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NCCPAP November 2010 Newsletter
2010
Business Owners in 419, 412i, Section 79 and Captive Insurance Plans
Will Probably Be Fined by the IRS Under Section 6707A
Lance Wallach
Taxpayers who previously adopted 419, 412i, captive insurance or Section 79 plans are in big
trouble. In recent years, the IRS has identified many of these arrangements as abusive devices to
funnel tax deductible dollars to shareholders and classified these arrangements as “listed
transactions.” These plans were sold by insurance agents, financial planners, accountants and
attorneys seeking large life insurance commissions. In general, taxpayers who engage in a “listed
transaction” must report such transaction to the IRS on Form 8886 every year that they “participate”
in the transaction, and the taxpayer does not necessarily have to make a contribution or claim a tax
deduction to be deemed to participate. Section 6707A of the Code imposes severe penalties
($200,000 for a business and $100,000 for an individual) for failure to file Form 8886 with respect to
a listed transaction. But a taxpayer can also be in trouble if they file incorrectly. I have received
numerous phone calls from business owners who filed and still got fined. Not only does
the taxpayer have to file Form 8886, but it has to be prepared correctly. I only know of two people in
the United States who have filed these forms properly for clients. They told me that the form was
prepared after hundreds of hours of research and over fifty phones calls to various IRS personnel.
The filing instructions for Form 8886 presume a timely filing. Most people file late and follow the
directions for currently preparing the forms. Then the IRS fines the business owner. The tax court
does not have
jurisdiction to abate or lower such penalties imposed by the IRS.
Many business owners adopted 412i, 419, captive insurance and Section 79 plans based upon
representations provided by insurance professionals that the plans were legitimate plans and
they were not informed that they were engaging in a listed transaction. Upon audit, these taxpayers
were shocked when the IRS asserted penalties under Section 6707A of the Code in the hundreds
of thousands of dollars. Numerous complaints from these taxpayers caused Congress to impose a
moratorium on assessment of Section 6707A penalties.
The moratorium on IRS fines expired on June 1, 2010. The IRS immediately started sending out
notices proposing the imposition of Section 6707A penalties along with requests for lengthy
extensions of the Statute of Limitations for the purpose of assessing tax. Many of these taxpayers
stopped taking deductions for contributions to these plans years ago, and are confused and upset
by the IRS’s inquiry, especially when the taxpayer had previously reached a monetary settlement
with the IRS regarding the deductions
taken in prior years. Logic and common sense dictate that a penalty should not apply if the taxpayer
no longer benefits from the arrangement.
Treas. Reg. Sec. 1.6011-4(c)(3)(i) provides that a taxpayer has participated in a listed transaction if
the taxpayer’s tax return reflects tax consequences or a tax strategy described in the published
guidance identifying the transaction as a listed transaction or a transaction that is the same or
substantially
similar to a listed transaction. Clearly, the primary benefit in the participation of these plans is the
large tax deduction generated by such participation. It follows that taxpayers who no longer enjoy the
benefit of those large deductions are no longer “participating” in the listed transaction.
But that is not the end of the story. Many taxpayers who are no longer taking current tax deductions
for these plans continue to enjoy the benefit of previous tax deductions by continuing the deferral of
income from contributions and deductions taken in prior years. While the regulations do not expand
on what constitutes “reflecting the tax consequences of the strategy,” it could be argued that
continued benefit from a tax deferral for a previous tax deduction is within the contemplation of a “tax
consequence” of the plan strategy. Also, many taxpayers who no longer make contributions or claim
tax deductions continue to pay administrative fees. Sometimes, money is taken from the plan to pay
premiums to keep life insurance policies in force. In these ways, it could be argued that these
taxpayers are still “contributing,” and thus still must file Form 8886.
It is clear that the extent to which a taxpayer benefits from the transaction depends on the purpose of
a particular transaction as described in the published guidance that caused such transaction to be
a listed transaction. Revenue Ruling 2004-20, which classifies 419(e) transactions, appears to be
concerned with the employer’s contribution/deduction amount rather than the continued deferral of
the income in previous years. This language may provide the taxpayer with a solid argument in the
event of an audit.
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;
speaks at more than ten conventions annually; writes for over fifty publications; is quoted regularly in
the press; and has been featured on TV and radio financial talk shows. Lance has written
numerous books including Protecting Clients from Fraud, Incompetence and Scams (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.
taxaudit419.com, www.lancewallack.com
Lance Wallach
68 Keswick Lane
Plainview, NY 11803
Ph.: (516)938-5007
Fax: (516)938-6330 www.vebaplan.com,
National Society of Accountants Speaker of The Year
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.
2010
Business Owners in 419, 412i, Section 79 and Captive Insurance Plans
Will Probably Be Fined by the IRS Under Section 6707A
Lance Wallach
Taxpayers who previously adopted 419, 412i, captive insurance or Section 79 plans are in big
trouble. In recent years, the IRS has identified many of these arrangements as abusive devices to
funnel tax deductible dollars to shareholders and classified these arrangements as “listed
transactions.” These plans were sold by insurance agents, financial planners, accountants and
attorneys seeking large life insurance commissions. In general, taxpayers who engage in a “listed
transaction” must report such transaction to the IRS on Form 8886 every year that they “participate”
in the transaction, and the taxpayer does not necessarily have to make a contribution or claim a tax
deduction to be deemed to participate. Section 6707A of the Code imposes severe penalties
($200,000 for a business and $100,000 for an individual) for failure to file Form 8886 with respect to
a listed transaction. But a taxpayer can also be in trouble if they file incorrectly. I have received
numerous phone calls from business owners who filed and still got fined. Not only does
the taxpayer have to file Form 8886, but it has to be prepared correctly. I only know of two people in
the United States who have filed these forms properly for clients. They told me that the form was
prepared after hundreds of hours of research and over fifty phones calls to various IRS personnel.
The filing instructions for Form 8886 presume a timely filing. Most people file late and follow the
directions for currently preparing the forms. Then the IRS fines the business owner. The tax court
does not have
jurisdiction to abate or lower such penalties imposed by the IRS.
Many business owners adopted 412i, 419, captive insurance and Section 79 plans based upon
representations provided by insurance professionals that the plans were legitimate plans and
they were not informed that they were engaging in a listed transaction. Upon audit, these taxpayers
were shocked when the IRS asserted penalties under Section 6707A of the Code in the hundreds
of thousands of dollars. Numerous complaints from these taxpayers caused Congress to impose a
moratorium on assessment of Section 6707A penalties.
