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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.