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| Lance Wallach Managing Director |
Specializing in the following services:
 | "IRS audit appeals" | |
| U.S. 'Tax Court' cases | |
| Multinational taxation consulting | |
| Recovering losses from insurance companies |
- & brokerage firms
| Tax shelter analysis | |
| Pension plan reviews & evaluations | |
| 419 & 412i benefit plan analysis | |
| 419 & 412i plan remediation | |
| Offshore tax shelter issues | |
| IRS listed transactions" assistance |
- Expert witness testimony for:
- IRS Taxes
- Insurance & retirement plan cases
| The Offices of Lance Wallach |
516-938-5007 Vebaplan.org
| "America's leading tax representation firm."(TM) |
| Serving clients nationwide Call us today: 516-938-5007 Email us at: LanWalla@aol.com |
The Lance Wallach Network TaxAudit419.com ReportableTransactions Listed Transactions IRS6707Apenalty IRSform8886 TaxAdvisorExperts ExpertTaxAdvisors Taxlibrary.us |
| Our consulting attorneys, CPAs & ex IRS agents have helped our clients save hundreds of thousands of dollars successfully defending them in lawsuits, IRS audits & cutting IRS penalties. |
| Every one of our consulting attorneys, CPAs & ex IRS Agents has over 25 years of professional experience! We believe that no firm has more experienced professionals to assist our clients than we do! |
Late breaking news: Large 419 plan files for
Bankruptcy.
Recent court cases and other developments have highlighted serious problems in
plans, popularly know as Benistar, issued by Nova Benefit Plans of Simsbury,
Connecticut. Recently unsealed IRS criminal case information now raises concerns with
other plans as well. If you have any type plan issued by NOVA Benefit Plans, U.S.
Benefits Group, Benefit Plan Advisors, Grist Mill trusts, Rex Insurance Service or
Benistar, get help at once. You may be subject to an audit or in some cases, criminal
prosecution.
On November 17th, 59 pages of search warrant materials were unsealed in the Nova
Benefit Plans litigation currently pending in the U.S. District Court for the District of
Connecticut. According to these documents, the IRS believes that Nova is involved in a
significant criminal conspiracy involving the crimes of Conspiracy to Impede the IRS and
Assisting in the Preparation of False Income Tax Returns.
Read more here.
Bankruptcy.
Recent court cases and other developments have highlighted serious problems in
plans, popularly know as Benistar, issued by Nova Benefit Plans of Simsbury,
Connecticut. Recently unsealed IRS criminal case information now raises concerns with
other plans as well. If you have any type plan issued by NOVA Benefit Plans, U.S.
Benefits Group, Benefit Plan Advisors, Grist Mill trusts, Rex Insurance Service or
Benistar, get help at once. You may be subject to an audit or in some cases, criminal
prosecution.
On November 17th, 59 pages of search warrant materials were unsealed in the Nova
Benefit Plans litigation currently pending in the U.S. District Court for the District of
Connecticut. According to these documents, the IRS believes that Nova is involved in a
significant criminal conspiracy involving the crimes of Conspiracy to Impede the IRS and
Assisting in the Preparation of False Income Tax Returns.
Read more here.
IRS Audits 419, 412i, Captive Insurance Plans With Life Insurance, and Section 79
Scams
By Lance Wallach June
The IRS started auditing 419 plans in the ‘90s, and then continued going after 412i and other plans that they considered abusive, listed, or reportable transactions,
or substantially similar to such transactions.
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 Service 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 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 Section 419 and Section 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% 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) plans;
· 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 contracts.
Following Curcio, as the Court has stipulated, the Court held that the contributions to Benistar were not deductible under section 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% 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 faith exception.
More you should know:
· In recent years, some section 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 412i 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 file forms, and they still all received very large IRS fines for not properly filling in the forms.
IRS has been attacking all 419 welfare benefit plans, many 412i 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 AICPA faculty of teaching professionals, is a frequent speaker on
retirement plans, abusive tax shelters, financial, international tax, and estate planning. He writes about 412(i), 419, Section79, FBAR, 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 the 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, lawallach@aol.com or visit www.vebaplan.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.
Scams
By Lance Wallach June
The IRS started auditing 419 plans in the ‘90s, and then continued going after 412i and other plans that they considered abusive, listed, or reportable transactions,
or substantially similar to such transactions.
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 Service 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 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 Section 419 and Section 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% 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) plans;
· 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 contracts.
Following Curcio, as the Court has stipulated, the Court held that the contributions to Benistar were not deductible under section 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% 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 faith exception.
More you should know:
· In recent years, some section 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 412i 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 file forms, and they still all received very large IRS fines for not properly filling in the forms.
IRS has been attacking all 419 welfare benefit plans, many 412i 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 AICPA faculty of teaching professionals, is a frequent speaker on
retirement plans, abusive tax shelters, financial, international tax, and estate planning. He writes about 412(i), 419, Section79, FBAR, 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 the 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, lawallach@aol.com or visit www.vebaplan.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.
| CAUTION: IRS is attacking 419 plans, 419, 412i, 412(e)(3), Section 79, Captive Insurance, many other benefit plans, and plans having life insurance. |
Accountants Get Fined By IRS And Sued By Their Clients
--------------------------------------------------------------------------------
By Lance Wallach, CLU, CHFC Abusive Tax Shelter, Listed Transaction, Reportable
Transaction Expert Witness
Call Lance Wallach at (516) 938-5007
--------------------------------------------------------------------------------
Form 8886 is required to be filed by any taxpayer who is participating, or in some cases has participated, in a listed or reportable
transaction.
