Abusive Plans: Welfare Benefit Plans

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Captive insurance and abusive tax shelter, 419 plans

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.

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Lance Wallach CHFC : Lance Wallach Lawline

Abusive Insurance Plans Get Red Flag

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.

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.

Welfare Benefit Plan

Big Problems For Co's With 419 Welfare Benefit Plans Funded By Life Insurance

Reportable Transactions .com: 419 Plan, 412i Plan

Reportable Transactions .com: 419 Plan, 412i Plan, Welfare benefit plan assistan...: 419 Plan, 412i Plan, Welfare benefit plan assistance, audits & Abusive tax shelters

Abusive Insurance, Welfare Benefit, and Retirement Plans

Published in Tax Practice: Tax Notes

March 2, 2009

By Lance Wallach

The IRS has various task forces auditing all section 419, section 412(i), and other plans that tend to be abusive. These plans are sold by most insurance agents. The IRS is looking to raise money and is not looking to correct plans or help taxpayers. The fines for being in a listed, abusive, or similar transaction are up to $200,000 per year (section 6707A), unless you report on yourself. 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 http://www.irs.gov and http://www.vebaplan.com.

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 $200,000 a year for being in what they called a listed transaction. Listed transactions can be found at http://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 $200,000 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 substantially similar plans are being sold by insurance agents.

Recently I came across the case of Hink, a small business owner who is facing $400,000 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 $30,000 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 $178,000 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. The $90,000 in 2005 contributions was put into the company’s retirement bank account along with the 2004 contributions.

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.

The IRS denied any appeal and ruled in October 2008 the $400,000 penalty would stand. The IRS fine for being in a listed, abusive, or similar transaction is $200,000 per year for corporations or $100,000 per year for unincorporated entities. The material advisor fine is $200,000 if you are incorporated or $100,000 if you are not.

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, potentially reaching $100,000 for individuals and $200,000 for other taxpayers. Targets also include some retirement plans.

One reason for the harsh treatment of 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.

Some of theses abusive employee benefit plans are represented as satisfying section 419, which sets limits on purposed and balances of “qualified asset accounts” for the benefits, although the plans purport to offer the deductibility of contributions without any corresponding income. Others attempt to take advantage of the exceptions to qualified asset account limits, such as sham union plans that try to exploit the exception for the separate welfare benefit funds under collective bargaining agreements provided by section 419A(f)(5). Others try to take advantage of exceptions for plans serving 10 or more employers, once popular under section 419A(f)(6). More recently, one may encounter plans relying on section 419(e) and, perhaps, defines benefit sections 412(i) pension plans.

Sections 419 and 419A were added to the code by the Deficit Reduction Act of 1984 in an attempt to end employers’ acceleration of deductions for plan contributions. But it wasn’t long before plan promoters found an end run around the new code sections. An industry developed in what came to be known as 10-or-more-employer plans.

The IRS steadily added these abusive plans to its designations of listed transactions. With Revenue Ruling 90-105, it warned against deducting some plan contributions attributable to compensation earned by plan participants after the end of the tax year. Purported exceptions to limits of sections 419 and 419A claimed by 10-or-more-employer benefit funds were likewise prescribed in Notice 95-24 (Doc 95-5046, 95 TNT 98-11). Both positions were designated as listed transactions in 2000.

At that point, where did all those promoters go? Evidence indicates many are now promoting plans purporting to comply with section 419(e). They are calling a life insurance plan a welfare benefit plan (or fund), somewhat as they once did, and promoting the plan as a vehicle to obtain large tax deductions. The only substantial difference is that theses are now single-employer plans. And again, the IRS has tried to rein them in, reminding taxpayers that listed transactions include those substantially similar to any that are specifically described and so designated.

On October 17, 2007, the IRS issues Notices 2007-83 (Doc 2007-23225, 2007 TNT 202-6) and 2007-84 (Doc 2007-23220, 2007 TNT 202-5). In the former, the IRS identified some trust arrangements involving cash value life insurance policies, and substantially similar arrangements, as listed transactions. The latter similarly warned against some postretirement medical and life insurance benefit arrangements, saying they might be subject to “alternative tax treatment.” The IRS at the same time issued related Rev. Rul. 2007-65 (Doc 2007-23226, 2007 TNT 202-7) to address situations in which an arrangement is considered a welfare benefit fund but the employer’s deduction for its contributions to the fund id denied in whole or in part for premiums paid by the trust on cash value life insurance policies. It states that a welfare benefit fund’s qualified direct cost under section 419 does not include premium amounts paid by the fund for cash value life insurance policies if the fund is directly or indirectly a beneficiary under the policy, as determined under sections264(a).

Notice 2007-83 targets promoted arrangements under which the fund trustee purchases cash value insurance policies on the lives of a business’s employee/owners, and sometimes key employees, while purchasing term insurance policies on the lives of other employees covered under the plan.

These plans anticipate being terminated and anticipate that the cash value policies will be distributed to the owners or key employees, with little distributed to other employees. The promoters claim that the insurance premiums are currently deductible by the business and that the distributed insurance policies are virtually tax free to the owners. The ruling makes it clear that, going forward, a business under most circumstances cannot deduct the cost of premiums paid through a welfare benefit plan for cash value life insurance on the lives of its employees.

