Participation in Benistar Plan Triggered Reportable Transaction Penalty

McGehee Family Clinic, P.A.,

The Tax Court has held that a medical clinic operated as a C corporation and one of its shareholders each was liable for a Code Sec. 6662A reportable transaction understatement penalty for their participation in a BenistarPlan, which the Court found was a listed transaction. The Court reached this result because the Benistar Plan was substantially similar to the transaction described in Notice 95-34, 1995-1 CB 309, which was first identified as a listed transaction in Notice 2000-15, 2000-1 CB 826.

Observation: As explained in greater detail below, Benistar Plans are purported multiple-employer welfare benefit trusts under Code Sec. 419A(f)(6) that were promoted ostensibly to provide preretirement life insurance to covered employees with corporate employers getting deductions for the contributions. However, IRS views them as an attempt to funnel pre-tax profits out to shareholders and their spouses.

Facts. In the case of the McGehee Family Clinic, P.A. (McGehee), a C corporation, IRS determined a deficiency in income tax for the tax year ended Mar. 31, 2005, of $16,042 and a Code Sec. 6662A penalty. With respect to Robert Prosser (a shareholder of McGehee), IRS determined a deficiency in income tax for 2004 of $17,500 and a Code Sec. 6662A penalty under $3,500. The principal issue was whether amounts paid by McGehee in connection with the Benistar Plan were deductible. For this issue, the taxpayers agreed to be bound by the decision of the highest court resolving a similar issue regarding Mark Curcio and other taxpayers. In the Tax Court decision in that case, the Court held that taxpayer contributions to a purported multi-employer welfare benefit trust ostensibly to provide life insurance benefits to participants weren't deductible business expenses. See Curcio, TC Memo 2010-115.

The Benistar Plan was crafted to be a multiple-employer welfare benefit trust under Code Sec. 419A(f)(6) providing preretirement life insurance to covered employees. Employers enrolled in Benistar Plan and made contributions to a trust account for the benefit of select employees. In return, Benistar Plan promised to pay death benefits to those employees if they die while employed. Benistar Plan advertised that enrolled employers' contributions were deductible.

Benistar Plan used employers' contributions to acquire one or more life insurance policies on employees covered by the plan. Benistar Plan withdrew from the trust account as necessary to pay the premiums on the underlying policies.

McGehee enrolled in Benistar Plan in May 2001 and first claimed a deduction for a contribution to Benistar Plan on its return filed July 8, 2002, for its tax year ended Mar. 31, 2002. McGehee contributed $50,000 to Benistar Plan in connection with plan participation in 2004. It claimed a deduction of $45,833 relating to the contribution to Benistar Plan during its tax year ended Mar. 31, 2005. McGehee's return did not include a Form 8886, Reportable Transaction Disclosure Statement. In a notice of deficiency dated Mar. 21, 2008, IRS disallowed McGehee Family Clinic's deduction of the contribution to Benistar Plan.

Robert Prosser was a shareholder of McGehee Family Clinic. His jointly filed return for 2004 did not include a Form 8886. In a notice of deficiency dated Mar. 21, 2008, IRS adjusted the Prossers' 2004 income to include the $50,000 payment to Benistar Plan from McGehee.

Background. Code Sec. 6662A imposes a 20% accuracy-related penalty on any “reportable transaction understatement,” as defined in Code Sec. 6662A(b). The penalty is 30% for any portion of any reportable transaction understatement for which the Code Sec. 6664(d)(3)(A) disclosure rules are not met. (Code Sec. 6662A(c)) Under the Code Sec. 6011 disclosure rules, a taxpayer must attach Form 8886, Reportable Transaction Disclosure Statement (or a successor form), to his original or amended tax return for each tax year for which he participates in a listed transaction.

Observation: Code Sec. 6662A(c) actually refers to Code Sec. 6664(d)(2)(A) rather than Code Sec. 6664(d)(3)(A) because Code Sec. 6662A(c) was not amended to reflect a renumbering by the Health Care and Education Reconciliation Act (PL 111-152, 3/30/2010). A technical correction may be necessary. The renumbering was made to reflect the addition of the Code Sec. 6664(d)(2) exception to the reasonable cause rule for transactions lacking economic substance.

Code Sec. 419 and Code Sec. 419A generally limit an employer's deductions for contributions to welfare benefit funds to an amount based on the cost of benefits provided during the year (plus additional amounts for reserves). Code Sec. 419A(f)(6) provides an exception for contributions to a fund that is part of a 10 or more employer plan, but only if the plan does not maintain experience-rating arrangements with respect to individual employers.

A listed transaction is one that is the same as or substantially similar to one of the types of transactions that IRS has determined to be a tax avoidance transaction and has identified by notice, regulation, or other form of published guidance as a listed transaction. (Code Sec. 6707A(c)(2)) Listed transactions include trust arrangements purported to qualify as multiple employer welfare benefit funds exempt from the limits of Code Sec. 419 and Code Sec. 419A, as described in Notice 95-34. See article in Federal Taxes Weekly Alert 07/23/2009 for an updated list of listed transactions.

IRS argument. IRS argued that the taxpayers were liable for the Code Sec. 6662A penalty because they participated in a listed transaction. According to IRS, the Benistar trust is substantially similar to the transaction described in Notice 95-34. In that notice, IRS observed that promoters had been offering trust arrangements that they claimed satisfied the requirements for the 10-or-more-employer plan exemption under Code Sec. 419A(f)(6). These arrangements were used to provide benefits such as life insurance, disability, and severance pay benefits. Promoters had claimed that all employer contributions were tax-deductible when paid, relying on Code Sec. 419A(f)(6) and the fact that they enrolled at least 10 employers in their multiple employer trusts. These arrangements typically were invested in variable life or universal life insurance contracts on the lives of the covered employees, but required large employer contributions relative to the cost of the amount of term insurance that would be required to provide the death benefits under the arrangement.

Penalties sustained. The Tax Court agreed with IRS. It concluded that the Benistar Plan was expected to obtain the same type of tax benefits as listed in Notice 95-34, i.e., the deduction of contributions made to the trust arrangement described in the notice. Benistar Plan advertised that contributions to the plan were tax deductible. The benefits of enrollment listed in the packet sent to newly enrolled employers included “virtually unlimited deductions.” Because the Benistar Plan obtains similar types of tax benefits and is factually similar to the listed transaction in Notice 95-34 , the Tax Court concluded that the Benistar Plan was a listed transaction under Code Sec. 6707A(c)(2).

Under Code Sec. 7491(c), IRS bears the burden of production with regard to penalties and must come forward with sufficient evidence indicating that it is appropriate to impose penalties. The Tax Court noted that the parties had agreed that McGehee deducted an amount related to a contribution to Benistar Plan during its tax year ended Mar. 31, 2005. The Tax Court thus found that McGehee's deduction of its contribution to the Benistar Plan was an improper tax treatment of an item attributable to a listed transaction under Code Sec. 6662A(b). Accordingly, it held that IRS met the burden of showing that it is appropriate to impose a penalty on McGehee under Code Sec. 6662A.

Likewise, the contribution to the Benistar Trust should have been included in the Prossers' income. Their failure to include the amount of the contribution in income was an improper tax treatment of an item attributable to a listed transaction. Accordingly, here, too, IRS met its burden for imposing the penalty.

Finally, the Tax Court sustained IRS's determination that McGehee was subject to the increased 30% penalty because its return did not include a disclosure statement indicating its participation in the Benistar trust.

Observation: Apparently, IRS did not seek an increased penalty from the Prossers.