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by Lance Wallach
Parts of this article are from the AICPA CPE self-study course Avoiding "Circular 230" Malpractice Traps and Common Abusive Small
Business Hot Spots, by Sid Kess, authored by "Lance" Wallach.
Many of the listed transactions that can get your clients into trouble with the IRS are exotic shelters that relatively few practitioners ever
encounter. When was the last time you saw someone file a return as a Guamanian trust (Notice 2000-61)? On the other hand, 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 arrangements purporting to allow deductibility of premiums paid
for "life insurance" under a welfare benefit plan.
Some of these abusive employee benefit plans are represented as satisfying section 419 of the Code, which sets limits on purposes and
balances of “qualified asset accounts” for such benefits, but purport to offer deductibility of contributions without any corresponding income.
Others attempt to take advantage of exceptions to qualified asset account limits, such as sham union plans that try to exploit the exception
for separate "welfare benefit funds" under collective-bargaining agreements provided by IRC § 419A(f)(5). Others try to take advantage of
exceptions for plans serving 10 or more employers, once popular under section 419A(f)(6). More recently, one may encounter plans relying
on section "419(e)" and, perhaps, defined-benefit pension plans established pursuant to the former section 412(i) (still so-called, even though
the subsection has since been redesignated section 412(e)(3). See sidebar “Defined-Benefit "412(i)" Plans Under Fire”).
Promoters and Their Best-Laid Plans
Sections 419 and 419A were added to the Code in 1984 by the Deficit Reduction Act of 1984 in an attempt to end employers’ acceleration of
deductions for plan contributions. But it wasn’t long before plan promoters found an end run around the new Code sections. An industry
developed in what came to be known as “10 or more employer plans.” The promoters of these plans, in conjunction with life insurance
companies who just wanted premiums on the books, would sell people on the idea of tax-deductible life insurance and other benefits, and
especially large tax deductions. It was almost, “How much can I deduct?” with the reply, “How much do you want to?” Adverse court decisions
(there were a few) and other law to the contrary were either glossed over or explained away.
The IRS steadily added these abusive plans to its designations of "listed transactions". With Revenue Ruling 90-105, it warned against
deducting certain plan contributions attributable to compensation earned by plan participants after the end of the taxable year. Purported
exceptions to limits of sections 419 and 419A claimed by 10 or more multiple-employer benefit funds were likewise proscribed in Notice 95-
34. Both positions were designated listed transactions in 2000.
At that point, where did all those promoters go? Evidence indicates many are now promoting plans purporting to comply with section 419(e).
They are calling a life insurance plan a "welfare benefit plan" (or fund), somewhat as they once did, and promoting the plan as a vehicle to
obtain large tax deductions. The only substantial difference is that these are now single-employer plans. And again, the IRS has tried to rein
them in, reminding that listed transactions include those substantially similar to any that are specifically described and so designated.
On Oct. 17, 2007, the IRS issued notices 2007-83 and 2007-84. In the former, the IRS identified certain trust arrangements involving cash-
value life insurance policies, and substantially similar arrangements, as listed transactions. The latter similarly warned against certain post-
retirement medical and life insurance benefit arrangements, saying they might be subject to “alternative tax treatment.” The IRS at the same
time issued related Revenue Ruling 2007-65 to address situations where an arrangement is considered a "welfare benefit fund" but the
employer’s deduction for its contributions to the fund is denied in whole or part for premiums paid by the trust on cash-value life insurance
policies. It states that a welfare benefit fund’s qualified direct cost under "Section 419" does not include premium amounts paid by the fund for
cash-value life insurance policies if the fund is directly or indirectly a beneficiary under the policy, as determined under section 264(a).
Notice 2007-83 is aimed at promoted arrangements under which the fund trustee purchases cash-value insurance policies on the lives of a
business’s employee/owners, and sometimes key employees, while purchasing term insurance policies on the lives of other employees
covered under the plan. These plans anticipate being terminated and that the cash-value policies will be distributed to the owners or key
employees, with very little distributed to other employees. The promoters claim that the insurance premiums are currently deductible by the
business, and that the distributed insurance policies are virtually tax-free to the owners. The ruling makes it clear that, going forward, a
business under most circumstances cannot deduct the cost of premiums paid through a welfare benefit plan for cash-value life insurance on
the lives of its employees. The IRS may challenge the claimed tax benefits of these arrangements for various reasons:
■ Some or all of the benefits or distributions provided to or for the benefit of owner-employees or key employees may be disqualified benefits
for purposes of the 100% excise tax under section 4976.
■ Whenever the property distributed from a trust has not been properly valued by the taxpayer, the IRS said in Notice 2007-84 that it intends
to challenge the value of the distributed property, including life insurance policies.
■ Under the tax benefit rule, some or all of an employer’s deductions in an earlier year may have to be included in income in a later year if an
event occurs that is fundamentally inconsistent with the premise on which the deduction was based.
■ An employer’s deductions for contributions to an arrangement that is properly characterized as a welfare benefit fund are subject to the
limitations and requirements of the rules in sections 419 and 419A, including reasonable actuarial assumptions and nondiscrimination.
