Sea Nine FAQs Posted in Response to Legal Developments

In response to recent developments in the U.S. government’s suit to enjoin the promotion of the Sea Nine VEBAs, Williams Coulson tax attorney Michael Lloyd provides the following answers to frequently asked questions.

Q.1. What action has the US Department of Justice taken against the promoters of the Sea Nine VEBA?

A.1. The US Department of Justice (“DOJ”) has brought an action against Mr. Elliott and other defendants to prevent further sales and promotion of the Sea Nine VEBAs. One of the other defendants consented to the permanent injunction and, as part of his settlement, he provided a list of participants in the Sea Nine VEBAs.

Q.2. Will the result of providing the customer list to the government result in the opening of IRS audits?

A.2. Maybe. There is no way to know if the IRS will audit all of the Sea Nine participants. Previously, in auditing promoters of other 419 plans, the IRS has obtained customer lists and then subsequently audited some percentage of participating employers. In this case, we understand from court pleadings that the IRS previously audited a sampling of Sea Nine participants. In those audits, the IRS took the position that the Sea Nine VEBAs were both noncompliant with the tax code relating to multiple employer plans and also were listed transactions (see below). It would not be surprising if the IRS chooses to open audits of Sea Nine participants as a result of obtaining the customer list.

Q.3. If I am not currently under audit, what can I do to minimize my IRS exposure?

A.3. There are several actions you should consider immediately.

  • Terminate Participation in the Plan. If you haven’t done so already, you should consider terminating your participation in the Plan and requesting a complete distribution of benefits. There are both tax and legal ramifications of this action, so you should have legal counsel assistance for this action.
  • Recognize Income. The IRS has informally recommended that taxpayers not under audit should consider amending their earliest open return to include the value of the policy and the cost of insurance in income. However, the IRS has also stated that amending back tax returns will not guarantee that a taxpayer will not be audited nor will it guarantee that the IRS won’t impose accuracy or listed transaction penalties. Another alternative is to include the value of the policy in income (together with the cost of insurance) for the year the plan is terminated based on the value received. Each of these theories of income inclusion has a basis and should be considered carefully with a tax professional.
  • Disclose Listed Transaction. Congress has enacted laws to help the IRS fight abusive tax shelters. These laws require taxpayers who participate in potentially abusive tax programs that are identified by the IRS as “listed transactions” to disclose such participation to the IRS. If a taxpayer is required to make such a disclosure and fails to do so, the following penalties apply. First, for every year that a taxpayer has an obligation to file a disclosure form (IRS Form 8886) and fails to do so completely and timely, the IRS shall impose a penalty equal to 75% of the tax benefit as shown on the return with a minimum penalty of $5,000 for individuals and $10,000 for businesses. There is also a maximum penalty of $100,000 per return for individuals and $200,000 per return for businesses. For C Corporations, the penalty generally applies only at the C Corporation level. For S Corporations and other flow-through entities the minimum ($10,000) penalty applies at the business level and the penalty also applies at the personal level. So, for example, if an S Corporation deducted $100,000 per year to the Sea Nine VEBA for years 2010 – 2012 and did not file a Form 8886, the nonreporting penalty that could apply would be $10,000 per year for three years for the business (total = $30,000) and $26,250 per year for three years for the individual (assuming a tax benefit of 35% for the individual), for a total penalty of $108,750. Second, the accuracy related penalty that often applies in an audit is 20% and can be reduced or waived upon a showing of reasonable cause and good faith. If a taxpayer is obligated to file Form 8886 and does not make that filing, the penalty is 30% and cannot be waived or reduced. Third and perhaps most important to this case, if neither the taxpayer nor any other party notifies the IRS of participation in the listed transaction, the statute of limitations does not begin to run. The IRS has used this provision to audit taxpayers for years that would otherwise be closed. Lastly, unlike other internal revenue laws, a taxpayer may not fight this penalty in tax court. Instead, a taxpayer must first pay the penalty to fight it in a refund action in Federal District Court.

Q.4. Do I have to file a Form 8886 when I terminate the Plan and include amounts in income personally?

A.4. The IRS Regulations state that every taxpayer who “participates” in a listed transaction for a year has an obligation to file a Form 8886. The term “participates” is defined to include a transaction that has a tax effect on the taxpayer’s tax return. Thus, although filing is more normally associated with the business taking deductions, it may also apply when amounts are included in the taxpayer’s income. A filing can be made on a protective basis if a taxpayer believes the filing is not required. The Form 8886 must be complete and accurate or it will be disregarded by the IRS.

Q.5. If I file a Form 8886, will that trigger an IRS audit?

A.5. Maybe. As above, it is always possible that filing a Form 8886 will trigger an audit. In my experience, however, I have generally observed audits to commence after the customer list is obtained and not as a result of filing Forms 8886. Actually, sometimes it appears that filing Forms 8886 reduce the chance of audit as the IRS loses the opportunity to assess the onerous nonreporting penalties.

Q.6. Is there any reason to file Forms 8886 for back years?

A.6. Yes, although filing a Form 8886 late cannot reduce or eliminate the possible assessment of the nonreporting penalty, it may serve to start the statute of limitations such that the IRS would have only a year to open an audit on years otherwise closed by the normal three year statute of limitations. This type of filing is different than a normal filing and should be considered with experienced tax counsel.

Q.7. Can Williams Coulson help with the termination of the Plan, inclusion of income, an IRS audit and completion of Forms 8886?

A.7. Yes. We have substantial experience representing participating employers in many different multiple and single employer plans, including the Sea Nine VEBAs. In the last seven years, we have represented more than 500 participating employers under audit and have prepared more than 1,000 Forms 8886.


Tax attorney Michael Lloyd regularly represents clients with respect to Section 419 Plans. He may be contacted at 412-454-0225 or