419 plan participant penalized under the listed tax transaction disclosure lawArticle added by Roccy DeFrancesco on October 1, 2010
Roccy Defrancesco

Roccy DeFrancesco


Joined: May 24, 2006

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.

419 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.
The McGehee Family Clinic, P.A. was recently hit with back taxes and a penalty under Code Sec. 666A in conjunction with a deduction to the Benistar 419 plan
I’m sure this was extremely distressing to Dr. McGehee. His clinic took a deduction for a 419 plan (the Benistar plan) back in 2005. Eventually, the McGhee Family Clinic was audited. After the audit, the doctor was told that the deduction would be disallowed and that back taxes were due. Additionally, Dr. McGehee was hit with a 20 percent accuracy-related penalty under Code Sec. 6662A. Finally, the tax court sustained the IRS's determination that McGehee was subject to the increased 30 percent penalty, because its return did not include a disclosure statement indicating its participation in the Benistar Trust.

That’s a train wreck of a plan — no deduction, back taxes due, and sizable penalties. Ouch!
Recent raid on the Benistar office included turning over client names to the IRS

If you didn’t hear, when the IRS attacked the Benistar 419 plan, one of its tactics was to demand the names of all the clients Benistar worked with — so they could be audited by the IRS, I’m sure. Benistar refused to give the names and actually appealed the decision to turn over the names. The appeal was denied, but Benistar officials still refused to give up the names. Recently, the IRS raided the Benistar office and took hundreds of boxes of information, which included information on clients who were in their 419 plan. In documents filed by Benistar itself, they stated that 35 to 50 armed IRS agents showed up at their office to seize documents.

Can you imagine that?

It’s important to understand what could happen to your clients if you get them involved in plans that are not above board. Their names could be turned over to the IRS, where audits could ensue, and where the outcome could be the repayment of back taxes and significant penalties.

It’s not worth it!

It’s getting closer to the end of the year. This is when every scammer known to man/woman comes out of the woodwork to sell some fly-by-night tax deductible plan to clients. I wanted to remind readers that, if it sounds too good to be true, it probably is.
I specifically wanted to remind you to avoid Section 79 plans (which are different than 419 Plans). Not because they are listed tax transactions, but simply because I do not think they are financially viable. Additionally, the economical implementation of Section 79 plans promotes lying to employees so they opt out of having permanent policies purchased on their lives. Not all Section 79 TPAs support lying to employees, but even when done right, I still do not recommend the plans.

Tax/wealth building plans that work
Of course, your clients can use 401(k), profit sharing, and/or defined benefit plans. There is nothing wrong with building wealth with these plans, unless your clients are going to have a high income in retirement and/or an estate tax problem at death.

If you have medium-to-small business clients, you should learn about the proper use of captive insurance companies (CICs). CICs are simple tools, and if you didn’t know it, over 25 states allow CIC to be setup/domiciled in their state. In the past, the problem with CICs wasn't that they were considered abusive tax structures; the problem was that the cost of CICs was so high that they only made sense for clients who could allocate a payment of $400,000 or more to a CIC each year.

Affordable CICs
The only “affordable” CIC structure available today will be priced for clients who can allocate as little as $100,000 a year to the structure. This is a significant development in the advancement of the use of CICs as a risk-management/wealth-building tool.

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To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
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