IRS Audits 419, 412i, Captive Insurance Plans With Life Insurance and Section 79 Scams




     Published on hgexperts.com
         By: Lance Wallach
The IRS started auditing 419 plans in the ‘90s, and then continued going after 412i and other plans that they considered abusive, listed, or reportable transactions. Listed designated as listed in published IRS material available to the general public or transactions that are substantially similar to the specific listed transactions. A reportable transaction is defined simply as one that has the potential for tax avoidance or evasion.
In a recent Tax Court Case, Curcio v. Commissioner (TC Memo 2010-15), the Tax Court ruled that an investment in an employee welfare benefit plan marketed under the name "Benistar" was a listed transaction in that the transaction in question was substantially similar to the transaction described in IRS Notice 95-34. A subsequent case, McGehee Family Clinic, largely followed Curcio, though it was technically decided on other grounds. The parties stipulated to be bound by Curcio on the issue of whether the amounts paid by McGehee in connection with the Benistar 419 Plan and Trust were deductible. Curcio 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, one must have an understanding of Notice 95-34, which was issued in response to trust arrangements sold to companies that were 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, by relying on the 10-or-more-employer exemption from the IRC § 419 limits. It was claimed that 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 419A(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, and 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, and the trust administrator may obtain cash to pay benefits other than death benefits, by such means as cashing in or withdrawing the cash value of the insurance policies. The plans are also often designed so that a particular employer’s contributions or its employees’ benefits may be determined in 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 to obtain the same type of tax benefits as listed in the transaction described in Notice 95-34. The benefits of enrollment listed in its advertising packet included:
 

-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 Curcio, in which the court also ruled in favor of the IRS. As noted in Curcio, the insurance policies, overwhelmingly variable or universal life policies, required large contributions relative 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 Curcio, as the parties had stipulated, on the question of the amnesty paid by Mcghee in connection with benistar, 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—despite the payment of benefits by Benistar seeming 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 no reason ever to forfeit a policy to the plan. In fact, in estimating life insurance rates, the taxpayers’ expert in Curcio 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 and claimed 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 2004 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 can 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 makes the plan 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.

A 412(i) plan in and of itself is not a listed transaction; however, the IRS has a task force auditing 412i plans.
An employer has not engaged in a listed transaction simply because it is in a 412(i) plan.

Just because a 412(i) plan was audited and sanctioned for certain items, does not necessarily mean the plan is 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 or reportable or similar transactions; an issue that was not before the Tax Court in either Curcio or McGehee. The disclosure needs to be made for every year the participant is in a plan. The forms need to be properly filed 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 prepared properly. A plan administrator told me that he assisted hundreds of his participants file forms, and they still all received very large IRS fines for not properly filling in the forms.

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.
 

Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals, is a frequent speaker on retirement plans, financial and estate planning, and abusive tax shelters.  He writes about 412(i), 419, and captive insurance plans. He speaks at more than ten conventions annually, writes for over fifty publications, is quoted regularly in the press and has been featured on television and radio financial talk shows including NBC, National Public Radio's All Things Considered, and others. Lance has written numerous books including Protecting Clients from Fraud, Incompetence and Scams published by John Wiley and Sons, Bisk Education's CPA's Guide to Life Insurance and Federal Estate and Gift Taxation, as well as AICPA best-selling books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots. 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 and www.taxlibrary.us

The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.

11 comments:

  1. Sea Nine Veba
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    ReplyDelete
  2. know many of you are thinking the same thing, “what is a captive insurance company?” In a nutshell, a captive insurance company is an insurance company which has common ownership with the entity it insures. Recently, numerous news agencies have reported that it appears the IRS is increasing scrutiny of these captive insurance arrangements. However, before one can understand why the IRS would increase scrutiny it is important to understand the benefit to such an entity.

    All businesses attempt to manage the various risks that can negatively affect them. Typically, the most significant risks are managed through insurance. There are numerous commercial insurance products which help businesses manage risks associated with property and casualty loss, professional malpractice, tort liability and the like. When businesses pay the premiums for these insurance policies, they are allowed to deduct the payments as ordinary and necessary expense of the business. This reduces the amount of business income that is subject to taxation. However, every business is also subject to additional risks that they cannot purchase insurance for because they cannot afford it or because commercial insurance policies do not exist for these risks. These risks may include loss of a key client, loss of a key employee, and losses associated with negative government regulation. Without an insurance option, companies will often self insure these risks by retaining earnings to create reserves that can be used if such risks come to fruition. The downfall to this approach is that the company does not get a deduction for the money it sets aside in a reserve account. This in turn increases the business income subject to taxation, which ultimately increases the amount of taxes paid by the business.

