Simply put, it is a tax plan where small business owners are allowed to take a 20 percent to 40 percent deduction through their business to purchase an individually owned cash-value life (CLV) insurance policy. If you just read the above paragraph, you’d think that a Section 79 Plan is the nirvana of plans (a tax deductible way to buy CVL insurance). However, when you break down the math and the sales pitch, you’ll know why I despise these plans.
Group underwriting for businesses with fewer than 10 employees For businesses with fewer than 10 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). Amazingly, one of the insurance companies offering these plans doesn’t have the ability to issue non-medically underwritten policies. This is laughable and pathetic all at the same time. Why are the finances of Section 79 Plans so marginal? Section 79 Plans are up to 40 percent deductible 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(TM), for example, would receive only a 5 percent to 8 percent deduction through the plan.
Converting the crummy policy after year five Section 79 Plans are funded into a crummy cash accumulating policy for five years. Then, the client is typically shown how the policy can be converted to a variable life policy or EIUL policy earning 9 percent annually going forward. Besides that, this is not a conservative example, the numbers are financially marginal even assuming a 9 percent rate of return. Why are so many agents trying to sell Section 79 Plans? This is what really moved me to write this article?
Agents are pitching Section 79 Plans to clients for two simple reasons:
Many small business clients will buy any plan that is “deductible” because they so despise paying income taxes,
Insurance advisors want to sell life insurance.
This brings up an interesting issue. If the plan is marginal from a wealth-building standpoint, then why are agents selling it? Again, there are two reasons:
1) Most advisors have not broken down the math so they can come to a correct conclusion, which is that the plans are not worth implementing from a pure financial standpoint.
2) Some advisors know the plan is marginal from a financial standpoint and don’t care because they know they can still sell it to business owners who are looking for deductions.
The first reason is somewhat excusable (or was, before you knew the truth). The second reason is what helps gives life insurance agents a bad reputation. Clients would be better off paying tax on their money and funding a “good” EIUL policy for wealth building. It sounds crazy, but it’s true. The math does not lie. Clients would be better off paying tax on their money and taking it home to buy a “good” cash accumulating policy.
Taxpayers must report certain transactions to the IRS under Section 6707A of the Tax Code, which was enacted in 2004 to help detect, deter, and shut down abusive tax shelter activities. For example, reportable transactions may include being in a 419,412i, or other insurance plans sold by insurance agents for tax deduction purposes. Other abusive transactions could include captive insurance and section 79 plans, which are usually sold by insurance agents for tax deductions. Taxpayers must disclose their participation in these and other transactions by filing a Reportable Transactions Disclosure Statement (Form 8886) with their income tax returns. People that sell these plans are called material advisors and must also file 8918 forms properly. Failure to report the transactions could result in monetary penalties in excess of $10,000. Accountants who sign tax returns, which have these deductions, can also be called material advisors and should also file forms 8918 properly.
The IRS has fined hundreds of taxpayers who did file under 6707A. They said that they did not fill out the forms properly, or did not file correctly. The plan administrator or a 412i advised over 200 of his clients how to file. They were then all fined by the IRS for filling out the forms wrong. The fines averaged about $500,000 per taxpayer.
A report by the Treasury Inspector General for Tax Administration (TIGTA) found that the procedures for documenting and assessing the Section 6707A penalty were not sufficient or formalized, and cases often are not fully developed.
TIGTA evaluated the IRS’s effectiveness in identifying, developing, and applying the Section 6707A penalty. Based on its review of 114 assessed Section 6707A penalties, TIGTA determined that many of these files were incomplete or did not contain sufficient audit evidence. TIGTA also found a need for better coordination between the IRS’s Office of Tax Shelter Analysis and other functions.
“As penalties are meant to encourage voluntary taxpayer compliance, it is important that IRS procedures for documenting and assessing them be well developed and fully documented,” said TIGTA Inspector General J. Russell George in a statement. “Any failure to do so raises the risk that taxpayers will not receive consistent and fair treatment under the law, and could further reduce their willingness to comply voluntarily.”
The Section 6707A penalty is a stand-alone penalty and does not require an associated income tax examination; therefore, it applies regardless of whether the reportable transaction results in an understatement of tax. TIGTA determined that, in most cases, the Section 6707A penalty was substantially higher than additional tax assessments taxpayers received from the audit of underlying tax returns. I have had phone calls from taxpayers that contributed less than $100.000 to a listed transaction and were fined over $500,000. I have had phone calls from taxpayers that went into 419, or 412i plans but made no contributions and were fined a large amount of money for being in a listed transaction and not properly filing forms under IRC section 6707A. The IRS claims that the fines are non-appealable.
On July 7, 2009, at the request of Congress, the IRS agreed to suspend collection enforcement actions. However, this did not preclude the issuance of notices of assessment that are required by law and adjustment notices that inform the taxpayer of any account activity. In addition, taxpayers continued to receive balance due and final notices of intent to levy and pay Section 6707A penalties.
