| The IRS has various task forces auditing all section | | | | option to keep the plan alive in some form while |
| 419, section 412(i), and other plans that tend to be | | | | simultaneously hoping to minimize the financial fallout |
| abusive. These plans are sold by most insurance | | | | from penalties. |
| agents. The IRS is looking to raise money and is not | | | | The sponsor of an abusive plan can expect to be |
| looking to correct plans or help taxpayers. The fines | | | | treated more harshly than participants. Although in |
| for being in a listed, abusive, or similar transaction are | | | | some situation something can be salvaged, the |
| up to $200,000 per year (section 6707A), unless you | | | | possibility is definitely on the table of having to treat the |
| report on yourself. The IRS calls accountants, | | | | plan as if it never existed, which of course triggers the |
| attorneys, and insurance agents "material advisors" | | | | full extent of back taxes, penalties, and interest on all |
| and also fines them the same amount, again unless the | | | | contributions that were made - not to mention leaving |
| client's participation in the transaction is reported. An | | | | behind no retirement plan whatsoever. |
| accountant is a material advisor if he signs the return | | | | Another plan the IRS is auditing is the section 419 plan. |
| or gives advice and gets paid. | | | | A few listed transactions concern relatively common |
| Bruce Hink, who has given me written permission to | | | | employee benefit plans the IRS has deemed tax |
| use his name and circumstances, is a perfect example | | | | avoidance schemes or otherwise abusive. Perhaps |
| of what the IRS is doing to unsuspecting business | | | | some of the most likely to crop up, especially in |
| owners. What follows is a story about how the IRS | | | | small-business returns, are the arrangements purporting |
| fines him $200,000 a year for being in what they called | | | | to allow the deductibility of premiums paid for life |
| a listed transaction. Also involved are what the IRS | | | | insurance under a welfare benefit plan or section 419 |
| calls abusive plans or what it refers to as substantially | | | | plan. These plans have been sold by most insurance |
| similar. Substantially similar to is very difficult to | | | | agents and insurance companies. |
| understand, but the IRS seems to be saying, "If it looks | | | | Some of theses abusive employee benefit plans are |
| like some other listed transaction, the fines apply." Also, | | | | represented as satisfying section 419, which sets limits |
| I believe that the accountant who signed the tax return | | | | on purposed and balances of "qualified asset |
| and the insurance agent who sold the retirement plan | | | | accounts" for the benefits, although the plans purport |
| will each be fined $200,000 as material advisors. We | | | | to offer the deductibility of contributions without any |
| have received many calls for help from accountants, | | | | corresponding income. Others attempt to take |
| attorneys, business owners, and insurance agents in | | | | advantage of the exceptions to qualified asset |
| similar situations. Don't think this will happen to you? It is | | | | account limits, such as sham union plans that try to |
| happening to a lot of accountants and business | | | | exploit the exception for the separate welfare benefit |
| owners, because most of theses so-called listed, | | | | funds under collective bargaining agreements provided |
| abusive, or substantially similar plans are being sold by | | | | by section 419A(f)(5). Others try to take advantage of |
| insurance agents. | | | | exceptions for plans serving 10 or more employers, |
| Recently I came across the case of Hink, a small | | | | once popular under section 419A(f)(6). More recently, |
| business owner who is facing $400,000 in IRS | | | | one may encounter plans relying on section 419(e) and, |
| penalties for 2004 and 2005 because of his | | | | perhaps, defines benefit sections 412(i) pension plans. |
| participation in a section 412(i) plan. (The penalties were | | | | Sections 419 and 419A were added to the code by |
| assessed under section 6707A.) | | | | the Deficit Reduction Act of 1984 in an attempt to end |
| In 2002 an insurance agent representing a 100-year-old, | | | | employers' acceleration of deductions for plan |
| well established insurance company suggested the | | | | contributions. But it wasn't long before plan promoters |
| owner start a pension plan. The owner was given a | | | | found an end run around the new code sections. An |
