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Showing posts with label abusive tax shelters. Show all posts
Showing posts with label abusive tax shelters. Show all posts
Retirement Plan & 419 Welfare Benefit Plan Abusive Tax-Shelter Litigation
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D. 412(i) Retirement Plan & 419 Welfare Benefit Plan Abusive Tax-Shelter Litigation
There has been much litigation arising out of insureds‘ and their employers‘ participation in defined benefit pension plans intended to meet the requirements of former Section 412(i) of the Internal Revenue Code (the ―Code‖) and welfare benefit plans intended to meet the requirements of Section 419A(f)(6) of the Code (for multiple employer plans) and Section 419(e) of the Code (for single employer plans). In many cases, life insurance policies were the funding vehicle, in whole or in part, for the 412(i) and 419 plans. From approximately 2002-2007, the IRS issued guidance regarding issues related to 412(i) and 419 plans and, since then, the IRS has focused increased scrutiny on the plans, concluding in many cases that the plans did not comply with the relevant Code sections, disallowing deductions taken by the employers and levying harsh penalties. As a result, insureds and their employers have filed lawsuits under various theories against the plan designers and the insurance companies claiming that they were misled regarding the tax benefits of the plans and the compliance of the plans with the Code.
1. Omni Home Fin., Inc. v. Hartford Life & Annuity Ins. Co., 2008 U.S. Dist. LEXIS 35259, 2008 WL 1925248, *5 (S.D. Cal. Apr. 29, 2008) (“Omni I”); Omni Home Fin., Inc. v. Hartford Life & Annuity Ins. Co., 2008 U.S. Dist. LEXIS 85581, 2008 WL 4616796, **3-4 (S.D. Cal. Aug. 1, 2008)(“Omni II”)
In many of the documents used to construct the 412 or 419 plans, the participant agrees that he is not relying on the insurance company‘s representations regarding the validity of the plan or its tax benefits, and the participant represents that he is relying on his own independent tax advisor in deciding to participate in the plan. For instance, in Omni I, the Southern District of California held that a disclosure statement provided to the Plaintiffs precluded claims for fraud and negligent misrepresentation because the plaintiffs could not establish reasonable reliance as a matter of law. Contrary to the language agreed upon in the disclaimer provision, the plaintiffs alleged that Hartford, among others, misrepresented to them the tax consequences of their contributions to a 412(i) plan. After an IRS audit found that the plaintiffs‘ plans did not comply with several requirements for the qualified plans, the plaintiffs filed suit. Despite the fact that the plaintiffs claimed that they did not read the disclaimers they signed, the Omni court held that the receipt of the disclosure statements by plaintiffs precluded a finding of reasonable reliance, and granted summary judgment in favor of Hartford on the plaintiffs‘ claims.
In Omni II, the plaintiffs‘ motion for reconsideration was denied as the court noted that ―the material disclosures were in short documents easily intelligible to plaintiffs, who were reasonably sophisticated businesspeople‖ and furthermore, that such contracts did not violate public policy, nor were they contracts of adhesion as ―it is objectively unreasonable for a sophisticated contracting party to fail to read short, readily comprehensible documents he or she signs.‖ However, the court in Berry v. Indianapolis Life Insurance Co. (discussed in Section II.D.3., supra) denied the insurers motions for summary judgment based on disclosures similar to the disclosures at issue in Omni I and Omni II. Most notably, the court denied summary judgment for the plaintiffs whose claims were governed by Texas law and Wisconsin law. Thus,
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the success of the ―disclaimer of reliance‖ argument may differ may from court to court and will depend on which state‘s law applies.
