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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.