The moratorium on IRS fines expired on June 1, 2010. The IRS immediately started sending out
notices proposing the imposition of Section 6707A penalties along with requests for lengthy
extensions of the Statute of Limitations for the purpose of assessing tax. Many of these taxpayers
stopped taking deductions for contributions to these plans years ago, and are confused and upset
by the IRS’s inquiry, especially when the taxpayer had previously reached a monetary settlement
with the IRS regarding the deductions
taken in prior years. Logic and common sense dictate that a penalty should not apply if the taxpayer
no longer benefits from the arrangement.
Treas. Reg. Sec. 1.6011-4(c)(3)(i) provides that a taxpayer has participated in a listed transaction if
the taxpayer’s tax return reflects tax consequences or a tax strategy described in the published
guidance identifying the transaction as a listed transaction or a transaction that is the same or
substantially
similar to a listed transaction. Clearly, the primary benefit in the participation of these plans is the
large tax deduction generated by such participation. It follows that taxpayers who no longer enjoy the
benefit of those large deductions are no longer “participating” in the listed transaction.
But that is not the end of the story. Many taxpayers who are no longer taking current tax deductions
for these plans continue to enjoy the benefit of previous tax deductions by continuing the deferral of
income from contributions and deductions taken in prior years. While the regulations do not expand
on what constitutes “reflecting the tax consequences of the strategy,” it could be argued that
continued benefit from a tax deferral for a previous tax deduction is within the contemplation of a “tax
consequence” of the plan strategy. Also, many taxpayers who no longer make contributions or claim
tax deductions continue to pay administrative fees. Sometimes, money is taken from the plan to pay
premiums to keep life insurance policies in force. In these ways, it could be argued that these
taxpayers are still “contributing,” and thus still must file Form 8886.
It is clear that the extent to which a taxpayer benefits from the transaction depends on the purpose of
a particular transaction as described in the published guidance that caused such transaction to be
a listed transaction. Revenue Ruling 2004-20, which classifies 419(e) transactions, appears to be
concerned with the employer’s contribution/deduction amount rather than the continued deferral of
the income in previous years. This language may provide the taxpayer with a solid argument in the
event of an audit.
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;
speaks at more than ten conventions annually; writes for over fifty publications; is quoted regularly in
the press; and has been featured on TV and radio financial talk shows. Lance has written
numerous books including Protecting Clients from Fraud, Incompetence and Scams (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.
taxaudit419.com, www.lancewallack.com
Lance Wallach
68 Keswick Lane
Plainview, NY 11803
Ph.: (516)938-5007
Fax: (516)938-6330 www.vebaplan.com,
National Society of Accountants Speaker of The Year
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.
IRS Audits 419, 412i, Captive Insurance Plans With Life
Insurance, and Section 79 Scams
Article Biz June 2011
Lance Wallach
The IRS started auditing 419 plans in the ‘90s, and then continued going after 412i
and other plans that they considered abusive, listed, or reportable transactions.
Listed designated as listed in published IRS material available to the general public or
transactions that are substantially similar to the specific listed transactions. A
reportable transaction is defined simply as one that has the potential for tax
avoidance or evasion.
In a recent Tax Court Case, Curcio v. Commissioner (TC Memo 2010-15), the Tax
Court ruled that an investment in an employee welfare benefit plan marketed under
the name "Benistar" was a listed transaction in that the transaction in question was
substantially similar to the transaction described in IRS Notice 95-34. A subsequent
case, McGehee Family Clinic, largely followed Curcio, though it was technically
decided on other grounds. The parties stipulated to be bound by Curcio on the issue
of whether the amounts paid by McGehee in connection with the Benistar 419 Plan
and Trust were deductible. Curcio did not appear to have been decided yet at the
time McGehee was argued. The McGehee opinion (Case No. 10-102) (United States
Tax Court, September 15, 2010) does contain an exhaustive analysis and discussion
of virtually all of the relevant issues.
Taxpayers and their representatives should be aware that the Service has disallowed
deductions for contributions to these arrangements. The IRS is cracking down on
small business owners who participate in tax reduction insurance plans and the
brokers who sold them. Some of these plans include defined benefit retirement plans,
IRAs, or even 401(k) plans with life insurance.
In order to fully grasp the severity of the situation, one must have an understanding of
Notice 95-34, which was issued in response to trust arrangements sold to companies
that were designed to provide deductible benefits such as life insurance, disability
and severance pay benefits. The promoters of these arrangements claimed that all
employer contributions were tax-deductible when paid, by relying on the 10-or-more-
employer exemption from the IRC § 419 limits. It was claimed that permissible tax
deductions were unlimited in amount.
In general, contributions to a welfare benefit fund are not fully deductible when paid.
Sections 419 and 419A impose strict limits on the amount of tax-deductible prefunding
permitted for contributions to a welfare benefit fund. Section 419A(F)(6) provides an
exemption from Section 419 and Section 419A for certain "10-or-more employers"
welfare benefit funds. In general, for this exemption to apply, the fund must have more
than one contributing employer, of which no single employer can contribute more than
10% of the total contributions, and the plan must not be experience-rated with respect
to individual employers.
According to the Notice, these arrangements typically involve an investment in
variable life or universal life insurance contracts on the lives of the covered
employees. The problem is that the employer contributions are large relative to the
cost of the amount of term insurance that would be required to provide the death
benefits under the arrangement, and the trust administrator may obtain cash to pay
benefits other than death benefits, by such means as cashing in or withdrawing the
cash value of the insurance policies. The plans are also often designed so that a
particular employer’s contributions or its employees’ benefits may be determined in a
way that insulates the employer to a significant extent from the experience of other
subscribing employers. In general, the contributions and claimed tax deductions tend
to be disproportionate to the economic realities of the arrangements.
Benistar advertised that enrollees should expect to obtain the same type of tax
benefits as listed in the transaction described in Notice 95-34. The benefits of
enrollment listed in its advertising packet included:
Virtually unlimited deductions for the employer;
Contributions could vary from year to year;
Benefits could be provided to one or more key executives on a selective basis;
No need to provide benefits to rank-and-file employees;
Contributions to the plan were not limited by qualified plan rules and would not
interfere with pension, profit sharing or 401(k) plans;
Funds inside the plan would accumulate tax-free;
Beneficiaries could receive death proceeds free of both income tax and estate tax;
The program could be arranged for tax-free distribution at a later date;
Funds in the plan were secure from the hands of creditors.
