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    Lines from Lance

    IRS Attacks Many Business Owners with
    Million Dollar Fines

    By Lance Wallach

    If you were in, or are still in, a 412(i), 419, captive insurance, or Section 79 plan, you are probably in
    big trouble. If you signed a tax return for a client in one of these plans, you are probably what the IRS
    calls a material advisor and subject to a maximum $200,000 fine. If you are an insurance professional
    that sold or advised on one of these plans, the same holds true for you. Business owners and material
    advisors needed to properly file under Section 6707A, or face large IRS fines. My office has received
    thousands of phone calls, many after the business owner has received the fine. In many cases, the
    accountant files the appropriate forms, but the IRS still levied the fine because the accountant made a
    mistake on the form. My office has reviewed many forms for accountants, tax attorneys, and others.
    We have not yet seen a form that was filled out properly. The improper preparation of these forms
    usually results in the client being fined more quickly then if the form were not filed at all. I have been
    an expert witness in lawsuits on point. None of my clients has ever lost when I was their expert

    The IRS will be soon attacking Section 79 scams. My early articles by the AICPA and others in the
    90s predicted attacks on 419s, which came true. My 412(i) article predictions came true. The Section
    79 scams soon will be attacked. Everyone in them should file protectively. Anyone that has not filed
    protectively in a 419 or older 412(i) had better get some good advice from someone who knows what
    is going on, and has extensive experience filing protectively. The IRS still has their task forces auditing
    these plans. Then they will move on to Section 79 scams, etc., including many of the illegal captives
    pushed by the insurance companies and agents. Not all captives are illegal. I am an expert witness in a
    lot of cases involving the 412(i) and 419 plans. It does not go well for the agents, accountants, plan
    promoters, insurance companies, etc. The insurance companies settle first, leaving the agents hanging
    out there. Then in many cases they fire the agents. I was just in a case as an expert witness where a
    large, well known, New England based, mutual insurance company did just that.

    If you are an insurance professional, do not count on your insurance company to back you up. Most
    likely they will stab you in the back, based on what I have seen. One of the agents was with the
    company over 25 years and was a leading producer with lots of company awards.

    Be careful. If you sold, gave tax advice, or signed a tax return and got paid a certain amount of money,
    you may be a material advisor. Under the newest proposed regulations, you had to file with the IRS to
    avoid the $200,000 fines. You had to fill out the forms properly. You had to advise those that you
    advised about the plans or sold the plan to. You had to send them a note, or call them, giving them the
    number that the IRS had assigned to you as a material advisor. This is the number that you obtain after
    you file the appropriate forms for yourself. Even though you obtain a number, you still may have filed
    your forms improperly or completed them wrong. Many accountants have called me after their clients
    were fined $800,000 or more by IRS for improperly filing, or not filing under 6707A. A plan
    administrator called me after a lot of his clients were fined millions. He told their accountants to file
    Form 8886, and most of them did. All of the clients were fined shortly thereafter. The forms need to
    be filled in exactly correct. In our numerous talks with IRS we were told if filled out wrong, the fine is
    still imposed. BE CAREFUL! Please be advised, we have not seen a form that has been filed out
    properly. Many accountants, tax attorneys, etc., send us their forms to be reviewed, mostly after they
    file for one client who then gets fined about one million dollars under the regulations. I DO NOT do the
    forms. A former IRS agent of 37 years, who is also a CPA and tax professor, does them, as does
    another person that I know.

    If you are a small business owner, accountant, or insurance professional, you may be in big trouble
    and not know it.  The IRS has been fining people like you $200,000 a year.  Most people that have
    received the fines were not aware that they had done anything wrong.  What is even worse is that the
    fines are not appeal-able.  This is not an isolated situation.  This has been happening to a lot of people.

    Currently, the Internal Revenue Service (“IRS”) has the discretion to assess hundreds of thousands of
    dollars in penalties under §6707A of the Internal Revenue Code (“Code”) in an attempt to curb tax
    avoidance shelters. This discretion can be applied regardless of the innocence of the taxpayer and was
    granted by Congress.  It works so that if the IRS determines you have engaged in a listed transaction
    and failed to properly disclose it, you will be subject to a potentially Draconian penalty regardless of
    any other facts and circumstances concerning the transaction. For some, this penalty has been
    assessed at almost a million dollars and for many it is the beginning of a long nightmare.

