Tag Archives: IRS Code

Court Hammers Taxpayers in 419 Ruling

www.insurancenewsnet.com

I’m not sure why this 419 case hasn’t been talked about much, but it certainly got my attention when it came across my desk.

If you’ll remember, 419 plans were the darling of the life insurance industry for years. The plans were sold as a way to buy cash-value life insurance in a 100 percent tax-deductible manner in which the death benefit would pay out tax-free. Additionally, individuals (usually business owners) could exit from the plans, at which time the cash-value life insurance policies would be distributed to the individuals. The individuals then could borrow from the policies tax-free in retirement.

If you know the history of 419 plans, you know that the Internal Revenue Service has despised them for over a decade. For the most part, the courts have ruled against taxpayers in cases involving 419 plans, and the IRS has acted several times to curb their use. The IRS essentially killed multi-employer plans, which spawned the use of single employer plans which were subsequently killed (or so we thought).

Scorpion and the frog — If you have never read the story of the scorpion and the frog, I highly recommend it. Many 419 administrators (such as Section 79 plan administrators) are scorpions. They do what they do, no matter the consequences to clients or to the advisors who recommend them.

Tax court sounds death knell on 419 plans?

On July 13, the same tax court that issued the landmark 419 case back in the day (Neonatology Associates v. Commissioner of Internal Revenue) came down hard on one of the few remaining 419 plans in the industry. It seems the judge was trying to send a message in his opinion, and I hope it will be received loud and clear.

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Internal Revenue Code Section 79 Plans and Captive Insurance History

by Lance Wallach
by Lance Wallach

When trying to understand how a product becomes the focus of IRS scrutiny it helps to know its history. In the case of plans that fall under Internal Revenue Code Section 79, that history is complex. Insurance companies, agents, financial planners, and others have pushed abusive 419 and 412i plans for years. They claimed business owners could obtain large tax deductions. Insurance companies, agents and others earned very large life insurance commissions in the process.

Eventually, the IRS cracked down on the unsuspecting business owners. Not only did they lose the tax deductions, but they were also fined, in addition to being charged penalties and interest. A skilled CPA with extensive IRS experience could usually eliminate the penalties and reduce the fines. Most accountants, tax attorneys and others, however, have been unsuccessful in accomplishing this.

After the business owner was assessed the fines and lost his tax deduction, he had another huge, unforeseen problem. The IRS then came back and fined him a huge amount of money for not telling on himself under IRC 6707A. If you participate in a listed or reportable transaction, you must alert the IRS or face a large fine.

In essence, you must alert the IRS if you were in a transaction that has the possibility of tax avoidance or evasion. Not only must you file Form 8886 telling on yourself, but the form needs to be filed properly, and done every year that you are in the plan in any way at all, even if you are no longer making contributions.

According to IRC 6707A Expert Lance Wallach, “I have received hundreds of phone calls from business owners who filed Form 8886, usually with the help of their accountants or the plan promoter. They got the fine for either improperly filing, or for making mistakes on the form.”

Obamacare-Tax-Small-Business-ConfusionThe IRS directions about preparing the form are vague, especially if the form is filed late. They presume a timely filing. In addition, many states also require forms to be filed.

“For example, if you work in New York State and manage to properly fill out the Federal form, but do not file the State form, you may still get fined,” says Wallach, adding that he only knows of two people that know how to properly prepare and file the forms, especially forms being filed late. As an expert witness in such cases, Lance Wallach’s side has never lost.

The result of the all of the above was many lawsuits against insurance companies, including Hartford, Pacific Life, Indianapolis Life, AIG, and Penn Mutual, to name just a few. Agents, accountants, and attorneys were also successfully sued.

Lately, insurance companies, agents, accountants, and others have been selling captive insurance and Section 79 scams. The motivations are exactly the same. They push large tax deductions for business owners. There are also huge commissions for salespeople, though this is usually mentioned only in passing, if at all.

Anyone participating in a listed or reportable transaction must properly file Form 8886 or face large IRS fines. A listed transaction is any transaction specifically identified as such by published IRS guidance, or one substantially similar to that transaction. A reportable transaction is any transaction that has the potential for tax avoidance or evasion.