The Court said that the Benistar Plan was factually similar to the plans described in
Notice 95-34 at all relevant times.
In rendering its decision the court heavily cited Curcio, in which the court also ruled in
favor of the IRS. As noted in Curcio, the insurance policies, overwhelmingly variable
or universal life policies, required large contributions relative to the cost of the amount
of term insurance that would be required to provide the death benefits under the
arrangement. The Benistar Plan owned the insurance contracts.
Following Curcio, as the parties had stipulated, on the question of the amnesty paid
by Mcghee in connection with benistar, the Court held that the contributions to
Benistar were not deductible under section 162(a) because participants could receive
the value reflected in the underlying insurance policies purchased by Benistar—
despite the payment of benefits by Benistar seeming to be contingent upon an
unanticipated event (the death of the insured while employed). As long as plan
participants were willing to abide by Benistar’s distribution policies, there was no
reason ever to forfeit a policy to the plan. In fact, in estimating life insurance rates, the
taxpayers’ expert in Curcio assumed that there would be no forfeitures, even though
he admitted that an insurance company would generally assume a reasonable rate of
policy lapses.
The McGehee Family Clinic had enrolled in the Benistar Plan in May 2001 and
claimed deductions for contributions to it in 2002 and 2005. The returns did not
include a Form 8886, Reportable Transaction Disclosure Statement, or similar
disclosure.
The IRS disallowed the latter deduction and adjusted the 2004 return of shareholder
Robert Prosser and his wife to include the $50,000 payment to the plan. The IRS also
assessed tax deficiencies and the enhanced 30% penalty totaling almost $21,000
against the clinic and $21,000 against the Prossers. The court ruled that the Prossers
failed to prove a reasonable cause or good faith exception.
More you should know:
In recent years, some section 412(i) plans have been funded with life insurance using
face amounts in excess of the maximum death benefit a qualified plan is permitted to
pay. Ideally, the plan should limit the proceeds that can be paid as a death benefit in
the event of a participant’s death. Excess amounts would revert to the plan. Effective
February 13, 2004, the purchase of excessive life insurance in any plan makes the
plan a listed transaction if the face amount of the insurance exceeds the amount that
can be issued by $100,000 or more and the employer has deducted the premiums for
the insurance.
A 412(i) plan in and of itself is not a listed transaction; however, the IRS has a task
force auditing 412i plans.
An employer has not engaged in a listed transaction simply because it is in a 412(i)
plan.
Just because a 412(i) plan was audited and sanctioned for certain items, does not
necessarily mean the plan is a listed transaction. Some 412(i) plans have been
audited and sanctioned for issues not related to listed transactions.
Companies should carefully evaluate proposed investments in plans such as the
Benistar Plan. The claimed deductions will not be available, and penalties will be
assessed for lack of disclosure if the investment is similar to the investments
described in Notice 95-34. In addition, under IRC 6707A, IRS fines participants a large
amount of money for not properly disclosing their participation in listed or reportable
or similar transactions; an issue that was not before the Tax Court in either Curcio or
McGehee. The disclosure needs to be made for every year the participant is in a
plan. The forms need to be properly filed even for years that no contributions are
made. I have received numerous calls from participants who did disclose and still got
fined because the forms were not prepared properly. A plan administrator told me that
he assisted hundreds of his participants file forms, and they still all received very
large IRS fines for not properly filling in the forms.
IRS has been attacking all 419 welfare benefit plans, many 412i retirement plans,
captive insurance plans with life insurance in them, and Section 79 plans.
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.taxadvisorexpert.
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.
Insurance, and Section 79 Scams
Article Biz June 2011
Lance Wallach
The IRS started auditing 419 plans in the ‘90s, and then continued going after 412i
and other plans that they considered abusive, listed, or reportable transactions.
Listed designated as listed in published IRS material available to the general public or
transactions that are substantially similar to the specific listed transactions. A
reportable transaction is defined simply as one that has the potential for tax
avoidance or evasion.
In a recent Tax Court Case, Curcio v. Commissioner (TC Memo 2010-15), the Tax
Court ruled that an investment in an employee welfare benefit plan marketed under
the name "Benistar" was a listed transaction in that the transaction in question was
substantially similar to the transaction described in IRS Notice 95-34. A subsequent
case, McGehee Family Clinic, largely followed Curcio, though it was technically
decided on other grounds. The parties stipulated to be bound by Curcio on the issue
of whether the amounts paid by McGehee in connection with the Benistar 419 Plan
and Trust were deductible. Curcio did not appear to have been decided yet at the
time McGehee was argued. The McGehee opinion (Case No. 10-102) (United States
Tax Court, September 15, 2010) does contain an exhaustive analysis and discussion
of virtually all of the relevant issues.
Taxpayers and their representatives should be aware that the Service has disallowed
deductions for contributions to these arrangements. The IRS is cracking down on
small business owners who participate in tax reduction insurance plans and the
brokers who sold them. Some of these plans include defined benefit retirement plans,
IRAs, or even 401(k) plans with life insurance.
In order to fully grasp the severity of the situation, one must have an understanding of
Notice 95-34, which was issued in response to trust arrangements sold to companies
that were designed to provide deductible benefits such as life insurance, disability
and severance pay benefits. The promoters of these arrangements claimed that all
employer contributions were tax-deductible when paid, by relying on the 10-or-more-
employer exemption from the IRC § 419 limits. It was claimed that permissible tax
deductions were unlimited in amount.
In general, contributions to a welfare benefit fund are not fully deductible when paid.
Sections 419 and 419A impose strict limits on the amount of tax-deductible prefunding
permitted for contributions to a welfare benefit fund. Section 419A(F)(6) provides an
exemption from Section 419 and Section 419A for certain "10-or-more employers"
welfare benefit funds. In general, for this exemption to apply, the fund must have more
than one contributing employer, of which no single employer can contribute more than
10% of the total contributions, and the plan must not be experience-rated with respect
to individual employers.
