What are 412(i) Plans and what are the problems with these plans
412(i) is a provision of the tax code. A 412(i) plan is a defined pension plan. A 412(i) plan differs from other defined benefit pension plans in that it must be funded exclusively by the purchase of individual life insurance products (insurance and annuities). It provides specific retirement benefits to participants once they reach retirement and must contain assets sufficient to pay those benefits. To create a 412(i) plan, there must be a plan to hold the assets. The employer funds the plan by making cash contributions to the plan, and the Code allows the employer to take a tax deduction in the amount of the contributions, i.e. the entire amount.
The plan uses the contributed funds to purchase some combination of life insurance products (insurance or annuities) for the plan. As the plan participants retire, the plan will usually sell the policies for their present cash value and purchase annuities with the proceeds. The revenue stream from the annuities pays the specified retirement benefit to plan participants.
Where did the problems start?
In the late 1990's brokers and promoters such as Kenneth Hartstein, Dennis Cunning, and others began selling 412(i) plans designed with policies created and sold through agents of Pacific Life, Hartford, Indianapolis life, and American General. These plans were sold or administered through companies such as Economic Concepts, Inc., Pension Professionals of America, Pension Strategies, L.L.C. and others.
These plans were very lucrative for the brokers, promoters, agents, and insurance companies. In addition to the costs associated with administering the plans, the policies of insurance had high commissions and high surrender charges.
These plans were often described as Pendulum Plans, or other similar names. In theory, the plans would work as follows. After the defined pension plan was set up, the plan would purchase a life insurance policy insuring the life of an individual. The plan would have no cash value (and high surrender charges) for 5 or more years. The Corporation would pay the premium on the policy and take a deduction for the entire amount. In year 5, when the policy had little or no cash value, the plan would transfer the policy to the individual, who would take it at a greatly reduced basis. Subsequently, the policy would bloom like a rose, and the individual would have a policy with significant cash value which he or she could withdraw tax free.
Who signed off on the plan?
Attorney Richard Smith at the law firm of Bryan Cave issued tax opinion letters opinion which stated that many of the plans complied with the tax code.
So what is the problem?
In the early 2000s, IRS officials began questioning Richard Smith and others and giving speeches at benefits conferences wherein they took the position that these plans were in violation of both the letter and spirit of the Internal Revenue Code.
In February 2004, the IRS issued guidance on 412(i) and began the process of making plans "listed transactions." Taxpayers involved in listed transaction are required to report them to the IRS. These transactions are to be reported using a form 8886. The failure to file a form 8886 subjects individual to penalties of $100,000 per year, and corporations $200,000 per year. These penalties are often referred to as section 6707 penalties. Advisors of these plans are required to maintain records regarding these plans and turn them over to the IRS, upon demand.
In October of 2005, the IRS invited those who sponsored 412(i) plans that were treated as listed transactions to enter a settlement program in which the taxpayer would recind the plan and pay the income taxes it would have paid had it not engaged in the plan, plus interest and reduced penalties.In late 2005, the IRS began obtaining information from advisors and actively auditing plans and more recently, levying section 6707 penalties.
The plan uses the contributed funds to purchase some combination of life insurance products (insurance or annuities) for the plan. As the plan participants retire, the plan will usually sell the policies for their present cash value and purchase annuities with the proceeds. The revenue stream from the annuities pays the specified retirement benefit to plan participants.
Where did the problems start?
In the late 1990's brokers and promoters such as Kenneth Hartstein, Dennis Cunning, and others began selling 412(i) plans designed with policies created and sold through agents of Pacific Life, Hartford, Indianapolis life, and American General. These plans were sold or administered through companies such as Economic Concepts, Inc., Pension Professionals of America, Pension Strategies, L.L.C. and others.
These plans were very lucrative for the brokers, promoters, agents, and insurance companies. In addition to the costs associated with administering the plans, the policies of insurance had high commissions and high surrender charges.
These plans were often described as Pendulum Plans, or other similar names. In theory, the plans would work as follows. After the defined pension plan was set up, the plan would purchase a life insurance policy insuring the life of an individual. The plan would have no cash value (and high surrender charges) for 5 or more years. The Corporation would pay the premium on the policy and take a deduction for the entire amount. In year 5, when the policy had little or no cash value, the plan would transfer the policy to the individual, who would take it at a greatly reduced basis. Subsequently, the policy would bloom like a rose, and the individual would have a policy with significant cash value which he or she could withdraw tax free.
Who signed off on the plan?
Attorney Richard Smith at the law firm of Bryan Cave issued tax opinion letters opinion which stated that many of the plans complied with the tax code.
So what is the problem?
In the early 2000s, IRS officials began questioning Richard Smith and others and giving speeches at benefits conferences wherein they took the position that these plans were in violation of both the letter and spirit of the Internal Revenue Code.