New BISK CPEasy™ CPE Self-Study Course
CPA’s Guide to Life Insurance
Author/Moderator: Lance Wallach, CLU, CHFC, CIMC
Below is an exert from one of Lance Wallach’s new books. It deals with how
Lance Wallach
What attracted the most attention with respect to it, until very recently, were the penalties for failure to file, which were $100,000
annually for individuals and $200,000 annually for corporations. Recent legislation has reduced those penalties in most cases.
However, there is still a minimum penalty of $5,000 annually for an individual and $10,000 annually for a corporation for failure to
file. And those are the MINIMUM penalties. If the minimum penalties do not apply, the annual penalty becomes 75 percent of
whatever tax benefit was derived from participation in the listed transaction, and the penalty is applied both to the business and to
the individual business owners. Since the form must be filed for every year of participation in the transaction, the penalties can be
cumulative; i.e., applied in more than one year. For example, a corporation that participated in five consecutive years could find
itself, depending on the amount of claimed tax deductions, looking at several hundred thousand dollars in fines, even under the
recently enacted legislation, before even thinking about back taxes, penalties, interest, etc., that could result from an audit. Even
the minimum fine would be $15,000 per year, again in addition to all other applicable taxes and penalties, etc. So even the
minimum fines could mount up fast.
The penalties can also be imposed for incomplete, inaccurate, and/or misleading filings. And the Service itself has not provided
totally clear, unequivocal guidance to those hoping to avoid errors and penalties. To illustrate this point, Lance Wallach, a leading
authority in this area who has received hundreds of calls and whose associates have literally aided dozens of taxpayers in
completing these forms, reports that his associates, on numerous occasions, have sought the opinions and assistance of
Service personnel, usually from the Office of Chief Counsel, with respect to questions arising while assisting taxpayers in
completing and filing the form. The answers are often somewhat vague, and tend to be accompanied by a disclaimer advising
not to rely on them.
One popular type of listed transaction is the so-called welfare benefit plan, which once relied in IRC Section 419A(F)(6) for its
authority to claim tax deductions, but now more commonly relies on Section 419(e). The 419A(F)(6) plans used to claim that
section completely exempted business owners from all limitations on how much tax could be deducted. In other words, it was
claimed, tax deductions were unlimited. These plans featured large amounts of life insurance and accompanying large
commissions, and were thus aggressively pushed by insurance agents, financial planners, and sometimes even accountants
and attorneys. Not to mention the insurance companies themselves, who put millions of dollars in premiums on the books and,
when confronted with questions about the outlandish tax claims made in marketing these plans, claimed to be only selling
product, not giving opinions on tax questions.
In the summer of 2003, the Service issued guidance that had the effect of severely curtailing those plans, and they began to
largely, though not completely, disappear from the landscape. Most welfare benefit plans now claim Section 419(e) as the
authority to claim a corporate tax deduction, though the promoters of these plans no longer claim that tax deductions are
unlimited. Instead, they acknowledge that the amount of possible tax deductions is limited by the limitations of Section 419A,
which Code section is a limitation on tax deductions that are authorized by other sections.
With respect to Section 419(e) welfare benefit plans, and of particular importance in this listed transaction/penalties arena, were
the events of October 17, 2007, which over time have had roughly the same effect on Section 419(e) welfare benefit plans as the
aforementioned 2003 developments had on Section 419A(F)(6) plans. On that date, the Service issued Notice 2007-83, which
identified certain trust arrangements involving cash value life insurance policies, and substantially similar arrangements, as
listed transactions. Translation: Section 419(e) welfare benefit plans that are funded by cash value life insurance contracts are
listed transactions, at least if a tax deduction is taken for the amount of premiums paid for such policies. On that same day, the
Service also issued Notice 2007-84 and Revenue Ruling 2007-65. The combined effect of these three IRS pronouncements was
that not only was the use of cash value life insurance in welfare benefit plans, if combined with claiming tax deductions for the
premiums paid, sufficient to cause IRS treatment of these plans as listed transactions, but that discrimination as between
owners and rank and file employees in these plans was also being targeted.
To illustrate, in many of these promoted arrangements, these Section 419(e) welfare benefit plans, cash value life insurance
policies are purchased on the lives of the owners of the business, and sometimes on key employees, while term insurance is
purchased on the lives of the rank and file employees. The plans in question tend to anticipate that the plan will be terminated
within five years or so, at which time the cash value policies will be distributed to the owners, and possibly key employees, with
very little distributed to rank and file employees. In general, the Internal Revenue Code will not countenance the claiming of a tax
deduction in connection with a welfare benefit plan where such blatant unequal treatment (discrimination) is exhibited.
Nevertheless, plan promoters claim that insurance premiums are currently deductible by the business, and that the insurance
policies, when distributed to the owners, can be done so virtually tax free. And this also despite the fact that an employer’s
deductions for contributions to an arrangement that is properly characterized as a welfare benefit fund are subject to the
limitations and requirements of the rules in IRC sections 419 and 419A, including the use of reasonable actuarial assumptions
and the satisfaction of nondiscrimination requirements.
With respect to the preparation and filing of Form 8886, incidentally, it should not surprise that welfare benefit promoters have
been active in this area. This would include both the promoters of plans that have been listed transactions for years as well as
those that became listed transactions, at least arguably, by virtue of the previously discussed October 2007 IRS activities. Some
promoters take the position that their plans are completely compliant and that, therefore, there is no need to file Form 8886.
Others take a more precautionary approach. While never admitting to being a listed transaction, they do urge clients to file on a
protective basis. At least one went so far as to offer plan participants complete guidance and instructions about precisely how to
file protectively. Many, if not most, plan promoters have, at the very least, forwarded completed sample forms to plan participants
for guidance and use in completing Form 8886. It is certainly possible to file protectively. Any remotely good faith belief that the
transaction is not a listed one justifies the protective filing. In fact and practice, the Service is actually treating protective filings in
the same manner as other filings.
