Section 79, Captive Insurance, 419, 412i Plans, Don’t go to arbitration sue

                                                                 Lance Wallach 

Thomas, Francis, Edward, and Dolores Ehlen¹("the Ehlens") are employees of Ehlen Floor Covering, Inc. ("Ehlen Floor"). In 2002, Ehlen Floor created a 412(I) employee benefit pension plan, the Ehlen Floor Coverings Retirement Plan ("the Plan"), with the help of advisors and administrators. IPS, a corporation specializing in pension plan design and administration for small businesses, took over as the Plan administrator at the start of 2003. As part of the commencement of IPS's services, Edward Ehlen, in his capacity as president of Ehlen Floor, signed an Arbitration Addendum ("AA") attached to an Administrative Services Agreement ("the Agreement") between IPS and Ehlen Floor. The AA called for arbitration of "any claim arising out of the rendition or lack of rendition of services under [the] [A]greement." The Agreement provided a list of available services that IPS could provide, such as performing annual reviews of the Plan, making amendments, and preparing annual report forms. The Agreement also stated that Ehlen Floor would indicate in Section VI of the Agreement which of the available services it desired for IPS to actually perform. There is no Section VI in the Agreement, nor is there any testimony or evidence that plaintiffs ever viewed a Section VI of the Agreement.

Shortly after IPS stepped in as administrator of the Plan, it became aware that the Plan was not in compliance with several Internal Revenue Service ("IRS") rules and regulations. IPS contends that it drafted an amendment to correct these flaws, but the amendment was never officially adopted. In 2004, the IRS promulgated new rules explaining that it would consider 412(i) plans with beneficiary payout limitations to be listed transactions², possibly subject to serious penalties. The rule required any plans that could be considered listed transactions to file Form 8886 to avoid potential penalties. IPS drafted another amendment to the Plan after determining that the Plan would likely be classified as a listed transaction under the new rules. Ehlen Floor was not informed about the pre-rule tax problems, the existence of the new rule, the additional filing requirements that the new rule imposed, or the drafting of the new amendment. The IRS instigated an audit on March 6, 2006, found the Plan to be non-compliant, and ultimately assessed significant penalties against Ehlen Floor.

In August 2007, plaintiffs filed a complaint in state court against a number of parties involved with the creation and initial administration of the Plan, asserting claims of negligence, fraudulent and negligent misrepresentation, negligent supervision, breaches of fiduciary duties, and unfair and deceptive trade practices. The case was removed to federal court on the basis of preemption under ERISA. In May 2009, as requested by the court, plaintiffs recast their complaints as federal matters in their Second Amended Complaint, but plaintiffs contested the removal and argued against federal jurisdiction. IPS was added as a defendant in the Second Amended Complaint. IPS then moved to compel arbitration of the dispute, claiming that the terms of the AA govern the matter. The district court denied the motion. IPS appeals; plaintiffs cross-appeal to challenge the existence of federal jurisdiction.

II. STANDARD

Innovative Pension Strategies, Inc. ("IPS") appeals the district court's denial of its motion to compel arbitration and stay plaintiffs' claims against it. Plaintiffs cross-appeal, disputing the preemption of their claims under the Employment Retirement Income Security Act ("ERISA") and alleging a lack of federal jurisdiction. We find that jurisdiction is proper and affirm the district court's denial of IPS's motion to compel arbitration.

Lance Wallach can be reached at: WallachInc@gmail.com

For more information, please visit www.taxadvisorexperts.org 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, abusive tax shelters, financial, international tax, and estate planning.  He writes about 412(i), 419, Section79, FBAR, 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 Pubic 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 the 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.taxadvisorexperts.com.

Lance Wallach
68 Keswick Lane
Plainview, NY 11803
Ph.: (516)938-5007
Fax: (516)938-6330 www.vebaplan.com

National Society of Accountants Speaker of The Year


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.