2. Berry v. Indianapolis Life Ins. Co., 600 F.Supp. 2d 805 (N.D. Tex. 2009)(“Berry I”); Berry v. Indianapolis Life Ins. Co., 638 F.Supp. 2d 732 (N.D. Tex. 2009)(“Berry II”); Berry v. Indianapolis Life Ins. Co., 2010 WL 3422873 (N.D. Tex. Aug. 26, 2010)(“Berry III”)
In this class action lawsuit, the plaintiffs, a nation-wide class consisting of doctors, dentists, and construction company owners, and the companies they operate, filed suit, alleging that the defendants sold life insurance policies to fund defined benefit plans in compliance with section 412(i) of the Internal Revenue Code, but were later deemed abusive tax-shelters by the IRS. Plaintiffs allege that four insurance companies (Indianapolis Life, Hartford, American General, and Pacific Life) knew or should have known that the plans would be scrutinized and found to be illegal by the IRS. Plaintiffs also allege that many of the defendants, including the four insurance companies, conspired to market these plans and made fraudulent or negligent misrepresentations about the tax benefits of these plans without disclosing any risk that the IRS would find the plans to be illegal. Ultimately, many of these claims were dismissed for failure to state a claim for relief. Because the alleged misrepresentations were made prior to the IRS pronouncements calling into question the tax benefits of various plans, they were either not false when made or predictions and opinion that are not actionable.
In Berry I, the court dismissed plaintiffs‘ fraud theory holding that there was no apparent reason why the alleged misrepresentations were false when they were made in 2001 and 2002. The rational behind the court‘s ruling was that the IRS had not made any definitive statement about the legality of the 412(i) plan at the time the plaintiffs enrolled in the plan and purchased life insurance policies to fund the plan. The court noted that the plaintiffs could not use the rulings and rulemakings by the IRS in 2004 and 2005 ―to retroactively demonstrate that representations made by [the insurer‘s] alleged agents in 2001-02 were false when made.‖ Moreover, the court held that, as a matter of law, representations regarding the validity and likely tax treatment of the plaintiffs‘ 412(i) plans were ―forward looking‖ statements or ―opinions‖ as to how the IRS would treat 412(i) plans after plaintiffs funded them with insurance policies. The court found that it was ―inherently unreasonable for any person to rely on a prediction of future IRS enactment, enforcement, or non-enforcement of the law by someone unaffiliated with the federal government.‖ The court concluded that, ―[a]s a matter of law, any representation or prediction by any alleged [insurance company] agent as to how the IRS would treat the 412(i) plans, and the funding thereof, in the future is either an unactionable opinion or was unjustifiably relied upon.‖
Subsequently, the Northern District of Texas allowed the plaintiffs an opportunity to re-plead, and it then reaffirmed its prior ruling and dismissed the Berry plaintiffs‘ fraud-based claims with prejudice. The claims against the other insurance company defendants in Berry have been dismissed for the same reasons but the court has not yet decided whether the plaintiffs will be allowed to re-plead. As of November 2010, the third amended complaint was filed, to which Pacific Life filed a reply. Hartford and Pacific Life filed responses to the synopsis of the third amended complaint.
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3. Zarrella v. Pacific Life Insurance Company, No. 10-60754-CIV, 755 F.Supp.2d 1231 (S.D. Fla. 2011)
In March of 2003, Plaintiffs purchased nine individual policies from Pacific Life for use in Zarrella Construction‘s 412(i) plan. It was not until February of 2004 when the IRS issued a declaration, naming such policies as abusive tax-shelters. Plaintiffs contend that Pacific Life ―marketed and expressly touted the Policies by highlighting these ‗special‘ benefits and/or incentives that – they knew or should have known – violated the IRS Code and presented substantial tax risks to Plaintiffs.‖ On May 10, 2010, Plaintiffs brought a class action against Pacific Life. Following Pacific Life‘s first motion to dismiss being partially granted, Plaintiffs filed their Amended Class Action Complaint in December of 2010. The Plaintiffs asserted the following claims: breach of contract, equitable fraud, negligence, and a violation of California Business and Professions Code § 17200, et seq. Plaintiff‘s alleged that there was a breach of contract ―because the Policies when used to fund 412(i), did not and could not satisfy the requirements of Section 412(i). The court countered by explaining that ―in the written contract, Pacific Life specifically did not guarantee any future tax or legal consequences.‖ Additionally, the court noted that Plaintiff‘s negligence claim failed because they failed to allege the existence of a legal duty.‖
Similarly, the court dismissed the class action fraud allegations against Pacific Life because the plaintiffs failed to explain why the defendants‘ alleged statements were false when made in 2003. The court also noted that fraud must be based on material facts, not a promise or prediction of future events and that the insurance company‘s alleged representations were just ―statements of opinion regarding future events.‖ Thus, once again, Pacific Life‘s 12(b)(6) motion was granted and the amended complaint was dismissed without prejudice on all counts. Accordingly, a second amended complaint was filed by Plaintiff‘s on April 12, 2011. The court has set the trial date for October 24, 2011 and the parties‘ response and reply to Pacific Life‘s motion to dismiss the second amended complaint are before the court.
