Dolan Media Newswires
01/22/2010
Small Business Retirement Plans Fuel Litigation
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.
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.
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 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.
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 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.
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.
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.
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.
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.
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.
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.
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.
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.
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."
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."
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.
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.
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.
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.
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.
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.
"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.
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."
what we know, Congress is looking to make the penalties more proportionate to
the tax benefit received instead of a fixed amount."
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