Lance Wallachelter help"

Mr. "Lance Wallach"

 Lance Wallach                                                                                                               June 2011

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, abusive tax shelters, financial, international tax, and estate planning.  He writes about 412(i), 419, Section79, FBAR, 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 Pubic 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 the 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.taxadvisorexpert.com.

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.

Stuart Felton

~ Founder & CEO: Researched Programs, Inc., Capital Formation Consultants LLC and
       Life Safety Products, LLC
~ Charter Member: National Association of Professional Bankers
~ Licensed Insurance Broker/Consultant- 1971 – 2007
~ Retired Officer of Supervisory Jurisdiction for NASD {Broker Dealer Division of } CITICORP

* Capital Formation Consultants

Founded in 1976, Capital Formation Consultants {a capital financing/development organization} with regional, national and international licensed professional affiliates specializing in the design and/or participation in the raising of private venture capital and marketing services.

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Robert Sherman, J.D.

~  St. John’s University School of Law

~ "Circular 230" expert

~ Financial and Taxation writer

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IRS Attacks Business Owners in 419, 412, Section 79 and Captive Insurance Plans Under Section 6707A

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 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 also has to be prepared correctly. I only know of two people in the U.S. who have filed these forms properly for clients. They tell me that was after hundreds of hours of research and over 50 phones calls to various IRS personnel. The filing instructions for Form 8886 presume a timely filling. 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 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."

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. 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. Another important issue is that the IRS has called CPAs material advisors if they signed tax returns containing the plan, and got paid a certain amount of money for tax advice on the plan. The fine is $100,000 for the CPA, or $200,000 if the CPA is incorporated. To avoid the fine, the CPA has to properly file Form 8918.

Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals, Wallach is a frequent speaker on retirement plans, financial and estate planning, and abusive tax shelters. He is also a featured writer and has been interviewed on television and financial talk shows including NBC, National Pubic Radio’s All Things Considered and others. Lance authored 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.

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.

Contact him at:

516.938.5007,

wallachinc@gmail.com, or

www.taxadvisorexperts.org, or

www.taxlibrary.us.

Ronald L. Noll

Ronald L. Noll, MS, CPA, CEA

~ Helped Congress Write the "Taxpayers Bill of Rights"
~ CPA and Investment Advisor for 40 Years
~ Past National President of Accounting Society
~ Author of AICPA Course on Taxation and Use  of Private Annuity Trusts
~ Real Estate Tax Expert and Investor
~ Expert in Wealth Accumulation, Perseveration and Transfer

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The A2Z Directory                                                                                                                                                                 March 2011 Lance Wallach                                                  

The IRS has various task forces auditing all section 419, section 412(i), and other plans that tend to be abusive.  Most insurance agents sell these plans.  The IRS is looking to raise money and is not looking to correct plans or help taxpayers. The IRS calls accountants, attorneys, and insurance agents “material advisors” and also fines them the same amount, again unless the client’s participation in the transaction is reported.  An accountant is a material advisor if he signs the return or gives advice and gets paid.  More details can be found on www.irs.gov and vebaplan.org.

Bruce Hink, who has given me written permission to use his name and circumstances, is a perfect example of what the IRS is doing to unsuspecting business owners.  What follows is a story about how the IRS fines him each year for being in what they called a listed transaction.  Listed transactions can be found at www.irs.gov.  Also involved are what the IRS calls abusive plans or what it refers to as substantially similar.  Substantially similar to is very difficult to understand, but the IRS seems to be saying, “If it looks like some other listed transaction, the fines apply.”  Also, I believe that the accountant who signed the tax return and the insurance agent who sold the retirement plan will each be fined as material advisors.  We have received many calls for help from accountants, attorneys, business owners, and insurance agents in similar situations.  Don’t think this will happen to you?  It is happening to a lot of accountants and business owners, because most of theses so-called listed, abusive, or insurance agents are selling substantially similar plans. Recently I came across the case of Hink, a small business owner who is facing thousands in IRS penalties for 2004 and 2005 because of his participation in a section 412(i) plan.  (The penalties were assessed under section 6707A.) 