4. Chau v. Aviva Life and Annuity, No. 3:09-cv-2305-B, 2011 WL 1990446 (N.D. Tex. May 20, 2011)
Doctors and dentists alleged that Indianapolis Life Insurance Company advertised, marketed, and consummated fraudulent business transactions, resulting in damages. Plaintiffs originally filed their complaint in April of 2009 in Washington state court and after Aviva removed the case to federal district court, the MDL Panel ordered the case transferred to the Northern District of Texas. Prior to the case being transferred, Plaintiffs filed their second amended complaint and subsequently, Aviva filed its motion to dismiss Plaintiff‘s second amended complaint on February 5, 2010. Plaintiffs allege that the insurer knew that the IRS had looked askance at the legality of similar tax-shelter arrangements (welfare benefit trusts) and indicated that these arrangements may be deemed abusive tax shelters, yet continued to market its § 419 Plan as a tax-avoidance plan.
Plaintiffs‘ motion for a suggestion of remand to the Judicial Panel of Multidistrict Litigation was filed on March 3, 2011 and was subsequently denied by the district court.
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However, the court noted that plaintiffs may motion again, should there be further developments in the case. Aviva‘s motion to dismiss the second amended complaint was granted in part and denied in part on May 20, 2011. In its motion, Aviva claimed that Plaintiffs‘ common law fraud/negligent misrepresentation claim did not meet the heightened pleading requirements of Rule 9(b), in addition to failing to state a claim, and the court agreed. However, on the breach of contract claim, the court found that under the applicable law governing the contract, plaintiff‘s claim was not due to be dismissed. The court elaborated on its reasoning, noting that allegations concerning oral representations made about the policies, specifically, their ability to obtain substantial tax savings with the 419 Plan. Plaintiffs asserted in their second amended complaint that those representations were false and resulted in ―substantial tax penalties and interest‖ due to an IRS audit. Thus, the court found that such allegations, accepted as true, state a claim for a breach of contract under Washington state law.
D. 412(i) Retirement Plan & 419 Welfare Benefit Plan Abusive Tax-Shelter Litigation
There has been much litigation arising out of insureds‘ and their employers‘ participation in defined benefit pension plans intended to meet the requirements of former Section 412(i) of the Internal Revenue Code (the ―Code‖) and welfare benefit plans intended to meet the requirements of Section 419A(f)(6) of the Code (for multiple employer plans) and Section 419(e) of the Code (for single employer plans). In many cases, life insurance policies were the funding vehicle, in whole or in part, for the 412(i) and 419 plans. From approximately 2002-2007, the IRS issued guidance regarding issues related to 412(i) and 419 plans and, since then, the IRS has focused increased scrutiny on the plans, concluding in many cases that the plans did not comply with the relevant Code sections, disallowing deductions taken by the employers and levying harsh penalties. As a result, insureds and their employers have filed lawsuits under various theories against the plan designers and the insurance companies claiming that they were misled regarding the tax benefits of the plans and the compliance of the plans with the Code.
