Tri State Tax Conference Presentation Interview with Michael Lloyd, Esq.

June 15, 2011

“IRS Attacks Welfare Benefit Plans – 

A Practitioner’s Guide to Protecting Taxpayers”©

Question. How many taxpayers have you represented with respect to IRS audits of 419 welfare benefit plans?

Answer.  In the past 7 years, my Firm has represented more than 500 taxpayers who have been audited with respect to their participation in single and multiple employer welfare benefit plans.  We have represented and currently represent taxpayers before the IRS Examination and Appeals Offices and have cases pending in the United States Tax Court.

Question.  Do you represent taxpayers who have participated in different welfare benefit plans?

Answer.  Yes.  We have knowledge of many different welfare benefit plans and experience in representing taxpayers who participate in those plans before the IRS.  A sampling of the plans that we know well include:

  • Millennium Plan
  • Insured Security Plan
  • Corporate Benefit Services Plan
  • Sea Nine Associates VEBA
  • Niche National Benefit Plans
  • Professional Benefit Trust (PBT)
  • Koresko STEP Plan
  • Bisys Plan
  • Xelan Plan
  • Sterling Plan

Question.  What is the IRS position on these plans?

Answer.  The IRS position appears to be that all multiple employer welfare benefit plans funded with permanent life insurance are abusive tax scams.  Their history is to open promoter audits on every such plan and eventually to obtain the client lists from the promoters and then audit their clients.  The IRS position on single employer welfare benefit plans that are spin-offs of the multiple employer plans appears to be the same.  Similarly, the IRS position on single employer welfare benefit plans invested in permanent life insurance where the employer deducts more than the term cost of insurance is that those plans are also abusive tax scams.

Question.  Has the IRS approved any multiple or single employer welfare benefit plan invested in permanent life insurance?

Answer.  Though an IRS private letter ruling is not immediately public, it is my understanding that the IRS has never “approved” of any multiple or single employer welfare benefit plan where permanent life insurance was used as a funding vehicle and the participating employer took a deduction for anything other than the current term insurance cost.


Question.  Are the IRS audits coordinated?

Answer.  Yes.  The IRS audits are both targeted and coordinated.  They are targeted meaning that the IRS obtains a list of the participating employers in a plan promotion and audits the participating employers (and owners) for the purpose of challenging the deductions taken with respect to the plan.  The audits are coordinated meaning that there is an IRS Issue Management Team for each promotion that has responsibility for both managing the promoter audit(s) and also developing the coordinated position to be followed by the Examination Agents.  Their intention is that all taxpayers under audit will receive the similar treatment in Exam.  There are also IRS Offices that specialize in 419 audits.  For example, IRS offices in upstate New York and in El Monte California will manage many audits of specific promotions.  Williams Coulson has significant experience in working with both of these offices.

Question.  What is the general IRS position on these plans?

Answer.  Though there can be some differences among plans, the basic IRS position is that the plans are not welfare benefit plans, but really plans of deferred compensation.  As such, the contributions remain deductible at the business level but are included in the owner’s 1040 income for every open year and the value of the insurance policy with respect to contributions in closed years is included in the owner’s income either in the first open year or the year of termination or transfer.  The IRS will normally apply 20% penalties on the tax applied and 30% with respect to nonreporting cases (see discussion below).

Question.  Is there a benefit to representing multiple taxpayers of the same promotion?

Answer.  We believe there is.  By representing large numbers of participating employers in a promotion, not only do we get a very detailed understanding of the promotion, but we have a chance to negotiate on a group basis with the IRS Examination Division, Appeals Division and ultimately the IRS Issue Management Team.  We also have the efficiencies of responding to IRS template documents such as 30 day letters and 90 day (statutory deficiency) letters with our protests and petitions that benefit from a standard template.  We also have the opportunity to learn of the best settlements and make sure that all of our clients receive the best deal from the IRS.  From a litigation standpoint, we have the opportunity to observe the best fact cases for purposes of making those be chosen as the first cases litigated.

Question.  Can the penalties ever be waived?

Answer.  Yes.  The penalties can often be waived upon a showing of the taxpayer’s due diligence and good faith reasonable cause.  For example, if the taxpayer can show reliance on an outside tax advisor who reviewed the plan and the law, the Examining Agent normally has the authority to waive the 20% negligence penalty.  Note that there are different standards for waiving penalties among the IRS Offices.  It is important to know the standards of each office before requesting a waiver.