But while many plan promoters have recognized the filing obligation and recommended filing, this has led to another problem. As
previously noted, they have been instructing taxpayers on how to complete and file the form, and the problem is that their
guidance, in many cases, has not been particularly helpful and sometimes dangerous. In some cases, though this is difficult if
not impossible to ascertain, the suggestions of the plan promoters seem designed more to protect the promoters than to assist
the taxpayer. While this is a difficult call to make, it is absolutely clear, Wallach says, that more than one promoter, whether
carelessly or otherwise, has sent taxpayers outdated forms to complete and file. Wallach, who you may recall has, between
himself and his associates, aided dozens of taxpayers in completing and filing Form 8886, notes that his associates have
frequently reported this problem. They also report never having seen a Form 8886 prepared completely correctly, especially
where a promoter’s instructions were relied on. So, because the fines may be imposed for incomplete, misleading, or incorrect
filings, the danger to plan participants can be clearly seen. And the taxpayer who discovers errors subsequent to filing must
decide whether to amend the filing or not, which some plan participants are reluctant to do.
Burdens On Professionals With Clients In Welfare Benefit Plans And Other Listed Transactions
Form 8918 must be filed with the Internal Revenue Service by all “material advisors” to clients who are participating in listed
transactions. Exactly who, then, is a material advisor? You are a material advisor if three requirements are satisfied. First, the
client must actually be participating in the listed transaction. Second, you must have given the client tax advice with respect to the
transaction. This does not necessarily mean that you recommended participation. For example, signing off on a tax return
claiming a tax deduction for participation in the listed transaction surely qualifies as having given tax advice with respect to the
transaction. In fact, even if you recommended against participation, you would satisfy this threshold so long as you rendered tax
advice, be it positive, negative, or neutral.
The third threshold is that you must have received $10,000 or more in compensation (yourself and/or a related entity). This is not
quite as simple as it sounds. The money need not all be received as a commission (as might be the case with a CPA who is
insurance licensed), or even in a lump sum for accounting services rendered in connection with the client’s participation. The
money could be received periodically over time. It is even possible that, so long as $10,000 in fees have been received from the
client for whatever reason over whatever period of time, the threshold is met. Lance Wallach, previously referred to in the
discussion about Form 8886 and whose associates are also expert in assisting CPAs and others in the preparation and filing of
Form 8918, reports that one of his associates put this question directly to an attorney in the Office of the Chief Counsel who
actually wrote published IRS guidance with respect to Form 8918. While the gentleman from the IRS was very courteous and
professional, trying his best to be of assistance, a clear, unqualified, unequivocal answer that could be “taken to the bank” proved
impossible to elicit.
Like Form 8886, however, Form 8918 can be filed protectively. Failure to file or incomplete, misleading, or inaccurate filings can
lead to the penalties that used to apply to Form 8886, to wit: $100,000.00 for individuals and $200,000.00 for corporations. For
this purpose, it is CRITICAL to note that the recent legislation reducing penalties applied ONLY to Form 8886. The penalties for
failure to file Form 8918, or for filing it incorrectly, remain the same as they were, to wit: $100,000 for individuals and $200,000 for
corporations.
A good faith belief that either you did not receive $10,000 in income or that the transaction in question is not a listed one enables
you to file on a protective basis. And, in fact, as with the 8886 form, the IRS is, in fact, treating all filings identically in any event.
When the CPA files this form ( it need only be filed once, not on an annual basis, as Form 8886 must be), the CPA is assigned a
number by the IRS. The CPA or other professional then gives this number to all of his affected clients, who are required to report
it on the 8886 forms that they must file. Also, as a perusal of Form 8918 makes clear, there is also a section where the material
advisor is to give all pertinent information with respect to other material advisors who participated in and/or advised the client with
respect to the transaction in question.
As with Form 8886, this area is replete with horror stories about advisors who, mostly innocently, have fallen into this trap. One
that we know of was sold by one promoter on a questionable plan, recommended it to about fifteen clients, and now has been
forced to file the 8918 form, help all those involved who have to file Form 8886, and expend a fair amount of his own funds, both
to find people who can assist his clients with Form 8886 and in “rescuing” clients who want to get out of this plan. Another called
about something else, and was horrified to discover that he had six clients in a plan that is a listed transaction. When he was
apprised of his situation, he sank into a depression. These are only two of the dozens of sad, and worse, stories in this area that
we have been privy to. The second person, for example, had no idea that anything was wrong. He initially called about something
totally unrelated. There have even been instances of professional discipline being imposed in connection with this area, of CPAs
being threatened with and perhaps even actually suffering loss of their licenses. Such is the terrain in which the CPA must now
operate.
Another problem is possible, especially if you recommended that the client participate. Most practitioners are familiar with
situations where, when things go wrong, clients often develop selective memory failure. This happens here, as it does
elsewhere. At best, it can lead to you spending an inordinate amount of time, and perhaps money, on what is essentially a
thankless exercise. At worst, if the situation worsens to the point where a lawsuit may be in the air, you could find yourself the
subject of some sort of client complaint or, worse, a named defendant in a lawsuit, in which case your malpractice carrier would
become involved, with all of the negative effects upon yourself and your practice that could entail.
Section 6707A – Past, Present, and Future
Returning now to the Form 8886 aspect of Section 6707A, the disclosure requirement that applies to actual participants in listed
transactions, it has been noted, and discussed, that Congress recently reduced the penalties under Section 6707A for many
taxpayers. But it is still imperative to realize that this is only a partial solution to the continuing problem caused by the penalties
imposed by that section. While the penalties have been reduced from the prior patently ridiculous, and probably illegal, level that
until so recently prevailed, they are still sufficient, in many cases, to put business owners out of business, just as the prior
penalties obviously were. And since the new legislation did not address or affect obligations and penalties with respect to Form
8918 at all, accountants, insurance professionals and other material advisors are as likely to be hurt as ever.
