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An Expert Discusses Section 79 and Listed Transactions
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The dangers of being "listed"
A warning for 419, 412i, Sec.79 and captive insurance

As published in:
AccountingToday: 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.  


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Abusive Insurance, Welfare Benefit, and Retirement Plans

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 over ,000 in 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.