for Nationwide Assistance.
The Law Offices of Mark Levinson, Esq.
By Lance Wallach
The IRS started auditing § 419 plans in the 1990s, and then continued going after § 412(i) and other plans that they
considered abusive, listed, or reportable transactions, or substantially similar to such transactions. If an IRS audit disallows
the § 419 plan or the § 412(i) plan, not only does the taxpayer lose the deduction and pay interest and penalties, but then
the IRS comes back under IRC 6707A and imposes large fines for not properly filing.
Insurance agents, financial planners and even accountants sold many of these plans. The main motivations for buying into
one were large tax deductions. The motivation for the sellers of the plans was the very large life insurance premiums
generated. These plans, which were vetted by the insurance companies, put lots of insurance on the books. Some of
these plans continue to be sold, even after IRS disallowances and lawsuits against insurance agents, plan promoters and
In a recent tax court case, Curcio v. Commissioner (TC Memo 2010-115), the tax court ruled that an investment in an
employee welfare benefit plan marketed under the name “Benistar” was a listed transaction in that the transaction in
question was substantially similar to the transaction described in IRS Notice 95-34. A subsequent case, McGehee Family
Clinic, largely followed Curcio, though it was technically decided on other grounds. The parties stipulated to be bound by
Curcio on the issue of whether the amounts paid by McGehee in connection with the Benistar 419 Plan and Trust were
deductible. Curcio did not appear to have been decided yet at the time McGehee was argued. The McGehee opinion
(Case No. 10-102, United States Tax Court, September 15, 2010) does contain an exhaustive analysis and discussion of
virtually all of the relevant issues.
Taxpayers and their representatives should be aware that the IRS has disallowed deductions for contributions to these
arrangements. The IRS is cracking down on small business owners who participate in tax reduction insurance plans and
the brokers who sold them. Some of these plans include defined benefit retirement plans, IRAs, or even 401(k) plans with
In order to fully grasp the severity of the situation, one must have an understanding of IRS Notice 95-34, which was issued
in response to trust arrangements sold to companies that were designed to provide deductible benefits such as life
insurance, disability and severance pay benefits. The promoters of these arrangements claimed that all employer
contributions were tax-deductible when paid, by relying on the 10-or-more-employer exemption from the IRC § 419 limits. It
was claimed that permissible tax deductions were unlimited in amount.
In general, contributions to a welfare benefit fund are not fully deductible when paid. Sections 419 and 419A impose strict
limits on the amount of tax-deductible prefunding permitted for contributions to a welfare benefit fund. Section 419A(F)(6)
provides an exemption from § 419 and § 419A for certain “10-or-more employers” welfare benefit funds. In general, for this
exemption to apply, the fund must have more than one contributing employer, of which no single employer can contribute
more than 10 percent of the total contributions, and the plan must not be experience-rated with respect to individual
According to the Notice, these arrangements typically involve an investment in variable life or universal life insurance
contracts on the lives of the covered employees. The problem is that the employer contributions are large relative to the
cost of the amount of term insurance that would be required to provide the death benefits under the arrangement, and the
trust administrator may obtain cash to pay benefits other than death benefits, by such means as cashing in or withdrawing
the cash value of the insurance policies. The plans are also often designed so that a particular employer’s contributions or
its employees’ benefits may be determined in a way that insulates the employer to a significant extent from the experience
of other subscribing employers. In general, the contributions and claimed tax deductions tend to be disproportionate to the
economic realities of the arrangements.
Benistar advertised that enrollees should expect to obtain the same type of tax benefits as listed in the transaction
described in Notice 95-34. The benefits of enrollment listed in its advertising packet included:
· Virtually unlimited deductions for the employer;
· Contributions could vary from year to year;
· Benefits could be provided to one or more key executives on a selective basis;
· No need to provide benefits to rank-and-file employees;
· Contributions to the plan were not limited by qualified plan rules and would not interfere with pension, profit sharing
or 401(k) plans;
· Funds inside the plan would accumulate tax-free;
· Beneficiaries could receive death proceeds free of both income tax and estate tax;
· The program could be arranged for tax-free distribution at a later date;
· Funds in the plan were secure from the hands of creditors.