TIGTA recommended that the IRS fully develop, document, and properly process Section 6707A penalties. The IRS agreed with TIGTA’s recommendation and plans to take appropriate corrective actions. I think as a result of this many taxpayers who have not yet been fined will shortly receive the fines. Unless a taxpayer files properly there is no statute of limitations. The IRS has, and will continue to go back many years and fine people that are in listed, reportable or similar to transactions.
If you are, or were in a 412i, 419, captive insurance or section 79 plan you should immediately file under 6707A protectively. If you have already filed you should find someone who knows what he is doing to review the forms. I only know of two people who know how to properly file. The IRS instructions are vague. If a taxpayer files wrong, or fills out the forms wrong he still gets the fine. I have had hundreds of phone calls from people in that situation.
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.
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.
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.
Taxpayers who previously adopted 419, 412i, captive insurance or Section 79 plans are in big trouble. 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 the taxpayer does not necessarily have to make a contribution or claim a tax deduction to be deemed 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 a taxpayer can also be in trouble if they file incorrectly. I have received numerous phone calls from business owners who filed and still got fined. Not only does the taxpayer 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 told me that the form was prepared after hundreds of hours of research and over fifty phones calls to various IRS personnel. The filing instructions for Form 8886 presume a timely filing. Most people file late and follow the directions for currently preparing the forms. Then the IRS fines the business owner. The tax court does not have jurisdiction to abate or lower such penalties imposed by the IRS.
Many business owners adopted 412i, 419, captive insurance and Section 79 plans based upon representations provided by insurance professionals that the plans were legitimate plans and
they were not informed that they were engaging in a listed transaction. Upon audit, these taxpayers were shocked when the IRS asserted penalties under Section 6707A of the Code in the hundreds
of thousands of dollars. Numerous complaints from these taxpayers caused Congress to impose a moratorium on assessment of Section 6707A penalties.
The moratorium on IRS fines expired on June 1, 2010. The IRS immediately started sending out notices proposing the imposition of Section 6707A penalties along with requests for lengthy extensions of the Statute of Limitations for the purpose of assessing tax. Many of these taxpayers stopped taking deductions for contributions to these plans years ago, and are confused and upset by the IRS’s inquiry, especially when the taxpayer had previously reached a monetary settlement with the IRS regarding the deductions taken in prior years. Logic and common sense dictate that a penalty should not apply if the taxpayer no longer benefits from the arrangement.
Treas. Reg. Sec. 1.6011-4(c)(3)(i) provides that a taxpayer has participated in a listed transaction if the taxpayer’s tax return reflects tax consequences or a tax strategy described in the published guidance identifying the transaction as a listed transaction or a transaction that is the same or substantially similar to a listed transaction. Clearly, the primary benefit in the participation of these plans is the large tax deduction generated by such participation. It follows that taxpayers who no longer enjoy the benefit of those large deductions are no longer “participating” in the listed transaction.
But that is not the end of the story. Many taxpayers who are no longer taking current tax deductions for these plans continue to enjoy the benefit of previous tax deductions by continuing the deferral of income from contributions and deductions taken in prior years. While the regulations do not expand on what constitutes “reflecting the tax consequences of the strategy,” it could be argued that continued benefit from a tax deferral for a previous tax deduction is within the contemplation of a “tax consequence” of the plan strategy. Also, many taxpayers who no longer make contributions or claim tax deductions continue to pay administrative fees. Sometimes, money is taken from the plan to pay premiums to keep life insurance policies in force. In these ways, it could be argued that these taxpayers are still “contributing,” and thus still must file Form 8886.
It is clear that the extent to which a taxpayer benefits from the transaction depends on the purpose of a particular transaction as described in the published guidance that caused such transaction to be a listed transaction. Revenue Ruling 2004-20, which classifies 419(e) transactions, appears to be concerned with the employer’s contribution/deduction amount rather than the continued deferral of the income in previous years. This language may provide the taxpayer with a solid argument in the event of an audit.
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 becamelisted 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.”
Several years ago at the advice of an accountant or investment advisor a client adopts a defined benefit plan for her business. She did so because she had been advised that under this type of plan she could contribute tax deductible contributions far greater than the limits permitted under a defined contribution plan. Each year she funds the maximum that the IRS permitted based on a report from her actuary. The plan investment returns have been very good.
She is now ready to sell her business or retire and informs her advisors that she wants to close out the plan and roll the money over into her Individual Retirement Account. The advisors come back with the following news. The plan is overfunded and some of the funds cannot be rolled over to an IRA. Those funds that are ineligible for a rollover must return to the company as taxable income and the IRS will in addition, levy a non-tax deductible penalty of at least 20%.
She has done nothing along the way that the IRS could challenge. What happened was a combination of several things.
