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The A2Z Directory                                                                 March 2011
Lance Wallach

The IRS has various task forces auditing all section 419, section 412(i), and other plans that tend to
be abusive.  Most insurance agents sell these plans.  The IRS is looking to raise money and is not
looking to correct plans or help taxpayers. The IRS calls accountants, attorneys, and insurance
agents “material advisors” and also fines them the same amount, again unless the client’s
participation in the transaction is reported.  An accountant is a material advisor if he signs the return
or gives advice and gets paid.  More details can be found on http://www.irs.gov and http://www.
vebaplan.com.

Bruce Hink, who has given me written permission to use his name and circumstances, is a perfect
example of what the IRS is doing to unsuspecting business owners.  What follows is a story about
how the IRS fines him each year for being in what they called a listed transaction.  Listed
transactions can be found at http://www.irs.gov.  Also involved are what the IRS calls abusive plans
or what it refers to as substantially similar.  Substantially similar to is very difficult to understand, but
the IRS seems to be saying, “If it looks like some other listed transaction, the fines apply.”  Also, I
believe that the accountant who signed the tax return and the insurance agent who sold the
retirement plan will each be fined as material advisors.  We have received many calls for help from
accountants, attorneys, business owners, and insurance agents in similar situations.  Don’t think
this will happen to you?  It is happening to a lot of accountants and business owners, because most
of theses so-called listed, abusive, or insurance agents are selling substantially similar plans.
Recently I came across the case of Hink, a small business owner who is facing thousands in IRS
penalties for 2004 and 2005 because of his participation in a section 412(i) plan.  (The penalties
were assessed under section 6707A.)

In 2002 an insurance agent representing a 100-year-old, well-established insurance company
suggested the owner start a pension plan.  The owner was given a portfolio of information from the
insurance company, which was given to the company’s outside CPA to review and give an opinion
on.  The CPA gave the plan the green light and the plan was started. Contributions were made in
2003.  The plan administrator came out with amendments to the plan, based on new IRS
guidelines, in October 2004. The business owner’s insurance agent disappeared in May 2005,
before implementing the new guidelines from the administrator with the insurance company.  The
business owner was left with a refund check from the insurance company, a deduction claim on his
2004 tax return that had not been applied, and no agent.

It took six months of making calls to the insurance company to get a new insurance agent
assigned.  By then, the IRS had started an examination of the pension plan.  Asking advice from the
CPA and a local attorney (who had no previous experience in these cases) made matters worse,
with a “big name” law firm being recommended and additional legal fees being billed in three
months. To make a long story short, the audit stretched on for over 2 ½ years to examine a 2-year-
old pension with four participants and the 8,000 in contributions. During the audit, no funds went to
the insurance company, which was awaiting formal IRS approval on restructuring the plan as a
traditional defined benefit plan, which the administrator had suggested and the IRS had indicated
would be acceptable. In March 2008 the business owner received a private e-mail apology from the
IRS agent who headed the examination, saying that her hands were tied and that she used to
believe she was correcting problems and helping taxpayers and not hurting people.
Could you or one of your clients be next?

To this point, I have focused, generally, on the horrors of running afoul of the IRS by participating in a
listed transaction, which includes various types of transactions and the various fines that can be
imposed on business owners and their advisors who participate in, sell, or advice on these
transactions.  I happened to use, as an example, someone in a section 412(i) plan, which was
deemed to be a listed transaction, pointing out the truly doleful consequences the person has
suffered.  Others who fall into this trap, even unwittingly, can suffer the same fate.

Now let’s go into more detail about section 412(i) plans.  This is important because these defined
benefit plans are popular and because few people think of retirement plans as tax shelters or listed
transactions.  People therefore may get into serious trouble in this area unwittingly, out of ignorance
of the law, and, for the same reason, many fail to take necessary and appropriate precautions. The
IRS has warned against the section 412(i) defined benefit pension plans, named for the former
code section governing them.  It warned against trust arrangements it deems abusive, some of
which may be regarded as listed transactions.  Falling into that category can result in taxpayers
having to disclose the participation under pain of penalties. Targets also include some retirement
plans.
One reason for the harsh treatment of some 412(i) plans is their discrimination in favor of owners
and key, highly compensated employees.  Also, the IRS does not consider the promised tax relief
proportionate to the economic realities of the transactions.  In general, IRS auditors divide audited
plan into those they consider noncompliant and other they consider abusive.  While the alternatives
available to the sponsor of noncompliant plan are problematic, it is frequently an option to keep the
plan alive in some form while simultaneously hoping to minimize the financial fallout from penalties.

The sponsor of an abusive plan can expect to be treated more harshly than participants.  Although in
some situation something can be salvaged, the possibility is definitely on the table of having to treat
the plan as if it never existed, which of course triggers the full extent of back taxes, penalties, and
interest on all contributions that were made – not to mention leaving behind no retirement plan
whatsoever. Another plan the IRS is auditing is the section 419 plan.  A few listed transactions
concern relatively common employee benefit plans the IRS has deemed tax avoidance schemes or
otherwise abusive.  Perhaps some of the most likely to crop up, especially in small-business
returns, are the arrangements purporting to allow the deductibility of premiums paid for life
insurance under a welfare benefit plan or section 419 plan.  These plans have been sold by most
insurance agents and insurance companies.