According to the Notice, these arrangements typically involve an investment in
variable life or universal life insurance contracts on the lives of the covered
employees. The problem is that the employer contributions are large relative to the
cost of the amount of term insurance that would be required to provide the death
benefits under the arrangement, and the trust administrator may obtain cash to pay
benefits other than death benefits, by such means as cashing in or withdrawing the
cash value of the insurance policies. The plans are also often designed so that a
particular employer’s contributions or its employees’ benefits may be determined in a
way that insulates the employer to a significant extent from the experience of other
subscribing employers. In general, the contributions and claimed tax deductions tend
to be disproportionate to the economic realities of the arrangements.
Benistar advertised that enrollees should expect to obtain the same type of tax
benefits as listed in the transaction described in Notice 95-34. The benefits of
enrollment listed in its advertising packet included:
Virtually unlimited deductions for the employer;
Contributions could vary from year to year;
Benefits could be provided to one or more key executives on a selective basis;
No need to provide benefits to rank-and-file employees;
Contributions to the plan were not limited by qualified plan rules and would not
interfere with pension, profit sharing or 401(k) plans;
Funds inside the plan would accumulate tax-free;
Beneficiaries could receive death proceeds free of both income tax and estate tax;
The program could be arranged for tax-free distribution at a later date;
Funds in the plan were secure from the hands of creditors.
The Court said that the Benistar Plan was factually similar to the plans described in
Notice 95-34 at all relevant times.
In rendering its decision the court heavily cited Curcio, in which the court also ruled in
favor of the IRS. As noted in Curcio, the insurance policies, overwhelmingly variable
or universal life policies, required large contributions relative to the cost of the amount
of term insurance that would be required to provide the death benefits under the
arrangement. The Benistar Plan owned the insurance contracts.
Following Curcio, as the parties had stipulated, on the question of the amnesty paid
by Mcghee in connection with benistar, the Court held that the contributions to
Benistar were not deductible under section 162(a) because participants could receive
the value reflected in the underlying insurance policies purchased by Benistar—
despite the payment of benefits by Benistar seeming to be contingent upon an
unanticipated event (the death of the insured while employed). As long as plan
participants were willing to abide by Benistar’s distribution policies, there was no
reason ever to forfeit a policy to the plan. In fact, in estimating life insurance rates, the
taxpayers’ expert in Curcio assumed that there would be no forfeitures, even though
he admitted that an insurance company would generally assume a reasonable rate of
policy lapses.
The McGehee Family Clinic had enrolled in the Benistar Plan in May 2001 and
claimed deductions for contributions to it in 2002 and 2005. The returns did not
include a Form 8886, Reportable Transaction Disclosure Statement, or similar
disclosure.
The IRS disallowed the latter deduction and adjusted the 2004 return of shareholder
Robert Prosser and his wife to include the $50,000 payment to the plan. The IRS also
assessed tax deficiencies and the enhanced 30% penalty totaling almost $21,000
against the clinic and $21,000 against the Prossers. The court ruled that the Prossers
failed to prove a reasonable cause or good faith exception.
More you should know:
In recent years, some section 412(i) plans have been funded with life insurance using
face amounts in excess of the maximum death benefit a qualified plan is permitted to
pay. Ideally, the plan should limit the proceeds that can be paid as a death benefit in
the event of a participant’s death. Excess amounts would revert to the plan. Effective
February 13, 2004, the purchase of excessive life insurance in any plan makes the
plan a listed transaction if the face amount of the insurance exceeds the amount that
can be issued by $100,000 or more and the employer has deducted the premiums for
the insurance.
A 412(i) plan in and of itself is not a listed transaction; however, the IRS has a task
force auditing 412i plans.
An employer has not engaged in a listed transaction simply because it is in a 412(i)
plan.
Just because a 412(i) plan was audited and sanctioned for certain items, does not
necessarily mean the plan is a listed transaction. Some 412(i) plans have been
audited and sanctioned for issues not related to listed transactions.
Companies should carefully evaluate proposed investments in plans such as the
Benistar Plan. The claimed deductions will not be available, and penalties will be
assessed for lack of disclosure if the investment is similar to the investments
described in Notice 95-34. In addition, under IRC 6707A, IRS fines participants a large
amount of money for not properly disclosing their participation in listed or reportable
or similar transactions; an issue that was not before the Tax Court in either Curcio or
McGehee. The disclosure needs to be made for every year the participant is in a
plan. The forms need to be properly filed even for years that no contributions are
made. I have received numerous calls from participants who did disclose and still got
fined because the forms were not prepared properly. A plan administrator told me that
he assisted hundreds of his participants file forms, and they still all received very
large IRS fines for not properly filling in the forms.
IRS has been attacking all 419 welfare benefit plans, many 412i retirement plans,
captive insurance plans with life insurance in them, and Section 79 plans.
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.taxadvisorexpert.
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.
Accounting Today
Don’t Become a ‘Material Advisor’
July 1, 2011
By Lance Wallach
Accountants, insurance professionals and others need to be careful that they don’t become what
the IRS calls material advisors.
If they sell or give advice, or sign tax returns for abusive, listed or similar plans; they risk a
minimum $100,000 fine. They will then probably be sued by their client, when the IRS finishes with
their client
In 2010, the IRS raided the offices of Benistar in Simsbury, Conn., and seized the retirement benefit
plan administration firm’s files and records. In McGehee Family Clinic, the Tax Court ruled that a
clinic and shareholder’s investment in an employee benefit plan marketed under the name
“Benistar” was a listed transaction because it was substantially similar to the transaction
described in Notice 95-34 (1995-1 C.B. 309). This is at least the second case in which the court
has ruled against the Benistar welfare benefit plan, by denominating it a listed transaction.
The McGehee Family Clinic enrolled in the Benistar Plan in May 2001 and claimed deductions for
contributions to it in 2002 and 2005. The returns did not include a Form 8886, Reportable
Transaction Disclosure Statement, or similar disclosure. The IRS disallowed the latter deduction
and adjusted the 2004 return of shareholder Robert Prosser and his wife to include the $50,000
payment to the plan.
The IRS assessed tax deficiencies and the enhanced 30 percent penalty under Section 6662A,
totaling almost $21,000, against the clinic and $21,000 against the Prossers. The court ruled that
the Prossers failed to prove a reasonable cause or good faith exception.
In rendering its decision, the court cited Curcio v. Commissioner, in which the court also ruled in
favor of the IRS. As noted in Curcio, the insurance policies, which were overwhelmingly variable or
universal life policies, required large contributions relative to the cost of the amount of term
insurance that would be required to provide the death benefits under the arrangement. The
Benistar Plan owned the insurance contracts. The excessive cost of providing death benefits was a
reason for the court’s finding in Curcio that tax deductions had been properly disallowed.
