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Section 79 and Other Abusive Plans Being Audited IRS


     By Lance Wallach, CLU, CHFC Abusive Tax Shelter, Listed Transaction, Reportable Transaction Expert Witness

PhoneCall Lance Wallach, National Society of Accountants Speaker of the Year at (516) 938-5007


The IRS is on guard and starting to attack Section 79 plans. The decision to participate in such plan requires commitment to ensure the legality and proper guidelines are being followed in income inclusion, tax deductions and reporting. Based on the number of phone calls we are receiving from people being audited in abusive Section 79 plans the buyer must be very careful.
Today I discovered that the IRS is considering section 79 plans with life insurance in them, as plans similar to listed transactions. The conclusion to me is that if anyone is in a section 79 plan they must file under section 6707a to avoid the horrendous IRS fines.

As the red flags are raised regarding Section 79 plans, there are court cases reflecting this as well. For example, Curcio v. Commissioner (TC Memo 2010-115), the tax court ruled that an investment in an employee welfare benefit plan named Benistar was a listed transaction in that the transaction in question was substantially similar to the transaction earlier described and designated as a listed transaction. I am an expert witness in some potential cases against Benistar and the insurance agents and companies that were involved with Benistar, Grist Mill Trust, Nova, and other related Benistar entities. The IRS raided their offices and removed client files if someone is in one of these plans they must immediately take action.

McGehee Family Clinic, P.A., et al. v. Commissioner, TC Memo 2010-202 was in favor of the commissioner and imposed penalties as a result of the understatement of income from the overstatement of deductions.

These are great examples illustrating the risk Section 79 plans pose to employees who are virtually unaware of such breach but will be held responsible for participation in a listed transaction as a result. Participants of Section 79 plans must be very cautious and pay close attention to the laws, regulations, and guidelines.

In recent years, the IRS has identified many 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 you do not necessarily have to make a contribution or claim a tax deduction to participate. Section 6707A of the Code imposes severe penalties, for failure to file Form 8886 with respect to a listed transaction.

But you are also in trouble if you file incorrectly.

I have received numerous phone calls from business owners who filed and still got fined. Not only do you have to file Form 8886, but also 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 tell me that was 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 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 its deductions. 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.

The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.

ABOUT THE AUTHOR: Lance Wallach, National Society of Accountants Speaker of the Year
Lance has written numerous books including Protecting Clients from Fraud, Incompetence and Scams published by John Wiley and Sons, Bisk Education's CPA's Guide to Life Insurance and Federal Estate and Gift Taxation, as well as AICPA best-selling books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots. He does expert witness testimony and has never lost a case.

Copyright Lance Wallach, CLU, CHFC

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While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.

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