 Posted: Tue Aug 23, 2011 1:30 pm Post subject: |
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WHAT YOU DON’T KNOW CAN HURT YOU – AVOID
EXPOSURE TO SEVERE PENALTIES
Welfare benefit plans are a creation of and are sanctioned by Section 419 of the Internal Revenue Code. There are single employer plans and multiple employer plans; the latter rely mostly on IRC Section 419A (f) (6) (in the most common cases where there are ten or more employers as part of the same plan). The 419A(f)(6) plans are, and perhaps always were, generally regarded as abusive, and were substantially curtailed in recent years by harsh IRS regulation. Amazingly, however, they refuse to totally die, and are still being marketed. There is absolutely no doubt that these plans are what are called listed transactions (more on that later). Single employer plans are now more popular. All welfare benefit plans tend to share certain characteristics, however. They tend to be marketed most frequently by insurance agents and financial planners, and sometimes by accountants and attorneys. Prospects tend to be professionals and profitable small businesses. The most attractive selling point is the ability to claim large tax deductions. Life insurance tends to be the funding vehicle. Often cheap term insurance is purchased for rank and file workers and some form of permanent coverage (universal life, variable life, etc., for the owners and key employees. For businesses looking to do as little as possible for workers, a selling point is that the great majority of benefits, in most cases, eventually go to the owners. This type of discrimination was recently addressed by IRC Notice 2007-84, which disallowed tax deductions and penalties with respect to welfare benefit plans that discriminate. If done correctly, the plans can accomplish things like facilitating estate planning, business succession, and asset protection. But the promised tax deduction is usually the sizzle that sells the steak.
In October of 2007, welfare benefit plans were affected by IRS rulings. The two most important developments were Revenue Ruling 2007-65, which declared, in essence, that premiums paid inside of a welfare benefit plan for cash value life insurance were not tax deductible, and Notice 2007-83, which identified the trust within welfare benefit plans involving cash value life insurance policies, AND substantially similar arrangements, as listed transactions. In other words, in essence, not only are premiums paid for cash value life insurance policies in welfare benefit plans not tax deductible, but, and far ,more importantly, the plans themselves are now listed transactions. This designation creates disclosure obligations with absurdly harsh penalties both for failure to disclose or incorrectly or incompletely disclosing, as we shall soon see.
Any practitioner who has clients in these plans must proceed with utmost caution, both for the client’s sake and his own. A listed transaction, basically, is any transaction identified as such by specific IRS guidance OR any transaction substantially similar to the specifically identified transaction. Participants in listed transaction must file Form 8886 with both the Service and the Office of Tax Shelter Analysis. Failure to timely and completely file leads to penalties of $100,000 for individuals and $200,000 for corporate taxpayers.
The practitioner has filing requirements, also, which can lead to equally severe penalties, if the practitioner qualifies as a “material advisor” with respect to one of these transactions. What is a material advisor? Basically, someone who gives advice, sells, or otherwise plays a significant part in the promotion, sale, or paperwork with respect to a taxpayer’s participation in a listed transaction. Put simply, from an accountant’s standpoint, you must give advice, the client must do it, and you must satisfy a certain income threshold with respect to the transaction, usually $10,000. The accountant who signs a return taking a tax deduction with respect to the transaction is surely a material advisor.
A problem is that many accountants are not even aware of these plans. Often it is discovered when preparing the client’s tax return, at which point the client expects you to allow the deduction and sign the return, since the client was sold a tax deduction. Or worse yet, the deduction may already have been disallowed on audit. The point is that, far too frequently, the practitioner does not even discover a client’s involvement in a listed transaction until too much damage has already been done. This is often the case if the contribution has already been made, as it usually has, and irretrievably so if the deductions have already been disallowed on audit. And added to all of this is the distaste that most professionals must have for all of these policing types of duties, to say nothing of the difficulties that are created with clients and, probably, the loss of some clients.
The material advisor must file Form 8918 describing his exact role in the client’s participation in the transaction. Failure to file can lead to penalties imposed on the advisor that are as unreasonably severe as these imposed on taxpayers ($100,000 for individuals and $200,000 for corporations) who fail to file Form 8886. The accountant may escape material advisor status by not meeting the $10,000 income threshold. A problem, however, is the accountant who is paid $10,000 in the aggregate by the client, but not that much specifically with respect to the listed transaction. Does such a person satisfy the income threshold? The author and his associates have discussed this point, among others, directly with IRS personnel who actually wrote published guidance in this area. They have not been very forthcoming; an unequivocal answer has been unobtainable. The best we have been able to get is a declaration that any test that would be applied to the determination of any of these issues would have to consider all surrounding facts and circumstances. This would be unlikely to yield any general rules, for each situation has its own facts and circumstances.
Another section that the practitioner, or at least the prudent one, should be aware of, largely apart from what has been discussed so far in this article, is Section 6701, entitled” penalties for aiding and abetting understatement of tax liability.” This penalty is imposed upon those who assist in, procure, or advise while knowing or having reason to believe that the subject matter will be used in connection with any material matter arising under the tax laws and who know that the use thereof would result in the understatement of another person’s tax liability. The penalty may be applied separately to each occurrence, and it is $1,000 if an individual is the taxpayer and $10,000 for a corporate taxpayer. Someone furnishing only what could be described as ministerial assistance is not subject to these penalties; this is not aiding and abetting. Also, for whatever it is worth, no one penalized under section 6701 is subject to section 6694 return preparer penalties, which are far less Draconian than what has been heretofore discussed, generally being limited to the fee for the particular engagement.
Three (3) definitions are now in order, which will hopefully help to clarify any confusion that may exist in the reader’s mind. A “material advisor” is any person who provides any material aid, assistance, or advice with respect to organizing, managing, promoting, selling, implementing, insuring, or carrying out any reportable transaction, and who directly or indirectly derives gross income in excess of a certain threshold amount. More on threshold soon, but the most common one is $10,000 for listed transactions. A “reportable transaction”, basically, is any transaction which has been deemed to have a potential for tax avoidance or evasion. That is pretty broad, and the reader should consult the regulations under section 6011 for more on this. Finally, a “listed transaction” is a reportable transaction which is identical or substantially similar to a transaction specifically identified as a tax avoidance transaction.
As for threshold amounts, in the case of reportable transactions, it is $50,000, if substantially all tax benefits are provided to natural persons, and $250,000 in other cases. Natural person is construed most broadly, generally ignoring trusts, corporations, and other such entities. For listed transactions, the numbers are $10,000 (previously discussed) and $25,000.
Lance Wallach speaks and writes about benefit plans, and has authored numerous books for the AICPA, Bisk Total tape, and others. He can be reached at (516) 938-5007 or lawallach@aol.com. For more articles on this or other subjects, feel free to visit his website at wvebaplan.com.
The information contained in this article is not intended as legal, accounting, financial or any other type of advice for any specific individual or entity. You should seek such advice from an appropriate professional.
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| Posted: Tue Oct 04, 2011 4:05 pm Post subject: |
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The dangers of being "listed"
A warning for 419, 412i, Sec.79 and captive insurance
Accounting Today: October 25, 2010
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.
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 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 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 taxaudit419.com or taxlibrary.
us.
The information provided herein is not intended as legal, accounting, financial or any
other type of advice for any specific individual or other entity. You should contact an
appropriate professional for any such advice.
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