As published in: AccountingToday: October 25, 2010
By: 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 you do not necessarily have to make a contribution or claim a tax deduction 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 you are also in trouble if you file incorrectly.
I have received numerous phone calls from business owners who filed and still got fined. Not only do you 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 tell me that was 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 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 its deductions. 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.
By: 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 you do not necessarily have to make a contribution or claim a tax deduction 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 you are also in trouble if you file incorrectly.
I have received numerous phone calls from business owners who filed and still got fined. Not only do you 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 tell me that was 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 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 its deductions. 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.
captive insurance section 79 insurance plan 412e3 412i audits lawsuits www.vebaplan.com
ReplyDeleteThe Truth Behind Section 79 Benefit Plans—I Can’t Stand the Hypocrisy Anymore
The Truth Behind Section 79 Benefit Plans—
I Can’t Stand the Hypocrisy Anymore
As you already know, I often tell the readers of my newsletter that many times they are not providing the best advice to their clients. Click here to read a list of cautionary newsletters.
I know I sometimes upset readers when I say they are not always providing the best advice. I walk a fine line between being seen as a straight shooter who just tells you how it is no matter what I’m discussing (sort of the Ralph Nader of the insurance/financial industry) and giving you useful information and tools so you can be unique and provide good advice to your clients.
What about Section 79 Plans? First, you can read my past few newsletters on Section 79 Plans by clicking here and looking for the newsletters from 7-14-08 and 7-22-08. I’ve been consistent in indicating that they are marginal plans from a wealth building standpoint, but I have not broken them down like I will in this newsletter.
What is a Section 79 Plan? Simply put, it is a tax-plan where small business owners are allowed to take a 20-40% deduction through their business to purchase an individually owned cash value life (CLV) insurance policy. This is the huge selling point of the plan.
If you just read the above paragraph, you’d think that a Section 79 Plan is the nirvana of plans because you’ve been trying to get your profitable small business owners to buy CVL for years.
Why are the finances of Section 79 so marginal? In short, the reason Section 79 Plans are up to 40% deductible is because the life insurance policy purchased is a crummy policy by design. That’s right, by design, the policy is a terrible cash accumulator.
The better the policy, the less the deduction. A good policy (Retirement Life) for example would receive only an 8-10% deduction through the plan.
Improving the finances of the Section 79 Plan Section 79 Plans are funded into a crummy cash accumulating policy for five years. Then the client is shown how the policy can be flipped to a variable life policy earning 9% annually going forward. Besides that this is not a conservative example, the numbers are marginal even assuming a 9% rate of return.
Now in the marketplace is a new Section 79 Plan using an EIUL policy. The EIUL policy was also designed to be a crummy cash accumulating policy in the early years so the client can obtain his/her 30-40% deduction (not to mention that the company screwed up their plan for groups under 10 employees by not dealing the non-medical underwriting issue).
Why are so many agents trying to sell Section 79 Plans? This is what really moved me to write this newsletter. Agents are pitching Section 79 Plans to clients for two simple reasons: 1) Many small business clients will buy any plan that is “deductible” because they so despise paying income taxes. 2) Insurance advisors want to sell life insurance.
This brings up an interesting issue. If the plan is marginal from a wealth building standpoint, then why are agents selling it?
Again two reasons: 1) Most advisors have not broken down the math so they can come to the conclusion I have which is that the plans are not worth implementing from a pure financial standpoint. 2) Some advisors know the plan is marginal from a financial standpoint and don’t care because they know they can still sell it to business owners who are looking for deductions.