Understanding IRC Sections 419(e) and 419A(f)(6) Plans

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Small Business Retirement Plans Fuel Litigation Maryland Trial Lawyer Dolan Media Newswires

Small Business Retirement Plans Fuel Litigation

Maryland Trial Lawyer- Dolan Media Newswires

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.comFor more information, please visit http://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 http://www.taxadvisorexperts.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.

Tax Shelter Penalty Cases Hurt Thousands of Small Business Owners

Gerson Lehrman Group

March, 2011

  • Analysis by: GLG Expert Contributor Lance Wallach

Summary

Insurance agents and others sell 412i, 419, captive insurance and section 79 plans to unsuspecting business owners. Since the IRS is calling these plans abusive tax shelters, many small business owners are getting audited and getting penalties under IRC 6707A. They have even fined material advisors and accountants for their participation, and small business owners need to know how to protect themselves from the long reach of the IRS.

Analysis

Insurance agents and others sell 412i, 419, captive insurance and section 79 scams to unsuspecting business owners. The IRS considers many of these plans abusive tax shelters, listed transactions, reportable transactions, or what it calls “similar to,” which allows them to target the plan. The unsuspecting business owners then get audited by the IRS, lose their deductions, and pay interest and penalties. Then comes the bad news. The IRS comes back and fines the business owners a large amount of money for not properly filing under IRC 6707A. They have even fined hundreds of business owners who have filed. The IRS says that they prepared the forms incorrectly or filed improperly, or lied to the IRS.

Taxpayers must report certain transactions to the IRS under Section 6707A of the Tax Code, which was enacted in 2004 to help detect, deter, and shut down abusive tax shelter activities. For example, reportable transactions may include being in a 419,412i, or other insurance plan sold by insurance agents for tax deduction purposes. Other abusive transactions could include captive insurance and section 79 plans, which are usually sold by insurance agents for tax deductions. Taxpayers must disclose their participation in these and other transactions by filing a Reportable Transactions Disclosure Statement (Form 8886) with their income tax returns. People that sell these plans are called material advisors and must also file 8918 forms properly. Failure to report the transactions could result in very large penalties. Accountants who sign tax returns that have these deductions can also be called material advisors and should also file forms 8918 properly.

The IRS has fined hundreds of taxpayers who did file under 6707A. They said that they did not fill out the forms properly, or did not file correctly. The plan administrator or a 412i advised over 200 of his clients how to file. They were then all fined by the IRS for filling out the forms wrong. The fines averaged about $500,000 per taxpayer.

A report by the Treasury Inspector General for Tax Administration (TIGTA) found that the procedures for documenting and assessing the Section 6707A penalty were not sufficient or formalized, and cases often are not fully developed.

TIGTA evaluated the IRS’s effectiveness in identifying, developing, and applying the Section 6707A penalty. Based on its review of 114 assessed Section 6707A penalties, TIGTA determined that many of these files were incomplete or did not contain sufficient audit evidence. TIGTA also found a need for better coordination between the IRS’s Office of Tax Shelter Analysis and other functions.

“As penalties are meant to encourage voluntary taxpayer compliance, it is important that IRS procedures for documenting and assessing them be well developed and fully documented,” said TIGTA Inspector General J. Russell George in a statement. “Any failure to do so raises the risk that taxpayers will not receive consistent and fair treatment under the law, and could further reduce their willingness to comply voluntarily.”

The Section 6707A penalty is a stand-alone penalty and does not require an associated income tax examination; therefore, it applies regardless of whether the reportable transaction results in an understatement of tax. TIGTA determined that, in most cases, the Section 6707A penalty was substantially higher than additional tax assessments taxpayers received from the audit of underlying tax returns. I have had phone calls from taxpayers that contributed less than $100,000 to a listed transaction and were fined over $500,000. I have had phone calls from taxpayers that went into 419, or 412i plans but made no contributions and were fined a large amount of money for being in a listed transaction and not properly filing forms under IRC section 6707A. The IRS claims that the fines are non appealable.

