Question: Are the IRS audits coordinated?
Answer: Yes. The IRS audits are both targeted and coordinated. They are targeted meaning that the IRS obtains a list of the participating employers in a plan promotion and audits the participating employers (and owners) for the purpose of challenging the deductions taken with respect to the plan. The audits are coordinated meaning that there is an IRS Issue Management Team for each promotion that has responsibility for both managing the promoter audit(s) and also developing the coordinated position to be followed by the Examination Agents. Their intention is that all taxpayers under audit will receive the similar treatment in Exam. There are also IRS Offices that specialize in 419 audits. For example, IRS offices in upstate New York and in El Monte California will manage many audits of specific promotions. Williams Coulson has significant experience in working with both of these offices.
Question: What is the general IRS position on these plans?
Answer: Though there can be some differences among plans, the basic IRS position is that the plans are not welfare benefit plans, but really plans of deferred compensation. As such, the contributions remain deductible at the business level but are included in the owner’s 1040 income for every open year and the value of the insurance policy with respect to contributions in closed years is included in the owner’s income either in the first open year or the year of termination or transfer. The IRS will normally apply 20% penalties on the tax applied and 30% with respect to non-reporting cases (see discussion below).
Question: Can the penalties ever be waived?
Answer: Yes. The penalties can often be waived upon a showing of the taxpayer’s due diligence and good faith reasonable cause. For example, if the taxpayer can show reliance on an outside tax advisor who reviewed the plan and the law, the Examining Agent normally has the authority to waive the 20% negligence penalty. Note that there are different standards for waiving penalties among the IRS Offices. It is important to know the standards of each office before requesting a waiver.
Question: What if there is an opinion letter issued on the plan – will that eliminate penalties?
Answer: Generally, the answer is a resounding – No. If the opinion letter was issued to the promoter or the promotion itself and a copy was merely provided to the taxpayer (even if the taxpayer paid for it), the IRS perceives the advice to be bias and not reasonable for reliance.
Question: What if the taxpayer relied upon the advisor who sold the promotion?
Answer: The IRS also discounts any advice provided by parties who are part of the sales team for the promotion. It is possible to negate the bias against professionals involved in the sale if you can demonstrate that the professional was first a tax advisor and gave advice in that role and not as a salesman.
Question: What are the “listed transaction” penalties?
Answer: The IRS has identified certain multiple and single employer welfare benefit plans as listed transactions. Taxpayers who participate in listed transactions have an obligation to notify the IRS of their participation on IRS Form 8886. The Form 8886 must be filed with every tax return where a tax effect of the transaction appears on the return and for the first year of filing must also be filed with the IRS Office of Tax Shelter Analysis (OTSA). There are penalties that apply for the failure to file the Form 8886. The IRS position appears to be that although only the C corporation must file the 8886, if the business is a pass-through entity like an S Corporation, LLC or partnership, then the Form 8886 must be filed at both the entity level and also the individual level. The penalty for non-filing is 75% of the tax reduction for the tax year. Note that it is very clear that a plan does not have to be proven to be defective or abusive for the penalty to apply. Further, the IRS has made it very clear that they will construe the duty to disclose broadly. Thus, if there is even a possibility that a plan is a listed transaction, the taxpayer should consider strongly filing the Form 8886.
Question: Are there other negatives to not filing the Form 8886?
Answer: Yes. In addition to the non-reporting penalty, the negligence penalty discussed above of 20% becomes 30% and is much more difficult to have waived. Further, the non-reporting penalty cannot be appealed to tax court. Therefore, the only recourse is to pay the penalty, file for a refund and fight the case in District Court.
Question: Whose responsibility is it to notify taxpayers of the need to file Form 8886?
Answer: It depends. Many promoters take the initiative to inform their customers that the promotion may be considered to be a listed transaction and that they should consider filing Forms 8886, though some promoters have actually taken the opposite view and have directed customers to not file the Form 8886 to keep them off the IRS radar. These promoters face potential liability if the penalties are assessed. Because the Form 8886 is filed with the tax returns, it may be partly the responsibility of the CPA who prepares the returns to file the Form, though many CPAs may not know that the transaction is a listed transaction or how to prepare the Form. From the IRS perspective, the responsibility is clear – it is the taxpayer who bears the ultimate responsibility and will be penalized if the Form is not filed.
Question: Are some plans better than others?
Answer: Yes. Even though the IRS appears to have thrown a giant net over the entire industry, I have observed that many promoters have worked hard to develop a plan that complies with the tax law. The plans are supported by substantial legal and actuarial authority and make it clear that they are welfare plans and not deferred compensation plans. These plans are often very strong in their marketing materials as to the nature of the plan and also provide for less deductible amounts. On the other hand, some promotions have ignored new IRS Regulations (issued in 2003) and continue to sell and market plans that have been out of compliance for years. They make no attempt to bring their plans into compliance and seek to stay under the radar by directing their customers to not file Forms 8886.
Question: Do taxpayers have causes of action?
Answer: Maybe. We see two potential causes of action. First, in cases where the promoter has either created a defective product, or has turned a blind eye towards law changes, the promoter and potentially the insurance companies may have liability for the creating, marketing, endorsing and selling a defective product. Second, where planners have sold the product to customers improperly, by describing the plan as a safe, IRS approved retirement plan with unlimited deductions, they may have liability for fraudulent sales.
I do not agree with everything in this well written sales pitch. As an expert witness Lance Wallach’s side has never lost a case. I only know of two people that have successfully filed under IRS 8886, after the fact. Many of the hundreds of phone calls that I receive each year involve misfiling of 8886 forms.
If you are, or were in an abusive tax shelter like a 419 or 412i plan to time to act is now. If you are in a captive insurance or section 79 plan you should speak with someone that does not sell them. Many former promoters of abusive 419 plans now sell captive insurance or section 79 plans. IRS audits those plans. Who should you believe as many people still promote these scams?
Google Lance Wallach and the man pushing the plan.