    Under a captive insurance arrangement, a business will form a separate insurance company. This insurance company will have common ownership with the insured business and it will underwrite the insurance policies the business is unable to obtain elsewhere. In return, the business will pay premiums to the insurance company, which are deductible as a business expense. This deduction provides an immediate tax benefit for the insured business. Generally, this benefit is offset by the fact that the captive insurance company recognizes the premiums it receives as income. Thus, under a general captive insurance arrangement, the tax savings are minimal. However, the Internal Revenue Code provides a much more favorable tax treatment for some captive insurance companies, often referred to as “microcaptives.”

    ReplyDelete
  3. know many of you are thinking the same thing, “what is a captive insurance company?” In a nutshell, a captive insurance company is an insurance company which has common ownership with the entity it insures. Recently, numerous news agencies have reported that it appears the IRS is increasing scrutiny of these captive insurance arrangements. However, before one can understand why the IRS would increase scrutiny it is important to understand the benefit to such an entity.

    All businesses attempt to manage the various risks that can negatively affect them. Typically, the most significant risks are managed through insurance. There are numerous commercial insurance products which help businesses manage risks associated with property and casualty loss, professional malpractice, tort liability and the like. When businesses pay the premiums for these insurance policies, they are allowed to deduct the payments as ordinary and necessary expense of the business. This reduces the amount of business income that is subject to taxation. However, every business is also subject to additional risks that they cannot purchase insurance for because they cannot afford it or because commercial insurance policies do not exist for these risks. These risks may include loss of a key client, loss of a key employee, and losses associated with negative government regulation. Without an insurance option, companies will often self insure these risks by retaining earnings to create reserves that can be used if such risks come to fruition. The downfall to this approach is that the company does not get a deduction for the money it sets aside in a reserve account. This in turn increases the business income subject to taxation, which ultimately increases the amount of taxes paid by the business.

    Under a captive insurance arrangement, a business will form a separate insurance company. This insurance company will have common ownership with the insured business and it will underwrite the insurance policies the business is unable to obtain elsewhere. In return, the business will pay premiums to the insurance company, which are deductible as a business expense. This deduction provides an immediate tax benefit for the insured business. Generally, this benefit is offset by the fact that the captive insurance company recognizes the premiums it receives as income. Thus, under a general captive insurance arrangement, the tax savings are minimal. However, the Internal Revenue Code provides a much more favorable tax treatment for some captive insurance companies, often referred to as “microcaptives.”

    ReplyDelete
  4. Wallach Articles 1
    IRS Tax Shelters and 419 Plans Litigation - Benistar - 412i, IRS Audit Experts for abusive insurance based plans deemed reportable or listed transactions by the IRS
    om the hands of creditors.

    ReplyDelete
  5. Wallach Articles 1
    IRS Tax Shelters and 419 Plans Litigation - Benistar - 412i, IRS Audit Experts for abusive insurance based plans deemed reportable or listed transactions by the IRS
    om the hands of creditors.

    ReplyDelete
  6. For a captive insurance arrangement to qualify as legitimate, the taxpayer must demonstrate that the premiums charged are appropriate and that the need for insurance is real. Companies that create captives to shelter taxable income can expect an audit and hefty penalties. Years ago, the captives industry was marred by widespread fraud. The resurgence of cell captives, which involve a parent company setting up separate cell insurance subsidiaries whose assets are kept separate from each other, has again attracted the IRS’s attention.

    According to one expert, the IRS is focused on companies that underwrite their own terrorism policies, which often involve charging premiums that bear no relationship to the actual risk. The IRS considers such arrangements to be abusive tax shelters. To be considered legitimate insurance, there must be adequate risk shifting and risk distribution (see Rev. Rul. 2008-8).

    Captive Insurance Poses Big Tax Risk for Small Businesses

    The risks for small businesses that improperly set up captives are huge—the IRS can disallow the deductibility of the premiums. And an even bigger risk is that, because the IRS believes that some of these arrangements are also abusive tax shelters, it could impose civil penalties under Sec. 6707A of up to $200,000 for failure to disclose a listed transaction.

    If a client plans on establishing a captive, a tax adviser should make sure he or she understands the rules or partners with another member firm or tax attorney who does. Past scams were often offered by offshore and internet promoters that possessed official-looking tax opinion letters and polished presentation materials. Unfortunately, those opinions were frequently worthless. If a client is approached by a promoter, the practitioner should be on high alert and insist the client perform some due diligence on the promoter. The author has seen several cases where the plan was considered an abusive tax shelter, and, even worse, the money was later stolen.

