412i, 419, Lawsuits, IRS Audits. Lance Wallach, expert witness.

419, 412i, plans are being audited by the IRS. Lawsuits are the result. Small businesses facing audits and potentially huge tax penalties over certain types of retirement plans are filing lawsuits against those who marketed, designed and sold the plans.

The 412(i) and 419(e) plans were marketed in the past several years as a way for small business owners to set up retirement or welfare benefits plans while leveraging huge tax savings, but the IRS put them on a list of abusive tax shelters and has more recently focused audits on them. The penalties for such transactions are extremely high and can pile up quickly - $100,000 per individual and $200,000 per entity per tax year for each failure to disclose the transaction - often exceeding the disallowed taxes.

There are business owners who owe $6,000 in taxes but have been assessed $1.2 million in penalties. The existing cases involve many types of businesses, including doctors' offices, dental practices, grocery store owners, mortgage companies and restaurant owners. Some are trying to negotiate with the IRS. Others are not waiting. A class action has been filed and cases in several states are ongoing. The business owners claim that they were targeted by insurance companies; and their agents to purchase the plans without any disclosure that the IRS viewed the plans as abusive tax shelters. Other defendants include financial advisers who recommended the plans, accountants who failed to fill out required tax forms and law firms that drafted opinion letters legitimizing the plans, which were used as marketing tools.

A 412(i) plan is a form of defined benefit pension plan. A 419(e) plan is a similar type of health and benefits plan. Typically, these were sold to small, privately held businesses with fewer than 20 employees and several million dollars in gross revenues. What distinguished a legitimate plan from the plans at issue were the life insurance policies used to fund them. The employer would make large cash contributions in the form of insurance premiums, deducting the entire amounts. The insurance policy was designed to have a "springing cash value," meaning that for the first 5-7 years it would have a near-zero cash value, and then spring up in value.

Just before it sprung, the owner would purchase the policy from the trust at the low cash value, thus making a tax-free transaction. After the cash value shot up, the owner could take tax-free loans against it. Meanwhile, the insurance agents collected exorbitant commissions on the premiums - 80 to 110 percent of the first year's premium, which could exceed $1 million.

Technically, the IRS's problems with the plans were that the "springing cash" structure disqualified them from being 412(i) plans and that the premiums, which dwarfed any payout to a beneficiary, violated incidental death benefit rules.

Under §6707A of the Internal Revenue Code, once the IRS flags something as an abusive tax shelter, or "listed transaction," penalties are imposed per year for each failure to disclose it. Another allegation is that businesses weren't told that they had to file Form 8886, which discloses a listed transaction.

According to Lance Wallach of Plainview, N.Y. (516-938-5007), who testifies as an expert in cases involving the plans, the vast majority of accountants either did not file the forms for their clients or did not fill them out correctly.
Because the IRS did not begin to focus audits on these types of plans until some years after they became listed transactions, the penalties have already stacked up by the time of the audits.

Another reason plaintiffs are going to court is that there are few alternatives - the penalties are not appealable and must be paid before filing an administrative claim for a refund.

The suits allege misrepresentation, fraud and other consumer claims. "In street language, they lied," said Peter Losavio, a plaintiffs' attorney in Baton Rouge, La., who is investigating several cases. So far they have had mixed results. Losavio said that the strength of an individual case would depend on the disclosures made and what the sellers knew or should have known about the risks.

In 2004, the IRS issued notices and revenue rulings indicating that the plans were listed transactions. But plaintiffs' lawyers allege that there were earlier signs that the plans ran afoul of the tax laws, evidenced by the fact that the IRS is auditing plans that existed before 2004.

"Insurance companies were aware this was dancing a tightrope," said William Noll, a tax attorney in Malvern, Pa. "These plans were being scrutinized by the IRS at the same time they were being promoted, but there wasn't any disclosure of the scrutiny to unwitting customers."