“In my experience, the desire to avoid taxes is usually the principal and sometimes the only reason why people participate in Section 79, captive insurance, or 419 plans. That is why I generally take the position that virtually everyone participating in one of these arrangements should properly file Form 8886, if only protectively as a precaution,” says Wallach.

If you do not properly file Form 8886, there is no Statute of Limitations. That means the IRS can come back and fine you many years later. Anyone that wants to risk an IRS audit by utilizing a captive insurance or Section 79 scam should, at the very least, engage a competent professional to file 8886 forms. By filing protectively and properly, the Statute of Limitations starts running and you avoid the very large IRS penalties under 6707A.

Never utilize directions from a plan promoter or salesman as to how to fill out 8886 forms. They would only be attempting to protect themselves, and doing so could result in you being fined. Lance Wallach stated that he knows of many examples of this happening, including a plan promoter who assisted almost 200 business owners in preparing and filing 8886 forms. All of them got fined for improper preparation of the forms.

The two people that have been successful in filing 8886 forms for business owners have had numerous conversations with IRS personnel. They get the impression that it is almost impossible for an accountant, tax attorney, or anyone else to properly prepare and file the forms. One of them, who spent 35 plus years with the IRS, has also been successful in fighting the IRS on penalties and fines assessed against business owners who participate in these plans, though the IRS publicly claims that you cannot appeal the fine under 6707A.

IRS Increases Audits of Section 79, 419, 412i and Captive Insurance

by Lance Wallach
by Lance Wallach

In recent years, the IRS has identified many of these arrangements as abusive devices to funnel tax deductible dollars to shareholders and classified these arrangements as “listed transactions.”

These plans were sold by insurance agents, financial planners, accountants and attorneys seeking large life insurance commissions. In general, taxpayers who engage in a “listed transaction” must report such transaction to the IRS on Form 8886 every year that they “participate” in the transaction, and you do not necessarily have to make a contribution or claim a tax deduction to participate. Section 6707A of the Code imposes severe penalties ($200,000 for a business and $100,000 for an individual) for failure to file Form 8886 with respect to a listed transaction.But you are also in trouble if you file incorrectly.I have received numerous phone calls from business owners who filed and still got fined. Not only do you have to file Form 8886, but it has to be prepared correctly. I only know of two people in the United States who have filed these forms properly for clients. They tell me that was after hundreds of hours of research and over fifty phones calls to various IRS personnel.

There is no doubt that while the public doesn’t really think much about buying life insurance, they have a need for it. Life insurance serves the purpose of funding the family’s continuation at death, and prevents the financial shock from the loss of the family’s main provider.

Uncle Sam Wants You To Pay TaxesLife insurance is also sold as a tax shelter of sorts. Because the investment growth on the cash value of a life insurance policy is not taxed, and in fact may never be taxed, life insurance can sometimes be a very efficient investment. (And sometimes not — eventually, the cost of insurance which increases dramatically with age can significantly eat away at investment returns, and more often than not the investment returns somehow never quite match the pollyannaish predictions of the illustrations shown to prospective buyers — those illustrations with unrealistic financial projections being known in the industry as “liar ledgers”).

The problem with life insurance as a tax shelter is that typically it must be purchased with post-tax dollars. Historical attempts by creative attorneys and financial advisers to manipulate various tax-free strategies to encompass a life insurance policy have nearly all ended in disaster: VEBAs, 412(i) plans, and 419 plans all ended with the taxpayers often paying more tax in the end than if they had done nothing in the first place, and lawsuits against advisers for professional negligence nearly hit the epidemic point.

For somewhat obvious reasons, the IRS has typically gone after arrangements that were pitched to clients that they could purchase a large amount of life insurance with pre-tax dollars like a heat-seeking missile. Yet, advisers persist in trying to wed life insurance to things that it shouldn’t be hitched to, so as to obtain the result of a pre-tax purchase of life insurance — and big commissions to the advisers, who if in good with their insurance company, might make upwards of 40% of the first-year’s premiums paid in on a Universal Life policy, and upwards of 80% on a Whole Life policy (they almost never disclose these commissions to their clients, of course).