    - See more at: http://www.thetaxadviser.com/issues/2013/dec/clinic-story-05.html#sthash.kmG7kMQ7.dpuf

    ReplyDelete
  7. For a captive insurance arrangement to qualify as legitimate, the taxpayer must demonstrate that the premiums charged are appropriate and that the need for insurance is real. Companies that create captives to shelter taxable income can expect an audit and hefty penalties. Years ago, the captives industry was marred by widespread fraud. The resurgence of cell captives, which involve a parent company setting up separate cell insurance subsidiaries whose assets are kept separate from each other, has again attracted the IRS’s attention.

    According to one expert, the IRS is focused on companies that underwrite their own terrorism policies, which often involve charging premiums that bear no relationship to the actual risk. The IRS considers such arrangements to be abusive tax shelters. To be considered legitimate insurance, there must be adequate risk shifting and risk distribution (see Rev. Rul. 2008-8).

    Captive Insurance Poses Big Tax Risk for Small Businesses

    The risks for small businesses that improperly set up captives are huge—the IRS can disallow the deductibility of the premiums. And an even bigger risk is that, because the IRS believes that some of these arrangements are also abusive tax shelters, it could impose civil penalties under Sec. 6707A of up to $200,000 for failure to disclose a listed transaction.

    If a client plans on establishing a captive, a tax adviser should make sure he or she understands the rules or partners with another member firm or tax attorney who does. Past scams were often offered by offshore and internet promoters that possessed official-looking tax opinion letters and polished presentation materials. Unfortunately, those opinions were frequently worthless. If a client is approached by a promoter, the practitioner should be on high alert and insist the client perform some due diligence on the promoter. The author has seen several cases where the plan was considered an abusive tax shelter, and, even worse, the money was later stolen.

    - See more at: http://www.thetaxadviser.com/issues/2013/dec/clinic-story-05.html#sthash.kmG7kMQ7.dpuf

    ReplyDelete

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    IRS6707Apenalty IRSform8886 TaxAdvisorExperts
    ExpertTaxAdvisors Taxlibrary.us

    ReplyDelete

  9. Our Professional Services:

    Our
    Services











    Serving clients
    nationwide

    Call us today:

    516-938-5007

    Email us at:

    LanWalla@aol.com

    Fax #:
    516-938-6330
    Every one of our
    consulting attorneys,
    CPAs & ex IRS Agents
    has over 25 years of
    professional experience!
    We believe that no firm
    has more experienced
    professionals to assist
    our clients than we do!!
    The Offices of Lance Wallach
    Tax penalty abatement
    IRS audit appeals
    U.S. Tax Court cases
    Multinational taxation consulting
    Incorporating your business
    Recovering losses from insurance
    companies & brokerage firms
    Tax shelter analysis
    Pension plan reviews & evaluations
    419 & 412 type benefit plan analysis,
    remediation
    Offshore tax shelter issues
    IRS listed transactions assistance
    Expert witness testimony for tax,
    insurance & retirement plan cases
    SSI & Disability benefits advocates
    Pension & Benefit Plan Fraud
    Insurance Company Fraud
    More Information From The Lance Wallach Network

    TaxAudit419.com ReportableTransactions Listed Transactions
    IRS6707Apenalty IRSform8886 TaxAdvisorExperts
    ExpertTaxAdvisors Taxlibrary.us

    ReplyDelete
  10. Today, I'd like to talk to you a little bit about a hot topic of captive insurance Audits and Litigation. Captive insurance is an area of an intense IRS scrutiny. The IRS is dedicating an enormous amount of resources to the area of captive insurance audits and captive insurance litigation. Presently, the IRS appears to be systematically auditing, virtually every captive insurance company and it's related insured. This issue at least from the IRS side is being extensively and carefully coordinated at the highest levels. For example, each of the revenue agents is being specifically trained in the area of captive insurance by the IRS's attorneys at the Office of Chief Counsel.http://www.taxcontroversy.com/blog/

    ReplyDelete
  11. Today, I'd like to talk to you a little bit about a hot topic of captive insurance Audits and Litigation. Captive insurance is an area of an intense IRS scrutiny. The IRS is dedicating an enormous amount of resources to the area of captive insurance audits and captive insurance litigation. Presently, the IRS appears to be systematically auditing, virtually every captive insurance company and it's related insured. This issue at least from the IRS side is being extensively and carefully coordinated at the highest levels. For example, each of the revenue agents is being specifically trained in the area of captive insurance by the IRS's attorneys at the Office of Chief Counsel.http://www.taxcontroversy.com/blog/

    ReplyDelete