By Lance Wallach
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 www.irs.gov and www.taxlibrary.us.
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
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
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 these 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.
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 Sections 264(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
Lance Wallach, the National Society of Accountants Speaker of the Year, speaks and writes
extensively about retirement plans, Circular 230 problems, and tax reduction strategies. He
speaks at more than 10 conventions annually, writes over 50 publications, and has written
numerous best-selling AICPA books, including Avoiding Circular 230 Malpractice Traps and
Common Abusive Business Hot Spots, Contact him at firstname.lastname@example.org,
www.taxadvisorexperts.org or call (516)-938-5007.
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.