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Abusive Insurance, Welfare Benefit, and Retirement Plans
The A2Z Directory March 2011
Lance Wallach
The IRS has various task forces auditing all section 419, section 412(i), and other plans that tend
to be abusive. Most insurance agents sell these plans. The IRS is looking to raise money and is
not looking to correct plans or help taxpayers. The IRS calls accountants, attorneys, and
insurance agents “material advisors” and also fines them the same amount, again unless the
client’s participation in the transaction is reported. An accountant is a material advisor if he
signs the return or gives advice and gets paid. More details can be found on http://www.irs.gov
and http://www.vebaplan.com.
Bruce Hink, who has given me written permission to use his name and circumstances, is a
perfect example of what the IRS is doing to unsuspecting business owners. What follows is a
story about how the IRS fines him each 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 as material advisors. We have received
many calls for help from accountants, attorneys, business owners, and insurance agents in
similar situations. Don’t think this will happen to you? It is happening to a lot of accountants and
business owners, because most of theses so-called listed, abusive, or insurance agents are
selling substantially similar plans. Recently I came across the case of Hink, a small business
owner who is facing thousands in IRS penalties for 2004 and 2005 because of his participation in
a section 412(i) plan. (The penalties were assessed under section 6707A.)
In 2002 an insurance agent representing a 100-year-old, well-established insurance company
suggested the owner start a pension plan. The owner was given a portfolio of information from
the insurance company, which was given to the company’s outside CPA to review and give an
opinion on. The CPA gave the plan the green light and the plan was started. Contributions were
made in 2003. The plan administrator came out with amendments to the plan, based on new IRS
guidelines, in October 2004. The business owner’s insurance agent disappeared in May 2005,
before implementing the new guidelines from the administrator with the insurance company.
The business owner was left with a refund check from the insurance company, a deduction
claim on his 2004 tax return that had not been applied, and no agent.
It took six months of making calls to the insurance company to get a new insurance agent
assigned. By then, the IRS had started an examination of the pension plan. Asking advice from
the CPA and a local attorney (who had no previous experience in these cases) made matters
worse, with a “big name” law firm being recommended and additional legal fees being billed in
three months. To make a long story short, the audit stretched on for over 2 ½ years to examine a
2-year-old pension with four participants and the 8,000 in contributions. During the audit, no funds
went to the insurance company, which was awaiting formal IRS approval on restructuring the
plan as a traditional defined benefit plan, which the administrator had suggested and the IRS had
indicated would be acceptable.In March 2008 the business owner received a private e-mail
apology from the IRS agent who headed the examination, saying that her hands were tied and
that she used to believe she was correcting problems and helping taxpayers and not hurting
people.
Could you or one of your clients be next?
To this point, I have focused, generally, on the horrors of running afoul of the IRS by participating
in a listed transaction, which includes various types of transactions and the various fines that
can be imposed on business owners and their advisors who participate in, sell, or advice on
these transactions. I happened to use, as an example, someone in a section 412(i) plan, which
was deemed to be a listed transaction, pointing out the truly doleful consequences the person
has suffered. Others who fall into this trap, even unwittingly, can suffer the same fate.
Now let’s go into more detail about section 412(i) plans. This is important because these defined
benefit plans are popular and because few people think of retirement plans as tax shelters or
listed transactions. People therefore may get into serious trouble in this area unwittingly, out of
ignorance of the law, and, for the same reason, many fail to take necessary and appropriate
precautions. The IRS has warned against the section 412(i) defined benefit pension plans, named
for the former code section governing them. It warned against trust arrangements it deems
abusive, some of which may be regarded as listed transactions. Falling into that category can
result in taxpayers having to disclose the participation under pain of penalties. Targets also
include some retirement plans.
One reason for the harsh treatment of some 412(i) plans is their discrimination in favor of
owners and key, highly compensated employees. Also, the IRS does not consider the promised
tax relief proportionate to the economic realities of the transactions. In general, IRS auditors
divide audited plan into those they consider noncompliant and other they consider abusive. While
the alternatives available to the sponsor of noncompliant plan are problematic, it is frequently an
option to keep the plan alive in some form while simultaneously hoping to minimize the financial
fallout from penalties.
The sponsor of an abusive plan can expect to be treated more harshly than participants.
