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Retirement today Sept 2011
Participate in a 419 or 412i Plan or Other Abusive Tax Shelter You could be fined a
large amount of Money
Lance Wallach
Did you get a letter from the IRS threatening to impose this fine? If you haven’t already, you still may.
Consider yourself lucky if you have not because this means that you have more time to straighten this situation
out. Do not wait for this letter to come from the IRS before you call an expert to help you. Even if you have
been audited already, you could still get the letter and/or fine. One has nothing to do with the other, and once
the fine has been imposed, it is not able to be appealed.
Many businesses that participated in a 412i retirement plan or the IRS is auditing a 419-welfare benefit plan.
Many of these plans were not in compliance with the law and are considered abusive tax shelters. Many
business owners are not even aware that the welfare benefit plan or retirement plan that they are participating
in may be an abusive tax shelter and that they are in serious jeopardy of huge IRS penalties for each year that
they have been in this type of plan.
Insurance companies, CPAs, sellers of these 419 welfare benefit plans or 412i retirement plans, as well as
anyone that gave tax advice or recommended participation in one or more of these plans, also known as a
material advisor, is in danger of being sued, fined by the IRS, or both.
There is help available if you think you may be involved with one of these 419 welfare benefit plans, 412i
retirement plans, or any abusive tax shelter. IRS penalty abatement is an option if you act now. Feel free to
contact me for more information. lancewallach.com,
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.
Abusive Insurance, Welfare Benefit, and Retirement Plans
The A2Z Directory March 2011
Lance Wallach
The IRS has various task forces auditing all section 419, section 412(i), and other plans that tend to be
abusive. Most insurance agents sell these plans. The IRS is looking to raise money and is not looking to
correct plans or help taxpayers. 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 www.irs.gov and vebaplan.org.
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
each year for being in what they called a listed transaction. Listed transactions can be found at 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 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 insurance agents are selling substantially similar plans. Recently I came across the case
of Hink, a small business owner who is facing thousands 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 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 8,000 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.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.
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. 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.
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
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.
The A2Z Directory March 2011
Lance Wallach
The IRS has various task forces auditing all section 419, section 412(i), and other plans that tend to be
abusive. Most insurance agents sell these plans. The IRS is looking to raise money and is not looking to
correct plans or help taxpayers. 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 www.irs.gov and vebaplan.org.
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
each year for being in what they called a listed transaction. Listed transactions can be found at 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 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 insurance agents are selling substantially similar plans. Recently I came across the case
of Hink, a small business owner who is facing thousands 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 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 8,000 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.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.
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. 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.
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
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.
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.
Small Business Retirement Plans Fuel Litigation
Maryland Trial Lawyer
Dolan Media Newswires January
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.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.