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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.

IRS Audits 419, 412i, Captive Insurance Plans With
Life Insurance, and Section 79 Scams

Article Biz June 2011
Lance Wallach

The IRS started auditing 419 plans in the ‘90s, and then continued going
after 412i and other plans that they considered abusive, listed, or
reportable transactions. Listed designated as listed in published IRS
material available to the general public or transactions that are
substantially similar to the specific listed transactions. A reportable
transaction is defined simply as one that has the potential for tax
avoidance or evasion.

In a recent Tax Court Case, Curcio v. Commissioner (TC Memo 2010-15),
the Tax Court ruled that an investment in an employee welfare benefit
plan marketed under the name "Benistar" was a listed transaction in that
the transaction in question was substantially similar to the transaction
described in IRS Notice 95-34. A subsequent case, McGehee Family
Clinic, largely followed Curcio, though it was technically decided on other
grounds. The parties stipulated to be bound by Curcio on the issue of
whether the amounts paid by McGehee in connection with the Benistar
419 Plan and Trust were deductible. Curcio did not appear to have been
decided yet at the time McGehee was argued. The McGehee opinion
(Case No. 10-102) (United States Tax Court, September 15, 2010) does
contain an exhaustive analysis and discussion of virtually all of the
relevant issues.

Taxpayers and their representatives should be aware that the Service has
disallowed deductions for contributions to these arrangements. 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.

In order to fully grasp the severity of the situation, one must have an
understanding of Notice 95-34, which was issued in response to trust
arrangements sold to companies that were designed to provide deductible
benefits such as life insurance, disability and severance pay benefits. The
promoters of these arrangements claimed that all employer contributions
were tax-deductible when paid, by relying on the 10-or-more-employer
exemption from the IRC § 419 limits. It was claimed that permissible tax
deductions were unlimited in amount.

In general, contributions to a welfare benefit fund are not fully deductible
when paid. Sections 419 and 419A impose strict limits on the amount of
tax-deductible prefunding permitted for contributions to a welfare benefit
fund. Section 419A(F)(6) provides an exemption from Section 419 and
Section 419A for certain "10-or-more employers" welfare benefit funds. In
general, for this exemption to apply, the fund must have more than one
contributing employer, of which no single employer can contribute more
than 10% of the total contributions, and the plan must not be experience-
rated with respect to individual employers.

According to the Notice, these arrangements typically involve an
investment in variable life or universal life insurance contracts on the lives
of the covered employees. The problem is that the employer contributions
are large relative to the cost of the amount of term insurance that would
be required to provide the death benefits under the arrangement, and the
trust administrator may obtain cash to pay benefits other than death
benefits, by such means as cashing in or withdrawing the cash value of
the insurance policies. The plans are also often designed so that a
particular employer’s contributions or its employees’ benefits may be
determined in a way that insulates the employer to a significant extent
from the experience of other subscribing employers. In general, the
contributions and claimed tax deductions tend to be disproportionate to
the economic realities of the arrangements.

Benistar advertised that enrollees should expect to obtain the same type
of tax benefits as listed in the transaction described in Notice 95-34. The
benefits of enrollment listed in its advertising packet included:
Virtually unlimited deductions for the employer;
Contributions could vary from year to year;
Benefits could be provided to one or more key executives on a selective
basis;
No need to provide benefits to rank-and-file employees;
Contributions to the plan were not limited by qualified plan rules and
would not interfere with pension, profit sharing or 401(k) plans;
Funds inside the plan would accumulate tax-free;
Beneficiaries could receive death proceeds free of both income tax and
estate tax;
The program could be arranged for tax-free distribution at a later date;
Funds in the plan were secure from the hands of creditors.

The Court said that the Benistar Plan was factually similar to the plans
described in Notice 95-34 at all relevant times.

In rendering its decision the court heavily cited Curcio, in which the court
also ruled in favor of the IRS. As noted in Curcio, the insurance policies,
overwhelmingly variable or universal life policies, required large
contributions relative to the cost of the amount of term insurance that
would be required to provide the death benefits under the arrangement.
The Benistar Plan owned the insurance contracts.

Following Curcio, as the parties had stipulated, on the question of the
amnesty paid by Mcghee in connection with benistar, the Court held that
the contributions to Benistar were not deductible under section 162(a)
because participants could receive the value reflected in the underlying
insurance policies purchased by Benistar—despite the payment of
benefits by Benistar seeming to be contingent upon an unanticipated
event (the death of the insured while employed). As long as plan
participants were willing to abide by Benistar’s distribution policies, there
was no reason ever to forfeit a policy to the plan. In fact, in estimating life
insurance rates, the taxpayers’ expert in Curcio assumed that there would
be no forfeitures, even though he admitted that an insurance company
would generally assume a reasonable rate of policy lapses.