| portfolio of information from the insurance company, | | | | industry developed in what came to be known as |
| which was given to the company's outside CPA to | | | | 10-or-more-employer plans. |
| review and give an opinion on. The CPA gave the plan | | | | The IRS steadily added these abusive plans to its |
| the green light and the plan was started. | | | | designations of listed transactions. With Revenue |
| Contributions were made in 2003. The plan | | | | Ruling 90-105, it warned against deducting some plan |
| administrator came out with amendments to the plan, | | | | contributions attributable to compensation earned by |
| based on new IRS guidelines, in October 2004. | | | | plan participants after the end of the tax year. |
| The business owner's insurance agent disappeared in | | | | Purported exceptions to limits of sections 419 and |
| May 2005, before implementing the new guidelines | | | | 419A claimed by 10-or-more-employer benefit funds |
| from the administrator with the insurance company. | | | | were likewise prescribed in Notice 95-24 (Doc |
| The business owner was left with a refund check | | | | 95-5046, 95 TNT 98-11). Both positions were |
| from the insurance company, a deduction claim on his | | | | designated as listed transactions in 2000. |
| 2004 tax return that had not been applied, and no | | | | At that point, where did all those promoters go? |
| agent. | | | | Evidence indicates many are now promoting plans |
| It took six months of making calls to the insurance | | | | purporting to comply with section 419(e). They are |
| company to get a new insurance agent assigned. By | | | | calling a life insurance plan a welfare benefit plan (or |
| then, the IRS had started an examination of the | | | | fund), somewhat as they once did, and promoting the |
| pension plan. Asking advice from the CPA and a local | | | | plan as a vehicle to obtain large tax deductions. The |
| attorney (who had no previous experience in these | | | | only substantial difference is that theses are now |
| cases) made matters worse, with a "big name" law | | | | single-employer plans. And again, the IRS has tried to |
| firm being recommended and over $30,000 in additional | | | | rein them in, reminding taxpayers that listed |
| legal fees being billed in three months. | | | | transactions include those substantially similar to any |
| To make a long story short, the audit stretched on for | | | | that are specifically described and so designated. |
| over 2 ½ years to examine a 2-year-old pension | | | | On October 17, 2007, the IRS issues Notices 2007-83 |
| with four participants and the $178,000 in contributions. | | | | (Doc 2007-23225, 2007 TNT 202-6) and 2007-84 |
| During the audit, no funds went to the insurance | | | | (Doc 2007-23220, 2007 TNT 202-5). In the former, the |
| company, which was awaiting formal IRS approval on | | | | IRS identified some trust arrangements involving cash |
| restructuring the plan as a traditional defined benefit | | | | value life insurance policies, and substantially similar |
| plan, which the administrator had suggested and the | | | | arrangements, as listed transactions. The latter similarly |
| IRS had indicated would be acceptable. The $90,000 in | | | | warned against some postretirement medical and life |
| 2005 contributions was put into the company's | | | | insurance benefit arrangements, saying they might be |
| retirement bank account along with the 2004 | | | | subject to "alternative tax treatment." The IRS at the |
| contributions. | | | | same time issued related Rev. Rul. 2007-65 (Doc |
| In March 2008 the business owner received a private | | | | 2007-23226, 2007 TNT 202-7) to address situations in |
| e-mail apology from the IRS agent who headed the | | | | which an arrangement is considered a welfare benefit |
| examination, saying that her hands were tied and that | | | | fund but the employer's deduction for its contributions |
| she used to believe she was correcting problems and | | | | to the fund id denied in whole or in part for premiums |
| helping taxpayers and not hurting people. | | | | paid by the trust on cash value life insurance policies. It |
| The IRS denied any appeal and ruled in October 2008 | | | | states that a welfare benefit fund's qualified direct cost |
| the $400,000 penalty would stand. The IRS fine for | | | | under section 419 does not include premium amounts |
| being in a listed, abusive, or similar transaction is | | | | paid by the fund for cash value life insurance policies if |
