Expert Witness and 419 Plans Litigation - IRS Audit Experts for abusive insurance based plans deemed reportable or listed transactions by the IRS
Expert Witness and 419 Plans Litigation - IRS Audit Experts for abusive insurance based plans deemed reportable or listed transactions by the IRS
As many of you know, the IRS lost its sense of humor regarding tax-reduction strategies several years ago. We were reminded of this recently, as you will see below.
ReplyDelete419 Plans of the old days
Ten years ago, 419 plans were all the rage. They were touted to business owners as a plan with unlimited deductibility through their companies, where money would grow tax free until needed in retirement. Some plans touted that the money at termination could come out tax free — the really abusive ones — and some were set up where the money would come out and would be taxable similar to a 40(k) or defined benefit plan.
Let me give you an example:
A 40-year-old doctor with four employees earns, as pre-tax take-home pay, $500,000 a year. The doctor can’t use a defined benefit plan to receive large deductions to grow his wealth, so he was told to tax deduct $200,000 a year into a 419 plan. The money would go into the plan, where it would grow in a tax-free manner because it was invested in cash value life insurance. After funding $1 million over five years, the policy would continue to grow tax deferred and, ultimately, would grow to some outrageous amount which would be used by the doctor in retirement.
Sounds great, right? Actually, once upon a time, there was guidance for how to use 419 plans correctly. Unfortunately, because of the aggressive promoters who wanted to push the envelope — marketing tax-free plans and ones that did not include employees — the IRS was forced to act to curb the abuses through revenue rulings (RRs) that killed the valid use of 419 plans.
419 plan participant hit with penalties for not disclosing the use of a listed tax transaction
The RRs that came out against 419 plans stated with clarity that 419 plans using cash value life insurance are listed tax transactions (Code Sec. 6662A). The consequence of which is that, if you use one of these plans, you have to notify the IRS that you are doing so. Sounds crazy, but it’s true.
Most promoters of 419 plans told clients that their plans complied with the laws and, therefore, did not fall under the listed tax transaction list. Unfortunately, the IRS doesn’t care what a promoter of a tax-avoidance plans says; they make their own determination and punish those who don’t comply.