthermore, if a tax preparer's client insists on an aggressive deduction, the preparer may include a form explaining the circumstances. This could eliminate the potential preparer penalty, but it is a certain red flag for the IRS.
This should anger taxpayers who feel strongly about particular deductions. What's more, these penalties do not apply to taxpayers preparing their own returns. This could prompt a taxpayer to tell a preparer: "who needs you; I'll do it myself". The remainder of this article explains why your accountant is reluctant to be aggressive anymore, and is less likely to give you the benefit of the doubt on tax deductions.
The new law alters the standard from a "realistic possibility" that a preparer's position will be sustained to a "more likely than not" standard, or more than 50% likelihood.
Instead of paying just $250 if an interpretation is disallowed, the preparer will now be penalized the greater of $1000 or half the income derived by the preparer. Thus, if a preparer charges $500 to do a routine 1040, he or she faces losing the income on two such returns, and if "willful or reckless conduct" is found, the penalty jumps from $1000 to the greater of $5000 or half the income derived by the tax preparer. But if the taxpayer prepares his or her own return, these "crimes" may bring absolutely no penalty.
Another new wrinkle not sitting well with preparers expands these penalties beyond income tax returns to other tax work: estate & gift tax returns, excise tax returns, exempt organization returns, and employment tax returns.
If an accountant allows a taxpayer to deduct what the accountant may think is a listed transaction, the accountant has to file a form with the IRS to alleviate a potential $200,000 penalty to the accountant. This form is likely to get the business owner audited. So what does the business owner do? He can forget about the deduction, prepare his own return, or he can retain an accountant that is not afraid to fight with the IRS. Unfortunately, all of these options are difficult or worse. The tax code is complex and very few accountants understand most of it. And the IRS has recently made the accountant a policeman. Most accountants are honest, knowledgeable and cautious. They try to do what is best for their clients, but the IRS has recently made that almost impossible. Also, every year, the tax laws are changed to one extent or another, and accountants are constantly challenged to remain current, knowledgeable, and proficient.
In light of this, you may want to test your accountant's knowledge. You may want to ask him the following questions:
1) Why haven't I been using a 412(e)(3) plan or a captive insurance company to reduce my taxes and other expenses?
2) Why haven't I been using a VEBA to reduce my health insurance costs?
3) Am I a good candidate for a double K to reduce my taxes and provide security for my retirement?
4) What strategies do you have whereby I can legally deduct the cost of my life insurance?
5) Why haven't you given me a copy of the IRS industry specialization report (which can be obtained free from the IRS) which shows the items that the IRS will be looking at in my industry, both with respect to who will be audited and what will be looked at in an audit, and will provide me with a lot of other useful information?
6) Am I currently using any strategies that the IRS considers abusive?
I would be willing to bet that your accountant has little or no knowledge of the above (6) items.
Lance Wallach is a frequent speaker at national conventions and writes for more than 50 publications. He was the National Society of Accountants Speaker of the Year. Lance welcomes your contact. Email - lawallach@aol.com or call 516-938-5007 for more info.
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.
Many times a tax preparer's work on a typical return is subject to 'interpretations' of the tax code. New legislation may force preparers who hope to lower a client's tax bill to be less aggressive with respect to these interpretations, or else they may risk substantially increased penalties.
Furthermore, if a tax preparer's client insists on an aggressive deduction, the preparer may include a form explaining the circumstances. This could eliminate the potential preparer penalty, but it is a certain red flag for the IRS.
This should anger taxpayers who feel strongly about particular deductions. What's more, these penalties do not apply to taxpayers preparing their own returns. This could prompt a taxpayer to tell a preparer: "who needs you; I'll do it myself". The remainder of this article explains why your accountant is reluctant to be aggressive anymore, and is less likely to give you the benefit of the doubt on tax deductions.
The new law alters the standard from a "realistic possibility" that a preparer's position will be sustained to a "more likely than not" standard, or more than 50% likelihood.
Instead of paying just $250 if an interpretation is disallowed, the preparer will now be penalized the greater of $1000 or half the income derived by the preparer. Thus, if a preparer charges $500 to do a routine 1040, he or she faces losing the income on two such returns, and if "willful or reckless conduct" is found, the penalty jumps from $1000 to the greater of $5000 or half the income derived by the tax preparer. But if the taxpayer prepares his or her own return, these "crimes" may bring absolutely no penalty.
Another new wrinkle not sitting well with preparers expands these penalties beyond income tax returns to other tax work: estate & gift tax returns, excise tax returns, exempt organization returns, and employment tax returns.