Should a client approach you with one of these plans, be especially cautious, for both of you. Advise your client to check out the promoter very carefully. Make it clear that the government has the names of all former section 419A(f)(6) promoters and, therefore, will be scrutinizing the promoter carefully if the promoter was once active in that area, as many current section 419(e) (welfare benefit fund or plan) promoters were. This makes an audit of your client more likely and far riskier.

It is worth noting that listed transactions are subject to a regulatory scheme applicable only to them, entirely separate from Circular 230 requirements, regulations, and sanctions. Participation in such a transaction must be disclosed on a tax return, and the penalties for failure to disclose are severe – up to $100,000 for individuals and $200,000 for corporations. The penalties apply to both taxpayers and practitioners. And the problem with disclosure, of course, is that it is apt to trigger an audit, in which case even if the listed transaction was to pass muster, something else may not.
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.

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.

Abusive Welfare Benefit and Retirement Plans Can Lead to Severe Penalties for Accountants

By Lance Wallach

Accountants who are unaware of recent developments are likely to encounter a nightmarish

scenario that may play out something like this: you sign a client’s tax return that claims a tax

deduction for participation in a “welfare benefit plan”. A few years pass, and nothing happens.

Then, on audit, the deductions are disallowed and your client is hit with back taxes, penalties, and

interest. He discovers that he may be looking at a large penalty for not disclosing his participation

in the plan to the IRS.

Naturally, at this point, your client wants out of the plan. But he discovers that he cannot get the

money that he has contributed out of the plan. He finds that the money is being used by the plan

sponsor to fight the IRS; his money is being used to defend a plan that he no longer wants to be

in. This is claimed to be legal. Or he may even find that the money is simply gone, that it has

been stolen or otherwise misappropriated.

And now you find that you are a “material advisor” with respect to your client’s participation in

the plan. Like your client, you were supposed to disclose your role here; in your case, as a

“material advisor”. You also may be looking at a large penalty for failing to disclose.

If you think this could never happen to you, think again.

Welfare benefit plans are a creation of and are sanctioned by Section 419 of the Internal Revenue

Code. There are single employer plans and multiple employer plans; the latter rely mostly on IRC

Section 419A (f) (6) (in the most common cases where there are ten or more employers as part

of the same plan). The 419A(f)(6) plans are, and perhaps always were, generally regarded as

abusive, and were substantially curtailed in recent years by harsh IRS regulation. Amazingly,

however, they refuse to totally die, and are still being marketed. These plans are called listed

transactions (more on that later).

While the principle purpose of this article is to discuss the current state of the welfare benefit

plan, and everything outside of this paragraph will do just that, it is perhaps worth noting that

welfare benefit plans are not the only subject of current IRS scrutiny and/or regulation. The

Section 412(i) defined benefit plan, for example, is such a target that a task force has been

formed internally solely to audit 412(i) plans. Many of them are being deemed listed transactions,

many of the plans are being involuntarily terminated, and back taxes, penalties, and interest are

being assessed. Not surprisingly, all of this has resulted in considerable litigation.

Single employer welfare benefit plans are now more popular than multiple employer plans. All

welfare benefit plans tend to share certain characteristics, however. They tend to be marketed

most frequently by insurance agents and financial planners, and sometimes by accountants and

attorneys. Prospects tend to be professionals and profitable small businesses. The most attractive

selling point is the ability to claim large tax deductions and remove money tax free. Life insurance

tends to be the funding vehicle. Often cheap term insurance is purchased for rank and file

workers and some form of permanent coverage (universal life, variable life, etc., for the owners

and key employees. But many times workers are completely left out of the plan. For businesses

looking to do as little as possible for workers, a selling point is that the great majority of benefits,

in most cases, eventually go to the owners. This type of discrimination was recently addressed

by IRS Notice 2007-84, which disallowed tax deductions and penalties with respect to welfare

benefit plans that discriminate. If done correctly, the plans can accomplish things like facilitating

estate planning, business succession, and asset protection. But the promised tax deduction is

usually the sizzle that sells the steak.

In October of 2007, welfare benefit plans were affected by IRS rulings. The two most important

developments were Revenue Ruling 2007-65, which declared, in essence, that premiums paid

inside of a welfare benefit plan for cash value life insurance were not tax deductible, and Notice

2007-83, which identified the trust within welfare benefit plans involving cash value life insurance

policies, AND substantially similar arrangements, as listed transactions. In other words, in

essence, not only are premiums paid for cash value life insurance policies in welfare benefit plans

not tax deductible, but, and far more importantly, the plans themselves are now listed

transactions. This, in turn, means that most welfare benefit plans are now listed transactions,

because most feature cash value life insurance. This designation creates disclosure obligations

with absurdly harsh penalties both for failure to disclose or incorrectly or incompletely disclosing,

as we shall soon see.

A listed transaction, basically, is any transaction identified as such by specific IRS guidance OR

any transaction substantially similar to the specifically identified transaction. Participants in listed

transaction must file Form 8886 with both the Service and the Office of Tax Shelter Analysis.

