Showing posts with label Life Insurance. Show all posts
Showing posts with label Life Insurance. Show all posts
412i-419 Plans: Lance Wallach's Nationwide Life Insurance Litigati...
412i-419 Plans: Lance Wallach's Nationwide Life Insurance Litigati...: Lance Wallach's Nationwide Life Insurance Litigation Blog
412i-419 Plans: IRS Attacks Many Business Owners with Huge Fines (...
412i-419 Plans: IRS Attacks Many Business Owners with Huge Fines (...: IRS Attacks Many Business Owners with Huge Fines (412i, 419, captives, sect 79) IRS may be auditing many more participating employers in t...
IRS Clarifies Legality of 419(e) Plans
IRS Clarifies Legality of 419(e) Plans
By Lance Wallach, CLU, ChFC, CIMC, and Ron Snyder, JD, EA
Following the U.S. Congress’ lead, on April 10 the IRS issued final regulations under Section 409A of the Internal Revenue Code. If the rules seemed unclear before, they are crystal clear now: Most of the so-called “419(e)” plans as well as the remaining 419A(f)(6) plans are in violation of the law and subject to hefty penalties.
A 419(e) plan is a benefit plan that generally seeks to make the purchase of life insurance tax-deductible to employers. While the concept is appealing, most of the existing arrangements have permitted the plans to transfer the insurance policies to the participants upon retirement.
The Purpose of 409A
Code Section 409A was enacted into law on Oct. 10, 2004, to provide some uniformity and to impose several requirements upon nonqualified deferred compensation plans and similar arrangements. The new rules imposed include a required written plan agreement; a limit of payments to death, disability or retirement; a substantial risk of forfeiture to avoid immediate taxation to the employee; and timing limitations on benefit distributions.
Congress drafted Section 409A broadly to include any payment to an employee after the year for which it was paid or after termination of employment, unless the payment falls under one of the named exceptions. Exceptions include payments within 75 days, COBRA benefits, de minimis cash-outs paid in the year of termination of employment, etc.
409A Applicability to Welfare Benefits
Section 409A does not apply to welfare benefits. In fact, several forms of welfare benefits are specifically excluded under 409A. However, such excluded arrangements do not permit transfer of property to the participant except for death, disability and payments made upon retirement in accordance with the 409A rules.
Most of the existing 419(e) and 419A(f)(6) welfare benefit plans do not comply with the 409A rules relative to transfers of insurance policies or cash payments other than upon death.
Compliance and Effective Dates
Significant penalties apply for noncompliance with Section 409A. In addition to having compensation included in income, tax penalties equal to the IRS underpayment rate plus 1 percent from the time the compensation should have been included in income, plus 20 percent of the compensation amount, apply. Additional penalties may apply for failure to report the arrangement appropriately.
When Section 409A was added, employers and consultants scrambled to comply because the rules were effective for years beginning after 2004 for all arrangements entered into after Oct. 3, 2004. Existing arrangements were given until the end of 2005 to comply. However, the IRS granted an extension for compliance for employers who made a “good-faith” effort to comply with the rules. Under the Final Regulations, plans have until Dec. 31, 2007, to be in full compliance.
Effect on CPAs, Plan Sponsors and Others
Under Circular 230 standards a CPA or attorney who advises his or her client about participating in a noncompliant welfare benefit plan may be liable for fines and other sanctions. The authors expect that opinion letters relative to such welfare benefit plans have either been withdrawn or will be shortly, and we admonish professionals to review carefully all communications with clients relative to such plans. The IRS has recently been successful in imposing huge fines on several law firms for blessing questionable transactions.
Sponsors of 419 plans have two choices: totally eliminate distributions from their plans (except medical reimbursements or death benefits), or comply with Code Section 409A and the regulations thereunder.
Employers have until Dec. 31 to be in compliance. Employers who have adopted 419 plans must choose immediately whether to remain in their current 419 plan, cancel their participation in such arrangement and have their benefits distributed by Dec. 31, or transfer to a plan that is fully compliant with the new rules.
Lance Wallach, CLU, ChFC, CIMC, can be reached at 516-938-5007 or lawallach@aol.com. Ron Snyder, JD, is an enrolled actuary.
412i, 419, Lawsuits, IRS Audits - HGExperts.com
419, 412i, plans are being audited by the IRS. Lawsuits are the result. 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 - $100,000 per individual and $200,000 per entity per tax year for each failure to disclose the transaction - often exceeding the disallowed taxes.
There are business owners who owe $6,000 in taxes but have been assessed $1.2 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 advisers 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 $1 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 appealable 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 $860,000 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.
Last July, in response to a letter from members of Congress, the IRS put a moratorium on collection of §6707A penalties, but only in cases where the tax benefits were less than $100,000 per year for individuals and $200,000 for entities. That moratorium was recently extended until March 1, 2010.
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."
Dolan Media Newswires 01/22
Small Business Retirement Plans Fuel Litigation
AUTHOR: Lance Wallach
Copyright Lance Wallach, CLU, CHFC
There are business owners who owe $6,000 in taxes but have been assessed $1.2 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 advisers 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 $1 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 appealable 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 $860,000 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.
Last July, in response to a letter from members of Congress, the IRS put a moratorium on collection of §6707A penalties, but only in cases where the tax benefits were less than $100,000 per year for individuals and $200,000 for entities. That moratorium was recently extended until March 1, 2010.
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."
Dolan Media Newswires 01/22
Small Business Retirement Plans Fuel Litigation
AUTHOR: Lance Wallach
Copyright Lance Wallach, CLU, CHFC
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