A defense attorney, who represents benefits professionals in pending lawsuits, said the main defense is that the plans complied with the regulations at the time and that "nobody can predict the future."

An employee benefits attorney who has settled several cases against insurance companies, said that although the lost tax benefit is not recoverable, other damages include the hefty commissions - which in one of his cases amounted to $860,000 the first year - as well as the costs of handling the audit and filing amended tax returns.
Defying the individualized approach an attorney filed a class action in federal court against four insurance companies claiming that they were aware that since the 1980s the IRS had been calling the policies potentially abusive and that in 2002 the IRS gave lectures calling the plans not just abusive but "criminal." A judge dismissed the case against one of the insurers that sold 412(i) plans.

The court said that the plaintiffs failed to show the statements made by the insurance companies were fraudulent at the time they were made, because IRS statements prior to the revenue rulings indicated that the agency may or may not take the position that the plans were abusive. The attorney, whose suit also names law firm for its opinion letters approving the plans, will appeal the dismissal to the 5th Circuit.

In a case that survived a similar motion to dismiss, a small business owner is suing Hartford Insurance to recover a "seven-figure" sum in penalties and fees paid to the IRS. A trial is expected in August.

Last July, in response to a letter from members of Congress, the IRS put a moratorium on collection of §6707A penalties, but only in cases where the tax benefits were less than $100,000 per year for individuals and $200,000 for entities. That moratorium was recently extended until March 1, 2010.

But tax experts say the audits and penalties continue. "There's a bit of a disconnect between what members of Congress thought they meant by suspending collection and what is happening in practice. Clients are still getting bills and threats of liens," Wallach said.

"Thousands of business owners are being hit with million-dollar-plus fines. ... The audits are continuing and escalating. I just got four calls today," he said. A bill has been introduced in Congress to make the penalties less draconian, but nobody is expecting a magic bullet.

"From what we know, Congress is looking to make the penalties more proportionate to the tax benefit received instead of a fixed amount."

Dolan Media Newswires 01/22
Small Business Retirement Plans Fuel Litigation

As an expert witness Lance Wallach's side has never lost a case. People need to be careful of 419 Welfare Benefit Plans, 412i plans, Section 79 plans and Captive Insurance Plans. Most of these plans are sold by insurance agents. If you are in an abusive, listed or similar transaction plan you need to file under IRS 6707a. The participant files form 8886, and the salesmen or accountant who signs the tax returns files form 8918 if they got paid over $10,000. They are called Material Advisors and face a minimum $100,000 fine. Some plans are offshore which could involve FBAR or OVDI filings. If you have money overseas you probably need to file for IRS tax amnesty. If you want to reduce the tax we suggest that you first file and then opt out. For more information Google Lance Wallach.

Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.


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    Friday, April 4, 2014

    Captive Insurance & 419 Plans Litigation: September 2013
    Captive Insurance & 419 Plans Litigation: September 2013
    Posted by Lance Wallach at 11:02 AM
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    Lance WallachApril 8, 2014 at 8:21 AM
    2 CJA And Associates Complaints and reviews from real people you ...
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  4. Small Business Tax News
    Strategic Advice on the Tax Implications of Business Planning
    March 2004
    By Lance Wallach & Ira Kaplan

    On Friday, February 3, 2004, the IRS issued proposed regulations concerning the valuation of insurance contracts in the context of qualified retirement plans.

    The IRS says that it is no longer reasonable to use the cash surrender value or the interpolated terminal reserve as the accurate value of a life insurance contract for income tax purposes. The IRS issued proposed regulations stating that the value of a life insurance contract in the context of qualified retirement plans should be the contract’s fair market value.

    The Service acknowledged in the regulations (and in a revenue procedure issued simultaneously) that the fair market value standard could create some confusion among taxpayers. They addressed this possibility by describing a safe harbor position.

    When I addressed the American Society of Pension Actuaries Annual National Convention, the IRS chief actuary also spoke about attacking abusive 412(i) pensions.