Failure to timely and completely file leads to penalties of $100,000 for individuals and $200,000

for corporate taxpayers.

The practitioner has filing requirements, also, which can lead to equally severe penalties, if the

practitioner qualifies as a “material advisor” with respect to one of these transactions. What is a

material advisor? Basically, someone who gives advice, sells, or otherwise plays a significant part

in the promotion, sale, or paperwork with respect to a taxpayer’s participation in a listed

transaction. Put simply, from an accountant’s standpoint, you must give advice, the client must

do it, and you must satisfy a certain income threshold with respect to the transaction, usually

$10,000. The accountant who signs a return taking a tax deduction with respect to the

transaction is surely a material advisor, if the income threshold is met.

A problem is that many accountants are not even aware of these plans. Often it is discovered

when preparing the client’s tax return, at which point the client expects you to allow the

deduction and sign the return, since the client was sold a tax deduction. Or worse yet, the

deduction may already have been disallowed on audit. The point is that, far too frequently, the

practitioner does not even discover a client’s involvement in a listed transaction until too much

damage has already been done. This is often the case if the contribution has already been made,

as it usually has, and irretrievably so if the deductions have already been disallowed on audit. And

added to all of this is the distaste that most professionals must have for all of these policing types

of duties, to say nothing of the difficulties that are created with clients and, probably, the loss of

some clients.

The material advisor must file Form 8918 describing her exact role in the client’s participation in

the transaction. Failure to file can lead to penalties imposed on the advisor that are as severe as

those imposed on taxpayers ($100,000 for individuals and $200,000 for corporations) who fail to

file Form 8886. The accountant may escape material advisor status by not meeting the $10,000

income threshold. A problem, however, is the accountant who is paid $10,000 in the aggregate

by the client, but not that much specifically with respect to the listed transaction. Does such a

person satisfy the income threshold? The author and his associates have discussed this point,

among others, directly with IRS personnel who actually wrote published guidance in this area.

The best we have been able to get is a declaration that any test that would be applied to the

determination of any of these issues would have to consider all surrounding facts and

circumstances. This would be unlikely to yield any general rules, for each situation has its own

facts and circumstances.

Another section that the practitioner, or at least the prudent one, should be aware of, largely apart

from what has been discussed so far in this article, is Section 6701, entitled “penalties for aiding

and abetting understatement of tax liability.” This penalty is imposed upon those who assist in,

procure, or advise while knowing or having reason to believe that the subject matter will be used

in connection with any material matter arising under the tax laws and who know that the use

thereof would result in the understatement of another person’s tax liability. The penalty may be

applied separately to each occurrence, and it is $1,000 if an individual is the taxpayer and $10,000

for a corporate taxpayer.

Three (3) definitions are now in order, which will hopefully help to clarify any confusion that

may exist in the reader’s mind. A “material advisor” is any person who provides any material aid,

assistance, or advice with respect to organizing, managing, promoting, selling, implementing,

insuring, or carrying out any reportable transaction, and who directly or indirectly derives gross

income in excess of a certain threshold amount. More on threshold soon, but the most common

one is $10,000 for listed transactions. A “reportable transaction”, basically, is any transaction

which has been deemed to have a potential for tax avoidance or evasion. That is pretty broad, and

the reader should consult the regulations under section 6011 for more on this. Finally, a “listed

transaction” is a reportable transaction which is identical or substantially similar to a transaction

specifically identified as a tax avoidance transaction.

As for threshold amounts, in the case of reportable transactions, it is $50,000, if substantially all

tax benefits are provided to natural persons, and $250,000 in other cases. Natural person is

construed most broadly, generally ignoring trusts, corporations, and other such entities. For listed

transactions, the numbers are $10,000 (previously discussed) and $25,000.

Lance Wallach speaks and writes about benefit plans, and has authored numerous books for the

AICPA, Bisk Total tape, and others. He can be reached at (516) 938-5007 or

wallachinc@gmail.com. For more articles on this or other subjects, feel free to visit his website

at www.taxlibrary.us.

The information contained in this article is not intended as legal, accounting, financial or any

other type of advice for any specific individual or entity. You should seek such advice from an

appropriate professional.

Lance Wallach on 419, 412i, and more

Testimonials

Great to speak with you and attached are some articles on 419, 412i section 79 etc.
From: Amanda.Andrews To: LanWalla@aol.com
Mr. Wallach,
Thank you for providing me with this information. I will review it next week and, I’m sure, be in touch. I very much appreciate your help.
Amanda J. Andrews
Associate Counsel, Legal Division
Arkansas Insurance Department

Happy New Year Mr. Wallach and thanks for
the article
Ronald R. Itzkowitz
National EP Customer Partnership Analyst
Internal Revenue Service - Employee Plans

"Mr. Wallach, thanks so much for taking the time to talk to me today about VEBAs. Any information you can
send me would be helpful. Hopefully, we can work together in the future as interest in VEBAs increase."
Corman G. Franklin Office of the Assistant Secretary for Policy U.S. Department of Labor