On July 7, 2009, at the request of Congress, the IRS agreed to suspend collection enforcement actions. However, this did not preclude the issuance of notices of assessment that are required by law and adjustment notices that inform the taxpayer of any account activity. In addition, taxpayers continued to receive balance due and final notices of intent to levy, and demands to pay Section 6707A penalties.

TIGTA recommended that the IRS fully develop, document, and properly process Section 6707A penalties. The IRS agreed with TIGTA’s recommendation and plans to take appropriate corrective actions. I think as a result of this many taxpayers who have not yet been fined will shortly receive the fines. Unless a taxpayer files properly there is no statute of limitations. The IRS has, and will continue to go back many years and fine people that are in listed, reportable or substantially similar to transactions.

If you are, or were in a 412i, 419, captive insurance or section 79 plan you should immediately file under 6707A protectively. If you have already filed you should find someone who knows what he is doing to review the forms. I only know of two people who know how to properly file. The IRS instructions are vague. If a taxpayer files wrong, or fills out the forms wrong he still gets the fine. I have had hundreds of phone calls from people in that situation.


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 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 AICPA best-selling books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots. He does expert witness testimony and his side has never lost a case. Visit www.taxaudit419.com for more on this subject.

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.

Abusive Insurance, Welfare Benefit, and Retirement Plans

 

Tax Practice: Tax Notes

March 2, 2009

 

By Lance Wallach

 

The IRS has various task forces auditing all section 419, section 412(i), and other plans that tend to be abusive.  These plans are sold by most insurance agents.  The IRS is looking to raise money and is not looking to correct plans or help taxpayers.  The fines for being in a listed, abusive, or similar transaction are up to $200,000 per year (section 6707A), unless you report on yourself.  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 $200,000 a 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 $200,000 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 substantially similar plans are being sold by insurance agents.

Recently I came across the case of Hink, a small business owner who is facing $400,000 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 over $30,000 in 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 $178,000 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.  The $90,000 in 2005 contributions was put into the company’s retirement bank account along with the 2004 contributions.

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.

The IRS denied any appeal and ruled in October 2008 the $400,000 penalty would stand.  The IRS fine for being in a listed, abusive, or similar transaction is $200,000 per year for corporations or $100,000 per year for unincorporated entities.  The material advisor fine is $200,000 if you are incorporated or $100,000 if you are not.

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, potentially reaching $100,000 for individuals and $200,000 for other taxpayers.  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.

Some of theses abusive employee benefit plans are represented as satisfying section 419, which sets limits on purposed and balances of “qualified asset accounts” for the benefits, although the plans purport to offer the deductibility of contributions without any corresponding income.  Others attempt to take advantage of the exceptions to qualified asset account limits, such as sham union plans that try to exploit the exception for the separate welfare benefit funds under collective bargaining agreements provided by section 419A(f)(5).  Others try to take advantage of exceptions for plans serving 10 or more employers, once popular under section 419A(f)(6).  More recently, one may encounter plans relying on section 419(e) and, perhaps, defines benefit sections 412(i) pension plans.

Sections 419 and 419A were added to the code by the Deficit Reduction Act of 1984 in an attempt to end employers’ acceleration of deductions for plan contributions.  But it wasn’t long before plan promoters found an end run around the new code sections.  An industry developed in what came to be known as 10-or-more-employer plans.

The IRS steadily added these abusive plans to its designations of listed transactions.  With Revenue Ruling 90-105, it warned against deducting some plan contributions attributable to compensation earned by plan participants after the end of the tax year.  Purported exceptions to limits of sections 419 and 419A claimed by 10-or-more-employer benefit funds were likewise prescribed in Notice 95-24 (Doc 95-5046, 95 TNT 98-11).  Both positions were designated as listed transactions in 2000.

At that point, where did all those promoters go?  Evidence indicates many are now promoting plans purporting to comply with section 419(e).  They are calling a life insurance plan a welfare benefit plan (or fund), somewhat as they once did, and promoting the plan as a vehicle to obtain large tax deductions.  The only substantial difference is that theses are now single-employer plans.  And again, the IRS has tried to rein them in, reminding taxpayers that listed transactions include those substantially similar to any that are specifically described and so designated.

