California Broker Magazine

    January 2009

    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 and

    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
    mentioned above.

    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, or visit or

    The information provided herein is not intended as legal, accounting, financial or any other type of
    advice for any specific individual or other entity.  You should contact an appropriate professional
    for any such advice.

Get A $200,000 IRS Fine and Have Your
Client Sue You