Section 79,
captive insurance, 412i, 419, audits, problems and lawsuits
April 24, 2012 By Lance Wallach, CLU, CHFC
Captive insurance, section 79, 419 and 412i problems
WebCPA
The dangers of being "listed"
A warning for 419, 412i, Sec.79 and captive insurance
Accounting Today: October 25,
By: 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 you do not necessarily have to
make a contribution or
claim a tax deduction 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 you are also in trouble if you file incorrectly.
I have received numerous phone calls from business owners who filed and still
got fined. Not
only do you 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 tell me that
was 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 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 its deductions. 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.
The dangers of being "listed"
A warning for 419, 412i, Sec.79 and captive insurance
Accounting Today: October 25,
By: 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 you do not necessarily have to
make a contribution or
claim a tax deduction 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 you are also in trouble if you file incorrectly.
I have received numerous phone calls from business owners who filed and still
got fined. Not
only do you 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 tell me that
was 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 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 its deductions. 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.
412i Plans
attacked by IRS, lawsuits
April 24, 2012 By Lance Wallach, CLU, CHFC
IRS has been attacking abusive 412i plans for years. Business men
have been suing the insurance agents who sold the plans.
have been suing the insurance agents who sold the plans.
The IRS has attacked 412i, 419 plans for years. As a result
promoters are now promoting section 79 and captive insurance plans. They are
just starting to be attacked by the IRS.
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.
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 adminstering the plans, the
policies of insurance had high commissions. If they were cancelled within a few
years of purchace the had very little cash value.
These plans were often described as Pendulum Plans, or other similar names. In
theory, the plans would work as follows. After the plan was set up, the plan
would purchase a life insurance policy insuring the life of an individual. The
plan would have very little (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 spring up with cash value, thus
the name springing cash value policy. The insured would have cash value which
he could withdraw almost tax free .
Attorney Richard Smith at the law firm of Bryan Cave issued tax opinion letters
opinion which stated that the design of many of the plans met the requirements
of section 412(i) of the tax code.
In the early 2000s, IRS officials began questioning the insurance
representatives, brokers, promoters, and their attorneys 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. When I
spoke at the annual national convention of the American Society of Pension Actuarys
in 2002 I heard such a speech given by Jim Holland, IRS chief actuary.
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 very large amounts, and failure of insurance agents,
accountants and others to file 8918 results in a $100,000 fine.
In late 2005, the IRS began obtaining information from advisors and actively
auditing plans and more recently, levying section 6707 penalties. First the IRS
would audit the business owner and deny the deduction. The business owner would
also owe interest and penalities. Then another unit of the IRS would assess
large additional fines for failure to properly file, or failure to file 8886
forms. The directions for these forms is very complicated, expecially if the
forms are filed after the fact. Many business owners still got fined even if
they filed the forms. If the forms were not filled in exactly right a fine was
still assessed.
The IRS's response to these 412(i) plans was predictable. They made it clear
that the IRS would not be gentle and even indicated that potential criminal
liability existed. The IRS made speeches and people like me wrote articles
about the problems.
Insurance company representatives attended these conferences and heard the IRS
warnings. Many of them ignored them.
Neither the brokers, promoters, or Insurance companies relayed this information
to their clients and insureds at this time. When I would speak about the
problems of 412i and 419 plans I would be attacked by promoters and salesmen.
When I testified againt a springing cash value policy in my first court case I
was challenged by the defendants attorney as not being an expert. The judge
allowed the jury to hear whether I was indeed an expert. The result was a huge
loss for the defense.
On February 13, 2004, the IRS issued a press release, two revenue rulings, and
proposed regulations to shut down abusive transactions involving specifically
designed life insurance policies in retirement plans, section 412(i) plans and
419 plans etc.
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.
MDL stands for Multidistrict Litigation. It was created by Congress in 1968 –
28 U.S.C. §1407.
The act created an MDL Panel of judges to determine whether civil actions
pending in different federal districts involve one or more common questions of
fact such that the actions should be transferred to one federal district for
coordinated or consolidated pretrial proceedings. In theory, the purposes of
this transfer or “centralization” process are to avoid duplication of
discovery, to prevent inconsistent pretrial rulings, and to conserve the
resources of the parties, their counsel and the judiciary. Transferred actions
which are not resolved in the MDL are remanded to their originating court or
district by the Panel for trial. Lots of people who were audited sued the
insurance companys, agents, accountants and others.
Then, Pacific Life, Hartford Life & Annuity moved for summary judgment in
the MDL. The court granted the motions in part, and denied the motions in part.
Specifically, the court dealt with the issue of the disclaimers contained
within the policies and signed by various policyholders.
Applying California law in evauating the disclosures and disclaimers, the Court
ruled that the California Plaintiffs failed to raise issues of material fact
that they reasonably relied on representations by Hartford and Pacific Life
regarding the tax and legal issues related to their 412(i) plans.
Conversely, the court ruled that pursuant to Wisconsin law, the disclaimers
were unenforceable. The court came to similar conclusion when applying Texas
law to the Plaintiffs claims.
Plaintiffs have been more successful in suing 419 plan promoters, insurance
companys, accountants ,etc. I have been an expert witness and my side has never
lost a case.