If an accountant allows a taxpayer to deduct what the accountant may think is a listed transaction, the accountant has to file a form with the IRS to alleviate a potential $200,000 penalty to the accountant. This form is likely to get the business owner audited. So what does the business owner do? He can forget about the deduction, prepare his own return, or he can retain an accountant that is not afraid to fight with the IRS. Unfortunately, all of these options are difficult or worse. The tax code is complex and very few accountants understand most of it. And the IRS has recently made the accountant a policeman. Most accountants are honest, knowledgeable and cautious. They try to do what is best for their clients, but the IRS has recently made that almost impossible. Also, every year, the tax laws are changed to one extent or another, and accountants are constantly challenged to remain current, knowledgeable, and proficient.
In light of this, you may want to test your accountant's knowledge. You may want to ask him the following questions:
1) Why haven't I been using a 412(e)(3) plan or a captive insurance company to reduce my taxes and other expenses?
2) Why haven't I been using a VEBA to reduce my health insurance costs?
3) Am I a good candidate for a double K to reduce my taxes and provide security for my retirement?
4) What strategies do you have whereby I can legally deduct the cost of my life insurance?
5) Why haven't you given me a copy of the IRS industry specialization report (which can be obtained free from the IRS) which shows the items that the IRS will be looking at in my industry, both with respect to who will be audited and what will be looked at in an audit, and will provide me with a lot of other useful information?
6) Am I currently using any strategies that the IRS considers abusive?
I would be willing to bet that your accountant has little or no knowledge of the above (6) items.
Lance Wallach is a frequent speaker at national conventions and writes for more than 50 publications. He was the National Society of Accountants Speaker of the Year. Lance welcomes your contact. Email - lawallach@aol.com or call 516-938-5007 for more info.
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.
IRS Attacks Benefit Plan
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The IRS has various task forces auditing all section 419, section 412(i), and other plans that tend to be abusive. Most insurance agents sell these plans. The IRS is looking to raise money and is not looking to correct plans or help taxpayers. The IRS calls accountants, attorneys, and insurance agents “material advisors” and also fines them the same amount, again unless the client’s participation in the transaction is reported. An accountant is a material advisor if he signs the return or gives advice and gets paid. More details can be found on www.irs.gov and vebaplan.org.
Bruce Hink, who has given me written permission to use his name and circumstances, is a perfect example of what the IRS is doing to unsuspecting business owners. What follows is a story about how the IRS fines him each year for being in what they called a listed transaction. Listed transactions can be found at www.irs.gov. Also involved are what the IRS calls abusive plans or what it refers to as substantially similar. Substantially similar to is very difficult to understand, but the IRS seems to be saying, “If it looks like some other listed transaction, the fines apply.” Also, I believe that the accountant who signed the tax return and the insurance agent who sold the retirement plan will each be fined as material advisors. We have received many calls for help from accountants, attorneys, business owners, and insurance agents in similar situations. Don’t think this will happen to you? It is happening to a lot of accountants and business owners, because most of theses so-called listed, abusive, or insurance agents are selling substantially similar plans. Recently I came across the case of Hink, a small business owner who is facing thousands in IRS penalties for 2004 and 2005 because of his participation in a section 412(i) plan. (The penalties were assessed under section 6707A.)
In 2002 an insurance agent representing a 100-year-old, well-established insurance company suggested the owner start a pension plan. The owner was given a portfolio of information from the insurance company, which was given to the company’s outside CPA to review and give an opinion on. The CPA gave the plan the green light and the plan was started. Contributions were made in 2003. The plan administrator came out with amendments to the plan, based on new IRS guidelines, in October 2004. The business owner’s insurance agent disappeared in May 2005, before implementing the new guidelines from the administrator with the insurance company. The business owner was left with a refund check from the insurance company, a deduction claim on his 2004 tax return that had not been applied, and no agent.
It took six months of making calls to the insurance company to get a new insurance agent assigned. By then, the IRS had started an examination of the pension plan. Asking advice from the CPA and a local attorney (who had no previous experience in these cases) made matters worse, with a “big name” law firm being recommended and over ,000 in additional legal fees being billed in three months. To make a long story short, the audit stretched on for over 2 ½ years to examine a 2-year-old pension with four participants and the 8,000 in contributions. During the audit, no funds went to the insurance company, which was awaiting formal IRS approval on restructuring the plan as a traditional defined benefit plan, which the administrator had suggested and the IRS had indicated would be acceptable.In March 2008 the business owner received a private e-mail apology from the IRS agent who headed the examination, saying that her hands were tied and that she used to believe she was correcting problems and helping taxpayers and not hurting people.
