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                                      California Enrolled Agent
                                               January 2, 2009


    How to Get Fined $100,000 by the IRS
    and Lose Your License
    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, the high life insurance commissions (often 90% of the contribution, or
    more) fostered an environment that led to the marketing and selling of aggressive and noncompliant
    plans.

    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 accountant advisors, the liability may be equally extreme. If an
    accountant signs a tax return with one of these plans on it, and if the IRS considers the plan an
    abusive, listed transaction or substantially similar to such a transaction, the accountant may be called a
    “material advisor”. The fine for a material advisor is $200,000 if the accountant is incorporated or
    $100,000 if the accountant is not incorporated. There is also an IRS referral to the Office of
    Professional Responsibility. We have received hundreds of phone calls recently from accountants,
    who are in this predicament. It is very difficult to help them after the fact. When I speak at national
    accounting conventions or AICPA events about these topics, most accountants in the audience do not
    understand what I am talking about, because they have never had this problem and are not aware of
    the recent IRS enforcement activities. Unfortunately, within a few weeks after I speak at a
    convention, attendees will call me after reviewing their clients’ tax returns. They often find one of
    these abusive plans on the return (these plans are very popular). If the plan is discovered before the
    IRS audit, many steps can be taken. If the IRS discovers the plan on audit, the results can be
    disastrous, both for your client and for you. The client gets fined $200,000 per year. For more
    information on this, see www.taxlibrary.us 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
    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, wallachinc@gmail.com or visit
    www.taxadvisorexperts.org or www.taxlibrary.us.  

    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.
How to Get Fined $100,000 by the
IRS and Lose Your License