    The following is an example:  Pursuant to a settlement with the IRS, the 412(i) plan was converted into
    a traditional defined benefit plan.  All of the contributions to the 412(i) plan would have been allowable
    if they had initially adopted a traditional defined benefit plan.  Based on negotiations with the IRS agent,
    the audit of the plan resulted in no income and minimal excise taxes due.   This is because as a
    traditional defined benefit plan, the taxpayers could have contributed and deducted the same amount as
    a 412(i) plan.
    Towards the end of the audit the business owner received a notice from the IRS.  The IRS assessed
    the client penalties under the §6707A of the Code in the amount of $900,000.00.  This penalty was
    assessed because the client allegedly participated in a listed transaction and allegedly failed to file Form
    8886 in a timely manner.        

    The IRS may call you a material advisor and fine you $200,000.00. The IRS may fine your clients over
    a million dollars for being in a retirement plan, 419 plan, etc. As you read this article, hundreds of
    unfortunate people are having their lives ruined by these fines. You may need to take action
    immediately. The Internal Revenue Service said it would extend until the end of March 1, 2010 a grace
    period granted to small business owners for collection of certain tax-shelter penalties.

    "Clearly, a number of taxpayers have been caught in a penalty regime that the legislation did not
    intend," wrote Shulman. "I understand that Congress is still considering this issue, and that a
    bipartisan, bicameral, bill may be in the works."  The issue relates to penalties for so-called listed
    transactions, the kinds of tax shelters the IRS has designated most egregious. A number of small
    business owners that bought employee retirement plans so called 419 and 412(i) plans and others, that
    were listed by the IRS, and who are now facing hundreds and thousands in penalties, contend that the
    penalty amounts are unfair.

    Leaders of tax-writing committees in the House and Senate have said they intend to pass legislation
    revising the penalty structure.

    The IRS has suspended collection efforts in cases where the tax benefit derived from the listed
    transaction was less than $100,000 for individuals, or less than $200,000 for firms. They are still,
    however, sending out notices that they intend to fine.

    Senator Ben Nelson (D-Nebraska) has sponsored legislation (S.765) to curtail the IRS and its nearly
    unlimited authority and power under Code Section 6707A. The bill seeks to scale back the scope of the
    Section 6707A reportable/listed transaction nondisclosure penalty to a more reasonable level. The
    current law provides for penalties that are Draconian by nature and offer no flexibility to the IRS to
    reduce or abate the imposition of the 6707A penalty. This has served as a weapon of mass destruction
    for the IRS and has hit many small businesses and their owners with unconscionable results.

    Internal Revenue Code 6707A was enacted as part of the American Jobs Creation Act on October 22,
    2004. It imposes a strict liability penalty for any person that failed to disclose either a listed transaction
    or reportable transaction per each occurrence. Reportable transactions usually fall within certain
    general types of transactions (e.g. confidential transactions, transactions with tax protection, certain
    loss generating transaction and transactions of interest arbitrarily so designated as by the IRS) that
    have the potential for tax avoidance. Listed transactions are specified transactions, which have been
    publicly designated by the IRS, including anything that is substantially similar to such a transaction (a
    phrase which is given very liberal construction by the IRS). There are currently 34 listed transactions,
    including certain retirement plans under Code Section 412(i) and certain employee welfare benefit plans
    funded in part with life insurance under Code Sections 419A(f)(5), 419(f)(6) and 419(e). Many of
    these plans were implemented by small businesses seeking to provide retirement income or health
    benefits to their employees.

    Strict liability requires the IRS to impose the 6707A penalty regardless of innocence of a person (i.e.
    whether the person knew that the transaction needed to be reported or not or whether the person made
    a good faith effort to report) or the level of the person’s reliance on professional advisors. A Section
    6707A penalty is imposed when the transaction becomes a reportable/listed transaction. Therefore, a
    person has the burden to keep up to date on all transactions requiring disclosure by the IRS into
    perpetuity for transactions entered into the past.

    Additionally, the 6707A penalty strictly penalizes nondisclosure irrespective of taxes owed.
    Accordingly, the penalty will be assessed even in legitimate tax planning situations when no additional
    tax is due but an IRS required filing was not properly and timely filed. It is worth noting that a failure
    to disclose in the view of the IRS encompasses both a failure to file the proper form as well as a failure
    to include sufficient information as to the nature and facts concerning the transaction. Hence, people
    may find themselves subject to the 6707A penalty if the IRS determines that a filing did not contain
    enough information on the transaction. A penalty is also imposed when a person does not file the
    required duplicate copy with a separate IRS office in addition to filing the required copy with the tax
    return. In our numerous talks with IRS, we were also told that improperly filling out the forms could
    almost be as bad as not filing the forms. We have reviewed hundreds of forms for accountants,
    business owners and others. We have not yet seen a form that was properly filled in. We have been
    retained to correct many of these forms.