The Court said that the Benistar Plan was factually similar to the plans described in Notice 95-34 at all relevant times.
In rendering its decision the court heavily cited Curcio, in which the court also ruled in favor of the IRS. As noted in Curcio,
the insurance policies, overwhelmingly variable or universal life policies, required large contributions relative to the cost of
the amount of term insurance that would be required to provide the death benefits under the arrangement. The Benistar
Plan owned the insurance contracts.
Following Curcio, as the Court has stipulated, the Court held that the contributions to Benistar were not deductible under §
162(a) because participants could receive the value reflected in the underlying insurance policies purchased by Benistar—
despite the payment of benefits by Benistar seeming to be contingent upon an unanticipated event (the death of the
insured while employed). As long as plan participants were willing to abide by Benistar’s distribution policies, there was no
reason ever to forfeit a policy to the plan. In fact, in estimating life insurance rates, the taxpayers’ expert in Curcio
assumed that there would be no forfeitures, even though he admitted that an insurance company would generally assume
a reasonable rate of policy lapses.
The McGehee Family Clinic had enrolled in the Benistar Plan in May 2001 and claimed deductions for contributions to it in
2002 and 2005. The returns did not include a Form 8886, Reportable Transaction Disclosure Statement, or similar
The IRS disallowed the latter deduction and adjusted the 2004 return of shareholder Robert Prosser and his wife to
include the $50,000 payment to the plan. The IRS also assessed tax deficiencies and the enhanced 30 percent penalty
totaling almost $21,000 against the clinic and $21,000 against the Prossers. The court ruled that the Prossers failed to
prove a reasonable cause or good faith exception.
Other important facts:
· In recent years, some § 412(i) plans have been funded with life insurance using face amounts in excess of the
maximum death benefit a qualified plan is permitted to pay. Ideally, the plan should limit the proceeds that can be paid as
a death benefit in the event of a participant’s death. Excess amounts would revert to the plan. Effective February 13,
2004, the purchase of excessive life insurance in any plan is considered a listed transaction if the face amount of the
insurance exceeds the amount that can be issued by $100,000 or more and the employer has deducted the premiums for
A 412(i) plan in and of itself is not a listed transaction; however, the IRS has a task force auditing 412(i) plans.
An employer has not engaged in a listed transaction simply because it is a 412(i) plan. Just because a 412(i) plan was
audited and sanctioned for certain items, does not necessarily mean the plan engaged in a listed transaction. Some 412(i)
plans have been audited and sanctioned for issues not related to listed transactions.
Companies should carefully evaluate proposed investments in plans such as the Benistar Plan. The claimed deductions
will not be available, and penalties will be assessed for lack of disclosure if the investment is similar to the investments
described in Notice 95-34. In addition, under IRC 6707A, IRS fines participants a large amount of money for not properly
disclosing their participation in listed, reportable or similar transactions; an issue that was not before the tax court in either
Curcio or McGehee. The disclosure needs to be made for every year the participant is in a plan. The forms need to be
properly filed even for years that no contributions are made. I have received numerous calls from participants who did
disclose and still got fined because the forms were not filled in properly. A plan administrator told me that he assisted
hundreds of his participants with filing forms, and they still all received very large IRS fines for not properly filling in the
IRS has targeted all 419 welfare benefit plans, many 412(i) retirement plans, captive insurance plans with life insurance in
them and Section 79 plans.
Lance Wallach, National Society of Accountants Speaker of the Year and member of the American Institute of CPAs faculty
of teaching professionals, is a frequent speaker on retirement plans, financial and estate planning, and abusive tax
shelters. He speaks at more than ten conventions annually and writes for over fifty publications. 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 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. Mr. Wallach may be reached at 516/938.5007, firstname.lastname@example.org, or at
www.taxaudit419.com or www.lancewallach.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.
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