Get a $200,000 IRS Fine and Have Your Client Sue You

By Lance Wallach

Over the past decade, business owners have been overwhelmed by a plethora of arrangements designed to reduce the cost of providing employee benefits and taxes while simultaneously increasing their own retirement savings. The solutions ranged from traditional pension and profit sharing plans to more advanced strategies.

Some strategies, such as IRS Section 419 and 412(i) plans, used life insurance as vehicles to bring about benefits. Unfortunately, almost all the plans were noncompliant, even though insurance companies vetted them and encouraged their agents to sell them. This fostered an environment that led to numerous IRS crackdowns, disallowing tax deductions, and spurned clients to sue their insurance agents and others.

The result has been thousands of audits and an IRS task force seeking out tax-shelter promotions. In addition, the IRS has been auditing most 412(i) defined benefit retirement plans and all 419 welfare benefit plans — plans offered by many insurance agents. For unknowing clients, the tax consequences are enormous. Yet for their professional insurance advisors, the liability may be equally extreme. If an insurance professional sells one of these plans, and the client takes a tax deduction on that plan the IRS now considers as abusive, to be a listed transaction or substantially similar to such a transaction, the insurance agent may be called a “material advisor.” The fine for being found a material advisor is $200,000 if incorporated, or $100,000 if unincorporated.

Most insurance agents think that they can avoid the fine by filing Form 8918 with the IRS and informing on their clients. But, all of the Form 8918s we have seen have been filled out improperly. In our discussions with the IRS officials who wrote the regulations, the impression that we received was that if the form is filled out improperly, you are lying to the government. That is almost as bad as not filing the form. This has also been a problem with all the forms that we have reviewed for accountants and insurance agents. We have reviewed hundreds of forms, and not a single one has been filled out properly. One of the reasons for this may be that the promoter of the abusive plan sends the form with instructions to the accountant and insurance agent. These instructions tend to protect the promoter, but do not necessarily protect the insurance agent or accountant. So please be careful with this entire situation. We have received hundreds of phone calls from accountants and insurance professionals recently who are in this predicament. But, it is very difficult to help them after the fact.

Recently, there has been an explosion in the marketing of a financial product called “captive insurance.” These so-called “captives” are typically small insurance companies designed to insure the risks of an individual business under IRS Code Section 831(b). When properly designed, a business can make tax-deductible premium payments to a related party insurance company. Depending on circumstances, underwriting profits, if any, can be paid out to the owners as dividends, and profits from liquidation of the company may be taxed as capital gains.

While captives can be a great cost-saving tool, they also are expensive to build and manage. Also, captives are allowed to garner tax benefits because they operate as real insurance companies. Advisors and business owners who misuse captives or market them as estate planning tools, asset protection vehicles, for tax deferral purposes or to obtain other benefits not related to the true business purpose of an insurance company face grave regulatory and tax consequences.

A recent concern is the integration of small captives with life insurance policies. Small captives, under Section 831(b), have no statutory authority to deduct life premiums. Also, if a small captive uses life insurance as an investment, the cash value of the life policy can be taxable at corporate rates, and then will be taxable again when distributed. The consequence of this double taxation is to devastate the effectiveness of the life insurance, and it extends serious liability to any accountant who recommends the plan or even signs the tax return of the business that pays premiums to the captive.

The IRS is aware that several large insurance companies are promoting their life insurance policies as investments with small captives. The outcome looks eerily like that of the 419 and 412(i) plans mentioned above.

Remember, if something looks too good to be true, it usually is. There are safe and conservative ways to use captive insurance structures to lower costs and obtain benefits for businesses. And, some types of captive insurance products do have statutory protection for deducting life insurance premiums (although not 831(b) captives). Learning what works and is safe is the first step an accountant should take in helping his or her clients use these powerful, but highly technical insurance tools.

*Source: This article was first published in the January 2009 issue of California Broker magazine.

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 does frequent expert witness work and assists insurance professionals, accountants and others in reviewing 8918 forms so they can avoid the IRS $200,000 penalty that applies to material advisors.

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.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.

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Senior Abuses

New and Bestselling
AICPA CPE Self-Study Courses

Best Sellers – March 2008

Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots, by Sid Kess

Author/Moderator: Lance Wallach, CLU, CHFC,

Publisher: AICPA

Excerpts have been taken from this book about:

Senior Abuses

The following example is unfortunately not an isolated incident of an abusive sales practice.  If accountants were consulted more often by their clients, maybe the following would never happen.

Senior citizen clients thought they had every reason to trust Mr. Sell BigPolicy as a financial counselor.  The insurance agent had obtained a designation recognizing him as WE DO NOT WANT TO MENTION THE NAME Senior Advisor.  He obtained this designation in 2002, a credential he made sure to advertise on fliers sent to retirees.