The latest attempt to wed life insurance to something that will result in a pre-tax purchase of life insurance is that involving smallish captive insurance companies. These companies make the 831(b) election so that they are not taxed on their premium income, with the result that the underlying company can quite lawfully pay some reasonable amount of premiums to the captive and take a current-year deduction for it, but the captive does not pick up the premiums received as income.

From a tax standpoint, the benefits of an 831(b) captive are not that great — most of the money should be used to pay claims if the actuarial calculations of the premiums are anything like close, and then the balance of the money is subject to capital gains taxes when the company is liquidated. In the meantime, an 831(b) captive is not allowed to deduct all, or even most, of its operating costs.

Plus — and here is where life insurance re-enters the picture — an 831(b) captive is internally taxed annually on its investment income, which further eats into the tax efficiency of the captive. But what if the captive could purchase life insurance — which grows tax-free — and thus avoid the tax on its investment income? Welcome to the life insurance tax shelter du jour.

There are now tax shelter promoters out there (many of them the same ones who sold VEBAs, 412(i), and 419A(f)(6) plans in past years) actively marketing and selling 831(b) companies as a conduit to purchase life insurance with pre-tax dollars. Sometimes they try to disguise the transaction by having the captive do a split-dollar transfer to a trust that buys the life insurance, or having the captive invest in a preferred share of an LLC that buys the life insurance. This is just putting lipstick on the pig. Others just tell their clients to purchase life insurance directly inside the captive.

The truth is that it is probably fine for a mature captive, meaning one that has been around for some years and has large reserves and surplus, to use a small amount of its investable assets to purchase a key-man policy, or maybe invest in life settlements or the like.

But this is not how the 831(b) captives are being sold; instead, clients are being shown illustrations where the life insurance is being purchased soon after the first premiums are paid to the captive (the advisers want their commissions now, not later), and the efficiency of the captive is being measured not in its effectiveness as a risk-management tool (it’s proper purpose) but rather as an investment and estate planning tool (the improper tax shelter purpose).

In reviewing these transactions, the presence of the 831(b) captive is simply a sham. Premiums in these deals are rarely calculated based on anything like real-world risks, but the promoters are making a determination of how big of a deduction the client wants, and then “backing in” the premium amounts with the help of actuaries who will testify that a $500,000 premium for $2 million worth of terrorism insurance for a business in Lenexa, Kansas, is reasonable, and, oh, also that the world is flat, water is dry, hot is cold, and the sun comes up in the West.

Section 79

by Lance Wallach
by Lance Wallach

For businesses with 10 or fewer employees, the law prohibits full medical underwriting of the policies that are issued (“group” underwriting is required, which is much more risky for an insurance company).

Beginning this article, I wanted to reiterate my comments on implementing plans with fewer than 10 employees.

Amazingly, one of the insurance companies offering this plan seemly doesn’t have the ability to issue non-medical underwriting policies. This is laughable and pathetic all at the same time, and a plan you’ll want to stay far away from.

As I briefly alluded to in my previous article, one of the reasons I really do not like Section 79 plans is that they basically force employers and those helping them set up Section 79 plans to lie to the employees when implementing the plan.

Non-discrimination

Section 79 plans are employee benefits plans. As such, employers are not supposed to discriminate in favor of key employees or business owners.

As you know, Section 79 plans are implemented so business owners can take a business deduction for the purchase of an individually owned life insurance policy that the owner can borrow from tax free in retirement.

It sounds great until you break down the math and understand that a client would be better off paying taxes on his/her money, taking it home, and funding a good cash value life policy rather than the low cash accumulation Section 79 Plan policy.

Notwithstanding the math behind Section 79 plans, let’s talk about the benefits for employees. The employee owner is going to buy a “permanent” policy that will carry cash and can be borrowed from tax free in retirement.

That same policy must be offered to all employees. If that actually happened in a full-disclosure manner, virtually all the employees would opt for the same permanent policy; and if that happened, the finances of the plan would really go out the window because of the tremendous costs for the employees.

How do you “work around” this issue?

The work around of this issue is a bit clever and deceptive. The employees will be scared into voluntarily opting for $50,000 of term insurance instead of the full-benefit policy (term or permanent).

