IRS attacks business owners, accountants, lawsuits over 412(i)/419 and similar insurance based plans. -------------------------------------------------------------------------------- February 27, 2013 By Lance Wallach What is it? A 412(i) plan is a “defined benefit plan” – a retirement plan, a pension plan that claims to offer very large tax deductions. It is funded with annuity and life insurance products. Lance Wallach A 419 plan is a “welfare benefit plan” – typically used for medical expenses, severance benefits, death benefits and the like. They started as 419af6 and then when the IRS went after them changed and were called 419e, single employer plans, or other names that promoters gave them. IRS calls most of them listed transactions. Late 1990's/early 2000's, agents sold life insurance, and annuity policies to fund such plans. Type of policy typically had high surrender charges, depressed cash value in early years - premiums paid by employer After premiums funded for a few years, employee purchases policy for the current depressed cash surrender value After policy purchased, surrender charges dramatically reduced, cash value “springs” to a high level Employee could then borrow from high value policy for tax-free cash flow. They were called springing cash value policies. Not all policies were of that type. In 1995 IRS issued IRS notice 9534 warning that they would come after 419 plans. In 2004/2005, IRS began investigating and issued regulations deeming such plans as abusive tax shelters - began nationwide audits of such plans. Plaintiffs in these matters are typically professional groups (doctors, dentists, small business owners) audited by the IRS - plans deemed abusive tax shelters – subject to substantial fees and penalties. Participants must file under IRS 6707A to avoid additional large fines. Material advisors, people that sold the plans and accountants that gave tax advice and got paid also get fined a minimum of $100,000 if they do not properly file and tell on their client. Professionals then file suit against insurance companies and agents claiming they were misled in the sale of these plans and policies. Allegations typically: defendants represented that policies used to fund plans would be valid and subject to favorable future tax consequences To Date - Mixed Results for Carriers: 1. Breach of contract Claim dismissed - contract never promised to satisfy § 412 requirements, specifically stated that it did not guarantee any future tax consequences. Zarrella v. Pacific Life, 755 F. Supp. 2d 1231 (S.D. FL March 29, 2011) (Florida law) Claim allowed to proceed - allegations pled existence of written and oral contracts promising tax benefits. Chau v. Aviva Life, 2011 U.S. Dist. LEXIS 54828 (N.D. Tex May 20, 2011) (applying Washington law). 2. Negligence Claim dismissed because carrier is under no duty to advise its insured’s regarding tax consequences of transactions. Zarrella v. Pacific Life, (S.D. FL March 29, 2011). 3. Fraud/Misrepresentation A. Future statements: alleged misrepresentations made before the IRS pronouncements calling into question tax benefits of the various plans generally dismissed on grounds: (i) statements were not false when made, or (ii) statements were mere opinions or predictions that are not actionable. Berry v. Indianapolis Life, 608 F. Supp. 2d 785 (N.D. Tex. 2009, August 26, 2010) Zarrella v. Pacific Life, 755 F. Supp. 2d 1231 (S.D. FL March 29, 2011) Chau v. Aviva Life, 2011 U.S. Dist. LEXIS 54828 (N.D. Tex May 20, 2011) Courts generally determine that statements made by agents prior to 2004/2005 are “forward-looking” statements or “opinions” and that “as a matter of law, any representation or prediction by any alleged agent as to how the IRS would treat the 412(i) plans and finding thereof in the future is either an un actionable opinion or was unjustifiably relied upon.” Berry v. Indianapolis Life To Date - Mixed Results for Carriers: B. “Disclaimer of Reliance” defense – results mixed Typically, in the plan documents, participant agrees he is not relying on carrier’s representations regarding the validity of the plan or its tax benefits - instead relying on own independent tax advisor Cal. law – signed disclosure statements by plaintiffs preclude reasonable reliance on representations as a matter of law - claim dismissed. Berry v. Indianapolis Life Omni Home v. Hartford Life, 2008 Dist. LEXIS 35259 (S.D. Cal. April 29, 2008). Texas and Wisconsin law – disclosure documents do not preclude reliance as a matter of law. Berry v. Indianapolis Life To date, success in dismissing claims depends upon the different courts, and applicable governing law. Note: If alleged misrepresentations made after applicable IRS pronouncement, then representations are not predictions or opinions, but rather statements regarding the existing state of the law – probably allowed to proceed. Most attorneys will lose these cases. As an expert witness Lance Wallach’s side has NEVER lost a case. To win you need to mitigate the damages. You need to properly file under IRS code 6707A. As an aside there is no IRS statute of limitations on fines etc. unless you PROPERLY file under IRS 6707A. It is very hard to properly file after the fact, as the IRS directions are not very helpful. Lance Wallach has received hundreds of phone calls from people seeking help on IRS fines etc. First IRS audits and denies the deductions with interest and penalties. Then, sometimes years later IRS comes back again to access very large fines under 6707A for not filing or not properly filing. Accountants tell their clients, after the first audit, you are done with the IRS. THIS is NOT TRUE. IRS comes back a second time if the forms are not properly filed, or not filed at all. To win you need to show that the disclaimers were fraudulent because they did not include the facts that IRS was looking into these plans. Lance Wallach spoke at the American Society of Pension Actuary’s national convention in 2002 about these plans. The IRS chief actuary also spoke about the IRS looking at these plans. IRS gave notice in 1995 under 9534 warning of these plans. Lance Wallach has been authoring articles for various accounting publications and books since the 90s warning of these plans. Insurance companies, promoters of these abusive tax shelters accountant and attorneys were on notice of the problems. As IRS continues to attack and shut down these abusive plans promoters and insurance companies are now marketing Section 79 and captive insurance plans. The IRS has started auditing, and a new cycle is beginning. Soon accountants and insurance companies will be sued and IRS steps up the audits. This author does not believe that all 419, 412i, section 79 and captive insurance plans are abusive. Many of the newer versions of 412i plans seem to be good. Many captive insurance plans, without life insurance seem to be good. One 419 plan was reviewed by senior IRS and treasury officials, with this other present, and they had no serious objections to the plan. If it seems to be too good to be true it is. For a lot more articles on point Google Lance Wallach. As you read this hundreds of business owners are being audited. Many insurances companies, agents and accountants are being sued. Don't think this will happen to you? Better to be safe than sorry. ABOUT THE AUTHOR: Lance Wallach Lance Wallach, CLU, ChFC, CIMC, speaks and writes extensively about financial planning, retirement plans, and tax reduction strategies. He is an American Institute of CPA’s course developer and instructor and has authored numerous bestselling books about abusive tax shelters, IRS crackdowns and attacks and other tax matters. He speaks at more than 20 national conventions annually and writes for more than 50 national publications. As an expert witness his side has never lost a case. For more information and additional articles on these subjects, call 516-938-5007. Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.