Further, a taxpayer cannot obtain a deduction for reserves for post-retirement medical or life benefits unless the employer intends to use the
contributions for that purpose.
■ The arrangement may be subject to the rules for split-dollar arrangements, depending on the facts and circumstances.
■ Contributions on behalf of an owner-employee may be characterized as dividends or as nonqualified deferred compensation subject to
section 404(a)(5), section 409A or both, depending on the facts and circumstances.
Higher Risks for Practitioners Under New Penalties
The updated "Circular 230 regulations" and the new law (IRC § 6694, preparer penalties) make it more important for CPAs to understand
what their clients are deducting on tax returns. A CPA may not prepare a tax return unless he or she has a reasonable belief that the tax
treatment of every position on the return would more likely than not be sustained on its merits. Proposed regulations issued in June 2008
spell out many new implications of these changes introduced by the Small Business and Work Opportunity Act of 2007.
The CPA should study all the facts and, based on that study, conclude that there is more than a 50% likelihood (“more likely than not”) that,
if the IRS challenges the tax treatment, it will be upheld. As an alternative, there must be a reasonable basis for each position on the tax
return, and each position needs to be adequately disclosed to the IRS. The reasonable-basis standard is not satisfied by an arguable claim.
A CPA may not take into account the possibility that a return will not be audited by the IRS, or that an issue will not be raised if there is an
It is worth noting that listed transactions are subject to a regulatory scheme applicable only to them, entirely separate from Circular 230
requirements, regulations and sanctions. Participation in such a transaction must be disclosed on a tax return, and the penalties for failure to
disclose are severe—up to $100,000 for individuals and $200,000 for corporations. The penalties apply to both taxpayers and practitioners.
And the problem with disclosure, of course, is that it is apt to trigger an audit, in which case even if the listed transaction were to pass muster,
something else may not.
Need for Caution
Should a client approach you with one of these plans, be especially cautious, for both of you. Advise your client to check out the promoter
very carefully. Make it clear that the government has the names of all former 419A(f)(6) promoters and therefore will be scrutinizing the
promoter carefully if the promoter was once active in that area, as many current 419(e) (welfare benefit fund or plan) promoters were. This
makes an audit of your client far riskier and more likely.
Defined-Benefit "412(i) Plans" Under Fire
The IRS has warned against so-called section 412(i) defined-benefit pension plans, named for the former IRC section governing them. It
warned against certain 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 such participation under pain of penalties, potentially reaching $100,000 for individuals
and $200,000 for other taxpayers. Targets also include some retirement plans.
One reason for the harsh treatment of 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 these transactions. In general, IRS auditors divide
audited plans into those they consider non-compliant and others they consider abusive. While the alternatives available to the sponsor of a
non-compliant 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. Although in some situations 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.
■ Some of the listed transactions CPA tax practitioners are most likely to encounter are employee benefit insurance plans that the IRS has
deemed abusive. Many of these plans have been sold by promoters in conjunction with life insurance companies.
■ As long ago as 1984, with the addition of IRC §§ 419 and 419A, Congress and the IRS took aim at unduly accelerated deductions and
other perceived abuses. More recently, with guidance and a ruling issued in fall 2007, the Service declared as abusive certain trust
arrangements involving cash-value life insurance and providing post-retirement medical and life insurance benefits.
■ The new “more likely than not” penalty standard for tax preparers under IRC § 6694 raises the stakes for CPAs whose clients may have
maintained or participated in such a plan. Failure to disclose a listed transaction carries particularly severe potential penalties.
Lance Wallach, CLU, ChFC, is the author of the AICPA’s The Team Approach to Tax, Financial and Estate Planning. He can be reached at firstname.lastname@example.org or
on the Web at www.vebaplan.com or at (516) 938-5007. The information in this article is not intended as accounting, legal, financial or any other type of advice for
any specific individual or other entity. You should consult an appropriate professional for such advice.
■ Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots, by Sid Kess, a CPE self-study course (#733720)
■ Sid Kess’ Practical Alternatives to Commonly Misused and Abused Small Business Tax Strategies: Insuring Your Client’s Future, a CPE self-
study course (#733730)
For more information or to place an order, go to www.cpa2biz.com or call the Institute at 888-777-7077.
AICPA PFP Center and PFS Credential
The AICPA Personal Financial Planning (PFP) Center provides a range of valuable resources that CPAs need for professional and ethical financial planning. The
center also contains information about the AICPA Personal Financial Specialist (PFS) credential and PFP section membership. For more information go to http://pfp.
Law, rulings and guidance
■ Internal Revenue Code §§ 264, 419, 419A, 6111 and 6112
■ News Releases IR 2007-170 and IR 2004-21
■ Revenue Ruling 2007-65
■ Notices 2007-83 and 2007-84
|Learn Here How the IRS Has Deemed Some Insurance and
Retirement Plans "Abusive"
And How Our Experts Contributed to the AICPA CPE Self-Study
Course Regarding Avoidance of Circular 230 Traps
Then email here for assistance
|Abusive Insurance and Retirement Plans
Single-employer section 419 welfare benefit plans are the latest
incarnation in insurance deductions the IRS deems abusive.
The Law Offices of Mark Levinson, Esq.
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