| $200,000 per year for corporations or $100,000 per | | | | the fund is directly or indirectly a beneficiary under the |
| year for unincorporated entities. The material advisor | | | | policy, as determined under sections264(a). |
| fine is $200,000 if you are incorporated or $100,000 if | | | | Notice 2007-83 targets promoted arrangements under |
| you are not. | | | | which the fund trustee purchases cash value |
| Could you or one of your clients be next? | | | | insurance policies on the lives of a business's |
| To this point, I have focused, generally, on the horrors | | | | employee/owners, and sometimes key employees, |
| of running afoul of the IRS by participating in a listed | | | | while purchasing term insurance policies on the lives of |
| transaction, which includes various types of | | | | other employees covered under the plan. These plans |
| transactions and the various fines that can be imposed | | | | anticipate being terminated and anticipate that the cash |
| on business owners and their advisors who participate | | | | value policies will be distributed to the owners or key |
| in, sell, or advice on these transactions. I happened to | | | | employees, with little distributed to other employees. |
| use, as an example, someone in a section 412(i) plan, | | | | The promoters claim that the insurance premiums are |
| which was deemed to be a listed transaction, pointing | | | | currently deductible by the business and that the |
| out the truly doleful consequences the person has | | | | distributed insurance policies are virtually tax free to |
| suffered. Others who fall into this trap, even unwittingly, | | | | the owners. The ruling makes it clear that, going |
| can suffer the same fate. | | | | forward, a business under most circumstances cannot |
| Now let's go into more detail about section 412(i) plans. | | | | deduct the cost of premiums paid through a welfare |
| This is important because these defined benefit plans | | | | benefit plan for cash value life insurance on the lives of |
| are popular and because few people think of | | | | its employees. |
| retirement plans as tax shelters or listed transactions. | | | | Should a client approach you with one of these plans, |
| People therefore may get into serious trouble in this | | | | be especially cautious, for both of you. Advise your |
| area unwittingly, out of ignorance of the law, and, for | | | | client to check out the promoter very carefully. Make it |
| the same reason, many fail to take necessary and | | | | clear that the government has the names of all former |
| appropriate precautions. | | | | section 419A(f)(6) promoters and, therefore, will be |
| The IRS has warned against the section 412(i) defined | | | | scrutinizing the promoter carefully if the promoter was |
| benefit pension plans, named for the former code | | | | once active in that area, as many current section |
| section governing them. It warned against trust | | | | 419(e) (welfare benefit fund or plan) promoters were. |
| arrangements it deems abusive, some of which may | | | | This makes an audit of your client more likely and far |
| be regarded as listed transactions. Falling into that | | | | riskier. |
| category can result in taxpayers having to disclose the | | | | It is worth noting that listed transactions are subject to |
| participation under pain of penalties, potentially reaching | | | | a regulatory scheme applicable only to them, entirely |
| $100,000 for individuals and $200,000 for other | | | | separate from Circular 230 requirements, regulations, |
| taxpayers. Targets also include some retirement plans. | | | | and sanctions. Participation in such a transaction must |
| One reason for the harsh treatment of some 412(i) | | | | be disclosed on a tax return, and the penalties for |
| plans is their discrimination in favor of owners and key, | | | | failure to disclose are severe - up to $100,000 for |
| highly compensated employees. Also, the IRS does not | | | | individuals and $200,000 for corporations. The penalties |
| consider the promised tax relief proportionate to the | | | | apply to both taxpayers and practitioners. And the |
| economic realities of the transactions. In general, IRS | | | | problem with disclosure, of course, is that it is apt to |
| auditors divide audited plan into those they consider | | | | trigger an audit, in which case even if the listed |
| noncompliant and other they consider abusive. While | | | | transaction was to pass muster, something else may |
| the alternatives available to the sponsor of | | | | not. |
| noncompliant plan are problematic, it is frequently an | | | | |