Reportable Transactions .com: Life Insurance, Listed, Abusive, IRS, Audits. 419 ...

Reportable Transactions .com: Life Insurance, Listed, Abusive, IRS, Audits. 419 ...

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  1. Not all 419 plans are created equally, or have the same legal standing

    Don't you suspect that if you could afford the best accountants, you, too, would be privy to the tax-saving secrets reserved for the business elite? Aren't you just a little intrigued by promoters who will reveal their unique and highly effective tax-reduction technique only after you sign an agreement not to reveal the details to others? Your clients are just as curious.

    Tax loopholes are based on an interpretation of our complex and often undecipherable Internal Revenue Code. The more popular the technique, the more it catches the attention of the IRS--and the more likely the law will be changed to curb abuse. Some promoters who have built businesses on these techniques may protest, claiming their particular arrangement is not affected by the new tax regulations. More prudent tax planners will adapt their programs or move on to other types of tax shelters.

    The 419 welfare benefit plan is a tax planning technique currently experiencing an evolution. Knowing its history and what is different today will help you make better recommendations to your clients.

    Welfare Benefit Plans of the Past

    One of the more popular tax reduction techniques of the last couple of decades was the multiple employer welfare benefit plan. Better known as the 419 plan, this tax shelter was particularly attractive to owner/employees who were worried about taxes and their retirement security. For the small business, the 419 plan promised unlimited tax deductions for benefits reserved for favored employees, including the owner. On paper, the plan was limited to medical, disability, death, or involuntary termination (severance) benefits. But in reality, the 419 plan promised retirement benefits for owners of S corporations and other pass-through tax entities that had little opportunity for deferred compensation or other fringe benefits.

    In 1984, Congress eliminated the tax-deductible contribution limits for welfare benefit plans that consisted of groups of 10 or more employers. Congress believed that, by grouping employers into one plan, each employer would contribute the minimum necessary to fund the desired benefits. There would be no incentive to overfund the plan and thus no need to place limits on contributions. In practice, individual employer contributions were not commingled, and participating employers were protected from the risk of paying for benefits triggered by other members' employees.

    As beneficial as Congress viewed welfare benefits, many employers were less interested in funding severance and death benefits than they were in securing retirement benefits for themselves. A skilled salesperson, however, could explain how to manipulate the 419 plan to benefit the business owner. The plan would be dismantled at the convenience of the business owner and the plan assets would be distributed pro rata to the participating employees. A good example would be a doctor winding down his practice prior to retirement. It is likely that he would be the last employee out the door and therefore the sole benefactor of the 419 plan. The distribution would be taxed like any other compensation.

    If It Looks Like a Duck . . .