I have been speaking with my IRS contacts about the newest abusive tax shelter
trends, captives and section 79 plans. They have started auditing participants
in these plans. The IRS has not yet decided if the plans are listed, abusive or
similar to. I think that captive insurance companies and section 79 plans may
become the next 412 and 419 problem for unsuspecting companies. Designed under
IRS Code 831(b), these captive insurance companies are designed to insure the
risks of an individual business. In theory and if properly designed, the
premiums are deducted when paid to a related company, and depending on claims,
profits can be paid out as dividends and when liquidated, the proceeds are
taxed at capital gains rates.
The problem with Captives is that they are expensive to set up and operate.
Captives must be opetate as a true risk assuming entity, not simply a tax
avoidance vehicle. Some variations are to rent a cell captives that can work
for a lot less money.
The IRS is looking into the sale of life insurance to fund Captives. They are
also looking at most section 79 plans. This sounds very familiar.
promoters are now promoting section 79 and captive insurance plans. They are
just starting to be attacked by the IRS.
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.
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 adminstering the plans, the
policies of insurance had high commissions. If they were cancelled within a few
years of purchace the had very little cash value.
These plans were often described as Pendulum Plans, or other similar names. In
theory, the plans would work as follows. After the plan was set up, the plan
would purchase a life insurance policy insuring the life of an individual. The
plan would have very little (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 spring up with cash value, thus
the name springing cash value policy. The insured would have cash value which
he could withdraw almost tax free .
Attorney Richard Smith at the law firm of Bryan Cave issued tax opinion letters
opinion which stated that the design of many of the plans met the requirements
of section 412(i) of the tax code.
In the early 2000s, IRS officials began questioning the insurance
representatives, brokers, promoters, and their attorneys 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. When I
spoke at the annual national convention of the American Society of Pension Actuarys
in 2002 I heard such a speech given by Jim Holland, IRS chief actuary.
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 very large amounts, and failure of insurance agents,
accountants and others to file 8918 results in a $100,000 fine.
In late 2005, the IRS began obtaining information from advisors and actively
auditing plans and more recently, levying section 6707 penalties. First the IRS
would audit the business owner and deny the deduction. The business owner would
also owe interest and penalities. Then another unit of the IRS would assess
large additional fines for failure to properly file, or failure to file 8886
forms. The directions for these forms is very complicated, expecially if the
forms are filed after the fact. Many business owners still got fined even if
they filed the forms. If the forms were not filled in exactly right a fine was
still assessed.
The IRS's response to these 412(i) plans was predictable. They made it clear
that the IRS would not be gentle and even indicated that potential criminal
liability existed. The IRS made speeches and people like me wrote articles
about the problems.
Insurance company representatives attended these conferences and heard the IRS
warnings. Many of them ignored them.
Neither the brokers, promoters, or Insurance companies relayed this information
to their clients and insureds at this time. When I would speak about the
problems of 412i and 419 plans I would be attacked by promoters and salesmen.
When I testified againt a springing cash value policy in my first court case I
was challenged by the defendants attorney as not being an expert. The judge
allowed the jury to hear whether I was indeed an expert. The result was a huge
loss for the defense.
On February 13, 2004, the IRS issued a press release, two revenue rulings, and
proposed regulations to shut down abusive transactions involving specifically
designed life insurance policies in retirement plans, section 412(i) plans and
419 plans etc.
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.
MDL stands for Multidistrict Litigation. It was created by Congress in 1968 –
28 U.S.C. §1407.
The act created an MDL Panel of judges to determine whether civil actions
pending in different federal districts involve one or more common questions of
fact such that the actions should be transferred to one federal district for
coordinated or consolidated pretrial proceedings. In theory, the purposes of
this transfer or “centralization” process are to avoid duplication of
discovery, to prevent inconsistent pretrial rulings, and to conserve the
resources of the parties, their counsel and the judiciary. Transferred actions
which are not resolved in the MDL are remanded to their originating court or
district by the Panel for trial. Lots of people who were audited sued the
insurance companys, agents, accountants and others.
Then, Pacific Life, Hartford Life & Annuity moved for summary judgment in
the MDL. The court granted the motions in part, and denied the motions in part.
Specifically, the court dealt with the issue of the disclaimers contained
within the policies and signed by various policyholders.
Applying California law in evauating the disclosures and disclaimers, the Court
ruled that the California Plaintiffs failed to raise issues of material fact
that they reasonably relied on representations by Hartford and Pacific Life
regarding the tax and legal issues related to their 412(i) plans.
Conversely, the court ruled that pursuant to Wisconsin law, the disclaimers
were unenforceable. The court came to similar conclusion when applying Texas
law to the Plaintiffs claims.
Plaintiffs have been more successful in suing 419 plan promoters, insurance
companys, accountants ,etc. I have been an expert witness and my side has never
lost a case.
I have been speaking with my IRS contacts about the newest abusive tax shelter
trends, captives and section 79 plans. They have started auditing participants
in these plans. The IRS has not yet decided if the plans are listed, abusive or
similar to. I think that captive insurance companies and section 79 plans may
become the next 412 and 419 problem for unsuspecting companies. Designed under
IRS Code 831(b), these captive insurance companies are designed to insure the
risks of an individual business. In theory and if properly designed, the
premiums are deducted when paid to a related company, and depending on claims,
profits can be paid out as dividends and when liquidated, the proceeds are
taxed at capital gains rates.
The problem with Captives is that they are expensive to set up and operate.
Captives must be opetate as a true risk assuming entity, not simply a tax
avoidance vehicle. Some variations are to rent a cell captives that can work
for a lot less money.
The IRS is looking into the sale of life insurance to fund Captives. They are
also looking at most section 79 plans. This sounds very familiar.
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