1. Though defined benefits allow larger contributions there are limits on the benefits that can be distributed based on the law, the individuals’ salary history, age and years in the plan.
2. The IRS allows companies to pre fund on a tax deductible basis benefits that have yet to be earned.
3. Very good investment returns increases the prospects of the assets growing too large.
4. Congress imposes a penalty on a company that terminates a plan and takes back excess money whether it is voluntary or required.
Is there anything that can be done to prevent this from happening to you?
The first thing you could do is request an analysis of the maximum benefits that would be payable if the plan needed to terminate. Compare this with the level of plan assets and decide whether the future contributions need to be reduced or the investment approach needs to be modified. If you are already past the point of no return; options may exist to minimize the negative consequences of the overfunding that require a high level of expertise.
While many employers offer life insurance and 401(k) plans to their employees, most don’t realize that there are additional benefits available within the IRS Code that provide specific benefits to business owners, executives, and key employees on a voluntary basis. Section 79 Plans are a part of the employee benefit section of the IRC (Internal Revenue Code) and include benefits that are offered to business owners and employees at almost all companies.
Some important features of available benefits:
Plan contributions are 100% deductible to the corporation as an employee benefit.
Plan participants can fund their plans with pre-tax earnings.
Contributions will reduce participant’s income and also lower payroll taxes for both the participant and organization.
Plans grow on a tax-deferred basis during the working years.
Section 79 Permanent Insurance plans allow for IRS penalty-free access to funds before age 59½.
Permanent plans include a tax-free death benefit for surviving beneficiaries.
Distribution may be made on a tax-free basis utilizing policy loan provision.
Taxpayers who previously adopted 419, 412i, captive insurance or Section 79 plans are in big trouble.
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 for failure to file Form 8886 with respect to a listed transaction. But you are also in trouble if you fi le 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 also has to be prepared correctly. I only know of two people in the U.S. who have filed these forms properly for clients. They tell me that was after hundreds of hours of research and over 50 phones calls to various IRS personnel. The filing instructions for Form 8886 presume a timely filing. Most people file late and follow the directions for currently preparing the forms. Then the IRS fi nes the business owner. The tax court does not have jurisdiction to abate or lower such penalties imposed by the IRS.
Many business owners adopted 412i, 419, captive insurance and Section 79 plans based upon representations provided by insurance professionals that the plans were legitimate plans and were not informed that they were engaging in a listed transaction.
Upon audit, these taxpayers were shocked when the IRS asserted penalties under Section 6707A of the Code in the hundreds of thousands of dollars. Numerous complaints from these taxpayers caused Congress to impose a moratorium on assessment of Section 6707A penalties.
The moratorium on IRS fines expired on June 1, 2010. The IRS immediately started sending out notices proposing the imposition of Section 6707A penalties along with requests for lengthy extensions of the Statute of Limitations for the purpose of assessing tax. Many of these taxpayers stopped taking deductions for contributions to these plans years ago, and are confused and upset by the IRS’s inquiry, especially when the taxpayer had previously reached a
monetary settlement with the IRS regarding its deductions. Logic and common sense dictate that a penalty should not apply if the taxpayer no longer benefits from the arrangement.
Treas. Reg. Sec. 1.6011-4(c)(3)(i) provides that a taxpayer has participated in a listed transaction if the taxpayer’s tax return reflects tax consequences or a tax strategy described in the published guidance identifying the transaction as a listed transaction or a transaction that is the same or substantially similar to a listed transaction. Clearly, the primary benefit in the participation of these plans is the large tax deduction generated by such participation. Many taxpayers who are no longer taking current tax deductions for these plans continue to enjoy the benefit of previous tax deductions by continuing the deferral of income from contributions and deductions taken in prior years. While the regulations do not expand on what constitutes “reflecting the tax consequences of the strategy,” it could be argued that continued benefit from a tax deferral for a previous tax deduction is within the contemplation of a “tax consequence” of the plan strategy. Also, many taxpayers who no longer make contributions or claim tax deductions continue to pay administrative fees. Sometimes, money is taken from the plan to pay premiums to keep life insurance policies in force. In these ways, it could be argued that these taxpayers are still “contributing,” and thus still must file Form 8886.
It is clear that the extent to which a taxpayer benefits from the transaction depends on the purpose of a particular transaction as described in the published guidance that caused such transaction to be a listed transaction. Revenue Ruling 2004-20 which classifies 419(e) transactions, appears to be concerned with the employer’s
contribution/deduction amount rather than the continued deferral of the income in previous years.
Another important issue is that the IRS has called CPAs material advisors if they signed tax returns containing the plan, and got paid a certain amount of money for tax advice on the plan. The fine is $100,000 for the CPA, or $200,000 if the CPA is incorporated. To
avoid the fi ne, the CPA has to properly fi le Form 8918.
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.
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.
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.”
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.