Why would an employee opt for $50,000 in term instead of a policy with several hundred thousands of dollars or even millions of dollars in death benefits? Because employees who are provided death benefits by an employer in excess of $50,000 are taxed on the additional benefit on an annual basis (and it increases every year).
Roccy is a good man and the author of the above article. I did not copy the entire article. I only copied the first page. Roccy D is a very smart man who is aware of the problems with abusive tax shelters including 412i 419 and the new abusive section 79 plans. It seems that over the years he and I have attacked abusive 419 and 412i plans, while everyone else was selling them. Now he and I are warning about section 79 scams.

The Truth Behind Section 79 Benefit Plans— I Can’t Stand the Hypocrisy Anymore

What is a Section 79 Plan? Simply put, it is a tax-plan where small business owners are allowed to take a 20-40% deduction through their business to purchase an individually owned cash value life (CLV) insurance policy. This is the huge selling point of the plan.

If you just read the above paragraph, you’d think that a Section 79 Plan is the nirvana of plans because you’ve been trying to get your profitable small business owners to buy CVL for years.

Why are the finances of Section 79 so marginal? In short, the reason Section 79 Plans are up to 40% deductible is because the life insurance policy purchased is a crummy policy by design. That’s right, by design, the policy is a terrible cash accumulator.

The better the policy, the less the deduction. A good policy (Retirement Life) for example would receive only an 8-10% deduction through the plan.

Improving the finances of the Section 79 Plan Section 79 Plans are funded into a crummy cash accumulating policy for five years. Then the client is shown how the policy can be flipped to a variable life policy earning 9% annually going forward. Besides that this is not a conservative example, the numbers are marginal even assuming a 9% rate of return.

Now in the marketplace is a new Section 79 Plan using an EIUL policy. The EIUL policy was also designed to be a crummy cash accumulating policy in the early years so the client can obtain his/her 30-40% deduction (not to mention that the company screwed up their plan for groups under 10 employees by not dealing the non-medical underwriting issue).

Why are so many agents trying to sell Section 79 Plans? This is what really moved me to write this newsletter. Agents are pitching Section 79 Plans to clients for two simple reasons: 1) Many small business clients will buy any plan that is “deductible” because they so despise paying income taxes. 2) Insurance advisors want to sell life insurance.

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Using Insurance to Reduce a Couple’s Taxes

The couple’s business had a banner year, generating about $1 million in profits–much of which they planned to take as personal income.

They’d worked with financial adviser Michael Turner to defer $100,000 of that income by establishing a Safe Harbor 401(k) and a profit-sharing plan. But the couple was interested in reducing their income taxes even further.

Unbeknown to Mr. Turner, they hatched an unusual plan to buy a second home in an income tax-free state, thinking it would exempt them from taxes. Mr. Turner had to explain that the laws regarding cross-state taxation meant that the second home likely wouldn’t have the effect they assumed.

“I told them that could still buy a second home if they wanted one, but if their goal was to reduce their income taxes, there were likely more effective options,” says Mr. Turner of Franklin Chase Wealth Management, which manages $5 million for 75 clients in Charlotte, N.C.

Putting additional money into their retirement plans wasn’t a good option, because the plan structures required that they also contribute more to their employees’ accounts at the same time. That wasn’t the couple’s immediate priority. So Mr. Turner found a solution that specifically benefited them: a Section 79 insurance plan.

continue reading the article here

Captive Insurance and Section 79 Scams, 419e and 412i Producing Large IRS fines

by Lance Wallach
by Lance Wallach

Have you ever heard of captive insurance, a 419 welfare benefit plan, a 412i defined benefit insurance plan or a Section 79 scam? You may have a client in one, or be in one yourself and not even know it. You would learn quickly when the IRS disallows your tax deduction and tries to fine you lots of money. What you are about to read about below may seem impossible in America. The IRS first audits,  disallows deductions, and charges interest and penalties for being in one of these abusive plans. You then think you are finished with them. Soon thereafter, you get fined hundreds of thousand of dollars for not reporting yourself to the IRS. I have been helping successful business owners and professionals with this problem for years. I have authored numerous books for the American Institute of CPAs with chapters on this problem.