Whatever the underlying Congressional intent was in enacting the original Section 6707A in 2004, whatever Congress hoped to
accomplish, the statute as it was written imposed clearly unconscionable burdens on taxpayers. Penalties of up to $300,000
annually could be imposed on taxpayers who had not underpaid tax and who had no knowledge that they had entered into
transactions that the IRS deems “listed”.
Tax provisions are seldom found to violate the United States Constitution, but it is certainly arguable that the imposition of such a
large penalty on a taxpayer who entered into a transaction that produced little or even no tax savings and without regard to the
taxpayer’s knowledge or intent violates the Eighth Amendment prohibition on excessive fines, etc. In practice, the requirement
that this penalty be imposed without regard to culpability often had the effect of bankrupting middle class families who had no
intention of entering into a tax shelter – an outcome that dismayed even hardened IRS enforcement personnel.
The section previously imposed a penalty of $100,000 per individual and $200,000 per entity for each failure to make special
disclosures with respect to a transaction that the Treasury Department characterizes as a “listed transaction” or “substantially
similar” to a listed transaction. A listed transaction is one that is specifically identified as such by published IRS guidance. The
question of what is “substantially similar” to such a transaction is increasingly troublesome, especially given the ever broadening
IRS definition of the term, beginning with Treasury Decision 9,000, which declared, on June 18, 2002, that, from that date forward,
the term “substantially similar” would be construed more broadly by the Service than it had up until that time. This started a trend
that continues to this day.
It is important for the reader to understand that the only thing that was accomplished by the new, amended Section 6707A is a
reduction in the penalties. The penalties are still severe, severe enough to seriously damage or even bankrupt most small
businesses. And professional readers must understand that there has been no effect on their obligations at all, and that the
same (in their case, even more severe) fines still apply.
For example, the following eleven statements are equally applicable to the new Section 6707A as they are to its predecessor:
1. The penalty applies without regard to whether the small business or the small business owners have knowledge that the
transaction has been listed.
2. The penalty applies even if the small business and/or the small business owners derived no tax benefit from the transaction.
Even under the new legislation, there are substantial minimum penalties that are applied even if there has been no tax benefit.
3. The penalty is applied at multiple levels, which is devastating to small businesses; the result is that the small business and
its owners are hit with multiple penalties. The two most common problems are that fines are imposed on both the business
entity and the owners as individuals, and also that fines are imposed each year, and thus are sometimes imposed for five years
or more. In the case of a small business, the penalties can easily exceed the total earnings of the business and cause
bankruptcy – totally out of proportion to any tax advantage that may or may not have been realized.
4. The penalty is final, must be imposed by the IRS (this is mandatory), and cannot be rescinded. There is no right of appeal, and
there is no “good faith” exception, as business advocates had hoped would be a part of the new legislation.
5. Judicial review is expressly prohibited, which raises another Constitutional issue, this time a separation of powers argument,
as it amounts to one branch of government prohibiting another from functioning.
6. The taxpayer’s disclosure must initially be made twice – once with the IRS Office of Tax Shelter Analysis and again with the tax
return for the year in which the transaction is first required to be disclosed. Thereafter, for each year that the taxpayer “benefits”
from the transaction, it must be reflected on the tax return. Aside: As a practical matter, the form should be filed with the tax return.
The IRS directions assume a timely filing. There are no directions on how to file late, which most taxpayers must do, since few
realized the need to disclose in this manner when they still could have timely filed. A few experts have figured out how to file late
and simultaneously avoid penalties, after months of study and numerous conversations with IRS personnel. Those
conversations were with IRS people that drafted the regulations, those that receive the forms, and others.
7. A taxpayer that discloses a transaction is subject to penalty if the Service deems the disclosure to be incomplete, incorrect,
and/or misleading. I have had numerous conversations with people who filed the disclosure forms and got fined. They did not
properly prepare and/or file the forms.
8. If a transaction is not “listed” at the time the taxpayer files a return but it subsequently becomes listed, the taxpayer becomes
responsible for filing a disclosure statement and will be penalized for failing to do so. This is true even if the taxpayer has no
knowledge that the transaction has been listed. This sort of thing is exactly why business interests , albeit unsuccessfully,
pushed for a “good faith” exception in the new legislation.
9. The penalty is imposed on transactions that the IRS, in its sole discretion, determines are “substantially similar” to a listed
transaction. Accordingly , taxpayers may never know or realize that they are in a listed transaction and, accordingly, the penalties
compound annually because they never made any disclosure. At least, if a transaction is specifically identified, people can find
out that it is a listed transaction. But how can anyone be sure that something is “substantially similar”, or not?
10. The taxpayer must disclose each year, which can result in compounding of already large penalties; and
11. The Statute of Limitations, usually three years, does not apply. IRC 6501(c)(10) tolls the statute until proper disclosure is
made.
The Treasury Department usually announces on a somewhat ad hoc basis what is a listed transaction. There is no regulatory
process or public comment period involved in determining what should be a listed transaction. Once that a transaction is
deemed to be a listed transaction, the Draconian Section 6707A penalties are triggered. Section 6707A penalties not only apply
to specifically listed transactions, but also to transactions that are deemed by Treasury to be “substantially similar” to any of the
specifically listed transactions. Some have said that under Section 6707A, IRS and Treasury are the judge, jury and executioner.
Be that as it may, once again Constitutional concerns need to be addressed, this time possible due process violations pursuant
to the Fourteenth Amendment.
Some Examples
A business owner bought a type of life insurance policy featuring what is known as a “springing cash value” as an alternative to a
pension plan. Two years later, this type of transaction was specifically identified as an abusive tax shelter, a listed transaction,
meaning that the business owner was now obligated to file Form 8886. But the financial advisor, who years before had actually
recommended this course of action, either willfully or out of ignorance failed to advise the business owner to disclose.
