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IRS Attacks Business Owners, Accountants, Lawsuits over 412(i)/419 and Similar Insurance Based Plans

A 412(i) plan is a “defined benefit plan” – a retirement plan, a pension plan that claims to offer very large tax deductions. It is funded with annuity and life insurance products.

Late 1990's/early 2000's, agents sold life insurance, and annuity policies to fund such plans.

Type of policy typically had high surrender charges, depressed cash value in early years - premiums paid by employer

After premiums funded for a few years, employee purchases policy for the current depressed cash surrender value

After policy purchased, surrender charges dramatically reduced, cash value “springs” to a high level

Employee could then borrow from high value policy for tax-free cash flow. They were called springing cash value policies.

Not all policies were of that type.

In 1995 IRS issued IRS notice 9534 warning that they would come after 419 plans. In 2004/2005, IRS began investigating and issued regulations deeming such plans as abusive tax shelters - began nationwide audits of such plans.

Plaintiffs in these matters are typically professional groups (doctors, dentists, small business owners) audited by the IRS - plans deemed abusive tax shelters – subject to substantial fees and penalties. Participants must file under IRS 6707A to avoid additional large fines. Material advisors, people that sold the plans and accountants that gave tax advice and got paid also get fined a minimum of $100,000 if they do not properly file and tell on their client.

Professionals then file suit against insurance companies and agents claiming they were misled in the sale of these plans and policies.

Allegations typically:

defendants represented that policies used to fund plans would be valid and subject to favorable future tax consequences

To Date - Mixed Results for Carriers:

1. Breach of contract

Claim dismissed - contract never promised to satisfy § 412 requirements, specifically stated that it did not guarantee any future tax consequences. Zarrella v. Pacific Life, 755 F. Supp. 2d 1231 (S.D. FL March 29, 2011) (Florida law)

Claim allowed to proceed - allegations pled existence of written and oral contracts promising tax benefits. Chau v. Aviva Life, 2011 U.S. Dist. LEXIS 54828 (N.D. Tex May 20, 2011) (applying Washington law).

2. Negligence

Claim dismissed because carrier is under no duty to advise its insured’s regarding tax consequences of transactions. Zarrella v. Pacific Life, (S.D. FL March 29, 2011).

3. Fraud/Misrepresentation

A. Future statements:

alleged misrepresentations made before the IRS pronouncements calling into question tax benefits of the various plans generally dismissed on grounds:

(i) statements were not false when made, or

(ii) statements were mere opinions or predictions that are not actionable.

Berry v. Indianapolis Life, 608 F. Supp. 2d 785 (N.D. Tex. 2009, August 26, 2010)

Zarrella v. Pacific Life, 755 F. Supp. 2d 1231 (S.D. FL March 29, 2011)

Chau v. Aviva Life, 2011 U.S. Dist. LEXIS 54828 (N.D. Tex May 20, 2011)

Courts generally determine that statements made by agents prior to 2004/2005 are “forward-looking” statements or “opinions” and that “as a matter of law, any representation or prediction by any alleged agent as to how the IRS would treat the 412(i) plans and finding thereof in the future is either an unactionable opinion or was unjustifiably relied upon.” Berry v. Indianapolis Life

To Date - Mixed Results for Carriers:

B. “Disclaimer of Reliance” defense – results mixed

Typically, in the plan documents, participant agrees he is not relying on carrier’s representations regarding the validity of the plan or its tax benefits - instead relying on own independent tax advisor

Cal. law – signed disclosure statements by plaintiffs preclude reasonable reliance on representations as a matter of law - claim dismissed.

Berry v. Indianapolis Life

Omni Home v. Hartford Life, 2008 Dist. LEXIS 35259 (S.D. Cal. April 29, 2008).

Texas and Wisconsin law – disclosure documents do not preclude reliance as a matter of law. Berry v. Indianapolis Life

To date, success in dismissing claims depends upon the different courts, and applicable governing law.

Note: If alleged misrepresentations made after applicable IRS pronouncement, then representations are not predictions or opinions, but rather statements regarding the existing state of the law – probably allowed to proceed.

By Lance Wallach, CLU, CHFC
Abusive Tax Shelter, Listed Transaction, Reportable Transaction Expert Witness
Lance Wallach, CLU, ChFC, CIMC, speaks and writes extensively about financial planning, retirement plans, and tax reduction strategies. He is an American Institute of CPA’s course developer and instructor and has authored numerous best selling books about abusive tax shelters, IRS crackdowns and attacks and other tax matters. He speaks at more than 20 national conventions annually and writes for more than 50 national publications. As an expert witness his side has never lost a case.

Copyright Lance Wallach, CLU, CHFC

Disclaimer: 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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