I have spoken at many conventions on this topic and argued with a lot of people who didn’t think this would ever happen to them. They purchased products sold primarily by insurance agents from large well known insurance companies like Prudential, Pacific Life, Mass Mutual, Guardian, American General, etc. The plans had opinion letters from lawyers. The business owner’s accountants signed tax returns taking deductions for these plans with insurance products. Why are the business owners and professionals being fined a huge amount of money by various divisions of the IRS for doing what seemed like a legitimate thing to do? How can something like this happen in America? When many of the business owners and accountants finally take their heads out of the sand, they are usually put out of business by these fines.

419, 412i, Captive Insurance and Section 79 Problems

by Lance Wallach
by Lance Wallach

Sometimes the IRS might disagree with planning you did with other advisors and you need to find help to ensure that your rights are protected, the facts are interpreted accurately and the law applied correctly.

Lance Wallach is among the few in this country who fully understand the mechanics and legal issues surrounding what has become known as “419 Plans,” 412i plans, captive insurance and section 79 programs. He wrote the book, that others read for CPE on these subjects. For that reason taxpayers throughout the country seek his services in dealing with the Internal Revenue Service in audits, appeals and in the Tax Court with his associates. As an expert witness Lance Wallach’s side has never lost a case. Sometimes it is easy to get your money back with a letter.

Expert Witness

Frankly, not everybody does it right. Whether through ignorance or ill-intent, some folks sell insurance based programs with tax benefits, such as 419 Plans and 412(i) Plans, or promote premium financing or STOLI programs to unsuspecting consumers leaving the consumer to be attacked, either by the IRS or by a turn in the economy, when all goes wrong. But the opposite is also true. Some 419 Plans and 412(i) Plan are very well designed and flawlessly implemented but the IRS just shoots first and aims second. Some legitimate premium financing might miscue. Using Lances knowledge of life insurance and the many ways life insurance has been and can be used in tax and wealth planning, lawyers for both plaintiffs and defendants throughout the US seek Lances services as an expert witness in cases between consumers and those who sold them these programs that develop after the IRS, right or wrong, initiates an audit or the investment goes under water. In looking for an expert witness examine credentials: Use the man that wrote the book on this. Use the man’s team that has never lost a case. Why use an attorney or CPA who will learn on the job. Why use an atty. or CPA that learned from one of Lance Wallach’s books or conventions. Want to win. Want to be made whole. Want this problem to go away. Google Lance Wallach and anyone else and you decide who is see who is the true expert.

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.

Small business retirement plans fuel litigation

section 79 scam
By Lance Wallach, CLU, ChFC, CIMC

Small businesses facing audits and potentially huge tax penalties over certain types of retirement plans are filing lawsuits against those who marketed, designed and sold the plans. The 412(i) and 419(e) plans were marketed in the past several years as a way for small business owners to set up retirement or welfare benefits plans while leveraging huge tax savings, but the IRS put them on a list of abusive tax shelters and has more recently focused audits on them.
The penalties for such transactions are extremely high and can pile up quickly – $100,000 per individual and $200,000 per entity per tax year for each failure to disclose the transaction – often exceeding the disallowed taxes.
There are business owners who owe $6,000 in taxes but have been assessed $1.2 million in penalties. The existing cases involve many types of businesses, including doctors’ offices, dental practices, grocery store owners, mortgage companies and restaurant owners. Some are trying to negotiate with the IRS. Others are not waiting. A class action has been filed and cases in several states are ongoing. The business owners claim that they were targeted by insurance companies; and their agents to purchase the plans without any disclosure that the IRS viewed the plans as abusive tax shelters. Other defendants include financial advisors who recommended the plans, accountants who failed to fill out required tax forms and law firms that drafted opinion letters legitimizing the plans, which were used as marketing tools.

