California Broker Magazine
Get A $200,000 IRS Fine and Have Your Client Sue You
By Lance Wallach, CLU, ChFC and Ira Kaplan, Esq., CPA, MBA
Over the past decade, business owners have been overwhelmed by a plethora of arrangements
designed to reduce the cost of providing employee benefits and taxes, while simultaneously increasing
their own retirement savings. The solutions ranged from traditional pension and profit sharing plans to
more advanced strategies.
Some strategies, such as IRS Section 419 and 412(i) plans, used life insurance as vehicles to bring
about benefits. Unfortunately, almost all the plans were noncompliant, even though insurance
companies vetted them and encouraged their agents to sell them. This fostered an environment that led
to numerous IRS crackdowns, disallowed tax deductions and clients suing their insurance agents and
The result has been thousands of audits and an IRS task force seeking out tax shelter promotion. In
addition, the IRS has been auditing most 412(i) defined benefit retirement plans and all 419 welfare
benefit plans. These plans are sold by many insurance agents. For unknowing clients, the tax
consequences are enormous. For their insurance professional advisors, the liability may be equally
extreme. If an insurance professional sells one of these plans, if the client takes a tax deduction, and if
the IRS considers the plan an abusive, listed transaction or substantially similar to such a transaction,
the insurance agent may be called a “material advisor”. The fine for a material advisor is $200,000 if
incorporated or $100,000 if unincorporated.
Most insurance agents think that they can avoid the fine by filing Form 8918 with the IRS and
informing on their clients. But all of the Form 8918s that we have seen have been filled out improperly.
In our discussions with the IRS officials who wrote the regulations, the impression that we received
was that if the form is filled out improperly, you are lying to the government. That is almost as bad as
not filing the form. This has also been a problem with all the forms that we have reviewed for
accountants and insurance agents. We have reviewed hundreds of forms, and not a single one has
been filled out properly. One of the reasons for this may be that the promoter of the abusive plan sends
the form with instructions to the accountant and insurance agent. These instructions tend to protect
the promoter, but do not necessarily protect the insurance agent or accountant. Please be careful with
this entire situation. We have received hundreds of phone calls from accountants and insurance
professionals recently who are in this predicament. It is very difficult to help them after the fact. For
more information on this, see www.taxaudit419.com and www.irs.gov.
Recently, there has been an explosion in the marketing of a financial product called captive insurance.
These so called “Captives” are typically small insurance companies designed to insure the risks of an
individual business under IRS Code Section 831(b). When properly designed, a business can make tax
deductible premium payments to a related party insurance company. Depending on circumstances,
underwriting profits, if any, can be paid out to the owners as dividends, and profits from liquidation of
the company may be taxed as capital gains.
While captives can be a great cost saving tool, they also are expensive to build and manage. Also,
captives are allowed to garner tax benefits because they operate as real insurance companies. Advisors
and business owners who misuse captives or market them as estate planning tools, asset protection
vehicles, tax deferral or to obtain other benefits not related to the true business purpose of an insurance
company face grave regulatory and tax consequences.
A recent concern is the integration of small captives with life insurance policies. Small captives, under
Section 831(b), have no statutory authority to deduct life premiums. Also, if a small captive uses life
insurance as an investment, the cash value of the life policy can be taxable at corporate rates, and then
will be taxable again when distributed. The consequence of this double taxation is to devastate the
effectiveness of the life insurance, and it extends serious liability to any accountant who recommends
the plan or even signs the tax return of the business that pays premiums to the captive.
The IRS is aware that several large insurance companies are promoting their life insurance policies as
investments with small captives. The outcome looks eerily like that of the 419 and 412(i) plans
Remember, if something looks too good to be true, it usually is. There are safe and conservative ways
to use captive insurance structures to lower costs and obtain benefits for businesses. And, some types
of captive insurance products do have statutory protection for deducting life insurance premiums
(although not 831(b) captives). Learning what works and is safe is the first step an accountant should
take in helping his or her clients use these powerful, but highly technical insurance tools.
Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA
faculty of teaching professionals, is a frequent speaker on retirement plans, financial and estate
planning, and abusive tax shelters. He writes about 412(i), 419, and captive insurance plans. He
speaks at more than ten conventions annually, writes for over fifty publications, is quoted regularly in
the press and has been featured on television and radio financial talk shows including NBC, National
Public Radio’s All Things Considered, and others. Lance has written numerous books including
Protecting Clients from Fraud, Incompetence and Scams published by John Wiley and Sons, Bisk
Education’s CPA’s Guide to Life Insurance and Federal Estate and Gift Taxation, as well as AICPA
best-selling books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Small
Business Hot Spots. He does expert witness testimony and has never lost a case. Contact him at
516.938.5007, firstname.lastname@example.org or visit www.taxadvisorexperts.org or www.taxlibrary.us.
advice for any specific individual or other entity. You should contact an appropriate professional
for any such advice.