Section 79 plans

Answer 1

The dangers of being "listed"

A warning for 419, 412i, Sec.79 and captive insurance

Accounting Today: October 25, 2010

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

($200,000 for a business and $100,000 for an individual) 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 has to be prepared correctly. I only know of two

people in the United States who have filed these forms properly for clients. They tell me that

was after hundreds of hours of research and over fifty phones calls to various IRS

personnel.

The filing instructions for Form 8886 presume a timely filing. 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 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. It

follows that taxpayers who no longer enjoy the benefit of those large deductions are no

longer "participating ' in the listed transaction. But that is not the end of the story.

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. This language may

provide the taxpayer with a solid argument in the event of an audit.

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.