A 412(i) plan is a form of defined benefit pension plan. A 419(e) plan is a similar type of health and benefits plan. Typically, these were sold to small, privately held businesses with fewer than 20 employees and several million dollars in gross revenues. What distinguished a legitimate plan from the plans at issue were the life insurance policies used to fund them. The employer would make large cash contributions in the form of insurance premiums, deducting the entire amounts. The insurance policy was designed to have a “springing cash value,” meaning that for the first 5-7 years it would have a near-zero cash value, and then spring up in value.
Just before it sprung, the owner would purchase the policy from the trust at the low cash value, thus making a tax-free transaction. After the cash value shot up, the owner could take tax-free loans against it. Meanwhile, the insurance agents collected exorbitant commissions on the premiums – 80 to 110 percent of the first year’s premium, which could exceed $1 million.
Technically, the IRS’s problems with the plans were that the “springing cash” structure disqualified them from being 412(i) plans and that the premiums, which dwarfed any payout to a beneficiary, violated incidental death benefit rules.
Under §6707A of the Internal Revenue Code, once the IRS flags something as an abusive tax shelter, or “listed transaction,” penalties are imposed per year for each failure to disclose it. Another allegation is that businesses weren’t told that they had to file Form 8886, which discloses a listed transaction.
According to Lance Wallach of Plainview, N.Y. (516-938-5007), who testifies as an expert in cases involving the plans, the vast majority of accountants either did not file the forms for their clients or did not fill them out correctly.
Because the IRS did not begin to focus audits on these types of plans until some years after they became listed transactions, the penalties have already stacked up by the time of the audits.
Another reason plaintiffs are going to court is that there are few alternatives – the penalties are not appealable and must be paid before filing an administrative claim for a refund.

The suits allege misrepresentation, fraud and other consumer claims. “In street language, they lied,” said Peter Losavio, a plaintiffs’ attorney in Baton Rouge, La., who is investigating several cases. So far they have had mixed results. Losavio said that the strength of an individual case would depend on the disclosures made and what the sellers knew or should have known about the risks.
In 2004, the IRS issued notices and revenue rulings indicating that the plans were listed transactions. But plaintiffs’ lawyers allege that there were earlier signs that the plans ran afoul of the tax laws, evidenced by the fact that the IRS is auditing plans that existed before 2004.
“Insurance companies were aware this was dancing a tightrope,” said William Noll, a tax attorney in Malvern, Pa. “These plans were being scrutinized by the IRS at the same time they were being promoted, but there wasn’t any disclosure of the scrutiny to unwitting customers.”
A defense attorney, who represents benefits professionals in pending lawsuits, said the main defense is that the plans complied with the regulations at the time and that “nobody can predict the future.”
An employee benefits attorney who has settled several cases against insurance companies, said that although the lost tax benefit is not recoverable, other damages include the hefty commissions – which in one of his cases amounted to $860,000 the first year – as well as the costs of handling the audit and filing amended tax returns.
Defying the individualized approach an attorney filed a class action in federal court against four insurance companies claiming that they were aware that since the 1980s the IRS had been calling the policies potentially abusive and that in 2002 the IRS gave lectures calling the plans not just abusive but “criminal.” A judge dismissed the case against one of the insurers that sold 412(i) plans.
The court said that the plaintiffs failed to show the statements made by the insurance companies were fraudulent at the time they were made, because IRS statements prior to the revenue rulings indicated that the agency may or may not take the position that the plans were abusive. The attorney, whose suit also names law firm for its opinion letters approving the plans, will appeal the dismissal to the 5th Circuit.
In a case that survived a similar motion to dismiss, a small business owner is suing Hartford Insurance to recover a “seven-figure” sum in penalties and fees paid to the IRS. A trial is expected in August.

Last July, in response to a letter from members of Congress, the IRS put a moratorium on collection of §6707A penalties, but only in cases where the tax benefits were less than $100,000 per year for individuals and $200,000 for entities. That moratorium was recently extended until March 1, 2010.

But tax experts say the audits and penalties continue. “There’s a bit of a disconnect between what members of Congress thought they meant by suspending collection and what is happening in practice. Clients are still getting bills and threats of liens,” Wallach said.

“Thousands of business owners are being hit with million-dollar-plus fines. … The audits are continuing and escalating. I just got four calls today,” he said. A bill has been introduced in Congress to make the penalties less draconian, but nobody is expecting a magic bullet.