To this point, I have focused, generally, on the horrors of running afoul of the IRS by participating in a listed transaction, which includes various types of transactions and the various fines that can be imposed on business owners and their advisors who participate in, sell, or advice on these transactions. I happened to use, as an example, someone in a section 412(i) plan, which was deemed to be a listed transaction, pointing out the truly doleful consequences the person has suffered. Others who fall into this trap, even unwittingly, can suffer the same fate.
Now let’s go into more detail about section 412(i) plans. This is important because these defined benefit plans are popular and because few people think of retirement plans as tax shelters or listed transactions. People therefore may get into serious trouble in this area unwittingly, out of ignorance of the law, and, for the same reason, many fail to take necessary and appropriate precautions. The IRS has warned against the section 412(i) defined benefit pension plans, named for the former code section governing them. It warned against trust arrangements it deems abusive, some of which may be regarded as listed transactions. Falling into that category can result in taxpayers having to disclose the participation under pain of penalties. Targets also include some retirement plans.
One reason for the harsh treatment of some 412(i) plans is their discrimination in favor of owners and key, highly compensated employees. Also, the IRS does not consider the promised tax relief proportionate to the economic realities of the transactions. In general, IRS auditors divide audited plan into those they consider noncompliant and other they consider abusive. While the alternatives available to the sponsor of noncompliant plan are problematic, it is frequently an option to keep the plan alive in some form while simultaneously hoping to minimize the financial fallout from penalties.
The sponsor of an abusive plan can expect to be treated more harshly than participants. Although in some situation something can be salvaged, the possibility is definitely on the table of having to treat the plan as if it never existed, which of course triggers the full extent of back taxes, penalties, and interest on all contributions that were made – not to mention leaving behind no retirement plan whatsoever. Another plan the IRS is auditing is the section 419 plan. A few listed transactions concern relatively common employee benefit plans the IRS has deemed tax avoidance schemes or otherwise abusive. Perhaps some of the most likely to crop up, especially in small-business returns, are the arrangements purporting to allow the deductibility of premiums paid for life insurance under a welfare benefit plan or section 419 plan. These plans have been sold by most insurance agents and insurance companies.
Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals, is a frequent speaker on retirement plans, abusive tax shelters, financial, international tax, and estate planning. He writes about 412(i), 419, Section79, FBAR, and captive insurance plans. He speaks at more than ten conventions annually, writes for over fifty publications, is quoted regularly in the press and has been featured on television and radio financial talk shows including NBC, National 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 the AICPA best-selling books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots.
He does expert witness testimony and has never lost a case. Contact him at 516.938.5007, wallachinc@gmail.com or visit www.taxadvisorexperts.com
The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
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The IRS has various task forces auditing all section 419, section 412(i), and other plans that tend to be abusive. Most insurance agents sell these plans. The IRS is looking to raise money and is not looking to correct plans or help taxpayers. The IRS calls accountants, attorneys, and insurance agents “material advisors” and also fines them the same amount, again unless the client’s participation in the transaction is reported. An accountant is a material advisor if he signs the return or gives advice and gets paid. More details can be found on www.irs.gov and vebaplan.org.
Bruce Hink, who has given me written permission to use his name and circumstances, is a perfect example of what the IRS is doing to unsuspecting business owners. What follows is a story about how the IRS fines him each year for being in what they called a listed transaction. Listed transactions can be found at www.irs.gov. Also involved are what the IRS calls abusive plans or what it refers to as substantially similar. Substantially similar to is very difficult to understand, but the IRS seems to be saying, “If it looks like some other listed transaction, the fines apply.” Also, I believe that the accountant who signed the tax return and the insurance agent who sold the retirement plan will each be fined as material advisors. We have received many calls for help from accountants, attorneys, business owners, and insurance agents in similar situations. Don’t think this will happen to you? It is happening to a lot of accountants and business owners, because most of theses so-called listed, abusive, or insurance agents are selling substantially similar plans. Recently I came across the case of Hink, a small business owner who is facing thousands in IRS penalties for 2004 and 2005 because of his participation in a section 412(i) plan. (The penalties were assessed under section 6707A.)
In 2002 an insurance agent representing a 100-year-old, well-established insurance company suggested the owner start a pension plan. The owner was given a portfolio of information from the insurance company, which was given to the company’s outside CPA to review and give an opinion on. The CPA gave the plan the green light and the plan was started. Contributions were made in 2003. The plan administrator came out with amendments to the plan, based on new IRS guidelines, in October 2004. The business owner’s insurance agent disappeared in May 2005, before implementing the new guidelines from the administrator with the insurance company. The business owner was left with a refund check from the insurance company, a deduction claim on his 2004 tax return that had not been applied, and no agent.