As in Curcio, the McGehee court held that the contributions to Benistar were not deductible under
Section 162(a) because the participants could receive the value reflected in the underlying
insurance policies purchased by Benistar—despite the payment of benefits by Benistar seeming to
be contingent upon an unanticipated event (the death of the insured while employed). As long as
plan participants were willing to abide by Benistar’s distribution policies, there was no reason ever
to forfeit a policy to the plan. In fact, in estimating life insurance rates, the taxpayers’ expert in Curcio
assumed that there would be no forfeitures, even though he admitted that an insurance company
would generally assume a reasonable rate of policy lapse.
Companies should carefully evaluate their proposed investments in plans such as the Benistar
Plan. The claimed deductions will be disallowed, and penalties will be assessed for lack of
disclosure if the investment is similar to the investments described in Notice 95-34, that is, if the
transaction is a listed transaction and Form 8886 is either not filed at all or is not properly filed. The
penalties, though perhaps not as severe, are also imposed for reportable transactions, which are
defined as transactions having the potential for tax avoidance or evasion.
Insurance agents have been selling such abusive plans since the 1990's. They started as 419A(F)
(6) plans and abusive 412i plans. The IRS went after them. They then evolved to single-employer
419(e) plans, which the IRS also went after. The latest scams may be the so-called captive
insurance plan and the so called Section 79 plan.
While captive insurance plans are legitimate for large corporations, they are usually not legitimate
for small business owners as a way to obtain a tax deduction. I have not yet seen a legitimate
Section 79 plan. Recently, I have sent some of the plan promoters’ materials over to my IRS
contacts, who were very interested in receiving them. Some of my associates are already trying to
help defend some unsuspecting business owners who are being audited by the IRS with respect
to these plans.
Similar, though perhaps not as abusive, plans fail after the IRS goes after them. Niche was one
example. The company first marketed a 419A(F)(6) plan that the IRS audited. They then marketed a
419(e) plan that the IRS audited. Niche, insurance companies, agents, and many accountants
were then sued after their clients lost their deductions, paid fines, interest, and penalties, and then
paid huge fines for failure to file properly under 6707A. Niche then went out of business.
Millennium sold 419A(F)(6) plans and then 419(e) plans through insurance companies. They
stupidly filed for a private letter ruling to the effect that they were not a listed transaction. They got
exactly the opposite: a private letter ruling saying that they were a listed transaction. Then many
participants were audited. The IRS disallowed the deductions, imposed penalties and interest, and
then assessed large fines for not filing properly under Section 6707A. The result was lawsuits
against agents, insurance companies and accountants. Millennium sought bankruptcy protection
after a lot of lawsuits.
I have been an expert witness in a lot of the lawsuits in these 419, 412i, etc., plans, and my side
has never lost a case. I have received thousands of phone calls over the years from business
owners, accountants, angry plan promoters, insurance agents, etc. In the 1990's, when I started
writing for the AICPA and other publications warning about these abusive plans, most people
laughed at me, especially the plan promoters.
In 2002, when I spoke at the annual national convention of the American Society of Pension
Actuaries in Washington, people took notice. The IRS chief actuary Jim Holland also held a
meeting, similar to mine on abusive 412i plans. Many IRS agents attended my meeting. I was also
invited to IRS headquarters, at the request of the acting IRS commissioner, to meet with high-level
IRS officials and Treasury officials to discuss 419 issues in depth, which I did after the meeting.
The IRS then set up task forces and started going after 419 and 412i plans. I have been warning
accountants to properly file under 6707A to avoid the large fines, but most do not. Even if they file, if
they make a mistake on the forms the IRS fines. Very few accountants have had experience filing
the forms, and the IRS instructions are difficult to follow. I only know of two people who have been
successful in properly filing the forms, especially after the fact. If the forms are filled out wrong they
should be amended and corrected Most accountants call me a few years later when they and their
clients get the large fines, either after improperly filling out the forms or not doing them at all, but
then it is too late. If they don’t call me then, then they call me when their clients sue them.
Lance Wallach is a frequent speaker on retirement plans, financial and estate planning, and
abusive tax shelters, and writes about 412(i), 419 and captive insurance plans. He can be reached
at (516) 938-5007, lawallach@aol.com, or visit www.vebaplan.com.
For more information, please visit www.taxadvisorexperts.org 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.
Lance Wallach
68 Keswick Lane
Plainview, NY 11803
Ph.: (516)938-5007
Fax: (516)938-6330 www.vebaplan.com
National Society of Accountants Speaker of The Year
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.
Don’t Become a ‘Material Advisor’
July 1, 2011
By Lance Wallach
Accountants, insurance professionals and others need to be careful that they don’t become what
the IRS calls material advisors.
If they sell or give advice, or sign tax returns for abusive, listed or similar plans; they risk a
minimum $100,000 fine. They will then probably be sued by their client, when the IRS finishes with
their client
In 2010, the IRS raided the offices of Benistar in Simsbury, Conn., and seized the retirement benefit
plan administration firm’s files and records. In McGehee Family Clinic, the Tax Court ruled that a
clinic and shareholder’s investment in an employee benefit plan marketed under the name
“Benistar” was a listed transaction because it was substantially similar to the transaction
described in Notice 95-34 (1995-1 C.B. 309). This is at least the second case in which the court
has ruled against the Benistar welfare benefit plan, by denominating it a listed transaction.
The McGehee Family Clinic enrolled in the Benistar Plan in May 2001 and claimed deductions for
contributions to it in 2002 and 2005. The returns did not include a Form 8886, Reportable
Transaction Disclosure Statement, or similar disclosure. The IRS disallowed the latter deduction
and adjusted the 2004 return of shareholder Robert Prosser and his wife to include the $50,000
payment to the plan.
The IRS assessed tax deficiencies and the enhanced 30 percent penalty under Section 6662A,
totaling almost $21,000, against the clinic and $21,000 against the Prossers. The court ruled that
the Prossers failed to prove a reasonable cause or good faith exception.
In rendering its decision, the court cited Curcio v. Commissioner, in which the court also ruled in
favor of the IRS. As noted in Curcio, the insurance policies, which were overwhelmingly variable or
universal life policies, required large contributions relative to the cost of the amount of term
insurance that would be required to provide the death benefits under the arrangement. The
Benistar Plan owned the insurance contracts. The excessive cost of providing death benefits was a
reason for the court’s finding in Curcio that tax deductions had been properly disallowed.
