Reportable Transactions Resources - Article
The IRS Says:
|Natural persons who fail
to disclose a reportable
transaction to the IRS
are subject to a $10,000
are subject to a $50,000
The penalties are
increased to $100,000
respectively, for natural
persons and other
taxpayers who fail to
disclose a reportable
transaction that is a
IRS Audits Focus on Captive Insurance Plans
April 2011 Edition
By Lance Wallach
The IRS started auditing § 419 plans in the 1990s, and then continued going after § 412(i) and other plans that they considered
abusive, listed, or reportable transactions, or substantially similar to such transactions. If an IRS audit disallows the § 419 plan or the
§ 412(i) plan, not only does the taxpayer lose the deduction and pay interest and penalties, but then the IRS comes back under IRC
6707A and imposes large fines for not properly filing.
Insurance agents, financial planners and even accountants sold many of these plans. The main motivations for buying into one were
large tax deductions. The motivation for the sellers of the plans was the very large life insurance premiums generated. These plans,
which were vetted by the insurance companies, put lots of insurance on the books. Some of these plans continue to be sold, even
after IRS disallowances and lawsuits against insurance agents, plan promoters and insurance companies.
In a recent tax court case, Curcio v. Commissioner (TC Memo 2010-115), 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 IRS 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 IRS 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 § 419 and § 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 percent 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)
· 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
Following Curcio, as the Court has stipulated, the Court held that the contributions to Benistar were not deductible under § 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 percent 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
Other important facts:
· In recent years, some § 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 is considered 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 412(i) plans.
· An employer has not engaged in a listed transaction simply because it is a 412(i) plan.
· Just because a 412(i) plan was audited and sanctioned for certain items, does not necessarily mean the plan engaged in 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, 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 filled in
properly. A plan administrator told me that he assisted hundreds of his participants with filing forms, and they still all received very
large IRS fines for not properly filling in the forms.
IRS has targeted all 419 welfare benefit plans, many 412(i) 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 American Institute of CPAs faculty of
teaching professionals, is a frequent speaker on retirement plans, financial and estate planning, and abusive tax shelters. He
speaks at more than ten conventions annually and writes for over fifty publications. 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. Mr. Wallach
may be reached at 516/938.5007, email@example.com, or at www.taxaudit419.com or www.lancewallach.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.