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419 Plan Participant Penalized under the Listed Tax Transaction Disclosure Law

By Roccy M. DeFrancesco, JD, CWPP™, CAPP™ - Email Editor

Dear Valued Reader,

As many of you know, the IRS lost its sense of humor with “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 used to be 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 401(k) or defined benefit plan.

Let me give you an example: Assume you have a 40-year-old doctor with four employees who earns as pre-tax take-home pay $750,000 a year. The doctor can’t use a defined benefit plan to receive large deductions to grow his wealth, and so he was told to tax deduct $300,000 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 $1.5 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, back in the day, there was guidance for how to use 419 Plans correctly. Unfortunately, because of all 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. To read the Revenue Rulings (RRs) that killed the valid use of 419 Plans, please click here.

Recent IRS Actions - 419 Plan participant hit with penalties for not disclosing to the IRS 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 used 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 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% accuracy-related penalty under Code Sec. 6662A. Finally, the Tax Court sustained IRS's determination that McGehee was subject to the increased 30% 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! To read a multi-page summary on the McGehee case, please click here.

Turning over client names to the IRS including recent raid on the Benistar office

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 the 35-50 armed IRS agents showed up at their office to seize documents. Can you imagine that?

It’s important to understand what could happen to you if you happen to get in plans that are not above board. Your name 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!

I wanted to remind readers that, if a plan 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 they are plans that are not financially useful and because most of the time you have to lie to employees to implement them in an economical manner. For more information about what’s wrong with Section 79 plans, please contact our office.

Tax/wealth building plans that work

If you are a business owner, you can use 401(k), profit sharing, and/or defined benefit plans to build your wealth. There is nothing wrong with building wealth with these plans unless you are going to have a high income in retirement and/or an estate tax problem at death.

However, if you own a profitable medium-to-small business, 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 of our United States allow CIC to be setup/domiciled in their states. In the past, the problem with CICs isn’t that they were considered abusive tax structures; the problem is 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 - in an upcoming newsletter, we will cover the only “affordable” CIC structure available today. It 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.

If you would like to be added to a list so you can learn more about the affordable CIC structure when it becomes available in a few weeks, please e-mail Click Here.

Call 888.916.7070 or email info@trustmakers.com

Until next time,

Roccy M. DeFrancesco, JD, CWPP™, CAPP™

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