It took six months of making calls to the insurance company to get a new insurance agent assigned. By then, the IRS had started an examination of the pension plan. Asking advice from the CPA and a local attorney (who had no previous experience in these cases) made matters worse, with a “big name” law firm being recommended and over ,000 in additional legal fees being billed in three months. To make a long story short, the audit stretched on for over 2 ½ years to examine a 2-year-old pension with four participants and the 8,000 in contributions. During the audit, no funds went to the insurance company, which was awaiting formal IRS approval on restructuring the plan as a traditional defined benefit plan, which the administrator had suggested and the IRS had indicated would be acceptable.In March 2008 the business owner received a private e-mail apology from the IRS agent who headed the examination, saying that her hands were tied and that she used to believe she was correcting problems and helping taxpayers and not hurting people.
Could you or one of your clients be next?
To this point, I have focused, generally, on the horrors of running afoul of the IRS by participating in a listed transaction, which includes various types of transactions and the various fines that can be imposed on business owners and their advisors who participate in, sell, or advice on these transactions. I happened to use, as an example, someone in a section 412(i) plan, which was deemed to be a listed transaction, pointing out the truly doleful consequences the person has suffered. Others who fall into this trap, even unwittingly, can suffer the same fate.
Now let’s go into more detail about section 412(i) plans. This is important because these defined benefit plans are popular and because few people think of retirement plans as tax shelters or listed transactions. People therefore may get into serious trouble in this area unwittingly, out of ignorance of the law, and, for the same reason, many fail to take necessary and appropriate precautions. The IRS has warned against the section 412(i) defined benefit pension plans, named for the former code section governing them. It warned against trust arrangements it deems abusive, some of which may be regarded as listed transactions. Falling into that category can result in taxpayers having to disclose the participation under pain of penalties. Targets also include some retirement plans.
One reason for the harsh treatment of some 412(i) plans is their discrimination in favor of owners and key, highly compensated employees. Also, the IRS does not consider the promised tax relief proportionate to the economic realities of the transactions. In general, IRS auditors divide audited plan into those they consider noncompliant and other they consider abusive. While the alternatives available to the sponsor of noncompliant plan are problematic, it is frequently an option to keep the plan alive in some form while simultaneously hoping to minimize the financial fallout from penalties.
The sponsor of an abusive plan can expect to be treated more harshly than participants. Although in some situation something can be salvaged, the possibility is definitely on the table of having to treat the plan as if it never existed, which of course triggers the full extent of back taxes, penalties, and interest on all contributions that were made – not to mention leaving behind no retirement plan whatsoever. Another plan the IRS is auditing is the section 419 plan. A few listed transactions concern relatively common employee benefit plans the IRS has deemed tax avoidance schemes or otherwise abusive. Perhaps some of the most likely to crop up, especially in small-business returns, are the arrangements purporting to allow the deductibility of premiums paid for life insurance under a welfare benefit plan or section 419 plan. These plans have been sold by most insurance agents and insurance companies.
Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals, is a frequent speaker on retirement plans, abusive tax shelters, financial, international tax, and estate planning. He writes about 412(i), 419, Section79, FBAR, and captive insurance plans. He speaks at more than ten conventions annually, writes for over fifty publications, is quoted regularly in the press and has been featured on television and radio financial talk shows including NBC, National 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 the AICPA best-selling books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots.
He does expert witness testimony and has never lost a case. Contact him at 516.938.5007, wallachinc@gmail.com or visit www.taxadvisorexperts.com
The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
Something Like this Can Happen to You
Several years ago at the advice of an accountant or investment advisor a client adopts a defined benefit plan for her business. She did so because she had been advised that under this type of plan she could contribute tax deductible contributions far greater than the limits permitted under a defined contribution plan. Each year she funds the maximum that the IRS permitted based on a report from her actuary. The plan investment returns have been very good.
She is now ready to sell her business or retire and informs her advisors that she wants to close out the plan and transfer the money over into her Individual Retirement Account. The advisors come back with the following news. The plan is overfunded and some of the funds cannot be rolled over to an IRA. Those funds that are ineligible for a rollover must return to the company as taxable income and the IRS will in addition, levy a non-tax deductible penalty of at least 20%.
What happened?
She has done nothing along the way that the IRS could challenge. What happened was a combination of several things.
What happened?
She has done nothing along the way that the IRS could challenge. What happened was a combination of several things.
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