By Lance Wallach
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.
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 section below, “ Defined-Benefit 412(i) Plans Under Fire.”
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.
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