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                                                                                 Abusive Welfare Benefit and
                                                                                 Retirement Plans Can Lead to
                                             Severe Penalties for Accountants

    By Lance Wallach
    Lance Wallach, 419 welfare benefit plans, 412i retirement plans, 412i, tax shelter litigation, abusive tax shelters, fight tax shelter penalty, Bankers Life, Hartford Life,
    CRESP, American General Life, Bisys, Benistar, United Financial Group, Grist Mill Trust
    Accountants who are unaware of recent developments are likely to encounter a nightmarish
    scenario that may play out something like this:  you sign a client’s tax return that claims a tax
    deduction for participation in a “welfare benefit plan”.  A few years pass, and nothing happens.  
    Then, on audit, the deductions are disallowed and your client is hit with back taxes, penalties, and
    interest.  He discovers that he may be looking at a large penalty for not disclosing his participation
    in the plan to the IRS.

    Naturally, at this point, your client wants out of the plan.  But he discovers that he cannot get the
    money that he has contributed out of the plan.  He finds that the money is being used by the plan
    sponsor to fight the IRS; his money is being used to defend a plan that he no longer wants to be
    in.  This is claimed to be legal.  Or he may even find that the money is simply gone, that it has
    been stolen or otherwise misappropriated.

    And now you find that you are a “material advisor” with respect to your client’s participation in
    the plan.  Like your client, you were supposed to disclose your role here; in your case, as a
    “material advisor”.  You also may be looking at a large penalty for failing to disclose.

    If you think this could never happen to you, think again.

    Welfare benefit plans are a creation of and are sanctioned by Section 419 of the Internal Revenue
    Code. There are single employer plans and multiple employer plans; the latter rely mostly on IRC
    Section 419A (f) (6) (in the most common cases where there are ten or more employers as part
    of the same plan). The 419A(f)(6) plans are, and perhaps always were, generally regarded as
    abusive, and were substantially curtailed in recent years by harsh IRS regulation. Amazingly,
    however, they refuse to totally die, and are still being marketed.  These plans are called listed
    transactions (more on that later).

    While the principle purpose of this article is to discuss the current state of the welfare benefit
    plan, and everything outside of this paragraph will do just that, it is perhaps worth noting that
    welfare benefit plans are not the only subject of current IRS scrutiny and/or regulation.  The
    Section 412(i) defined benefit plan, for example, is such a target that a task force has been
    formed internally solely to audit 412(i) plans.  Many of them are being deemed listed transactions,
    many of the plans are being involuntarily terminated, and back taxes, penalties, and interest are
    being assessed.  Not surprisingly, all of this has resulted in considerable litigation.

    Single employer welfare benefit plans are now more popular than multiple employer plans. All
    welfare benefit plans tend to share certain characteristics, however. They tend to be marketed
    most frequently by insurance agents and financial planners, and sometimes by accountants and
    attorneys. Prospects tend to be professionals and profitable small businesses. The most attractive
    selling point is the ability to claim large tax deductions and remove money tax free. Life insurance
    tends to be the funding vehicle. Often cheap term insurance is purchased for rank and file
    workers and some form of permanent coverage (universal life, variable life, etc., for the owners
    and key employees. But many times workers are completely left out of the plan. For businesses
    looking to do as little as possible for workers, a selling point is that the great majority of benefits,
    in most cases, eventually go to the owners. This type of discrimination was recently addressed
    by IRS Notice 2007-84, which disallowed tax deductions and penalties with respect to welfare
    benefit plans that discriminate. If done correctly, the plans can accomplish things like facilitating
    estate planning, business succession, and asset protection. But the promised tax deduction is
    usually the sizzle that sells the steak.

