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| Lawyer 4 Audits .com The Law Offices of Ira Kaplan |
California Enrolled Agent
January 2, 2009
Abusive 412(i) Retirement Plans Can Get Accountants Fined $200,000
By Lance Wallach & Ira Kaplan, Esq.
Most insurance agents sell 412(i) retirement plans. The large insurance commissions generate
some of the enthusiasm. Unlike other retirement plans, the 412(i) plan must have insurance
products as the funding mechanism. This seems to generate enthusiasm among insurance
agents. The IRS has been auditing almost all participants in 412(i) plans for the last few years. At
first, they thought all 412(i) plans were abusive. Many participants’ contributions were disallowed
and there were additional fines of $200,000 per year for the participants. The accountants who
signed the tax returns (who the IRS called “material advisors”) were also fined $200,000 with a
referral to the Office of Professional Responsibility. For more articles and details, see www.
vebaplan.com and www.irs.gov/.
On Friday February 13, 2004, the IRS issued proposed regulations concerning the valuation of
insurance contracts in the context of qualified retirement plans.
The IRS said that it is no longer reasonable to use the cash surrender value or the interpolated
terminal reserve as the accurate value of a life insurance contract for income tax purposes. The
proposed regulations stated that the value of a life insurance contract in the context of qualified
retirement plans should be the contract’s fair market value.
The Service acknowledged in the regulations (and in a revenue procedure issued simultaneously)
that the fair market value standard could create some confusion among taxpayers. They
addressed this possibility by describing a safe harbor position.
When I addressed the American Society of Pension Actuaries Annual National Convention, the IRS
chief actuary also spoke about attacking abusive 412(i) pensions.
A “Section 412(i) plan” is a tax-qualified retirement plan that is funded entirely by a life insurance
contract or an annuity. The employer claims tax deductions for contributions that are used by the
plan to pay premiums on an insurance contract covering an employee. The plan may hold the
contract until the employee dies, or it may distribute or sell the contract to the employee at a
specific point, such as when the employee retires.
“The guidance targets specific abuses occurring with Section 412(i) plans”, stated Assistant
Secretary for Tax Policy Pam Olson. “There are many legitimate Section 412(i) plans, but some
push the envelope, claiming tax results for employees and employers that do not reflect the
underlying economics of the arrangements.” Or, to put it another way, tax deductions are being
claimed, in some cases, that the Service does not feel are reasonable given the taxpayer’s facts
and circumstances.
“Again and again, we’ve uncovered abusive tax avoidance transactions that game the system to the
detriment of those who play by the rules,” said IRS Commissioner Mark W. Everson.
The IRS has warned against Section 412(i) defined benefit pension plans, named for the former
IRC section governing them. It warned against certain 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 such participation under pain of penalties, potentially reaching $100,000 for
individuals and $200,000 for other taxpayers. Targets also include some retirement plans.
One reason for the harsh treatment of 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 these transactions. In general, IRS auditors divide audited
plans into those they consider noncompliant and others they consider abusive. While the
alternatives available to the sponsor of a 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. Although in some situations
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. In
addition, if the participant did not file Form 8886 and the accountant did not file Form 8918 (to
report themselves), they would be fined $200,000.
Lance Wallach, the National Society of Accountants Speaker of the Year, speaks and writes
extensively about retirement plans, Circular 230 problems and tax reduction strategies. He speaks
at more than 40 conventions annually, writes for over 50 publications and has written numerous
best selling AICPA books, including Avoiding Circular 230 Malpractice Traps and Common Abusive
Business Hot Spots. Contact him at 516.938.5007 or visit www.vebaplan.com.
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.