On October 17, 2007, the IRS issues Notices 2007-83 (Doc 2007-23225, 2007 TNT 202-6) and 2007-84 (Doc 2007-23220, 2007 TNT 202-5).  In the former, the IRS identified some trust arrangements involving cash value life insurance policies, and substantially similar arrangements, as listed transactions. The latter similarly warned against some postretirement medical and life insurance benefit arrangements, saying they might be subject to “alternative tax treatment.”  The IRS at the same time issued related Rev. Rul. 2007-65 (Doc 2007-23226, 2007 TNT 202-7) to address situations in which an arrangement is considered a welfare benefit fund but the employer’s deduction for its contributions to the fund id denied in whole or in part for premiums paid by the trust on cash value life insurance policies.  It states that a welfare benefit fund’s qualified direct cost under section 419 does not include premium amounts paid by the fund for cash value life insurance policies if the fund is directly or indirectly a beneficiary under the policy, as determined under sections264(a).

Notice 2007-83 targets promoted arrangements under which the fund trustee                                                         purchases cash value insurance policies on the lives of a business’s employee/owners, and sometimes key employees, while purchasing term insurance policies on the lives of other employees covered under the plan.

These plans anticipate being terminated and anticipate that the cash value policies will be distributed to the owners or key employees, with little distributed to other employees.  The promoters claim that the insurance premiums are currently deductible by the business and that the distributed insurance policies are virtually tax free to the owners.  The ruling makes it clear that, going forward, a business under most circumstances cannot deduct the cost of premiums paid through a welfare benefit plan for cash value life insurance on the lives of its employees.

Should a client approach you with one of these plans, be especially cautious, for both of you.  Advise your client to check out the promoter very carefully.  Make it clear that the government has the names of all former section 419A(f)(6) promoters and, therefore, will be scrutinizing the promoter carefully if the promoter was once active in that area, as many current section 419(e) (welfare benefit fund or plan) promoters were.  This makes an audit of your client more likely and far riskier.

It is worth noting that listed transactions are subject to a regulatory scheme applicable only to them, entirely separate from Circular 230 requirements, regulations, and sanctions.  Participation in such a transaction must be disclosed on a tax return, and the penalties for failure to disclose are severe – up to $100,000 for individuals and $200,000 for corporations.  The penalties apply to both taxpayers and practitioners.  And the problem with disclosure, of course, is that it is apt to trigger an audit, in which case even if the listed transaction was to pass muster, something else may not.

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 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 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.taxaudit419.com/TaxHelp.html and www.taxlibrary.us

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.

Listed Transactions-Excerpt from Protecting Clients From Fraud, Incompetence, and Scams

Protecting Clients From Fraud, Incompetence, and Scams

By: Lance Wallach

Published by John Wiley and Sons, Inc.

Copyright 2010.  All rights reserved.

Excerpts have been taken from this book about:

Bruce Hink, who has given me permission to utilize his name and circumstances, is a perfect example of what the IRS is doing to unsuspecting business owners.  What follows is a story about Bruce Hink and how the IRS fined him $200,000 a year for being in what they called a “listed transaction”.  In addition, I believe that the accountant who signed the tax return and the insurance agent who sold the retirement plan will each be fined $200,000 as material advisors.  We have received a large number of calls for help from accountants, 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 these so-called listed, abusive plans, or plans substantially similar to the so-called listed, are currently being sold by most insurance agents.

Bruce was a small business owner facing $400,000 in IRS penalties for 2004 and 2005 for his 412(i) plan (IRC6707A).  Here is how the story developed.

In 2002 an insurance agent representing a 100-year-old well-established insurance company suggested he start a pension plan.  Bruce was given a portfolio of information from the insurance company, which was given to the company’s outside CPA to review and to offer an opinion.  The CPA gave the plan the green light and the plan was started for tax year 2002.

Contributions were made in 2003.  Then the administrator came out with amendments to the plan, based on new IRS guidelines, in October 2004.

The business owner’s 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 without an agent.

I 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.  Bruce asked for advice from the CPA and the local attorney (who had no previous experience in such cases), which made matters worse, with a “big name” law firm being recommended and more than $30,000 in additional legal fees being billed in three months.

To make a long story short, the audit stretched on for more than two years to examine a two-year old pension with four participants and $178,000 in contributions.