The IRS demanded back taxes and interest in the neighborhood of $60,000. It also assessed $600,000 of penalties under
Section 6707A for failing to disclose participation in a listed transaction for two separate years.
Another taxpayer filed Form 8886 with his tax returns, but failed to file, in the first year, with the Office of Tax Shelter Analysis. The
penalty was assessed for that failure, even though the IRS had the form, though perhaps in a different place. Again, this scenario
cries out for the “good faith” exception that was not included in the new legislation.
Then there was the doctor who thought that he had settled his 419 welfare benefit plan issues with the Service. He entered into a
closing agreement and paid all taxes due and owing. Later, he was assessed the penalty for failing to file Form 8886. Of course,
this issue had been neither raised nor even discussed in the doctor’s prior communications, negotiations, etc. with the Service.
I could go on and on with these horror stories, but the reader probably gets my drift by now. I have been urging business owners
to properly file Form 8886 for years. A surprising number of accountants have little or no knowledge in this area, even being
unaware of the fines that can be imposed on “material advisors” which, as previously noted, have NOT changed as a result of the
new legislation. And if a professional assumes that he has no clients in “listed transactions”, he should realize that there are
numerous types of listed transactions. They are not restricted to welfare benefit plans. For example, they include the popular
Section 412(i) defined benefit pension plan, and even some of the ubiquitous 401(k) plans. No business owner, and especially
no financial, insurance or accounting professional should ever assume that he or she is immune from any or all of the possible
repercussions outlined herein.
Summing up, the new legislation does reduce possible Section 6707A penalties for most taxpayers. That, in my view, is its only
benefit. And the reduction is not as great as one might expect. Depending on surrounding circumstances, penalties of hundreds
of thousands of dollars are still quite possible. Even the minimum penalties, which are applied in the event that there is no tax
benefit, amount to $15,000 annually. Who can afford to just brush that aside? Over a period of years, and the fines in the 8886
area are still applied annually, the minimum fines all be themselves can add up to a considerable amount.
Both the 8886 and 8918 forms must still be filed properly. The fines and penalties for failure to do so remain substantial and
unfair.
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.
ABOUT THE AUTHOR: Lance Wallach
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, abusive tax shelters, financial, international tax, and estate planning. He writes about
412(i), 419, Section79, FBAR and captive insurance plans. He speaks at more than ten conventions annually, writes for more
than 50 publications and is quoted regularly in the press. He does expert witness testimony and has never lost a case. Contact
him at 516.938.5007, or visit www.taxadvisorexpert.com.
--------------------------------------------------------------------------------
By Lance Wallach, CLU, CHFC Abusive Tax Shelter, Listed Transaction, Reportable
Transaction Expert Witness
Call Lance Wallach at (516) 938-5007
--------------------------------------------------------------------------------
Form 8886 is required to be filed by any taxpayer who is participating, or in some cases has participated, in a listed or reportable
transaction.
New BISK CPEasy™ CPE Self-Study Course
CPA’s Guide to Life Insurance
Author/Moderator: Lance Wallach, CLU, CHFC, CIMC
Below is an exert from one of Lance Wallach’s new books. It deals with how
Lance Wallach
What attracted the most attention with respect to it, until very recently, were the penalties for failure to file, which were $100,000
annually for individuals and $200,000 annually for corporations. Recent legislation has reduced those penalties in most cases.
However, there is still a minimum penalty of $5,000 annually for an individual and $10,000 annually for a corporation for failure to
file. And those are the MINIMUM penalties. If the minimum penalties do not apply, the annual penalty becomes 75 percent of
whatever tax benefit was derived from participation in the listed transaction, and the penalty is applied both to the business and to
the individual business owners. Since the form must be filed for every year of participation in the transaction, the penalties can be
cumulative; i.e., applied in more than one year. For example, a corporation that participated in five consecutive years could find
itself, depending on the amount of claimed tax deductions, looking at several hundred thousand dollars in fines, even under the
recently enacted legislation, before even thinking about back taxes, penalties, interest, etc., that could result from an audit. Even
the minimum fine would be $15,000 per year, again in addition to all other applicable taxes and penalties, etc. So even the
minimum fines could mount up fast.
The penalties can also be imposed for incomplete, inaccurate, and/or misleading filings. And the Service itself has not provided
totally clear, unequivocal guidance to those hoping to avoid errors and penalties. To illustrate this point, Lance Wallach, a leading
authority in this area who has received hundreds of calls and whose associates have literally aided dozens of taxpayers in
completing these forms, reports that his associates, on numerous occasions, have sought the opinions and assistance of
Service personnel, usually from the Office of Chief Counsel, with respect to questions arising while assisting taxpayers in
completing and filing the form. The answers are often somewhat vague, and tend to be accompanied by a disclaimer advising
not to rely on them.
One popular type of listed transaction is the so-called welfare benefit plan, which once relied in IRC Section 419A(F)(6) for its
authority to claim tax deductions, but now more commonly relies on Section 419(e). The 419A(F)(6) plans used to claim that
section completely exempted business owners from all limitations on how much tax could be deducted. In other words, it was
claimed, tax deductions were unlimited. These plans featured large amounts of life insurance and accompanying large
commissions, and were thus aggressively pushed by insurance agents, financial planners, and sometimes even accountants
and attorneys. Not to mention the insurance companies themselves, who put millions of dollars in premiums on the books and,
when confronted with questions about the outlandish tax claims made in marketing these plans, claimed to be only selling
product, not giving opinions on tax questions.
In the summer of 2003, the Service issued guidance that had the effect of severely curtailing those plans, and they began to
largely, though not completely, disappear from the landscape. Most welfare benefit plans now claim Section 419(e) as the
authority to claim a corporate tax deduction, though the promoters of these plans no longer claim that tax deductions are
unlimited. Instead, they acknowledge that the amount of possible tax deductions is limited by the limitations of Section 419A,
which Code section is a limitation on tax deductions that are authorized by other sections.