In 2002 an insurance agent representing a 100-year-old, well-established insurance company suggested the owner start a pension plan.  The owner was given a portfolio of information from the insurance company, which was given to the company’s outside CPA to review and give an opinion on.  The CPA gave the plan the green light and the plan was started. Contributions were made in 2003.  The plan administrator came out with amendments to the plan, based on new IRS guidelines, in October 2004. The business owner’s insurance agent disappeared in May 2005, before implementing the new guidelines from the administrator with the insurance company.  The business owner was left with a refund check from the insurance company, a deduction claim on his 2004 tax return that had not been applied, and no agent.

It took six months of making calls to the insurance company to get a new insurance agent assigned.  By then, the IRS had started an examination of the pension plan.  Asking advice from the CPA and a local attorney (who had no previous experience in these cases) made matters worse, with a “big name” law firm being recommended and over ,000 in additional legal fees being billed in three months. To make a long story short, the audit stretched on for over 2 ½ years to examine a 2-year-old pension with four participants and the 8,000 in contributions. During the audit, no funds went to the insurance company, which was awaiting formal IRS approval on restructuring the plan as a traditional defined benefit plan, which the administrator had suggested and the IRS had indicated would be acceptable.In March 2008 the business owner received a private e-mail apology from the IRS agent who headed the examination, saying that her hands were tied and that she used to believe she was correcting problems and helping taxpayers and not hurting people.

 Could you or one of your clients be next?

To this point, I have focused, generally, on the horrors of running afoul of the IRS by participating in a listed transaction, which includes various types of transactions and the various fines that can be imposed on business owners and their advisors who participate in, sell, or advice on these transactions.  I happened to use, as an example, someone in a section 412(i) plan, which was deemed to be a listed transaction, pointing out the truly doleful consequences the person has suffered.  Others who fall into this trap, even unwittingly, can suffer the same fate.

Now let’s go into more detail about section 412(i) plans.  This is important because these defined benefit plans are popular and because few people think of retirement plans as tax shelters or listed transactions.  People therefore may get into serious trouble in this area unwittingly, out of ignorance of the law, and, for the same reason, many fail to take necessary and appropriate precautions. The IRS has warned against the section 412(i) defined benefit pension plans, named for the former code section governing them.  It warned against trust arrangements it deems abusive, some of which may be regarded as listed transactions.  Falling into that category can result in taxpayers having to disclose the participation under pain of penalties. Targets also include some retirement plans.

One reason for the harsh treatment of some 412(i) plans is their discrimination in favor of owners and key, highly compensated employees.  Also, the IRS does not consider the promised tax relief proportionate to the economic realities of the transactions.  In general, IRS auditors divide audited plan into those they consider noncompliant and other they consider abusive.  While the alternatives available to the sponsor of noncompliant plan are problematic, it is frequently an option to keep the plan alive in some form while simultaneously hoping to minimize the financial fallout from penalties.

The sponsor of an abusive plan can expect to be treated more harshly than participants.  Although in some situation something can be salvaged, the possibility is definitely on the table of having to treat the plan as if it never existed, which of course triggers the full extent of back taxes, penalties, and interest on all contributions that were made – not to mention leaving behind no retirement plan whatsoever. Another plan the IRS is auditing is the section 419 plan.  A few listed transactions concern relatively common employee benefit plans the IRS has deemed tax avoidance schemes or otherwise abusive.  Perhaps some of the most likely to crop up, especially in small-business returns, are the arrangements purporting to allow the deductibility of premiums paid for life insurance under a welfare benefit plan or section 419 plan.  These plans have been sold by most insurance agents and insurance companies.

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, abusive tax shelters, financial, international tax, and estate planning.  He writes about 412(i), 419, Section79, FBAR, 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 Pubic 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 the 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.taxadvisorexperts.com

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.