1. Omni Home Fin., Inc. v. Hartford Life & Annuity Ins. Co., 2008 U.S. Dist. LEXIS 35259, 2008 WL 1925248, *5 (S.D. Cal. Apr. 29, 2008) (“Omni I”); Omni Home Fin., Inc. v. Hartford Life & Annuity Ins. Co., 2008 U.S. Dist. LEXIS 85581, 2008 WL 4616796, **3-4 (S.D. Cal. Aug. 1, 2008)(“Omni II”)
In many of the documents used to construct the 412 or 419 plans, the participant agrees that he is not relying on the insurance company‘s representations regarding the validity of the plan or its tax benefits, and the participant represents that he is relying on his own independent tax advisor in deciding to participate in the plan. For instance, in Omni I, the Southern District of California held that a disclosure statement provided to the Plaintiffs precluded claims for fraud and negligent misrepresentation because the plaintiffs could not establish reasonable reliance as a matter of law. Contrary to the language agreed upon in the disclaimer provision, the plaintiffs alleged that Hartford, among others, misrepresented to them the tax consequences of their contributions to a 412(i) plan. After an IRS audit found that the plaintiffs‘ plans did not comply with several requirements for the qualified plans, the plaintiffs filed suit. Despite the fact that the plaintiffs claimed that they did not read the disclaimers they signed, the Omni court held that the receipt of the disclosure statements by plaintiffs precluded a finding of reasonable reliance, and granted summary judgment in favor of Hartford on the plaintiffs‘ claims.
In Omni II, the plaintiffs‘ motion for reconsideration was denied as the court noted that ―the material disclosures were in short documents easily intelligible to plaintiffs, who were reasonably sophisticated businesspeople‖ and furthermore, that such contracts did not violate public policy, nor were they contracts of adhesion as ―it is objectively unreasonable for a sophisticated contracting party to fail to read short, readily comprehensible documents he or she signs.‖ However, the court in Berry v. Indianapolis Life Insurance Co. (discussed in Section II.D.3., supra) denied the insurers motions for summary judgment based on disclosures similar to the disclosures at issue in Omni I and Omni II. Most notably, the court denied summary judgment for the plaintiffs whose claims were governed by Texas law and Wisconsin law. Thus,
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the success of the ―disclaimer of reliance‖ argument may differ may from court to court and will depend on which state‘s law applies.
2. Berry v. Indianapolis Life Ins. Co., 600 F.Supp. 2d 805 (N.D. Tex. 2009)(“Berry I”); Berry v. Indianapolis Life Ins. Co., 638 F.Supp. 2d 732 (N.D. Tex. 2009)(“Berry II”); Berry v. Indianapolis Life Ins. Co., 2010 WL 3422873 (N.D. Tex. Aug. 26, 2010)(“Berry III”)
In this class action lawsuit, the plaintiffs, a nation-wide class consisting of doctors, dentists, and construction company owners, and the companies they operate, filed suit, alleging that the defendants sold life insurance policies to fund defined benefit plans in compliance with section 412(i) of the Internal Revenue Code, but were later deemed abusive tax-shelters by the IRS. Plaintiffs allege that four insurance companies (Indianapolis Life, Hartford, American General, and Pacific Life) knew or should have known that the plans would be scrutinized and found to be illegal by the IRS. Plaintiffs also allege that many of the defendants, including the four insurance companies, conspired to market these plans and made fraudulent or negligent misrepresentations about the tax benefits of these plans without disclosing any risk that the IRS would find the plans to be illegal. Ultimately, many of these claims were dismissed for failure to state a claim for relief. Because the alleged misrepresentations were made prior to the IRS pronouncements calling into question the tax benefits of various plans, they were either not false when made or predictions and opinion that are not actionable.