During the audit, no funds went to the insurance company.  The company was awaiting IRS approval and restructuring the plan as a traditional defined benefit plan, which the administrator had suggested and which the IRS had indicated would be acceptable.  The $90,000 2005 contribution was put into the company’s retirement bank account along with the 2004 contribution.

In March 2008, the business owner received an apology from the IRS agent who headed the examination.  Even this sympathetic IRS agent thinks there is a problem with the IRS enforcement of these Draconian penalties.  Below is one of her emails to the business owner who was fined $400,000.

From:  XXXXXXXX XXXXX <XXXXXXXX.XXXXX@irs.gov>

Date: Tue, Mar 4, 2008 at 7:12 AM

Subject: RE: Urgent

To: Bruce Hink  <brucehink@XXXXXXX.com>

Thanks Bruce – yes – please just overnight then to the Grand Rapids address.  Once again, I’m sorry about this.  Basically, our Counsel told us that we needed language specific to the IRC 6707A penalty in order for that statute to be extended.  I will ask the Reviewer to hold off an extra day.

I’m also very sorry that this is getting you down.  Deeply sorry.  It’s very difficult for me as well – before I started working on this project (412(i)) I was doing audits of 401(k) and profit sharing plans.  If there was an error on the plan, the employer would just fix it and the audit was over.  There wasn’t anything controversial about it – and I felt like I was helping people – employers and plan participants.  I really liked my job.  In two years time, that has completely changed.  I know it’s not very “professional” to make such confessions – so forgive me.  But I guess I just wanted you to know that I really sympathize with your situation – and have been doing whatever I can to help.  I know that having this hanging over your head can’t be fun – but as this project goes forward – I think that the IRS is going to have to soften their position somewhat – so these delays may be to your benefit.

Also, I’m not really supposed to be sending emails to you – but when I went through the file I couldn’t find a good phone number for you.  Could you just send me a note or an email with a current phone number?

Looking to receive the signed 872s on Thursday.  If you have any questions at any time – please call me at XXX-XXX-XXXX. I’m usually in the office in the mornings.

The IRS subsequently denied any appeal and ruled in October 2008 that the $400,000 penalty would stand.

Could You or One of Your Clients Be Next?

Some of the areas SB/SE will be examining include pass-though entities, high-income filers, and abusive transactions.  S corporations are likely to receive particular scrutiny.  Further review would not be limited to S corporations, but would extend to pass-through entities like partnerships, which can expect to receive a “significant amount of attention” because SB/SE has found an area of abuse and would like to curb what is called a growing trend of abusive high-income filers, typically classified as those with an adjusted gross income of more than $200,000.

The IRS has been cracking down on what it considers to be abusive tax shelters.  Many of them are being marketed to small business owners by insurance professionals, financial planners, and even accountants and attorneys.  I speak at numerous conventions, for both business owners and accountants.  And after I speak, I am always approached by many people who have questions about tax reduction plans that they have heard about.

I have been an expert witness in many of these 419 and 412(i) lawsuits and I have not lost one of them.  If you sold one or more of these plans, get someone who really knows what they are doing to help you immediately.  Many advisors will take your money and claim to be able to help you.  Make sure they have experience helping accountants who signed the tax returns.  IRS calls them material advisors and fines them $200,000 if they are incorporated or $100,000 if they are not.  Do not let them learn on the job, with your career and money at stake.

Lance Wallach, a member of the AICPA faculty of teaching professionals and an AICPA course developer, is a frequent and popular speaker on retirement plans, financial and estate planning, reducing health insurance costs, and tax-oriented strategies at accounting and financial planning conventions. He has authored numerous books including The Team Approach to Tax, Financial and Estate Planning, Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots, and Sid Kess’ Alternatives to Commonly Misused Tax Strategies: Ensuring Your Client’s Future, all published by the AICPA, and Wealth Preservation Planning by the National Society of Accountants. His newest books CPAs’ Guide to Life Insurance and CPAs’ Guide to Federal and Estate Gift Taxation by Bisk CPEasy, and Protecting Clients from Fraud, Incompetence, and Scams, published by John Wiley and Sons, Inc.