Although in some situation something can be salvaged, the possibility is definitely on the table of
having to treat the plan as if it never existed, which of course triggers the full extent of back
taxes, penalties, and interest on all contributions that were made – not to mention leaving behind
no retirement plan whatsoever. Another plan the IRS is auditing is the section 419 plan. A few
listed transactions concern relatively common employee benefit plans the IRS has deemed tax
avoidance schemes or otherwise abusive. Perhaps some of the most likely to crop up,
especially in small-business returns, are the arrangements purporting to allow the deductibility
of premiums paid for life insurance under a welfare benefit plan or section 419 plan. These plans
have been sold by most insurance agents and insurance companies.
Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA
faculty of teaching professionals, is a frequent speaker on retirement plans, abusive tax
shelters, financial, international tax, and estate planning. He writes about 412(i), 419, Section79,
FBAR, and captive insurance plans. He speaks at more than ten conventions annually, writes for
over fifty publications, is quoted regularly in the press and has been featured on television and
radio financial talk shows including NBC, National Pubic Radio’s All Things Considered, and
others. Lance has written numerous books including Protecting Clients from Fraud,
Incompetence and Scams published by John Wiley and Sons, Bisk Education’s CPA’s Guide to
Life Insurance and Federal Estate and Gift Taxation, as well as the AICPA best-selling books,
including Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot
Spots. He does expert witness testimony and has never lost a case. Contact him at
516.938.5007, wallachinc@gmail.com or visit www.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.
The A2Z Directory March 2011
Lance Wallach
The IRS has various task forces auditing all section 419, section 412(i), and other plans that tend
to be abusive. Most insurance agents sell these plans. The IRS is looking to raise money and is
not looking to correct plans or help taxpayers. The IRS calls accountants, attorneys, and
insurance agents “material advisors” and also fines them the same amount, again unless the
client’s participation in the transaction is reported. An accountant is a material advisor if he
signs the return or gives advice and gets paid. More details can be found on http://www.irs.gov
and http://www.vebaplan.com.
Bruce Hink, who has given me written permission to use his name and circumstances, is a
perfect example of what the IRS is doing to unsuspecting business owners. What follows is a
story about how the IRS fines him each 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 as material advisors. We have received
many calls for help from accountants, attorneys, business owners, and insurance agents in
similar situations. Don’t think this will happen to you? It is happening to a lot of accountants and
business owners, because most of theses so-called listed, abusive, or insurance agents are
selling substantially similar plans. Recently I came across the case of Hink, a small business
owner who is facing thousands in IRS penalties for 2004 and 2005 because of his participation in
a section 412(i) plan. (The penalties were assessed under section 6707A.)
In 2002 an insurance agent representing a 100-year-old, well-established insurance company
suggested the owner start a pension plan. The owner was given a portfolio of information from
the insurance company, which was given to the company’s outside CPA to review and give an
opinion on. The CPA gave the plan the green light and the plan was started. Contributions were
made in 2003. The plan administrator came out with amendments to the plan, based on new IRS
guidelines, in October 2004. The business owner’s insurance agent disappeared in May 2005,
before implementing the new guidelines from the administrator with the insurance company.
The business owner was left with a refund check from the insurance company, a deduction
claim on his 2004 tax return that had not been applied, and no agent.
It took six months of making calls to the insurance company to get a new insurance agent
assigned. By then, the IRS had started an examination of the pension plan. Asking advice from
the CPA and a local attorney (who had no previous experience in these cases) made matters
worse, with a “big name” law firm being recommended and additional legal fees being billed in
three months. To make a long story short, the audit stretched on for over 2 ½ years to examine a
2-year-old pension with four participants and the 8,000 in contributions. During the audit, no funds
went to the insurance company, which was awaiting formal IRS approval on restructuring the
plan as a traditional defined benefit plan, which the administrator had suggested and the IRS had
indicated would be acceptable.In March 2008 the business owner received a private e-mail
apology from the IRS agent who headed the examination, saying that her hands were tied and
that she used to believe she was correcting problems and helping taxpayers and not hurting
people.
Could you or one of your clients be next?