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, wallachinc@gmail.com or visit
www.taxadvisorexpert.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.

Massachusetts Society of Certified Public Accounts, Inc.
Winter 2010

IRS Attacks Business Owners in 419, 412, Section 79 and Captive Insurance
Plans Under Section 6707A

By Lance Wallach

Taxpayers who previously adopted 419, 412i, captive
insurance or Section 79 plans are in big trouble.

In recent years, the IRS has identified many of these arrangements as abusive devices to funnel tax deductible
dollars to shareholders and classified these arrangements as listed transactions." These plans were sold by
insurance agents, financial planners, accountants and attorneys seeking large life insurance commissions. In
general, taxpayers who engage in a “listed transaction” must report such transaction to the IRS on Form 8886
every year that they “participate” in the transaction, and you do not necessarily have to make a contribution or
claim a tax deduction to participate. Section 6707A of the Code imposes severe penalties for failure to file Form
8886 with respect to a listed transaction. But you are also in trouble if you file incorrectly. I have received
numerous phone calls from business owners who filed and still got fined. Not only do you have to file Form 8886,
but it also has to be prepared correctly. I only know of two people in the U.S. who have filed these forms properly
for clients. They tell me that was after hundreds of hours of research and over 50 phones calls to various IRS
personnel. The filing instructions for Form 8886 presume a timely filling. Most people file late and follow the
directions for currently preparing the forms. Then the IRS fines the business owner. The tax court does not have
jurisdiction to abate or lower such penalties imposed by the IRS.

"Many taxpayers who are no longer taking current tax deductions for these plans continue to enjoy the benefit of
previous tax deductions by continuing the deferral of income from contributions and deductions taken in prior
years."

Many business owners adopted 412i, 419, captive insurance and Section 79 plans based upon representations
provided by insurance professionals that the plans were legitimate plans and were not informed that they were
engaging in a listed transaction. Upon audit, these taxpayers were shocked when the IRS asserted penalties under
Section 6707A of the Code in the hundreds of thousands of dollars. Numerous complaints from these taxpayers
caused Congress to impose a moratorium on assessment of Section 6707A penalties.

The moratorium on IRS fines expired on June 1, 2010. The IRS immediately started sending out notices
proposing the imposition of Section 6707A penalties along with requests for lengthy extensions of the Statute of
Limitations for the purpose of assessing tax. Many of these taxpayers stopped taking deductions for contributions to
these plans years ago, and are confused and upset by the IRS’s inquiry, especially when the taxpayer had
previously reached a monetary settlement with the IRS regarding its deductions. Logic and common sense dictate
that a penalty should not apply if the taxpayer no longer benefits from the arrangement. Treas. Reg. Sec. 1.6011-4
(c)(3)(i) provides that a taxpayer has participated in a listed transaction if the taxpayer’s tax return reflects tax
consequences or a tax strategy described in the published guidance identifying the transaction as a listed
transaction or a transaction that is the same or substantially similar to a listed transaction.

Clearly, the primary benefit in the participation of these plans is the large tax deduction generated by such
participation. Many taxpayers who are no longer taking current tax deductions for these plans continue to enjoy
the benefit of previous tax deductions by continuing the deferral of income from contributions and deductions
taken in prior years. While the regulations do not expand on what constitutes “reflecting the tax consequences of
the strategy,” it could be argued that continued benefit from a tax deferral for a previous tax deduction is within
the contemplation of a “tax consequence” of the plan strategy. Also, many taxpayers who no longer make
contributions or claim tax deductions continue to pay administrative fees. Sometimes, money is taken from the
plan to pay premiums to keep life insurance policies in force. In these ways, it could be argued that these
taxpayers are still “contributing,” and thus still must file Form 8886.

It is clear that the extent to which a taxpayer benefits from the transaction depends on the purpose of a particular
transaction as described in the published guidance that caused such transaction to be a listed transaction.
Revenue Ruling 2004-20, which classifies 419(e) transactions, appears to be concerned with the employer’s
contribution/deduction amount rather than the continued deferral of the income in previous years. Another
important issue is that the IRS has called CPAs material advisors if they signed tax returns containing the plan,
and got paid a certain amount of money for tax advice on the plan. The fine is $100,000 for the CPA, or
$200,000 if the CPA is incorporated. To avoid the fine, the CPA has to properly file Form 8918.

Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of
teaching professionals, Wallach is a frequent speaker on retirement plans, financial and estate planning, and
abusive tax shelters. He is also a featured writer and has been interviewed on television and financial talk shows
including NBC, National Pubic Radio’s All Things Considered and others. Lance authored 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.
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.

Contact him at:
516.938.5007,

wallachinc@gmail.com, or
www.taxadvisorexperts.org, or
www.taxlibrary.us.