As in Curcio, the McGehee court held that the contributions to Benistar were not deductible under
Section 162(a) because the participants could receive the value reflected in the underlying
insurance policies purchased by Benistar—despite the payment of benefits by Benistar seeming to
be contingent upon an unanticipated event (the death of the insured while employed). As long as
plan participants were willing to abide by Benistar’s distribution policies, there was no reason ever
to forfeit a policy to the plan. In fact, in estimating life insurance rates, the taxpayers’ expert in Curcio
assumed that there would be no forfeitures, even though he admitted that an insurance company
would generally assume a reasonable rate of policy lapse.
Companies should carefully evaluate their proposed investments in plans such as the Benistar
Plan. The claimed deductions will be disallowed, and penalties will be assessed for lack of
disclosure if the investment is similar to the investments described in Notice 95-34, that is, if the
transaction is a listed transaction and Form 8886 is either not filed at all or is not properly filed. The
penalties, though perhaps not as severe, are also imposed for reportable transactions, which are
defined as transactions having the potential for tax avoidance or evasion.
Insurance agents have been selling such abusive plans since the 1990's. They started as 419A(F)
(6) plans and abusive 412i plans. The IRS went after them. They then evolved to single-employer
419(e) plans, which the IRS also went after. The latest scams may be the so-called captive
insurance plan and the so called Section 79 plan.
While captive insurance plans are legitimate for large corporations, they are usually not legitimate
for small business owners as a way to obtain a tax deduction. I have not yet seen a legitimate
Section 79 plan. Recently, I have sent some of the plan promoters’ materials over to my IRS
contacts, who were very interested in receiving them. Some of my associates are already trying to
help defend some unsuspecting business owners who are being audited by the IRS with respect
to these plans.
Similar, though perhaps not as abusive, plans fail after the IRS goes after them. Niche was one
example. The company first marketed a 419A(F)(6) plan that the IRS audited. They then marketed a
419(e) plan that the IRS audited. Niche, insurance companies, agents, and many accountants
were then sued after their clients lost their deductions, paid fines, interest, and penalties, and then
paid huge fines for failure to file properly under 6707A. Niche then went out of business.
Millennium sold 419A(F)(6) plans and then 419(e) plans through insurance companies. They
stupidly filed for a private letter ruling to the effect that they were not a listed transaction. They got
exactly the opposite: a private letter ruling saying that they were a listed transaction. Then many
participants were audited. The IRS disallowed the deductions, imposed penalties and interest, and
then assessed large fines for not filing properly under Section 6707A. The result was lawsuits
against agents, insurance companies and accountants. Millennium sought bankruptcy protection
after a lot of lawsuits.
I have been an expert witness in a lot of the lawsuits in these 419, 412i, etc., plans, and my side
has never lost a case. I have received thousands of phone calls over the years from business
owners, accountants, angry plan promoters, insurance agents, etc. In the 1990's, when I started
writing for the AICPA and other publications warning about these abusive plans, most people
laughed at me, especially the plan promoters.
In 2002, when I spoke at the annual national convention of the American Society of Pension
Actuaries in Washington, people took notice. The IRS chief actuary Jim Holland also held a
meeting, similar to mine on abusive 412i plans. Many IRS agents attended my meeting. I was also
invited to IRS headquarters, at the request of the acting IRS commissioner, to meet with high-level
IRS officials and Treasury officials to discuss 419 issues in depth, which I did after the meeting.
The IRS then set up task forces and started going after 419 and 412i plans. I have been warning
accountants to properly file under 6707A to avoid the large fines, but most do not. Even if they file, if
they make a mistake on the forms the IRS fines. Very few accountants have had experience filing
the forms, and the IRS instructions are difficult to follow. I only know of two people who have been
successful in properly filing the forms, especially after the fact. If the forms are filled out wrong they
should be amended and corrected Most accountants call me a few years later when they and their
clients get the large fines, either after improperly filling out the forms or not doing them at all, but
then it is too late. If they don’t call me then, then they call me when their clients sue them.
Lance Wallach is a frequent speaker on retirement plans, financial and estate planning, and
abusive tax shelters, and writes about 412(i), 419 and captive insurance plans. He can be reached
at (516) 938-5007, lawallach@aol.com, or visit www.vebaplan.com.
For more information, please visit www.taxadvisorexperts.org 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.
Lance Wallach
68 Keswick Lane
Plainview, NY 11803
Ph.: (516)938-5007
Fax: (516)938-6330 www.vebaplan.com
National Society of Accountants Speaker of The Year
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.
IRS Audits 419, 412i, Captive Insurance Plans With Life
Insurance, and Section 79 Scams
Article Biz June 2011
Lance Wallach
The IRS started auditing 419 plans in the ‘90s, and then continued going after 412i
and other plans that they considered abusive, listed, or reportable transactions.
Listed designated as listed in published IRS material available to the general public
or transactions that are substantially similar to the specific listed transactions. A
reportable transaction is defined simply as one that has the potential for tax
avoidance or evasion.
In a recent Tax Court Case, Curcio v. Commissioner (TC Memo 2010-15), the Tax
Court ruled that an investment in an employee welfare benefit plan marketed under
the name "Benistar" was a listed transaction in that the transaction in question was
substantially similar to the transaction described in IRS Notice 95-34. A subsequent
case, McGehee Family Clinic, largely followed Curcio, though it was technically
decided on other grounds. The parties stipulated to be bound by Curcio on the issue
of whether the amounts paid by McGehee in connection with the Benistar 419 Plan
and Trust were deductible. Curcio did not appear to have been decided yet at the
time McGehee was argued. The McGehee opinion (Case No. 10-102) (United States
Tax Court, September 15, 2010) does contain an exhaustive analysis and discussion
of virtually all of the relevant issues.
Taxpayers and their representatives should be aware that the Service has
disallowed deductions for contributions to these arrangements. The IRS is cracking
down on small business owners who participate in tax reduction insurance plans and
the brokers who sold them. Some of these plans include defined benefit retirement
plans, IRAs, or even 401(k) plans with life insurance.
In order to fully grasp the severity of the situation, one must have an understanding
of Notice 95-34, which was issued in response to trust arrangements sold to
companies that were designed to provide deductible benefits such as life insurance,
disability and severance pay benefits. The promoters of these arrangements claimed
that all employer contributions were tax-deductible when paid, by relying on the 10-
or-more-employer exemption from the IRC § 419 limits. It was claimed that
permissible tax deductions were unlimited in amount.