With respect to Section 419(e) welfare benefit plans, and of particular importance in this listed transaction/penalties arena, were
the events of October 17, 2007, which over time have had roughly the same effect on Section 419(e) welfare benefit plans as the
aforementioned 2003 developments had on Section 419A(F)(6) plans. On that date, the Service issued Notice 2007-83, which
identified certain trust arrangements involving cash value life insurance policies, and substantially similar arrangements, as
listed transactions. Translation: Section 419(e) welfare benefit plans that are funded by cash value life insurance contracts are
listed transactions, at least if a tax deduction is taken for the amount of premiums paid for such policies. On that same day, the
Service also issued Notice 2007-84 and Revenue Ruling 2007-65. The combined effect of these three IRS pronouncements was
that not only was the use of cash value life insurance in welfare benefit plans, if combined with claiming tax deductions for the
premiums paid, sufficient to cause IRS treatment of these plans as listed transactions, but that discrimination as between
owners and rank and file employees in these plans was also being targeted.
To illustrate, in many of these promoted arrangements, these Section 419(e) welfare benefit plans, cash value life insurance
policies are purchased on the lives of the owners of the business, and sometimes on key employees, while term insurance is
purchased on the lives of the rank and file employees. The plans in question tend to anticipate that the plan will be terminated
within five years or so, at which time the cash value policies will be distributed to the owners, and possibly key employees, with
very little distributed to rank and file employees. In general, the Internal Revenue Code will not countenance the claiming of a tax
deduction in connection with a welfare benefit plan where such blatant unequal treatment (discrimination) is exhibited.
Nevertheless, plan promoters claim that insurance premiums are currently deductible by the business, and that the insurance
policies, when distributed to the owners, can be done so virtually tax free. And this also despite the fact that an employer’s
deductions for contributions to an arrangement that is properly characterized as a welfare benefit fund are subject to the
limitations and requirements of the rules in IRC sections 419 and 419A, including the use of reasonable actuarial assumptions
and the satisfaction of nondiscrimination requirements.
With respect to the preparation and filing of Form 8886, incidentally, it should not surprise that welfare benefit promoters have
been active in this area. This would include both the promoters of plans that have been listed transactions for years as well as
those that became listed transactions, at least arguably, by virtue of the previously discussed October 2007 IRS activities. Some
promoters take the position that their plans are completely compliant and that, therefore, there is no need to file Form 8886.
Others take a more precautionary approach. While never admitting to being a listed transaction, they do urge clients to file on a
protective basis. At least one went so far as to offer plan participants complete guidance and instructions about precisely how to
file protectively. Many, if not most, plan promoters have, at the very least, forwarded completed sample forms to plan participants
for guidance and use in completing Form 8886. It is certainly possible to file protectively. Any remotely good faith belief that the
transaction is not a listed one justifies the protective filing. In fact and practice, the Service is actually treating protective filings in
the same manner as other filings.
But while many plan promoters have recognized the filing obligation and recommended filing, this has led to another problem. As
previously noted, they have been instructing taxpayers on how to complete and file the form, and the problem is that their
guidance, in many cases, has not been particularly helpful and sometimes dangerous. In some cases, though this is difficult if
not impossible to ascertain, the suggestions of the plan promoters seem designed more to protect the promoters than to assist
the taxpayer. While this is a difficult call to make, it is absolutely clear, Wallach says, that more than one promoter, whether
carelessly or otherwise, has sent taxpayers outdated forms to complete and file. Wallach, who you may recall has, between
himself and his associates, aided dozens of taxpayers in completing and filing Form 8886, notes that his associates have
frequently reported this problem. They also report never having seen a Form 8886 prepared completely correctly, especially
where a promoter’s instructions were relied on. So, because the fines may be imposed for incomplete, misleading, or incorrect
filings, the danger to plan participants can be clearly seen. And the taxpayer who discovers errors subsequent to filing must
decide whether to amend the filing or not, which some plan participants are reluctant to do.
Burdens On Professionals With Clients In Welfare Benefit Plans And Other Listed Transactions
Form 8918 must be filed with the Internal Revenue Service by all “material advisors” to clients who are participating in listed
transactions. Exactly who, then, is a material advisor? You are a material advisor if three requirements are satisfied. First, the
client must actually be participating in the listed transaction. Second, you must have given the client tax advice with respect to the
transaction. This does not necessarily mean that you recommended participation. For example, signing off on a tax return
claiming a tax deduction for participation in the listed transaction surely qualifies as having given tax advice with respect to the
transaction. In fact, even if you recommended against participation, you would satisfy this threshold so long as you rendered tax
advice, be it positive, negative, or neutral.
The third threshold is that you must have received $10,000 or more in compensation (yourself and/or a related entity). This is not
quite as simple as it sounds. The money need not all be received as a commission (as might be the case with a CPA who is
insurance licensed), or even in a lump sum for accounting services rendered in connection with the client’s participation. The
money could be received periodically over time. It is even possible that, so long as $10,000 in fees have been received from the
client for whatever reason over whatever period of time, the threshold is met. Lance Wallach, previously referred to in the
discussion about Form 8886 and whose associates are also expert in assisting CPAs and others in the preparation and filing of
Form 8918, reports that one of his associates put this question directly to an attorney in the Office of the Chief Counsel who
actually wrote published IRS guidance with respect to Form 8918. While the gentleman from the IRS was very courteous and
professional, trying his best to be of assistance, a clear, unqualified, unequivocal answer that could be “taken to the bank” proved
impossible to elicit.