In Berry I, the court dismissed plaintiffs‘ fraud theory holding that there was no apparent reason why the alleged misrepresentations were false when they were made in 2001 and 2002. The rational behind the court‘s ruling was that the IRS had not made any definitive statement about the legality of the 412(i) plan at the time the plaintiffs enrolled in the plan and purchased life insurance policies to fund the plan. The court noted that the plaintiffs could not use the rulings and rulemakings by the IRS in 2004 and 2005 ―to retroactively demonstrate that representations made by [the insurer‘s] alleged agents in 2001-02 were false when made.‖ Moreover, the court held that, as a matter of law, representations regarding the validity and likely tax treatment of the plaintiffs‘ 412(i) plans were ―forward looking‖ statements or ―opinions‖ as to how the IRS would treat 412(i) plans after plaintiffs funded them with insurance policies. The court found that it was ―inherently unreasonable for any person to rely on a prediction of future IRS enactment, enforcement, or non-enforcement of the law by someone unaffiliated with the federal government.‖ The court concluded that, ―[a]s a matter of law, any representation or prediction by any alleged [insurance company] agent as to how the IRS would treat the 412(i) plans, and the funding thereof, in the future is either an unactionable opinion or was unjustifiably relied upon.‖
Subsequently, the Northern District of Texas allowed the plaintiffs an opportunity to re-plead, and it then reaffirmed its prior ruling and dismissed the Berry plaintiffs‘ fraud-based claims with prejudice. The claims against the other insurance company defendants in Berry have been dismissed for the same reasons but the court has not yet decided whether the plaintiffs will be allowed to re-plead. As of November 2010, the third amended complaint was filed, to which Pacific Life filed a reply. Hartford and Pacific Life filed responses to the synopsis of the third amended complaint.
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3. Zarrella v. Pacific Life Insurance Company, No. 10-60754-CIV, 755 F.Supp.2d 1231 (S.D. Fla. 2011)
In March of 2003, Plaintiffs purchased nine individual policies from Pacific Life for use in Zarrella Construction‘s 412(i) plan. It was not until February of 2004 when the IRS issued a declaration, naming such policies as abusive tax-shelters. Plaintiffs contend that Pacific Life ―marketed and expressly touted the Policies by highlighting these ‗special‘ benefits and/or incentives that – they knew or should have known – violated the IRS Code and presented substantial tax risks to Plaintiffs.‖ On May 10, 2010, Plaintiffs brought a class action against Pacific Life. Following Pacific Life‘s first motion to dismiss being partially granted, Plaintiffs filed their Amended Class Action Complaint in December of 2010. The Plaintiffs asserted the following claims: breach of contract, equitable fraud, negligence, and a violation of California Business and Professions Code § 17200, et seq. Plaintiff‘s alleged that there was a breach of contract ―because the Policies when used to fund 412(i), did not and could not satisfy the requirements of Section 412(i). The court countered by explaining that ―in the written contract, Pacific Life specifically did not guarantee any future tax or legal consequences.‖ Additionally, the court noted that Plaintiff‘s negligence claim failed because they failed to allege the existence of a legal duty.‖
Similarly, the court dismissed the class action fraud allegations against Pacific Life because the plaintiffs failed to explain why the defendants‘ alleged statements were false when made in 2003. The court also noted that fraud must be based on material facts, not a promise or prediction of future events and that the insurance company‘s alleged representations were just ―statements of opinion regarding future events.‖ Thus, once again, Pacific Life‘s 12(b)(6) motion was granted and the amended complaint was dismissed without prejudice on all counts. Accordingly, a second amended complaint was filed by Plaintiff‘s on April 12, 2011. The court has set the trial date for October 24, 2011 and the parties‘ response and reply to Pacific Life‘s motion to dismiss the second amended complaint are before the court.