    For more information see,, or e-mail us at

    The imposition of a 6707A penalty is not subject to judicial review regardless of whether the penalty is
    imposed for a listed or reportable transaction. Accordingly, the IRS’s determination is conclusive,
    binding and final. The next step from the IRS is sending your file to collection, where your assets may
    be forcibly taken, publicly recorded liens may be placed against your property, and/or garnishment of
    your wages or business profits may occur, amongst other measures.

    The 6707A penalty amount for each listed transaction is generally $200,000 per year per each person
    that is not an individual and $100,000 per year per individual who failed to properly disclose each listed
    transaction. The 6707A penalty amount for each reportable transaction is generally $50,000 per year
    for each person that is not an individual and $10,000 per year per each individual who failed to
    properly disclose each reportable transaction. The IRS is obligated to impose the listed transaction
    penalty by law and cannot remove the penalty by law. The IRS is obligated to impose the reportable
    transaction penalty by law, as well, but may remove the penalty when the IRS determines that removal
    of the penalty would promote compliance and support effective tax administration.

    The 6707A penalty is particularly harmful in the small business context, where many business owners
    operate through an S corporation or limited liability company in order to provide liability protection to
    the owner/operators. Numerous cases are coming to light where the IRS is imposing a $200,000
    penalty at the entity level and then imposing a $100,000 penalty per individual shareholder or member
    per year.

    The individuals are generally left with one of two options:
    •        Declare bankruptcy
    •        Face a $300,000 penalty per year.

    Keep in mind, taxes do not need to be due nor does the transaction have to be proven illegal or
    illegitimate for this penalty to apply. The only proof required by the IRS is that the person did not
    properly and timely disclose a transaction that the IRS believes the person should have disclosed. It is
    important to note in this context that for non-disclosed listed transactions, the Statue of Limitations
    does not begin until a proper disclosure is filed with the IRS.

    Many practitioners believe the scope and authority given to the IRS under 6707A, which allows the
    IRS to act as judge, jury and executioner, is unconstitutional. Numerous real life stories abound
    illustrating the punitive nature of the 6707A penalty and its application to small businesses and their
    owners. In one case, the IRS demanded that the business and its owner pay a 6707A total of $600,000
    for his and his business’ participation in a Code Section 412(i) plan. The actual taxes and interest on
    the transaction, assuming the IRS was correct in its determination that the tax benefits were not
    allowable, was $60,000. Regardless of the IRS’s ultimate determination as to the legality of the
    underlying 412(i) transaction, the $600,000 was due as the IRS’s determination was final and absolute
    with respect to the 6707A penalty. Another case involved a taxpayer who was a dentist and his wife
    whom the IRS determined had engaged in a listed transaction with respect to a limited liability
    company. The IRS determined that the couple owed taxes on the transaction of $6,812, since the tax
    benefits of the transactions were not allowable. In addition, the IRS determined that the taxpayers
    owed a $1,200,000 Section 6707A penalty for both their individual nondisclosure of the transaction
    along with the nondisclosure by the limited liability company.

    Even the IRS personnel continue to question both the legality and the fairness of the IRS’s imposition
    of 6707A penalties. An IRS appeals officer in an email to a senior attorney within the IRS wrote that
    “…I am both an attorney and CPA and in my 29 years with the IRS I have never {before} worked a
    case or issue that left me questioning whether in good conscience I could uphold the Government’s
    position even though it is supported by the language of the law.” The Taxpayers Advocate, an office
    within the IRS, even went so far as to publicly assert that the 6707A should be modified as it “raises
    significant Constitutional concerns, including possible violations of the Eighth Amendment’s prohibition
    against excessive government fines, and due process protection.”

    Senate Bill 765, the bill sponsored by Senator Nelson, seeks to alleviate some of above cited concerns.
    Specifically, the bill makes three major changes to the current version of Code Section 6707A. The bill
    would allow an IRS imposed 6707A penalty for nondisclosure of a listed transaction to be rescinded if
    a taxpayer’s failure to file was due to reasonable cause and not willful neglect. The bill would make a
    6707A penalty proportional to an understatement of any tax due.