In general, contributions to a welfare benefit fund are not fully deductible when paid.
Sections 419 and 419A impose strict limits on the amount of tax-deductible
prefunding permitted for contributions to a welfare benefit fund. Section 419A(F)(6)
provides an exemption from Section 419 and Section 419A for certain "10-or-more
employers" welfare benefit funds. In general, for this exemption to apply, the fund
must have more than one contributing employer, of which no single employer can
contribute more than 10% of the total contributions, and the plan must not be
experience-rated with respect to individual employers.
According to the Notice, these arrangements typically involve an investment in
variable life or universal life insurance contracts on the lives of the covered
employees. The problem is that the employer contributions are large relative to the
cost of the amount of term insurance that would be required to provide the death
benefits under the arrangement, and the trust administrator may obtain cash to pay
benefits other than death benefits, by such means as cashing in or withdrawing the
cash value of the insurance policies. The plans are also often designed so that a
particular employer’s contributions or its employees’ benefits may be determined in a
way that insulates the employer to a significant extent from the experience of other
subscribing employers. In general, the contributions and claimed tax deductions tend
to be disproportionate to the economic realities of the arrangements.
Benistar advertised that enrollees should expect to obtain the same type of tax
benefits as listed in the transaction described in Notice 95-34. The benefits of
enrollment listed in its advertising packet included:
Virtually unlimited deductions for the employer;
Contributions could vary from year to year;
Benefits could be provided to one or more key executives on a selective basis;
No need to provide benefits to rank-and-file employees;
Contributions to the plan were not limited by qualified plan rules and would not
interfere with pension, profit sharing or 401(k) plans;
Funds inside the plan would accumulate tax-free;
Beneficiaries could receive death proceeds free of both income tax and estate tax;
The program could be arranged for tax-free distribution at a later date;
Funds in the plan were secure from the hands of creditors.
The Court said that the Benistar Plan was factually similar to the plans described in
Notice 95-34 at all relevant times.
In rendering its decision the court heavily cited Curcio, in which the court also ruled
in favor of the IRS. As noted in Curcio, the insurance policies, overwhelmingly
variable or universal life policies, required large contributions relative to the cost of
the amount of term insurance that would be required to provide the death benefits
under the arrangement. The Benistar Plan owned the insurance contracts.
Following Curcio, as the parties had stipulated, on the question of the amnesty paid
by Mcghee in connection with benistar, the Court held that the contributions to
Benistar were not deductible under section 162(a) because participants could
receive the value reflected in the underlying insurance policies purchased by
Benistar—despite the payment of benefits by Benistar seeming to be contingent
upon an unanticipated event (the death of the insured while employed). As long as
plan participants were willing to abide by Benistar’s distribution policies, there was no
reason ever to forfeit a policy to the plan. In fact, in estimating life insurance rates,
the taxpayers’ expert in Curcio assumed that there would be no forfeitures, even
though he admitted that an insurance company would generally assume a
reasonable rate of policy lapses.
The McGehee Family Clinic had enrolled in the Benistar Plan in May 2001 and
claimed deductions for contributions to it in 2002 and 2005. The returns did not
include a Form 8886, Reportable Transaction Disclosure Statement, or similar
disclosure.
The IRS disallowed the latter deduction and adjusted the 2004 return of shareholder
Robert Prosser and his wife to include the $50,000 payment to the plan. The IRS
also assessed tax deficiencies and the enhanced 30% penalty totaling almost
$21,000 against the clinic and $21,000 against the Prossers. The court ruled that
the Prossers failed to prove a reasonable cause or good faith exception.
More you should know:
In recent years, some section 412(i) plans have been funded with life insurance
using face amounts in excess of the maximum death benefit a qualified plan is
permitted to pay. Ideally, the plan should limit the proceeds that can be paid as a
death benefit in the event of a participant’s death. Excess amounts would revert to
the plan. Effective February 13, 2004, the purchase of excessive life insurance in
any plan makes the plan a listed transaction if the face amount of the insurance
exceeds the amount that can be issued by $100,000 or more and the employer has
deducted the premiums for the insurance.
A 412(i) plan in and of itself is not a listed transaction; however, the IRS has a task
force auditing 412i plans.
An employer has not engaged in a listed transaction simply because it is in a 412(i)
plan.
Just because a 412(i) plan was audited and sanctioned for certain items, does not
necessarily mean the plan is a listed transaction. Some 412(i) plans have been
audited and sanctioned for issues not related to listed transactions.
Companies should carefully evaluate proposed investments in plans such as the
Benistar Plan. The claimed deductions will not be available, and penalties will be
assessed for lack of disclosure if the investment is similar to the investments
described in Notice 95-34. In addition, under IRC 6707A, IRS fines participants a
large amount of money for not properly disclosing their participation in listed or
reportable or similar transactions; an issue that was not before the Tax Court in
either Curcio or McGehee. The disclosure needs to be made for every year the
participant is in a plan. The forms need to be properly filed even for years that no
contributions are made. I have received numerous calls from participants who did
disclose and still got fined because the forms were not prepared properly. A plan
administrator told me that he assisted hundreds of his participants file forms, and
they still all received very large IRS fines for not properly filling in the forms.
IRS has been attacking all 419 welfare benefit plans, many 412i retirement plans,
captive insurance plans with life insurance in them, and Section 79 plans.
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.
taxadvisorexpert.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.
Insurance, and Section 79 Scams
Article Biz June 2011
Lance Wallach
The IRS started auditing 419 plans in the ‘90s, and then continued going after 412i
and other plans that they considered abusive, listed, or reportable transactions.
Listed designated as listed in published IRS material available to the general public
or transactions that are substantially similar to the specific listed transactions. A
reportable transaction is defined simply as one that has the potential for tax
avoidance or evasion.
In a recent Tax Court Case, Curcio v. Commissioner (TC Memo 2010-15), the Tax
Court ruled that an investment in an employee welfare benefit plan marketed under
the name "Benistar" was a listed transaction in that the transaction in question was
substantially similar to the transaction described in IRS Notice 95-34. A subsequent
case, McGehee Family Clinic, largely followed Curcio, though it was technically
decided on other grounds. The parties stipulated to be bound by Curcio on the issue
of whether the amounts paid by McGehee in connection with the Benistar 419 Plan
and Trust were deductible. Curcio did not appear to have been decided yet at the
time McGehee was argued. The McGehee opinion (Case No. 10-102) (United States
Tax Court, September 15, 2010) does contain an exhaustive analysis and discussion
of virtually all of the relevant issues.