4. Chau v. Aviva Life and Annuity, No. 3:09-cv-2305-B, 2011 WL 1990446 (N.D. Tex. May 20, 2011)
Doctors and dentists alleged that Indianapolis Life Insurance Company advertised, marketed, and consummated fraudulent business transactions, resulting in damages. Plaintiffs originally filed their complaint in April of 2009 in Washington state court and after Aviva removed the case to federal district court, the MDL Panel ordered the case transferred to the Northern District of Texas. Prior to the case being transferred, Plaintiffs filed their second amended complaint and subsequently, Aviva filed its motion to dismiss Plaintiff‘s second amended complaint on February 5, 2010. Plaintiffs allege that the insurer knew that the IRS had looked askance at the legality of similar tax-shelter arrangements (welfare benefit trusts) and indicated that these arrangements may be deemed abusive tax shelters, yet continued to market its § 419 Plan as a tax-avoidance plan.
Plaintiffs‘ motion for a suggestion of remand to the Judicial Panel of Multidistrict Litigation was filed on March 3, 2011 and was subsequently denied by the district court.
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However, the court noted that plaintiffs may motion again, should there be further developments in the case. Aviva‘s motion to dismiss the second amended complaint was granted in part and denied in part on May 20, 2011. In its motion, Aviva claimed that Plaintiffs‘ common law fraud/negligent misrepresentation claim did not meet the heightened pleading requirements of Rule 9(b), in addition to failing to state a claim, and the court agreed. However, on the breach of contract claim, the court found that under the applicable law governing the contract, plaintiff‘s claim was not due to be dismissed. The court elaborated on its reasoning, noting that allegations concerning oral representations made about the policies, specifically, their ability to obtain substantial tax savings with the 419 Plan. Plaintiffs asserted in their second amended complaint that those representations were false and resulted in ―substantial tax penalties and interest‖ due to an IRS audit. Thus, the court found that such allegations, accepted as true, state a claim for a breach of contract under Washington state law.
Captive Insurance and Other Abusive Tax Shelters
By Lance Wallach, CLU, CHFC Abusive Tax Shelter, Listed Transaction, Reportable Transaction Expert Witness
Call Lance Wallach at (516) 938-5007
Call Lance Wallach at (516) 938-5007
Captive insurance arrangements that are funded with cash-value life insurance are the hot tax shelter for 2014. But serious questions exist whether they work as the promoter’s promise they will do.
During the savings & loan crisis of the late 1980s and early 1990s, the courts used a particular acronym to describe cases where a physician had made an obviously bad investment in an oil & gas deal, and then sued to try to recoup their losses. Such a case was known as a "DDC", which was short for "Dumb Doctor Case".
Some doctors have a habit of getting into deals that don't make any sense. There's a saying that doctors will crawl on their bellies over broken glass for a mile to get to a bad deal, but they won't walk across the street to get to a good one.
Life insurance companies started pushing 412i plans and 419 welfare benefit plans in the 90s to business owners. When I spoke at the annual national convention of the National Society of Actuary’s about the problems with 419 and 412i plans in 2002 the IRS invited me to address their high level people that were writing regulations on point. We discussed the problems with these plans. The IRS then came up with additional regulations and set up task forces to audit these plans. The results for the business owners and Doctors were audits and very large taxes. I warned in financial publications and at conventions that I spoke at about the upcoming problems. I told people to file under IRS 6707A properly to at least reduce IRS fines on audit. In 2002 I also wrote to life insurance companies like Hartford Life etc. What was the result? The insurance companies continued to push these abusive plans and the IRS audited them. As an expert witness against these insurance companies and plans my side has never lost a case.
Some doctors have a habit of getting into deals that don't make any sense. There's a saying that doctors will crawl on their bellies over broken glass for a mile to get to a bad deal, but they won't walk across the street to get to a good one.