    Accordingly, non-tax paying entities such as S corporations and limited liability companies would not
    be subject to a 6707A penalty (individuals, C corporations and certain trusts and estates would remain
    subject to the 6707A penalty).

    There are a number of interesting points to note about this action:

    1.  In the letter, the IRS acknowledges that, in certain cases, the penalty imposed by section 6707A for
    failure to report participation in a “listed transaction” is disproportionate to the tax benefits obtained by
    the transaction.

    2.  In the letter, the IRS says that it is taking this action because Congress has indicated its intention to
    amend the Code to modify the penalty provision, so that the penalty for failure to disclose will be more
    in line with the tax benefits resulting from a listed transaction.

    3.  The IRS will not suspend audits or collection efforts in appropriate cases.  It cannot suspend
    imposition of the penalty, because, at least with respect to listed transactions, it does not have the
    discretion to not impose the penalty.  It is simply suspending collection efforts in cases where the tax
    benefits are below the penalty threshold in order to give Congress time to amend the penalty provision,
    as Congress has indicated to the IRS it intends to do.  

    4.  The legislation does not change the penalty provisions for material advisors.

    The following is taken directly from the IRS website:

    “Congress has enacted a series of income tax laws designed to halt the growth of abusive tax
    avoidance transactions. These provisions include the disclosure of reportable transactions. Each
    taxpayer that has participated in a reportable transaction and that is required to file a tax return must
    disclose information for each reportable transaction in which the taxpayer participates. Use Form 8886
    to disclose information for each reportable transaction in which participation has occurred. Generally,
    Form 8886 must be attached to the tax return for each tax year in which participation in a reportable
    transaction has occurred. If a transaction is identified as a listed transaction or transaction of interest
    after the filing of a tax return (including amended returns), the transaction must be disclosed either
    within 90 days of the transaction being identified as a listed transaction or a transaction of interest or
    with the next filed return, depending on which version of the regulations is applicable.”

    January 15, 2010: Brand New Update: The new proposed regulations specify a requirement that
    reporting forms filed under 6707A filed late must have additional attachments. Wherein is described
    many additional details not covered in the original regulations. In addition, various parties must sign a
    statement on the attachments under penalty of perjury. The proposed regulations also specify that the
    late filing must be done in a specific manner.  If this filing is not done according to these rules, the one-
    year period for statute of limitations will not commence, etc. In addition, the form should include a
    statement at the top in the manner the IRS suggests.  If a tax payer fails to include, on any return or
    statement, for any taxable year, any information with respect to a listed transaction as defined in
    CODE SECTION 6707A, which is required to be included with such return or statement the time for
    assessment of any tax imposed by this title with respect to such transaction shall not expire before the
    date, which is one year after the earlier of; the date on which the secretary is furnished the information
    so required, or the date that a material advisor meets the requirements relating to such transaction with
    respect to such tax-payer. As you know, Congress has armed the IRS with many weapons for
    enforcement. Usually there is three-year Statute of Limitations granted to all taxpayers. In the situation
    above there will be no Statute of Limitations, unless the forms are filled in correctly with no errors at
    all.  In addition, the forms must be sent to the proper IRS authorities at their various locations. Lance
    Wallach’s commentary: It seems to me and to the only two people that I know who have been filing
    these forms correctly that that the IRS has purposely made it almost impossible for accountants and
    tax attorneys to properly fill out these forms and to comply with regulations under SECTION 6707A.
    The result is that a business owner in one of these plans asks his accountant or attorney to file the
    disclosures. The business owner then gets fined, on average, ABOUT A MILLION DOLLARS. Or the
    business owner does not file the forms and gets the same fine. The same goes for the material advisor.
    The two people that have been filing these forms properly to my knowledge have repeatedly had
    discussions with the authors of these regulations and various other IRS personnel, including the Office
    of Tax Shelter Analysis.  Based on those many conversations with IRS personnel, repeatedly re-
    reading the various regulations and experience in filing many of the form under these code sections,
    these two people have developed their expertise. I only have their word that no one has been fined that
    they have helped. One of these individuals has been preparing the forms after the fact, late, for the last
    few years. I am not endorsing using anyone in particular for these forms. I am just writing about my
    experience in this area.

    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.
IRS Attacks Many Business Owners with
Million Dollar Fines