Taxpayers and their representatives should be aware that the Service has
disallowed deductions for contributions to these arrangements. The IRS is cracking
down on small business owners who participate in tax reduction insurance plans and
the brokers who sold them. Some of these plans include defined benefit retirement
plans, IRAs, or even 401(k) plans with life insurance.
In order to fully grasp the severity of the situation, one must have an understanding
of Notice 95-34, which was issued in response to trust arrangements sold to
companies that were designed to provide deductible benefits such as life insurance,
disability and severance pay benefits. The promoters of these arrangements claimed
that all employer contributions were tax-deductible when paid, by relying on the 10-
or-more-employer exemption from the IRC § 419 limits. It was claimed that
permissible tax deductions were unlimited in amount.
In general, contributions to a welfare benefit fund are not fully deductible when paid.
Sections 419 and 419A impose strict limits on the amount of tax-deductible
prefunding permitted for contributions to a welfare benefit fund. Section 419A(F)(6)
provides an exemption from Section 419 and Section 419A for certain "10-or-more
employers" welfare benefit funds. In general, for this exemption to apply, the fund
must have more than one contributing employer, of which no single employer can
contribute more than 10% of the total contributions, and the plan must not be
experience-rated with respect to individual employers.
According to the Notice, these arrangements typically involve an investment in
variable life or universal life insurance contracts on the lives of the covered
employees. The problem is that the employer contributions are large relative to the
cost of the amount of term insurance that would be required to provide the death
benefits under the arrangement, and the trust administrator may obtain cash to pay
benefits other than death benefits, by such means as cashing in or withdrawing the
cash value of the insurance policies. The plans are also often designed so that a
particular employer’s contributions or its employees’ benefits may be determined in a
way that insulates the employer to a significant extent from the experience of other
subscribing employers. In general, the contributions and claimed tax deductions tend
to be disproportionate to the economic realities of the arrangements.
Benistar advertised that enrollees should expect to obtain the same type of tax
benefits as listed in the transaction described in Notice 95-34. The benefits of
enrollment listed in its advertising packet included:
Virtually unlimited deductions for the employer;
Contributions could vary from year to year;
Benefits could be provided to one or more key executives on a selective basis;
No need to provide benefits to rank-and-file employees;
Contributions to the plan were not limited by qualified plan rules and would not
interfere with pension, profit sharing or 401(k) plans;
Funds inside the plan would accumulate tax-free;
Beneficiaries could receive death proceeds free of both income tax and estate tax;
The program could be arranged for tax-free distribution at a later date;
Funds in the plan were secure from the hands of creditors.
The Court said that the Benistar Plan was factually similar to the plans described in
Notice 95-34 at all relevant times.
In rendering its decision the court heavily cited Curcio, in which the court also ruled
in favor of the IRS. As noted in Curcio, the insurance policies, overwhelmingly
variable or universal life policies, required large contributions relative to the cost of
the amount of term insurance that would be required to provide the death benefits
under the arrangement. The Benistar Plan owned the insurance contracts.
Following Curcio, as the parties had stipulated, on the question of the amnesty paid
by Mcghee in connection with benistar, the Court held that the contributions to
Benistar were not deductible under section 162(a) because participants could
receive the value reflected in the underlying insurance policies purchased by
Benistar—despite the payment of benefits by Benistar seeming to be contingent
upon an unanticipated event (the death of the insured while employed). As long as
plan participants were willing to abide by Benistar’s distribution policies, there was no
reason ever to forfeit a policy to the plan. In fact, in estimating life insurance rates,
the taxpayers’ expert in Curcio assumed that there would be no forfeitures, even
though he admitted that an insurance company would generally assume a
reasonable rate of policy lapses.
The McGehee Family Clinic had enrolled in the Benistar Plan in May 2001 and
claimed deductions for contributions to it in 2002 and 2005. The returns did not
include a Form 8886, Reportable Transaction Disclosure Statement, or similar
disclosure.
The IRS disallowed the latter deduction and adjusted the 2004 return of shareholder
Robert Prosser and his wife to include the $50,000 payment to the plan. The IRS
also assessed tax deficiencies and the enhanced 30% penalty totaling almost
$21,000 against the clinic and $21,000 against the Prossers. The court ruled that
the Prossers failed to prove a reasonable cause or good faith exception.
More you should know:
In recent years, some section 412(i) plans have been funded with life insurance
using face amounts in excess of the maximum death benefit a qualified plan is
permitted to pay. Ideally, the plan should limit the proceeds that can be paid as a
death benefit in the event of a participant’s death. Excess amounts would revert to
the plan. Effective February 13, 2004, the purchase of excessive life insurance in
any plan makes the plan a listed transaction if the face amount of the insurance
exceeds the amount that can be issued by $100,000 or more and the employer has
deducted the premiums for the insurance.
A 412(i) plan in and of itself is not a listed transaction; however, the IRS has a task
force auditing 412i plans.
An employer has not engaged in a listed transaction simply because it is in a 412(i)
plan.
Just because a 412(i) plan was audited and sanctioned for certain items, does not
necessarily mean the plan is a listed transaction. Some 412(i) plans have been
audited and sanctioned for issues not related to listed transactions.
Companies should carefully evaluate proposed investments in plans such as the
Benistar Plan. The claimed deductions will not be available, and penalties will be
assessed for lack of disclosure if the investment is similar to the investments
described in Notice 95-34. In addition, under IRC 6707A, IRS fines participants a
large amount of money for not properly disclosing their participation in listed or
reportable or similar transactions; an issue that was not before the Tax Court in
either Curcio or McGehee. The disclosure needs to be made for every year the
participant is in a plan. The forms need to be properly filed even for years that no
contributions are made. I have received numerous calls from participants who did
disclose and still got fined because the forms were not prepared properly. A plan
administrator told me that he assisted hundreds of his participants file forms, and
they still all received very large IRS fines for not properly filling in the forms.
IRS has been attacking all 419 welfare benefit plans, many 412i retirement plans,
captive insurance plans with life insurance in them, and Section 79 plans.
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.
taxadvisorexpert.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.