Mr. Wallach, CLU, CHFC, is a leading speaker on accounting and taxation topics and the author of numerous AICPA CPA exam publications.  In addition to developing CPE courses, he is also a member of the AICPA faculty of teaching professionals, and has been featured in the Wall Street Journal, the New York Times, Bloomberg Financial News, NBC, National Pubic Radio’s All Things Considered, and other radio talk shows.  Mr. Wallach is listed in Who’s Who in Finance and Business.

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.

Be Advised – Everything is Not Fine

By Lance Wallach

 

A few years ago, I testified as an expert witness in a case where a physician was in an abusive 401(k) plan with life insurance. It had a so-called “springing cash value” policy in it. The IRS calls plans with these types of policies “listed transactions.” The judge called the insurance broker “a crook.”

 

Keeping that in mind, you should know that the IRS is cracking down on small business owners who participate in tax reduction insurance plans and the brokers who sold them. Some of these plans include defined benefit retirement plans, IRAs, or even 401(k) plans with life insurance.

 

Who is involved

 

For the business owner, the motivation is a large tax deduction. For the insurance broker and the insurance carrier, the motivation is a substantial commission. Thus, the IRS is cracking down on accountants, insurance brokers and other.

 

If your client is (or was) in a 412(i), 419, captive insurance, or Section 79 plan, then you may be in big trouble.

 

If you are an accountant and signed a tax return for a client in one of these plans, you are probably what the IRS calls a “material adviser” and subject to a maximum $200,000 fine.

 

If you are an insurance professional that sold or advised on one of these plans, the same holds true for you.

 

What happened

 

Both business owners and brokers need to file properly under Section 6707A or face large IRS fines. In many cases, the accountant filed the appropriate forms, but the IRS still levied the fine because the accountant made a mistake when filling out the form.

 

The improper preparation of these forms usually results in the client being fined more quickly than if the form were not filed at all. My office has reviewed many forms and we have not yet seen one that was filled out properly.

 

The IRS will be soon attacking Section 79 scams as well, I am told. In Section 79 scams, small business owners are told that they can take a tax deduction through their businesses to purchase life insurance. That sounds good, but when you break down the math and sales pitch, it doesn’t make sense.

 

Predictions come true

 

In articles I wrote for the American Institute for Certified Public Accountants back in the ‘90s, I predicted attacks by the IRS on 419s. Those predictions came true.

 

Then I predicted attacks on 412s. They came true too.

 

Now I’m predicting that these Section 79 scams will be attacked.

 

How to act

 

To protects themselves, everyone in these Section 79 plans should file protectively under Section 6707A, and anyone who has not filed protectively in a 419 or 412(i) had better get some good advice from someone who knows what is going on and has extensive experience filing protectively.

 

The IRS has its task forces auditing these plans now; after that they will move on to the Section 79 scams and the brokers who sold them.

 

I have been an expert witness in a lot of cases involving 412(i) and 419 issues. They rarely go well for brokers, accountants, plan promoters, or insurance companies.

 

Watch your back

 

If you are an insurance professional, it’s important to understand that you should not count on your insurance company to back you up.

 

Based on what I have seen, insurance companies are more likely to stab you in the back. In an IRS investigation, the insurance companies settle first, leaving the brokers hanging. Then, in many cases, they fire the brokers.

 

So be careful. If you sold plans, gave tax advice, or signed a tax return and got paid a certain amount of money, you may be a material adviser, and subject to a fine of up to $200,000.

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 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 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.taxaudit419.com and www.Experttaxdvisors.org

 

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.

 

Small Business Retirement Plans Fuel Litigation

Dolan Media Newswires 01/22/2010


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 – $100,000 per individual and $200,000 per entity per tax year for each failure to disclose the transaction – often exceeding the disallowed taxes.

There are business owners who owe $6,000 in taxes but have been assessed $1.2 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 $1 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 appealable 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 $860,000 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.

Last July, in response to a letter from members of Congress, the IRS put a moratorium on collection of §6707A penalties, but only in cases where the tax benefits were less than $100,000 per year for individuals and $200,000 for entities. That moratorium was recently extended until March 1, 2010.

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, 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 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 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.taxaudit419.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.