He did not mention how easy it had been to get that title.

He had paid $1,095 for a correspondence course, then took a multiple-choice exam with questions like, “Marketing can best be described as:” (The answer: “The process or technique of promoting the sale or distribution of a product or service.”) Like more than 18,700 other applicants since 1997, he passed.

Insurance companies, eager for sales representatives, embraced Mr. Sell Bigpolicy, as they have thousands of other newly credentialed advisors.

The following year, multiple insurers paid him commissions totaling $720,000 as his business with retirees soared.

But many of those sales came from steering older Americans into unwise investments, regulators contend in a lawsuit.

Mr. Sell Bigpolicy denies all wrongdoing, but one of his clients – a 73-year-old widow caring for a son with Down syndrome – said he tricked her into buying complicated insurance contracts that left her unable to pay dental and home repair bills.

“His office was filled with things saying he was certified to help seniors,” said that client.  “The only one he really helped was himself.”

Taking care of the finances of older Americans is a huge and potentially lucrative field, and the market is growing.  Attracted by this market, many financial planners have shifted their focus to it – and bring widely varying attitudes and professional training to the consultation table.  Training and certification in financial gerontology is now being offered by at least four groups.

The Securities and Exchange Commission does not regulate these groups – or any other groups that provide financial planning certification, for that matter.  “The S.E.C. does not endorse any professional designation,” said Susan Wyderko, director of the office of investor education of the S.E.C.

The absence of government supervision is a problem, said Stephen Brobeck, executive director of the Consumer Federation of America.  “There’s an opportunity for fraud,” he said, adding that older people need to be very careful about whom they trust for advice.

Regardless of any planner’s credentials, the S.E.C. and consumer organizations say the best approach is “buyers beware.”

Investors can learn how to check the background of a financial planner, including any disciplinary actions, at the S.E.C.’s website, www.sec.gov.  Such background checks, along with a discussion about an advisor’s approach to investing, are well advised before signing up with a planner.

“We see too many investors who might have avoided trouble,” Ms. Wyderko of the S.E.C. said, “had they asked basic questions right from the start.”

Mr. Sell Bigpolicy is one of tens of thousands of financial advisers working hand-in-hand with insurance companies to market themselves to older Americans using impressive sounding credentials.

Many of these titles can be earned in just a few days from businesses concerned only with the bottom line and sound similar to established credentials that require years of study, difficult tests and extensive background checks.

Many graduates of these short programs say they only want to help older Americans. But they are frequently dispensing financial counsel that they are not qualified to offer, advocates for the elderly say. And thousands of them are paid by some of the country’s largest insurance companies to sell elderly clients complicated investments that some economists say most retirees should never own.

More than two dozen such programs now exist, and have enrolled more than 39,000 people over the last decade.

But some of the existing programs, which are often linked to insurance companies, have taught agents to use abusive sales techniques, regulators say.

Some insurers have been listed as sponsors at seminars with names like the Million Dollar Academy, where thousands of sales representatives were advised to scare retirees by saying, “I am all that stands between you and potential catastrophic loss.” Other seminars instructed agents to “drive a wedge” between retirees and their established advisors.

“The insurers are happy to turn a blind eye to what salesmen are doing, as long as they make a sale,” said Minnesota’s attorney general, Lori Swanson, who is suing several companies, contending that their products are at best inappropriate, and possibly worse.

Insurance companies say they investigate the backgrounds of all agents, screen all sales to consumers to make sure they are appropriate, and have terminated representatives using improper sales methods. Those companies said they were not aware of abusive methods taught at any seminar they endorsed.

Some insurance companies say that they do not tolerate misrepresentation.

Another insurance company, in a statement, said “Any evidence of sales agent misconduct, without exception, results in immediate termination.”

Nonetheless, complaints over sales of insurance products have soared.  In particular, grievances have stemmed from annuity sales.  Obviously, occasionally a buyer of a product buys it without a full understanding of the product.  If the product does not perform as expected, possibly because the stock market went down, the buyer may have a selective memory failure.  The buyer can then complain to the insurance company, among other places.  If the salesperson sold in good faith, and the product was appropriate, sometimes the buyer may still have recourse.  Is this fair?

Over one third of all cases of financial exploitation of the elderly involve annuities, according to the North American Securities Administrators Association, a regulatory group [EM1]. Hundreds of lawsuits have been filed against insurers over annuity sales to the elderly. A judge in Minnesota ruled in 2007 that just one class action suit against a large insurance company could encompass as many as 400,000 plaintiffs.  Do all of the plaintiffs deserve to be compensated? Who ends up with much of the money if the lawsuit is won?  If you do not know the answer to the last question, ask yourself if it is a coincidence that huge class action litigation attracts prestigious large law firms like a picnic does flies.