Question.  What if there is an opinion letter issued on the plan – will that eliminate penalties?

Answer.  Generally, the answer is a resounding – No.  If the opinion letter was issued to the promoter or the promotion itself and a copy was merely provided to the taxpayer (even if the taxpayer paid for it), the IRS perceives the advice to be bias and not reasonable for reliance.

Question.  What if the taxpayer relied upon the advisor who sold the promotion?

Answer.  The IRS also discounts any advice provided by parties who are part of the sales team for the promotion.  It is possible to negate the bias against professionals involved in the sale if you can demonstrate that the professional was first a tax advisor and gave advice in that role and not as a salesman.

Question.  What are the “listed transaction” penalties?

Answer.  The IRS has identified certain multiple and single employer welfare benefit plans as listed transactions.  Taxpayers who participate in listed transactions have an obligation to notify the IRS of their participation on IRS Form 8886.  The Form 8886 must be filed with every tax return where a tax effect of the transaction appears on the return and for the first year of filing must also be filed with the IRS Office of Tax Shelter Analysis (OTSA).  There are penalties that apply for the failure to file the Form 8886.  The IRS position appears to be that although only the C corporation must file the 8886, if the business is a pass-through entity like an S Corporation, LLC or partnership, then the Form 8886 must be filed at both the entity level and also the individual level.  The penalty for non-filing is 75% of the tax reduction for the tax year.  Note, that it is very clear that a plan does not have to be proven to be defective or abusive for the penalty to apply.  Further, the IRS has made it very clear that they will construe the duty to disclose broadly.  Thus, if there is even a possibility that a plan is a listed transaction, the taxpayer should consider strongly filing the Form 8886.

Question.  Are there other negatives to not filing the Form 8886?

Answer.  Yes.  In addition to the nonreporting penalty, the negligence penalty discussed above of 20% becomes 30% and is much more difficult to have waived.  Further, the nonreporting penalty cannot be appealed to tax court.  Therefore, the only recourse is to pay the penalty, file for a refund and fight the case in District Court.

Whose responsibility is it to notify taxpayers of the need to file Form 8886?

Answer.  It depends.  Many promoters take the initiative to inform their customers that the promotion may be considered to be a listed transaction and that they should consider filing Forms 8886, though some promoters have actually taken the opposite view and have directed customers to not file the Form 8886 to keep them off the IRS radar.  These promoters face potential liability if the penalties are assessed.  Because the Form 8886 is filed with the tax returns, it may be partly the responsibility of the CPA who prepares the returns to file the Form, though many CPAs may not know that the transaction is a listed transaction or how to prepare the Form.  From the IRS perspective, the responsibility is clear – it is the taxpayer who bears the ultimate responsibility and will be penalized if the Form is not filed.

Question. Are some plans better than others?

Answer.  Yes.  Even though the IRS appears to have thrown a giant net over the entire industry, I have observed that many promoters have worked hard to develop a plan that complies with the tax law.  The plans are supported by substantial legal and actuarial authority and make it clear that they are welfare plans and not deferred compensation plans.  These plans are often very strong in their marketing materials as to the nature of the plan and also provide for less deductible amounts.  On the other hand, some promotions have ignored new IRS Regulations (issued in 2003) and continue to sell and market plans that have been out of compliance for years.  They make no attempt to bring their plans into compliance and seek to stay under the radar by directing their customers to not file Forms 8886.

Question.  Do taxpayers have causes of action?

Answer.  Maybe.  We see two potential causes of action.  First, in cases where the promoter has either created a defective product, or has turned a blind eye towards law changes, the promoter and potentially the insurance companies may have liability for the creating, marketing, endorsing and selling a defective product.  Second, where planners have sold the product to customers improperly, by describing the plan as a safe, IRS approved retirement plan with unlimited deductions, they may have liability for fraudulent sales.

Question.  Does Williams Coulson handle civil cases against promoters?

Answer.  Yes.  Although normally we spend most of our time defending taxpayers (and thus defending the plans) against the IRS, we have observed extreme cases where we believe that liability applies.  We currently have active civil litigation against individuals and entities involved in marketing and selling the Southern California Medical Profession Association VEBA (Sea Nine Associates and Ken Elliott VEBA).