Like Form 8886, however, Form 8918 can be filed protectively. Failure to file or incomplete, misleading, or inaccurate filings can
lead to the penalties that used to apply to Form 8886, to wit: $100,000.00 for individuals and $200,000.00 for corporations. For
this purpose, it is CRITICAL to note that the recent legislation reducing penalties applied ONLY to Form 8886. The penalties for
failure to file Form 8918, or for filing it incorrectly, remain the same as they were, to wit: $100,000 for individuals and $200,000 for
corporations.
A good faith belief that either you did not receive $10,000 in income or that the transaction in question is not a listed one enables
you to file on a protective basis. And, in fact, as with the 8886 form, the IRS is, in fact, treating all filings identically in any event.
When the CPA files this form ( it need only be filed once, not on an annual basis, as Form 8886 must be), the CPA is assigned a
number by the IRS. The CPA or other professional then gives this number to all of his affected clients, who are required to report
it on the 8886 forms that they must file. Also, as a perusal of Form 8918 makes clear, there is also a section where the material
advisor is to give all pertinent information with respect to other material advisors who participated in and/or advised the client with
respect to the transaction in question.
As with Form 8886, this area is replete with horror stories about advisors who, mostly innocently, have fallen into this trap. One
that we know of was sold by one promoter on a questionable plan, recommended it to about fifteen clients, and now has been
forced to file the 8918 form, help all those involved who have to file Form 8886, and expend a fair amount of his own funds, both
to find people who can assist his clients with Form 8886 and in “rescuing” clients who want to get out of this plan. Another called
about something else, and was horrified to discover that he had six clients in a plan that is a listed transaction. When he was
apprised of his situation, he sank into a depression. These are only two of the dozens of sad, and worse, stories in this area that
we have been privy to. The second person, for example, had no idea that anything was wrong. He initially called about something
totally unrelated. There have even been instances of professional discipline being imposed in connection with this area, of CPAs
being threatened with and perhaps even actually suffering loss of their licenses. Such is the terrain in which the CPA must now
operate.
Another problem is possible, especially if you recommended that the client participate. Most practitioners are familiar with
situations where, when things go wrong, clients often develop selective memory failure. This happens here, as it does
elsewhere. At best, it can lead to you spending an inordinate amount of time, and perhaps money, on what is essentially a
thankless exercise. At worst, if the situation worsens to the point where a lawsuit may be in the air, you could find yourself the
subject of some sort of client complaint or, worse, a named defendant in a lawsuit, in which case your malpractice carrier would
become involved, with all of the negative effects upon yourself and your practice that could entail.
Section 6707A – Past, Present, and Future
Returning now to the Form 8886 aspect of Section 6707A, the disclosure requirement that applies to actual participants in listed
transactions, it has been noted, and discussed, that Congress recently reduced the penalties under Section 6707A for many
taxpayers. But it is still imperative to realize that this is only a partial solution to the continuing problem caused by the penalties
imposed by that section. While the penalties have been reduced from the prior patently ridiculous, and probably illegal, level that
until so recently prevailed, they are still sufficient, in many cases, to put business owners out of business, just as the prior
penalties obviously were. And since the new legislation did not address or affect obligations and penalties with respect to Form
8918 at all, accountants, insurance professionals and other material advisors are as likely to be hurt as ever.
Whatever the underlying Congressional intent was in enacting the original Section 6707A in 2004, whatever Congress hoped to
accomplish, the statute as it was written imposed clearly unconscionable burdens on taxpayers. Penalties of up to $300,000
annually could be imposed on taxpayers who had not underpaid tax and who had no knowledge that they had entered into
transactions that the IRS deems “listed”.
Tax provisions are seldom found to violate the United States Constitution, but it is certainly arguable that the imposition of such a
large penalty on a taxpayer who entered into a transaction that produced little or even no tax savings and without regard to the
taxpayer’s knowledge or intent violates the Eighth Amendment prohibition on excessive fines, etc. In practice, the requirement
that this penalty be imposed without regard to culpability often had the effect of bankrupting middle class families who had no
intention of entering into a tax shelter – an outcome that dismayed even hardened IRS enforcement personnel.
The section previously imposed a penalty of $100,000 per individual and $200,000 per entity for each failure to make special
disclosures with respect to a transaction that the Treasury Department characterizes as a “listed transaction” or “substantially
similar” to a listed transaction. A listed transaction is one that is specifically identified as such by published IRS guidance. The
question of what is “substantially similar” to such a transaction is increasingly troublesome, especially given the ever broadening
IRS definition of the term, beginning with Treasury Decision 9,000, which declared, on June 18, 2002, that, from that date forward,
the term “substantially similar” would be construed more broadly by the Service than it had up until that time. This started a trend
that continues to this day.
It is important for the reader to understand that the only thing that was accomplished by the new, amended Section 6707A is a
reduction in the penalties. The penalties are still severe, severe enough to seriously damage or even bankrupt most small
businesses. And professional readers must understand that there has been no effect on their obligations at all, and that the
same (in their case, even more severe) fines still apply.
For example, the following eleven statements are equally applicable to the new Section 6707A as they are to its predecessor:
1. The penalty applies without regard to whether the small business or the small business owners have knowledge that the
transaction has been listed.
2. The penalty applies even if the small business and/or the small business owners derived no tax benefit from the transaction.
Even under the new legislation, there are substantial minimum penalties that are applied even if there has been no tax benefit.
3. The penalty is applied at multiple levels, which is devastating to small businesses; the result is that the small business and
its owners are hit with multiple penalties. The two most common problems are that fines are imposed on both the business
entity and the owners as individuals, and also that fines are imposed each year, and thus are sometimes imposed for five years
or more. In the case of a small business, the penalties can easily exceed the total earnings of the business and cause
bankruptcy – totally out of proportion to any tax advantage that may or may not have been realized.
