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NCCPAP November 2010 Newsletter 2010
Business Owners in 419, 412i, Section 79 and Captive Insurance Plans Will Probably Be Fined by the
IRS Under Section 6707A
Lance Wallach
Taxpayers who previously adopted 419, 412i, captive insurance or Section 79 plans are in big trouble. In recent years, the IRS has identified
many of these 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 the taxpayer does not necessarily have to make a contribution or claim a tax deduction to be deemed
to participate. Section 6707A of the Code imposes severe penalties ($200,000 for a business and $100,000 for an individual) for failure to file
Form 8886 with respect to a listed transaction. But a taxpayer can also be in trouble if they file incorrectly. I have received numerous phone
calls from business owners who filed and still got fined. Not only does
the taxpayer have to file Form 8886, but 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 told me that the form was prepared 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
they 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 the deductions
taken in prior years. 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.
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; speaks at more than ten conventions annually; writes for over fifty publications; is quoted regularly in the press; and has been featured
on TV and radio financial talk shows. Lance has written numerous books including Protecting Clients from Fraud, Incompetence and Scams
(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. Contact him at 516.938.5007, wallachinc@gmail.com www.lancewallack.com,
www.taxadvisorexperts.org or www.taxaudit419.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.
Business Owners in 419, 412i, Section 79 and Captive Insurance Plans Will Probably Be Fined by the
IRS Under Section 6707A
Lance Wallach
Taxpayers who previously adopted 419, 412i, captive insurance or Section 79 plans are in big trouble. In recent years, the IRS has identified
many of these 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 the taxpayer does not necessarily have to make a contribution or claim a tax deduction to be deemed
to participate. Section 6707A of the Code imposes severe penalties ($200,000 for a business and $100,000 for an individual) for failure to file
Form 8886 with respect to a listed transaction. But a taxpayer can also be in trouble if they file incorrectly. I have received numerous phone
calls from business owners who filed and still got fined. Not only does
the taxpayer have to file Form 8886, but 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 told me that the form was prepared 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
they 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 the deductions
taken in prior years. 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.
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; speaks at more than ten conventions annually; writes for over fifty publications; is quoted regularly in the press; and has been featured
on TV and radio financial talk shows. Lance has written numerous books including Protecting Clients from Fraud, Incompetence and Scams
(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. Contact him at 516.938.5007, wallachinc@gmail.com www.lancewallack.com,
www.taxadvisorexperts.org or www.taxaudit419.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.
Small Business Retirement Plans Fuel Litigation
Maryland Trial Lawyer
Dolan Media Newswires January
Lance Wallach
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.