6707A Penalties & 419 Plans Litigation: Court CaseSea Nine Veba


419 Plan, 412i Plan, Welfare benefit plan assistance, audits & Abusive tax shelters


Big Trouble Ahead For Many 419 Welfare Benefit Plan and 412i Retirement Plan Participants

Business owners and professionals who have adopted some 419 welfare benefit plan and 412i retirement plan arrangements are in big trouble. The IRS has attacked these arrangements as "listed transactions." Business owners who engage in a "listed transaction" must report such transactions on IRS Form 8886 every year that they are participating in the transaction, and you ARE participating even in years when you DO NOT make any contribution! Internal Revenue Code 6707A imposes severe penalties ($200,000 annually for a business and $100,000 per year for an individual) for failure to file Form 8886 with respect to a listed transaction. Tax Court, according to both the IRS Appeals Office and its own decisions, does not have jurisdiction to abate or lower any penalties imposed by the IRS. Complaints caused Congress to impose a moratorium on collection of Section 6707A penalties. On June 1, 2010, the moratorium ended, and the IRS immediately began sending out notices warning of possible imposition of 6707A penalties. When you get this notice it should be taken very seriously.

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419 Plan, 412i Plan, Welfare benefit plan assistance, audits & Abusive tax shelters


IRS Criminal Investigation Department Audits Section 79, Captive Insurance, 412i and 419 Scams

IRS Criminal Investigation (CI) has developed a nationally coordinated program to combat these abusive tax schemes. CI's primary focus is on the identification and investigation of the tax scheme promoters as well as those who play a substantial or integral role in facilitating, aiding, assisting, or furthering the abusive tax scheme, such as accountants or lawyers. Just as important is the investigation of investors who knowingly participate in abusive tax schemes.

First the IRS started auditing § 419 plans in the 1990s, and then continued going after § 412(i) and other plans that they considered abusive, listed, or reportable transactions, or substantially similar to such transactions. If an IRS audit disallows the § 419 plan or the § 412(i) plan, not only does the taxpayer lose the deduction and pay interest and penalties, but then the IRS comes back under IRC 6707A and imposes large fines for not properly filing.

IRS Audits Focus on Captive Insurance Plans - Lance Wallach

California Broker, June 2011

Employee Retirement Plans
By Lance Wallach412i, 419, Captive Insurance and Section 79 Plans; Buyer BewareThe 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.  IRS is aggressively auditing various plans and calling them “listed transactions,” “abusive tax shelters,” or 
“reportable transactions,” participation in any of which must be disclosed to the Service.  The result has been IRS audits, disallowances, 
and huge fines for not properly reporting under IRC 6707A.
In a recent tax court case, Curico v. Commissioner (TC Memo 2010-115), the Tax Court ruled that an investment in an employee welfare 
benefit plan marketed under the name “Benistar” was a listed transaction.  It was substantially similar to the transaction described in IRS 
Notice 95-34.  A subsequent case, McGehee Family Clinic, largely followed Curico, though it was technically decided on other grounds.  
The parties stipulated to be bound by Curico regarding whether the amounts paid by McGehee in connection with the Benistar 419 Plan 
and Trust were deductible.  Curico 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, you have to understand Notice 95-34.  It was issued in response to trust arrangements 
that were sold to companies 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.  They relied on the 10-or-more-
employer exemption from the IRC § 419 limits.  They claimed that the 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 419(A)(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.  Also, 
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.  Also, the trust administrator can cash in or withdraw the cash 
value of the insurance policies to get cash to pay benefits other than death benefits.  The plans are often designed to determine an 
employer’s contributions or its employees’ benefits based on 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 the same type of tax benefits as listed in the transaction described in Notice 95-34.  The 
advertising packet listed the following benefits of enrollment:
·        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 Curico, in which the court also ruled in favor of the IRS.  As noted in Curico, the insurance policies, which 
were overwhelmingly variable or universal life policies, required large contributions compared 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 Curico, 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.  This is despite the fact that payment of benefits by 
Benistar seemed 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 never a reason to forfeit a policy to the plan.  In fact, in estimating life 
insurance rates, the taxpayers’ expert in Curico 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 andclaimed 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 2005 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 could 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 is considered 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.
·        By itself, a 412(i) plan is not a listed transaction; however, the IRS has a task force auditing 412(i) plans.
·        An employer has not engaged in a listed transaction simply because it is a 412(i) plan.
·        Just because a 412(i) plan was audited and sanctioned for certain items, does not necessarily mean the plan engaged in 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, 
reportable, or similar transactions; an issue that was not before the Tax Court in either Curico or McGehee.  The disclosure needs to be 
made for every year the participant is in a plan.  The forms need to be filed properly 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 filled in properly.  A plan 
administrator told me that he helps hundreds of his participants file forms, and they all still received very large IRS fines for not filling in the 
forms properly.
Lance Wallach is National society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals.  He 
does expert witness testimony and has never lost a case.  Contact him at 516-938-5007, wallachinc@gmail.com, or visit www.taxaudit419.
com or www.lancewallach.com.  The information provided herein is not intended as legal, accounting, financial, or any other type of advice 
for any specific individual or other entity.  You should contact an appropriate professional for any such advice.

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