“From what we know, Congress is looking to make the penalties more proportionate to the tax benefit received instead of a fixed amount.”

Section 79 Scams and Captive Insurance History

When trying to understand how a product becomes a target of government scrutiny it helps to know its history. In the case of plans that fall under Internal Revenue Code Section 79, that history is complex.

Insurance companies, agents, financial planners, and others have pushed abusive 419 and 412i plans for years. They claimed business owners could obtain large tax deductions. Insurance companies, agents and others earned very large life insurance commissions in the process. Eventually, the IRS cracked down on the unsuspecting business owners. Not only did they lose the tax deductions, but they were also fined, in addition to being charged penalties and interest. A skilled CPA with extensive IRS experience could usually eliminate 
the penalties and reduce the fines. Most accountants, tax attorneys and others have been unsuccessful in accomplishing this.

After the business owner was assessed the fines and lost his tax deduction, he had another huge, unforeseen problem. The IRS then came back and fined him a huge amount of money for not telling on himself under IRC 6707A. If you participate in a listed or reportable transaction, you must alert the IRS or face a large fine.  In essence, you must  alert the IRS if you were in a transaction that has the possibility of tax avoidance or evasion. Not only must you file Form 8886 telling on yourself, but the form needs to be filed properly, and done every year that you are in the plan in any way at all, even if you are no longer making contributions. According to IRC 6707A Expert Lance Wallach, “I have received hundreds of phone calls from business owners who filed Form 8886, usually with the help of their accountants or the plan promoter. They got the fine for either improperly filing, or for making mistakes on the form.”

“The IRS directions about preparing the form are vague, especially if the form is filed late. They presume a timely filing. In addition, many states also require forms to be filed. For example, if you work in New York State and manage to properly fill out the Federal form, but do not file the State form, you may still get fined,” says Wallach, adding that he only knows of two people that know how to properly prepare and file the forms, especially forms being filed late. As an expert witness in such cases, Lance Wallach’s side has never lost.

The result of the all of the above was many lawsuits against insurance companies, including Hartford, Pacific Life, Indianapolis Life, AIG, and Penn Mutual, to name just a few. Agents, accountants, and attorneys were also successfully sued.

Lately, insurance companies, agents, accountants, and others have been selling captive insurance and Section 79 scams. The motivations are exactly the same. They push large tax deductions for business owners. There are also huge commissions for salespeople, though this is usually mentioned only in passing, if
at all.

Anyone participating in a listed or reportable transaction must properly file Form 8886 or face large IRS fines. A listed transaction is any transaction specifically identified as such by published IRS guidance, or one substantially similar to that transaction.

A reportable transaction is any transaction that has the potential for tax avoidance or evasion. In my experience, the desire to avoid taxes is usually the principal and sometimes the only reason why people 
participate in Section 79, captive insurance, or 419 plans.  That is why I generally take the position that virtually everyone participating in one of these arrangements should PROPERLY file Form 8886, if only protectively as a precaution.

If you do not properly file Form 8886, there is no Statute of Limitations. That means the IRS can come back and fine you many years later.

Anyone that wants to risk an IRS audit by utilizing a captive insurance or Section 79 scam should, at the very least, engage a competent professional to file 8886 forms. By filing protectively and properly, the Statute of Limitations starts running and you avoid the very large IRS penalties under 6707A. But as I have previously 
stated, I only know two people who I would trust to undertake the preparation of the forms, especially if the forms are not being filed timely.

Never utilize directions from a plan promoter or salesman as to how to fill out 8886 forms. They would only be attempting to protect themselves, and doing so usually results in you being fined. Lance Wallach knows of many examples of this happening, including a plan promoter who assisted almost 200 business owners in preparing and filing 8886 forms. All of them got fined for improper preparation of the forms.

The two people that have been successful in filing 8886 forms for business owners have had numerous conversations with IRS personnel. They get the impression that it is almost impossible for an accountant, tax attorney, or anyone else to properly prepare and file the forms.  One of them, who spent 35 plus years with the IRS, has also been successful in fighting the IRS on penalties and fines assessed against business owners who participate in these plans, though the IRS publicly claims that you cannot appeal the fine under 
6707A.

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.