To this point, I have focused, generally, on the horrors of running afoul of the IRS by participating
in a listed transaction, which includes various types of transactions and the various fines that
can be imposed on business owners and their advisors who participate in, sell, or advice on
these transactions. I happened to use, as an example, someone in a section 412(i) plan, which
was deemed to be a listed transaction, pointing out the truly doleful consequences the person
has suffered. Others who fall into this trap, even unwittingly, can suffer the same fate.
Now let’s go into more detail about section 412(i) plans. This is important because these defined
benefit plans are popular and because few people think of retirement plans as tax shelters or
listed transactions. People therefore may get into serious trouble in this area unwittingly, out of
ignorance of the law, and, for the same reason, many fail to take necessary and appropriate
precautions. The IRS has warned against the section 412(i) defined benefit pension plans, named
for the former code section governing them. It warned against trust arrangements it deems
abusive, some of which may be regarded as listed transactions. Falling into that category can
result in taxpayers having to disclose the participation under pain of penalties. Targets also
include some retirement plans.
One reason for the harsh treatment of some 412(i) plans is their discrimination in favor of
owners and key, highly compensated employees. Also, the IRS does not consider the promised
tax relief proportionate to the economic realities of the transactions. In general, IRS auditors
divide audited plan into those they consider noncompliant and other they consider abusive. While
the alternatives available to the sponsor of noncompliant plan are problematic, it is frequently an
option to keep the plan alive in some form while simultaneously hoping to minimize the financial
fallout from penalties.
The sponsor of an abusive plan can expect to be treated more harshly than participants.
Although in some situation something can be salvaged, the possibility is definitely on the table of
having to treat the plan as if it never existed, which of course triggers the full extent of back
taxes, penalties, and interest on all contributions that were made – not to mention leaving behind
no retirement plan whatsoever. Another plan the IRS is auditing is the section 419 plan. A few
listed transactions concern relatively common employee benefit plans the IRS has deemed tax
avoidance schemes or otherwise abusive. Perhaps some of the most likely to crop up,
especially in small-business returns, are the arrangements purporting to allow the deductibility
of premiums paid for life insurance under a welfare benefit plan or section 419 plan. These plans
have been sold by most insurance agents and insurance companies.
Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA
faculty of teaching professionals, is a frequent speaker on retirement plans, abusive tax
shelters, financial, international tax, and estate planning. He writes about 412(i), 419, Section79,
FBAR, and captive insurance plans. He speaks at more than ten conventions annually, writes for
over fifty publications, is quoted regularly in the press and has been featured on television and
radio financial talk shows including NBC, National Pubic Radio’s All Things Considered, and
others. Lance has written numerous books including Protecting Clients from Fraud,
Incompetence and Scams published by John Wiley and Sons, Bisk Education’s CPA’s Guide to
Life Insurance and Federal Estate and Gift Taxation, as well as the AICPA best-selling books,
including Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot
Spots. He does expert witness testimony and has never lost a case. Contact him at
516.938.5007, wallachinc@gmail.com or visit www.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.
Small Business Retirement Plans Fuel Litigation
Maryland Trial Lawyer
Dolan Media
Newswires January
Small businesses facing audits and potentially huge tax penalties over certain types of
retirement plans are filing lawsuits against those who marketed, designed and sold the plans.
The 412(i) and 419(e) plans were marketed in the past several years as a way for small business
owners to set up retirement or welfare benefits plans while leveraging huge tax savings, but the
IRS put them on a list of abusive tax shelters and has more recently focused audits on them.
The penalties for such transactions are extremely high and can pile up quickly.
There are business owners who owe taxes but have been assessed 2 million in penalties. The
existing cases involve many types of businesses, including doctors’ offices, dental practices,
grocery store owners, mortgage companies and restaurant owners. Some are trying to
negotiate with the IRS. Others are not waiting. A class action has been filed and cases in several
states are ongoing. The business owners claim that they were targeted by insurance
companies; and their agents to purchase the plans without any disclosure that the IRS viewed
the plans as abusive tax shelters. Other defendants include financial advisors who
recommended the plans, accountants who failed to fill out required tax forms and law firms that
drafted opinion letters legitimizing the plans, which were used as marketing tools.