Life insurance companies started pushing 412i plans and 419 welfare benefit plans in the 90s to business owners. When I spoke at the annual national convention of the National Society of Actuary’s about the problems with 419 and 412i plans in 2002 the IRS invited me to address their high level people that were writing regulations on point. We discussed the problems with these plans. The IRS then came up with additional regulations and set up task forces to audit these plans. The results for the business owners and Doctors were audits and very large taxes. I warned in financial publications and at conventions that I spoke at about the upcoming problems. I told people to file under IRS 6707A properly to at least reduce IRS fines on audit. In 2002 I also wrote to life insurance companies like Hartford Life etc. What was the result? The insurance companies continued to push these abusive plans and the IRS audited them. As an expert witness against these insurance companies and plans my side has never lost a case.
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.
READ THE REST HERE
Captive Insurance - Buyers Beware!
Parts of this article are from the book by John Wiley and Sons, Protecting Clients from Fraud, Incompetence and Scams, authored by Lance Wallach.
September 24, 2010
Herol Graham has turned defensive boxing into a poetic art. Trouble is, nobody ever got knocked out by a poem.
—Eddie Shaw
Every accountant knows that increased cash flow and cost savings are critical for businesses in 2009. What is uncertain is the best path to recommend to garner 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 range 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 percent 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. Small companies have been copying a method to control insurance costs and reduce taxes that used to be the domain of large businesses: setting up their own insurance companies to provide coverage when they think that outside insurers are charging too much. A captive insurance company would be an insurance subsidiary that is owned by its parent business(es). There are now nearly 5,000 captive insurers worldwide. More than 80 percent of Fortune 500 companies take advantage of some sort of captive insurance company arrangement. Now small companies can, too.
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. Single-parent captives allow an organization to cover any risk they wish to fund, and generally eliminate the commission-price component from the premiums. Jurisdictions in the United States and in certain parts of the world have adopted a series of laws and regulations that allow small non–life insurance companies, taxed under IRC Section 831(b), or as 831(b) companies.
Captives can be a great cost-saving tool, but they can also be 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 or tax deferral vehicles, 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 within 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. 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, 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 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 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.org or www.taxlibrary.us.
The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.
412i Tax Shelter Fraud Litigation - How It Works
Lance Wallach
PARTIES:
Typically, these transactions will include an Insurance company, accountant, tax attorney, and a promoter (someone with an insurance background, perhaps an actuary, who knows how to structure the policy itself). These groups will use insurance brokerages and sub-agents (licensed in the various states) to sell the policies themselves.
INSURANCE COMPANIES
AMERICAN GENERAL LIFE INSURANCE COMPANY® INDIANAPOLIS LIFE INSURANCE COMPANY®
HARTFORD LIFE AND ANNUITY INSURANCE COMPANY® PACIFIC LIFE INSURANCE COMPANY®
BANKERS LIFE and OTHERS®?
4121iHOW THESE PLANS WORK:
In the late 1990’s, 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 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 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.
I am not an attorney but I learned some of the above information from attorney’s Mr. Ford’s website.
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 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 AICPA best-selling books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots. He does expert witness testimony and has never lost a case. Contact him at 516.938.5007, wallachinc@gmail.com or visit www.taxaudit419.com and www.taxlibrary.us
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.
PARTIES:
Typically, these transactions will include an Insurance company, accountant, tax attorney, and a promoter (someone with an insurance background, perhaps an actuary, who knows how to structure the policy itself). These groups will use insurance brokerages and sub-agents (licensed in the various states) to sell the policies themselves.
INSURANCE COMPANIES
AMERICAN GENERAL LIFE INSURANCE COMPANY® INDIANAPOLIS LIFE INSURANCE COMPANY®
HARTFORD LIFE AND ANNUITY INSURANCE COMPANY® PACIFIC LIFE INSURANCE COMPANY®
BANKERS LIFE and OTHERS®?
4121iHOW THESE PLANS WORK:
In the late 1990’s, 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 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 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.
I am not an attorney but I learned some of the above information from attorney’s Mr. Ford’s website.
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 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 AICPA best-selling books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots. He does expert witness testimony and has never lost a case. Contact him at 516.938.5007, wallachinc@gmail.com or visit www.taxaudit419.com and www.taxlibrary.us
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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