In February 2004, the IRS issued guidance on 412(i) and began the process of making plans "listed transactions." Taxpayers involved in listed transaction are required to report them to the IRS. These transactions are to be reported using a form 8886. The failure to file a form 8886 subjects individual to penalties of $100,000 per year, and corporations $200,000 per year. These penalties are often referred to as section 6707 penalties. Advisors of these plans are required to maintain records regarding these plans and turn them over to the IRS, upon demand.
In October of 2005, the IRS invited those who sponsored 412(i) plans that were treated as listed transactions to enter a settlement program in which the taxpayer would recind the plan and pay the income taxes it would have paid had it not engaged in the plan, plus interest and reduced penalties.In late 2005, the IRS began obtaining information from advisors and actively auditing plans and more recently, levying section 6707 penalties.
Many small business owners or doctors have lost money in a 419 plan. The IRS considers most of these plans to be abusive tax shelters. Unfortunately, quite an industry developed over the last decade selling these plans to unwary consumers. The promoters claim that the plan is a legitimate way to invest money without paying taxes. These plans were often marketed through seminars and sometimes by insurance agents and accountants.
ReplyDeleteThe “lucky” participants simply made a lousy investment in unneeded insurance. The rest, however, either received a huge tax bill from the IRS or found they were unable to get back their money when needed. The really unlucky both lost their money and had to pay the IRS. A recent case from the United States Tax Court once again points out the perils in 419 welfare benefit plans. (If you have invested in a similar tax shelter such as a Chapter 79 captive insurance company, 412 plan or shark finned CLATs, keep reading. The same advice probably pertains to you as well.)
The newest decision involves Dr. Jerald White, a physician from Tennessee. He and his wife contributed $200,000 a year to a so-called xelan 419 plan. When xélan pulled the plug on their plan, he converted his plan to one operated by Millennium.
xélan was a membership organization for physicians. It’s stated mission was to offer insurance products to its members. One of their offerings was a “Tax Reduction Program.” Dr. White and his wife signed up and invested $200,000 per year of pre tax dollars. Unlike some of the 419 plans, which involved outright theft, the xelan plan required a significant amount of paperwork and a legal opinion to even join. In other words, it appeared legitimate.
It was not. How the Whites got scammed and how they lost their battle with the IRS is a story worth repeating. There are plenty of lessons to be learned for anyone stuck in one of these or similar plans.
Like many similar welfare benefit plan participants, an insurance agent originally recruited Dr. White after attending an informational seminar. Most participants are very educated and
Abusive 419 welfare benefit insurance plans - CommPartners
ReplyDeleteeo2.commpartners.com/users/nsa/downloads/NSA_419.doc
NSA MEMBER LINK January 23, 2008. WELFARE BENEFIT 419 INSURANCE PLANS NAMED LISTED TRANSACTIONS. Lance Wallach. During tax season ...
419 Welfare Benefit Plan Promoter - Asset Protectio
In re Indianapolis Life Ins. Co. Internal Revenue Service § 412(i) Plans Life Insurance Marketing Litig., (MDL No. 1983), was originally created to centralize claims relating to the design, marketing, and sale of specially designed life insurance policies used to fund defined benefit pension plans under § 412(i) of the Internal Revenue Code. Indianapolis Life recently requested that the proceeding be expanded to include cases, such as Paul v. Aviva Life and Annuity Company (the successor to Indianapolis Life), which assert claims relating to employee benefit plans formed under § 419 of the tax code because the core factual allegations asserted in these actions are nearly identical, with each asserting a variety of fraud-based claims relating to the design, marketing, and sale of certain Indianapolis Life insurance policies used by the plaintiffs to fund employee benefit plans for their small businesses.
ReplyDeleteOn August 10, 2009, the MDL Panel issued an order transferring Paul to MDL No. 1983 for centralized pretrial proceedings. The MDL Panel recognized the “common questions of fact” between the actions and noted that “[t]he previously centralized MDL No. 1983 actions involve the funding of small business defined benefit pension plans with Indianapolis Life insurance policies which were represented to be in compliance with U.S. Internal Revenue Service (I.R.S.) § 412(i). Paul involves similar allegations involving Indianapolis Life policies used to fund small business I.R.S. § 419 welfare benefit plans.” The MDL Panel noted that although “Paul may involve some unique questions of fact relating to § 419 plans, the transferee judge can establish a separate track, if necessary, to address any unique factual and legal issues which may arise.” The MDL Panel also renamed MDL No. 1983 “In re Indianapolis Life Ins. Co. I.R.S. § 412(i) and § 419 Plans Life Insurance Marketing Litig.” to reflect the inclusion of cases asserting claims relating to § 419 welfare benefit plans. Jorden Burt represents Indianapolis Life in these cases.