A 412(i) plan is a form of defined benefit pension plan. A 419(e) plan is a similar type of health
and benefits plan. Typically, these were sold to small, privately held businesses with fewer than
20 employees and several million dollars in gross revenues. What distinguished a legitimate plan
from the plans at issue were the life insurance policies used to fund them. The employer would
make large cash contributions in the form of insurance premiums, deducting the entire
amounts. The insurance policy was designed to have a “springing cash value,” meaning that for
the first 5-7 years it would have a near-zero cash value, and then spring up in value.
Just before it sprung, the owner would purchase the policy from the trust at the low cash value,
thus making a tax-free transaction. After the cash value shot up, the owner could take tax-free
loans against it. Meanwhile, the insurance agents collected exorbitant commissions on the
premiums – 80 to 110 percent of the first year’s premium, which could exceed million.
Technically, the IRS’s problems with the plans were that the “springing cash” structure
disqualified them from being 412(i) plans and that the premiums, which dwarfed any payout to a
beneficiary, violated incidental death benefit rules.
Under §6707A of the Internal Revenue Code, once the IRS flags something as an abusive tax
shelter, or “listed transaction,” penalties are imposed per year for each failure to disclose it.
Another allegation is that businesses weren’t told that they had to file Form 8886, which
discloses a listed transaction.
According to Lance Wallach of Plainview, N.Y. (516-938-5007), who testifies as an expert in
cases involving the plans, the vast majority of accountants either did not file the forms for their
clients or did not fill them out correctly.
Because the IRS did not begin to focus audits on these types of plans until some years after they
became listed transactions, the penalties have already stacked up by the time of the audits.
Another reason plaintiffs are going to court is that there are few alternatives – the penalties are
not appeasable and must be paid before filing an administrative claim for a refund.
The suits allege misrepresentation, fraud and other consumer claims. “In street language, they
lied,” said Peter Losavio, a plaintiffs’ attorney in Baton Rouge, La., who is investigating several
cases. So far they have had mixed results. Losavio said that the strength of an individual case
would depend on the disclosures made and what the sellers knew or should have known about
the risks.
In 2004, the IRS issued notices and revenue rulings indicating that the plans were listed
transactions. But plaintiffs’ lawyers allege that there were earlier signs that the plans ran afoul
of the tax laws, evidenced by the fact that the IRS is auditing plans that existed before 2004.
“Insurance companies were aware this was dancing a tightrope,” said William Noll, a tax
attorney in Malvern, Pa. “These plans were being scrutinized by the IRS at the same time they
were being promoted, but there wasn’t any disclosure of the scrutiny to unwitting customers.”
A defense attorney, who represents benefits professionals in pending lawsuits, said the main
defense is that the plans complied with the regulations at the time and that “nobody can predict
the future.”
An employee benefits attorney who has settled several cases against insurance companies,
said that although the lost tax benefit is not recoverable, other damages include the hefty
commissions – which in one of his cases amounted to 400,000 the first year – as well as the
costs of handling the audit and filing amended tax returns.
Defying the individualized approach an attorney filed a class action in federal court against four
insurance companies claiming that they were aware that since the 1980s the IRS had been
calling the policies potentially abusive and that in 2002 the IRS gave lectures calling the plans not
just abusive but “criminal.” A judge dismissed the case against one of the insurers that sold 412
(i) plans.
The court said that the plaintiffs failed to show the statements made by the insurance
companies were fraudulent at the time they were made, because IRS statements prior to the
revenue rulings indicated that the agency may or may not take the position that the plans were
abusive. The attorney, whose suit also names law firm for its opinion letters approving the plans,
will appeal the dismissal to the 5th Circuit.
In a case that survived a similar motion to dismiss, a small business owner is suing Hartford
Insurance to recover a “seven-figure” sum in penalties and fees paid to the IRS. A trial is
expected in August.
But tax experts say the audits and penalties continue. “There’s a bit of a disconnect between
what members of Congress thought they meant by suspending collection and what is happening
in practice. Clients are still getting bills and threats of liens,” Wallach said. “Thousands of
business owners are being hit with million-dollar-plus fines. … The audits are continuing and
escalating. I just got four calls today,” he said. A bill has been introduced in Congress to make
the penalties less draconian, but nobody is expecting a magic bullet.
“From what we know, Congress is looking to make the penalties more proportionate to the tax
benefit received instead of a fixed amount.”
Lance Wallach can be reached at: WallachInc@gmail.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.