The McGehee Family Clinic had enrolled in the Benistar Plan in May 2001
and claimed deductions for contributions to it in 2002 and 2005. The
returns did not include a Form 8886, Reportable Transaction Disclosure
Statement, or similar disclosure.

The IRS disallowed the latter deduction and adjusted the 2004 return of
shareholder Robert Prosser and his wife to include the $50,000 payment
to the plan. The IRS also assessed tax deficiencies and the enhanced
30% penalty totaling almost $21,000 against the clinic and $21,000
against the Prossers. The court ruled that the Prossers failed to prove a
reasonable cause or good faith exception.

More you should know:

In recent years, some section 412(i) plans have been funded with life
insurance using face amounts in excess of the maximum death benefit a
qualified plan is permitted to pay. Ideally, the plan should limit the
proceeds that can be paid as a death benefit in the event of a participant’
s death. Excess amounts would revert to the plan. Effective February 13,
2004, the purchase of excessive life insurance in any plan makes the plan
a listed transaction if the face amount of the insurance exceeds the
amount that can be issued by $100,000 or more and the employer has
deducted the premiums for the insurance.
A 412(i) plan in and of itself is not a listed transaction; however, the IRS
has a task force auditing 412i plans.
An employer has not engaged in a listed transaction simply because it is
in a 412(i) plan.
Just because a 412(i) plan was audited and sanctioned for certain items,
does not necessarily mean the plan is a listed transaction. Some 412(i)
plans have been audited and sanctioned for issues not related to listed
transactions.

Companies should carefully evaluate proposed investments in plans such
as the Benistar Plan. The claimed deductions will not be available, and
penalties will be assessed for lack of disclosure if the investment is similar
to the investments described in Notice 95-34. In addition, under IRC
6707A, IRS fines participants a large amount of money for not properly
disclosing their participation in listed or reportable or similar transactions;
an issue that was not before the Tax Court in either Curcio or McGehee.
The disclosure needs to be made for every year the participant is in a
plan. The forms need to be properly filed even for years that no
contributions are made. I have received numerous calls from participants
who did disclose and still got fined because the forms were not prepared
properly. A plan administrator told me that he assisted hundreds of his
participants file forms, and they still all received very large IRS fines for
not properly filling in the forms.

IRS has been attacking all 419 welfare benefit plans, many 412i
retirement plans, captive insurance plans with life insurance in them, and
Section 79 plans.

Lance Wallach, National Society of Accountants Speaker of the Year and
member of the AICPA faculty of teaching professionals, is a frequent
speaker on retirement plans, abusive tax shelters, financial, international
tax, and estate planning. He writes about 412(i), 419, Section79, FBAR,
and captive insurance plans. He speaks at more than ten conventions
annually, writes for over fifty publications, is quoted regularly in the press
and has been featured on television and radio financial talk shows
including NBC, National Pubic Radio’s All Things Considered, and others.
Lance has written numerous books including Protecting Clients from
Fraud, Incompetence and Scams published by John Wiley and Sons, Bisk
Education’s CPA’s Guide to Life Insurance and Federal Estate and Gift
Taxation, as well as the AICPA best-selling books, including Avoiding
Circular 230 Malpractice Traps and Common Abusive Small Business Hot
Spots. He does expert witness testimony and has never lost a case.
Contact him at 516.938.5007, wallachinc@gmail.com or visit www.
taxadvisorexpert.com.
The information provided herein is not intended as legal, accounting,
financial or any type of advice for any specific individual or other entity.
You should contact an appropriate professional for any such advice.

