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Lance Wallach
Managing Director

    California Broker Magazine
    Oct. 2008

    By Lance Wallach, CLU, ChFC and Ira Kaplan, Esq., CPA, MBA                        

    Over the past decade, business owners have been overwhelmed by a plethora of
    arrangements designed to reduce the cost of providing employee benefits and taxes,
    while simultaneously increasing their own retirement savings. The solutions ranged
    from traditional pension and profit sharing plans to more advanced strategies.

    Some strategies, such as IRS Section 419 and 412(i) plans, used life insurance as
    vehicles to bring about benefits. Unfortunately, the high life insurance commissions
    (often 90% of the contribution, or more) fostered an environment that led to the
    marketing and selling of aggressive and non-compliant plans.

    The result has been thousands of audits and an IRS task force seeking out tax shelter
    promotion.  In addition, the IRS has been auditing most 412(i) defined benefit
    retirement plans and all 419 welfare benefit plans. These plans are sold by many
    insurance agents. For unknowing clients, the tax consequences are enormous. For
    their accountant advisors, the liability may be equally extreme. If an accountant signs
    a tax return with one of these plans on it, and if the IRS considers the plan an
    abusive, listed transaction or substantially similar to such a transaction, the
    accountant may be called a “material advisor”. The fine for a material advisor is $200,000
    if the accountant is incorporated or $100,000 if the accountant is not incorporated. There
    is also an IRS referral to the Office of Professional Responsibility. We have received
    hundreds of phone calls recently from accountants, who are in this predicament. It is
    very difficult to help them after the fact. When I speak at national accounting
    conventions or AICPA events about these topics, most accountants in the audience
    do not understand what I am talking about, because they have never had this problem
    and are not aware of the recent IRS enforcement activities.

    Unfortunately, within a few weeks after I speak at a convention, attendees will call me
    after reviewing their clients’ tax returns. They often find one of these abusive plans
    on the return (these plans are very popular). If the plan is discovered before the IRS
    audit, many steps can be taken. If the IRS discovers the plan on audit, the results can
    be disastrous, both for your client and for you. The client gets fined $200,000 per year.
    For more information on this, see and

    Recently, there has been an explosion in the marketing of a financial product called
    captive insurance. These so called “Captives” are typically small insurance
    companies designed to insure the risks of an individual business under IRS Code
    Section 831(b). When properly designed, a business can make tax deductible premium
    payments to a related party insurance company. Depending on circumstances,
    underwriting profits, if any, can be paid out to the owners as dividends, and profits
    from liquidation of the company may be taxed as capital gains.

    While captives can be a great cost saving tool, they also are expensive to build and
    manage. Also, captives are allowed to garner tax benefits because they operate as
    real insurance companies. Advisors and business owners who misuse captives or
    market them as estate planning tools, asset protection vehicles, tax deferral or to
    obtain other benefits not related to the true business purpose of an insurance
    company face grave regulatory and tax consequences.

    A recent concern is the integration of small captives with life insurance policies. Small
    captives, under Section 831(b), have no statutory authority to deduct life premiums.
    Also, if a small captive uses life insurance as an investment, the cash value of the life
    policy can be taxable at corporate rates, and then will be taxable again when
    distributed.  The consequence of this double taxation is to devastate the
    effectiveness of the life insurance, and it extends serious liability to any accountant
    who recommends the plan or even signs the tax return of the business that pays
    premiums to the captive.

    The IRS is aware that several large insurance companies are promoting their life
    insurance policies as investments with small captives. The outcome looks eerily like
    that of the 419 and 412(i) plans mentioned above.

    Remember, if something looks too good to be true, it usually is. There are safe and
    conservative ways to use captive insurance structures to lower costs and obtain
    benefits for businesses. And, some types of captive insurance products do have
    statutory protection for deducting life insurance premiums (although not 831(b)
    captives). Learning what works and is safe is the first step an accountant should take
    in helping his or her clients use these powerful, but highly technical insurance tools.

    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 and has written numerous best-selling AICPA books, including Avoiding
    Circular 230 Malpractice Traps and Common Abusive Business Hot Spots.  Contact him
    at 516.938.5007 or visit

    The information provided herein is not intended as legal, accounting, financial or any
    other type of advice for any specific individual or other entity.  You should contact an
    appropriate professional for any such advice.


How to Get Fined $100,000 by the IRS
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