    A “Section 412(i) plan” is a tax-qualified retirement plan that is funded entirely by a life insurance contract or an annuity. The employer claims tax deductions for contributions that are used by the plan to pay premiums on an insurance contract covering an employee. The plan may hold the contract until the employee dies, or it may distribute or sell the contract to the employee at a specific point, such as when the employee retires.

    “The guidance targets specific abuses occurring with Section 412(i) plans”, stated Assistant Secretary for Tax Policy Pam Olson. “There are many legitimate Section 412(i) plans, but some push the envelope, claiming tax results for employees and employers that do not reflect the underlying economics of the arrangements.” Or, to put it another way, tax deductions are being claimed, in some cases, that the Service does not feel are reasonable given the taxpayer’s facts and circumstances.

    “Again and again, we’ve uncovered abusive tax avoidance transactions that game the system to the detriment of those who play by the rules,” said IRS Commissioner Mark W. Everson.

    I have been published by the AICPA and others for years about these and similar abuses. Finally, the IRS is doing something. If someone is in an abusive 412(i) plan, they had better seek counsel quickly.

    Editor's note: The author and publisher are not rendering professional advice and assume no liability in connection with its use. Consult your tax adviser and accountant before making any investment or tax-related decisions.•

    Lance Wallach is a member of Small Business Tax News’ Advisory Board. He is a frequent speaker on tax-related subjects including VEBAs, pensions, and tax-oriented strategies.•
    Ira Kaplan, Esq., CPA, MBA, is a national speaker and author. For more information call Lance Wallach at (516)938-5007.

  5. Bestselling AICPA CPE Self-Study Courses -Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots, by Sid Kess

    Lance Wallach Dec 30, 2010 | Comments (0)

    Best Sellers – March 2008
    Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots, by Sid Kess
    Author/Moderator: Lance Wallach, CLU, CHFC, CIMC

    Publisher: AICPA

    This course will enable the practitioner to better understand many of the abusive insurance and annuity-based products being marketed to your clients and how you can alleviate exposure to IRS scrutiny.


    Identify potentially abusive deductions claimed on your client’s tax return
    Enable the practitioner to advise his clients so they can avoid IRS penalties and deduction disallowances
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    Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals, is a frequent speaker on retirement plans, financial and estate planning, and abusive tax shelters. He writes about 412(i), 419, and captive insurance plans. He speaks at more than ten conventions annually, writes for over fifty publications, is quoted regularly in the press and has been featured on television and radio financial talk shows including NBC, National Pubic Radio's All Things Considered, and others. 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. Contact him at 516.938.5007, wallachinc@gmail.com

    Share This Article With a Friend

    Lance Wallach speaks and writes about benefit plans, and has authored numerous books for the AICPA, Bisk Total tape, and others. He can be reached at (516) 938-5007 or wallachinc@gmail.com. For more articles on this or other subjects, feel free to visit his website at www.taxadvisorexperts.org.

    Lance Wallach, the National Society of Accountants Speaker of the Year, speaks and writes extensively about retirement plans, Circular 230 problems and tax reduction strategies. He speaks at more than 40 conventions annually, writes for over 50 publications, is quoted regularly in the press, and has written numerous best-selling AICPA books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Business Hot Spots. He does extensive expert witness work and has never lost a case. Contact him at 516.938.5007 or visit www.taxadvisorexperts.org.
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  6. Accountantexpert.Org


    IRS is attacking 419 plans, 419, 412i, 412(e)(3), Section 79,

    Captive Insurance,

    many other benefit plans, and plans having life insurance.

    Home Page
    Expert Witness Service
    How to get Sued
    Lance in the Press
    More Helpful Information
    Lance is Regularly Asked for His Opinion Regarding tax matters, 419e, 412i, abusive tax shelters, IRC 6707A and Section 79 problems!