4. The penalty is final, must be imposed by the IRS (this is mandatory), and cannot be rescinded. There is no right of appeal, and
there is no “good faith” exception, as business advocates had hoped would be a part of the new legislation.
5. Judicial review is expressly prohibited, which raises another Constitutional issue, this time a separation of powers argument,
as it amounts to one branch of government prohibiting another from functioning.
6. The taxpayer’s disclosure must initially be made twice – once with the IRS Office of Tax Shelter Analysis and again with the tax
return for the year in which the transaction is first required to be disclosed. Thereafter, for each year that the taxpayer “benefits”
from the transaction, it must be reflected on the tax return. Aside: As a practical matter, the form should be filed with the tax return.
The IRS directions assume a timely filing. There are no directions on how to file late, which most taxpayers must do, since few
realized the need to disclose in this manner when they still could have timely filed. A few experts have figured out how to file late
and simultaneously avoid penalties, after months of study and numerous conversations with IRS personnel. Those
conversations were with IRS people that drafted the regulations, those that receive the forms, and others.
7. A taxpayer that discloses a transaction is subject to penalty if the Service deems the disclosure to be incomplete, incorrect,
and/or misleading. I have had numerous conversations with people who filed the disclosure forms and got fined. They did not
properly prepare and/or file the forms.
8. If a transaction is not “listed” at the time the taxpayer files a return but it subsequently becomes listed, the taxpayer becomes
responsible for filing a disclosure statement and will be penalized for failing to do so. This is true even if the taxpayer has no
knowledge that the transaction has been listed. This sort of thing is exactly why business interests , albeit unsuccessfully,
pushed for a “good faith” exception in the new legislation.
9. The penalty is imposed on transactions that the IRS, in its sole discretion, determines are “substantially similar” to a listed
transaction. Accordingly , taxpayers may never know or realize that they are in a listed transaction and, accordingly, the penalties
compound annually because they never made any disclosure. At least, if a transaction is specifically identified, people can find
out that it is a listed transaction. But how can anyone be sure that something is “substantially similar”, or not?
10. The taxpayer must disclose each year, which can result in compounding of already large penalties; and
11. The Statute of Limitations, usually three years, does not apply. IRC 6501(c)(10) tolls the statute until proper disclosure is
made.
The Treasury Department usually announces on a somewhat ad hoc basis what is a listed transaction. There is no regulatory
process or public comment period involved in determining what should be a listed transaction. Once that a transaction is
deemed to be a listed transaction, the Draconian Section 6707A penalties are triggered. Section 6707A penalties not only apply
to specifically listed transactions, but also to transactions that are deemed by Treasury to be “substantially similar” to any of the
specifically listed transactions. Some have said that under Section 6707A, IRS and Treasury are the judge, jury and executioner.
Be that as it may, once again Constitutional concerns need to be addressed, this time possible due process violations pursuant
to the Fourteenth Amendment.
Some Examples
A business owner bought a type of life insurance policy featuring what is known as a “springing cash value” as an alternative to a
pension plan. Two years later, this type of transaction was specifically identified as an abusive tax shelter, a listed transaction,
meaning that the business owner was now obligated to file Form 8886. But the financial advisor, who years before had actually
recommended this course of action, either willfully or out of ignorance failed to advise the business owner to disclose.
The IRS demanded back taxes and interest in the neighborhood of $60,000. It also assessed $600,000 of penalties under
Section 6707A for failing to disclose participation in a listed transaction for two separate years.
Another taxpayer filed Form 8886 with his tax returns, but failed to file, in the first year, with the Office of Tax Shelter Analysis. The
penalty was assessed for that failure, even though the IRS had the form, though perhaps in a different place. Again, this scenario
cries out for the “good faith” exception that was not included in the new legislation.
Then there was the doctor who thought that he had settled his 419 welfare benefit plan issues with the Service. He entered into a
closing agreement and paid all taxes due and owing. Later, he was assessed the penalty for failing to file Form 8886. Of course,
this issue had been neither raised nor even discussed in the doctor’s prior communications, negotiations, etc. with the Service.
I could go on and on with these horror stories, but the reader probably gets my drift by now. I have been urging business owners
to properly file Form 8886 for years. A surprising number of accountants have little or no knowledge in this area, even being
unaware of the fines that can be imposed on “material advisors” which, as previously noted, have NOT changed as a result of the
new legislation. And if a professional assumes that he has no clients in “listed transactions”, he should realize that there are
numerous types of listed transactions. They are not restricted to welfare benefit plans. For example, they include the popular
Section 412(i) defined benefit pension plan, and even some of the ubiquitous 401(k) plans. No business owner, and especially
no financial, insurance or accounting professional should ever assume that he or she is immune from any or all of the possible
repercussions outlined herein.
Summing up, the new legislation does reduce possible Section 6707A penalties for most taxpayers. That, in my view, is its only
benefit. And the reduction is not as great as one might expect. Depending on surrounding circumstances, penalties of hundreds
of thousands of dollars are still quite possible. Even the minimum penalties, which are applied in the event that there is no tax
benefit, amount to $15,000 annually. Who can afford to just brush that aside? Over a period of years, and the fines in the 8886
area are still applied annually, the minimum fines all be themselves can add up to a considerable amount.
Both the 8886 and 8918 forms must still be filed properly. The fines and penalties for failure to do so remain substantial and
unfair.
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.
ABOUT THE AUTHOR: Lance Wallach
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, abusive tax shelters, financial, international tax, and estate planning. He writes about
412(i), 419, Section79, FBAR and captive insurance plans. He speaks at more than ten conventions annually, writes for more
than 50 publications and is quoted regularly in the press. He does expert witness testimony and has never lost a case. Contact
him at 516.938.5007, or visit www.taxadvisorexpert.com.
| Copyright (C) 2013 Lance Wallach All rights reserved |