In interviews, sales agents who have been accused of wrongdoing invariably say that they followed the guidance of insurance companies.

But consider, for example, that the vast majority of annuity sales do not offer immediate payouts. Instead, they require buyers to wait as long as 10 years to begin receiving benefits. Such contracts, known as deferred annuities, made up 97% of all annuity sales last year.

Deferred annuities, however, offer sales agents the richest commissions, which is one reason so many of them are sold every year, regulators say. Selling a $100,000 deferred annuity, for example, typically earns a sales representative $9,000, though buyers are sometimes prohibited from touching much of their money for 10 years without incurring penalties.  No-load annuities, may feature little or no commission, and may not have penalties.  Annuities with shorter tie ups carry much smaller commissions.

In summation, if it is true that sales agents who push large deferred annuities with long tie up periods are only following company guidance, that may be as negative a commentary on the companies as on the agents.

“An annuity that pays a fixed immediate income offers seniors a lot of security,” said Jean Setzfand, director of financial security with AARP. “But a deferred annuity is almost always a bad idea for a retiree.”

Those concerns, however, have not stopped many insurance agents from aggressively selling deferred annuities.

Some of those agents have been trained by organizations that require only a few days of classroom instruction.

For instance, the 1,200 people who have enrolled in a different senior adviser program spent only four days in a classroom, according to a spokesman.

The organization which gave Mr. Sell Bigpolicy his credentials is a for-profit company that has trained 24,000 enrollees since it was started in 1997.

The company that gave Mr. Sell Bigpolicy his designation has a course that lasts three and a half days, according to recent participants, and includes uplifting lectures, overviews on the sociology of aging and exercises including peering through vision-blurring lenses to get a sense of how some clients’ eyesight can falter.

Regulatory authorities tend to be ultra critical of these programs.

“There are limitless phrases being coined to convey an expertise in senior finances,” said Massachusetts securities regulator William F. Galvin. “Most of them seem designed to trick seniors into listening to swindlers.”

Most insurance salespeople are honorable and are not swindlers.  As in most lines of work, however, not everyone is honorable and does the correct thing.

A representative for the organization said the program’s courses and questions were written and evaluated by experts. In a statement, the company said its training was intended to supplement, not substitute for, professional credentials and education. The organization began asking titleholders in March to disclose to potential clients that designation alone does not imply expertise in financial, health or social matters.

Despite that disclaimer, the company has trained thousands of insurance agents and other financial advisors. And about 100 companies, many of them insurers, endorse the designation, said a spokesman for the group.

Soon after Mr. Sell Bigpolicy received his designation, Mr. Sell Bigpolicy started displaying it in ads and on letters inviting retirees to seminars over free chicken lunches, according to Massachusetts regulators.

At those meetings, Mr. Sell Bigpolicy told retirees that they were perilously close to financial calamity, according to Massachusetts regulators and attendees. He warned them that the stock market’s ability to offset inflation was “a big lie,” according to documents collected by those regulators. Banks contained “weapons of mass destruction,” read one handout.

But annuities, Mr. Sell Bigpolicy noted, offered guaranteed returns, attendees said. At the time, he was authorized to sell annuities offered by more than two dozen insurance companies, state records show.

Mr. Sell Bigpolicy’s script, Massachusetts regulators say, used materials from another training company that had more than a dozen insurers as “partners” or “carriers” on the company’s Web site.

There are a few dozen companies, like the training company in question, that teach sales agents how to find retirees willing to buy annuities.

Some insurance companies say they endorse only training programs that are committed to ethical sales tactics and that their support is often limited to providing speakers or marketing materials. But they acknowledge that they cannot always police how agents present themselves.

Dozens of lawsuits against insurers contend that those companies failed to adequately supervise sales agents who sold inappropriate annuities to aging clients and then did not act when buyers complained.

Some insurers, in court filings and interviews, say they spend millions of dollars supervising sales agents and investigating consumer complaints.

Some insurance companies, and some state regulators, have changed the rules governing how annuity sales agents can behave.

This year, Massachusetts prohibited most financial advisers from using some titles unless they were recognized by an accreditation organization or the state. In 2007, two of the largest insurers told sales agents they could not use the designation of WE DO NOT WANT TO MENTION THE NAME senior adviser.

But in most other states and at most insurance companies, sales representatives can use any title they choose.

For his part, Mr. Sell Big Policy, while he awaits the outcome of his case, is still approved to sell annuities by more than two dozen insurers, according to state records. This is not an isolated example, which does not mean that an accountant should think that all insurance salespeople behave like this sales person.  This example, in differing versions, does happen.  If the customer consulted his or her accountant, which admittedly most do not, the above example, or something like it, may not happen.

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 other type of advice for any specific individual or other entity.  You should contact an appropriate professional for any such advice.