Accounting Today

Don’t Become a ‘Material Advisor’
July 1, 2011

By Lance Wallach

Accountants, insurance professionals and others need to be careful that they don’t
become what the IRS calls material advisors.
If they sell or give advice, or sign tax returns for abusive, listed or similar plans; they
risk a minimum $100,000 fine. They will then probably be sued by their client, when
the IRS finishes with their client
In 2010, the IRS raided the offices of Benistar in Simsbury, Conn., and seized the
retirement benefit plan administration firm’s files and records. In McGehee Family
Clinic, the Tax Court ruled that a clinic and shareholder’s investment in an employee
benefit plan marketed under the name “Benistar” was a listed transaction because it
was substantially similar to the transaction described in Notice 95-34 (1995-1 C.B.
309). This is at least the second case in which the court has ruled against the
Benistar welfare benefit plan, by denominating it a listed transaction.
The McGehee Family Clinic enrolled in the Benistar Plan in May 2001 and claimed
deductions for contributions to it in 2002 and 2005. The returns did not include a
Form 8886, Reportable Transaction Disclosure Statement, or similar disclosure.
The IRS disallowed the latter deduction and adjusted the 2004 return of shareholder
Robert Prosser and his wife to include the $50,000 payment to the plan.
The IRS assessed tax deficiencies and the enhanced 30 percent penalty under
Section 6662A, totaling almost $21,000, against the clinic and $21,000 against the
Prossers. The court ruled that the Prossers failed to prove a reasonable cause or
good faith exception.
In rendering its decision, the court cited Curcio v. Commissioner, in which the court
also ruled in favor of the IRS. As noted in Curcio, the insurance policies, which were
overwhelmingly variable or universal life policies, required large contributions relative
to the cost of the amount of term insurance that would be required to provide the
death benefits under the arrangement. The Benistar Plan owned the insurance
contracts. The excessive cost of providing death benefits was a reason for the court’s
finding in Curcio that tax deductions had been properly disallowed.
As in Curcio, the McGehee court held that the contributions to Benistar were not
deductible under Section 162(a) because the participants could receive the value
reflected in the underlying insurance policies purchased by Benistar—despite the
payment of benefits by Benistar seeming to be contingent upon an unanticipated
event (the death of the insured while employed). As long as plan participants were
willing to abide by Benistar’s distribution policies, there was no reason ever to forfeit
a policy to the plan. In fact, in estimating life insurance rates, the taxpayers’ expert in
Curcio assumed that there would be no forfeitures, even though he admitted that an
insurance company would generally assume a reasonable rate of policy lapse.
Companies should carefully evaluate their proposed investments in plans such as
the Benistar Plan. The claimed deductions will be disallowed, and penalties will be
assessed for lack of disclosure if the investment is similar to the investments
described in Notice 95-34, that is, if the transaction is a listed transaction and Form
8886 is either not filed at all or is not properly filed. The penalties, though perhaps
not as severe, are also imposed for reportable transactions, which are defined as
transactions having the potential for tax avoidance or evasion.
Insurance agents have been selling such abusive plans since the 1990's. They
started as 419A(F)(6) plans and abusive 412i plans. The IRS went after them. They
then evolved to single-employer 419(e) plans, which the IRS also went after. The
latest scams may be the so-called captive insurance plan and the so called Section
79 plan.
While captive insurance plans are legitimate for large corporations, they are usually
not legitimate for small business owners as a way to obtain a tax deduction. I have
not yet seen a legitimate Section 79 plan. Recently, I have sent some of the plan
promoters’ materials over to my IRS contacts, who were very interested in receiving
them. Some of my associates are already trying to help defend some unsuspecting
business owners who are being audited by the IRS with respect to these plans.
Similar, though perhaps not as abusive, plans fail after the IRS goes after them.
Niche was one example. The company first marketed a 419A(F)(6) plan that the IRS
audited. They then marketed a 419(e) plan that the IRS audited. Niche, insurance
companies, agents, and many accountants were then sued after their clients lost
their deductions, paid fines, interest, and penalties, and then paid huge fines for
failure to file properly under 6707A. Niche then went out of business.
Millennium sold 419A(F)(6) plans and then 419(e) plans through insurance
companies. They stupidly filed for a private letter ruling to the effect that they were not
a listed transaction. They got exactly the opposite: a private letter ruling saying that
they were a listed transaction. Then many participants were audited. The IRS
disallowed the deductions, imposed penalties and interest, and then assessed
large fines for not filing properly under Section 6707A. The result was lawsuits
against agents, insurance companies and accountants. Millennium sought
bankruptcy protection after a lot of lawsuits.
I have been an expert witness in a lot of the lawsuits in these 419, 412i, etc., plans,
and my side has never lost a case. I have received thousands of phone calls over the
years from business owners, accountants, angry plan promoters, insurance agents,
etc. In the 1990's, when I started writing for the AICPA and other publications warning
about these abusive plans, most people laughed at me, especially the plan
promoters.
In 2002, when I spoke at the annual national convention of the American Society of
Pension Actuaries in Washington, people took notice. The IRS chief actuary Jim
Holland also held a meeting, similar to mine on abusive 412i plans. Many IRS
agents attended my meeting. I was also invited to IRS headquarters, at the request
of the acting IRS commissioner, to meet with high-level IRS officials and Treasury
officials to discuss 419 issues in depth, which I did after the meeting.
The IRS then set up task forces and started going after 419 and 412i plans. I have
been warning accountants to properly file under 6707A to avoid the large fines, but
most do not. Even if they file, if they make a mistake on the forms the IRS fines. Very
few accountants have had experience filing the forms, and the IRS instructions are
difficult to follow. I only know of two people who have been successful in properly
filing the forms, especially after the fact. If the forms are filled out wrong they should
be amended and corrected Most accountants call me a few years later when they
and their clients get the large fines, either after improperly filling out the forms or not
doing them at all, but then it is too late. If they don’t call me then, then they call me
when their clients sue them.

Lance Wallach is a frequent speaker on retirement plans, financial and estate
planning, and abusive tax shelters, and writes about 412(i), 419 and captive
insurance plans. He can be reached at (516) 938-5007, lawallach@aol.com, or visit
www.vebaplan.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.