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Large IRS Fines for Participants in 419, 412i, Captive Insurance, Section 79 Plans

In a recent U.S. Tax Court case, some taxpayers suffered a double loss. The taxpayers, consisting of four couples, had purchased welfare benefit plans marketed by Benistar 419 Plan Services. Under the plan, Benistar provided pre-retirement life insurance to select employees of companies enrolled in the plan.

Small employers like the plans because they allow pretax contributions to be shielded from taxation. The plan was marketed through seminars geared towards insurance agents. Benistar did not sell directly to the participants. Ultimately, the court decided that contributions to the plan were not tax deductible.

The loss of the deduction is not the only loss suffered by the taxpayers in this case. In addition to losing the tax deduction on the plan contributions, and the resulting hefty tax bill, the taxpayers were also assessed with penalties. The taxpayers argued that they acted in good faith and with reasonable cause stating they had relied on professional advice. While the taxpayers claimed they relied on their accountants, the court found that there was no evidence the accountants had any particular expertise in welfare benefit plans or that the taxpayers thought their accountants possessed such expertise.

The court did acknowledge that a prominent tax lawyer and author of a book on 419 plans developed the Benistar plan. The court also acknowledged the several legal opinions finding the Benistar plans were not abusive tax shelters. Again, that was not good enough for the court. What does all this mean? The IRS and U.S. Tax Court look unfavorably on welfare benefit and other 419 plans.

Businesses that invested in these plans can expect the IRS to disallow the tax benefits that made these plans so attractive. Not only will the deductions be disallowed, penalties will likely be imposed. Notwithstanding all the legal opinions that surround many of these plans, the tax court will likely find that there was no reasonable reliance on professional advice. The court found specifically that taxpayers couldn’t rely on the advice of insurance agents. Even reliance on accountants and legal opinions may not be enough.

Not at issue in the tax court decision were the huge penalties the IRS now imposes for engaging in a listed transaction under IRS code 6707A. The IRS considers many of these plans to be abusive tax shelters requiring additional disclosures to be filed with the IRS. Because that was not addressed in this court opinion, it is difficult to know with certainty how the IRS will treat these penalties. Everything else with welfare benefit plans, however, suggests the IRS will also be strict with these penalties.

Taxpayers and their representatives should be aware that the Service has disallowed deductions for contributions to these arrangements and other schemes that are substantially similar to them. The IRS is cracking down on small business owners who participate in tax reduction insurance plans and the brokers and others who sell them. Some of these plans include defined benefit retirement plans, 419 welfare benefit plans, 412(i) plans, captive insurance, Section 79 plans, IRA s, or even 401(k) plans with life insurance.

Some Section 412(i) plans have been funded with life insurance using face amounts in excess of the qualified 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 renders that particular 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 is not in and of itself a listed transaction. However, the IRS does have a task force auditing 412(i) plans. An employer has not necessarily engaged in a listed transaction simply by virtue of participation in a Section 412(i) plan.

Simply because a 412(i) plan was audited and sanctioned for certain items does not necessarily mean that the plan is a listed transaction. Some Section 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 be disallowed, and penalties will be assessed for lack of disclosure if the investment is similar to the investments described in Notice 95-34, to wit: if the transaction is a listed transaction and Form 8886 is either not filed at all or is not properly filed. In addition, under IRC Section 6707A, the IRS fines participants a large amount of money for not properly disclosing their participation in listed or reportable transactions, an issue that was not before the court in either Curcio or McGehee. A listed transaction is one which has been specifically designated as such by the Service in a written pronouncement that is available to the general public , or which is substantially similar to such a transaction; a reportable transaction, quite simply, is any transaction having the potential for tax avoidance or evasion.

The disclosure needs to be made for every year that a participant is in the plan. The forms need to be properly filed even for years when no contribution was made. I have received numerous telephone calls from participants who did disclose and were still fined because the forms were not properly prepared. A plan administrator told me that he helped hundreds of his participants to file, and they still all received very large IRs fines for not properly preparing the forms. Do not follow the plan promoter’s directions as to how to file Form 8886. If you did, immediately re-file the forms and use someone who has extensive experience preparing the forms. I would not use someone to redo or to do the forms unless he or she has prepared many others and has had no, or at most very little trouble with the IRS on this issue.

The IRS has been attacking all Section 419 welfare benefit plans, many 412(i) retirement plans, captive insurance plans with life insurance inside of them, and Section 79 plans. I have received hundreds of telephone calls from accountants, business owners, and others who are being attacked by the IRS because of their participation in these plans. Accountants who sign tax returns and/or meet a certain income threshold are called material advisors by the IRS. They also have a disclosure obligation, and failure to meet it results in fines of $100,000 for individuals and $200,000 for corporations.

By Lance Wallach, CLU, CHFC
Abusive Tax Shelter, Listed Transaction, Reportable Transaction Expert Witness
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. He speaks at more than ten conventions annually, writes for more than 20 publications, is quoted regularly in the press and has been featured on television and radio financial talk shows.

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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