    In October of 2007, welfare benefit plans were affected by IRS rulings. The two most important
    developments were Revenue Ruling 2007-65, which declared, in essence, that premiums paid
    inside of a welfare benefit plan for cash value life insurance were not tax deductible, and Notice
    2007-83, which identified the trust within welfare benefit plans involving cash value life insurance
    policies, AND substantially similar arrangements, as listed transactions. In other words, in
    essence, not only are premiums paid for cash value life insurance policies in welfare benefit plans
    not tax deductible, but, and far more importantly, the plans themselves are now listed
    transactions. This, in turn, means that most welfare benefit plans are now listed transactions,
    because most feature cash value life insurance.  This designation creates disclosure obligations
    with absurdly harsh penalties both for failure to disclose or incorrectly or incompletely disclosing,
    as we shall soon see.

    A listed transaction, basically, is any transaction identified as such by specific IRS guidance OR
    any transaction substantially similar to the specifically identified transaction. Participants in listed
    transaction must file Form 8886 with both the Service and the Office of Tax Shelter Analysis.
    Failure to timely and completely file leads to penalties of $100,000 for individuals and $200,000
    for corporate taxpayers.

    The practitioner has filing requirements, also, which can lead to equally severe penalties, if the
    practitioner qualifies as a “material advisor” with respect to one of these transactions. What is a
    material advisor? Basically, someone who gives advice, sells, or otherwise plays a significant part
    in the promotion, sale, or paperwork with respect to a taxpayer’s participation in a listed
    transaction. Put simply, from an accountant’s standpoint, you must give advice, the client must
    do it, and you must satisfy a certain income threshold with respect to the transaction, usually
    $10,000. The accountant who signs a return taking a tax deduction with respect to the
    transaction is surely a material advisor, if the income threshold is met.

    A problem is that many accountants are not even aware of these plans. Often it is discovered
    when preparing the client’s tax return, at which point the client expects you to allow the
    deduction and sign the return, since the client was sold a tax deduction. Or worse yet, the
    deduction may already have been disallowed on audit. The point is that, far too frequently, the
    practitioner does not even discover a client’s involvement in a listed transaction until too much
    damage has already been done. This is often the case if the contribution has already been made,
    as it usually has, and irretrievably so if the deductions have already been disallowed on audit. And
    added to all of this is the distaste that most professionals must have for all of these policing types
    of duties, to say nothing of the difficulties that are created with clients and, probably, the loss of
    some clients.         

    The material advisor must file Form 8918 describing her exact role in the client’s participation in
    the transaction. Failure to file can lead to penalties imposed on the advisor that are as severe as
    those imposed on taxpayers ($100,000 for individuals and $200,000 for corporations) who fail to
    file Form 8886. The accountant may escape material advisor status by not meeting the $10,000
    income threshold. A problem, however, is the accountant who is paid $10,000 in the aggregate
    by the client, but not that much specifically with respect to the listed transaction. Does such a
    person satisfy the income threshold? The author and his associates have discussed this point,
    among others, directly with IRS personnel who actually wrote published guidance in this area.
    The best we have been able to get is a declaration that any test that would be applied to the
    determination of any of these issues would have to consider all surrounding facts and
    circumstances. This would be unlikely to yield any general rules, for each situation has its own
    facts and circumstances.

    Another section that the practitioner, or at least the prudent one, should be aware of, largely apart
    from what has been discussed so far in this article, is Section 6701, entitled “penalties for aiding
    and abetting understatement of tax liability.” This penalty is imposed upon those who assist in,
    procure, or advise while knowing or having reason to believe that the subject matter will be used
    in connection with any material matter arising under the tax laws and who know that the use
    thereof would result in the understatement of another person’s tax liability. The penalty may be
    applied separately to each occurrence, and it is $1,000 if an individual is the taxpayer and $10,000
    for a corporate taxpayer.  

    Three (3) definitions are now in order, which will hopefully help to clarify any confusion that
    may exist in the reader’s mind. A “material advisor” is any person who provides any material aid,
    assistance, or advice with respect to organizing, managing, promoting, selling, implementing,
    insuring, or carrying out any reportable transaction, and who directly or indirectly derives gross
    income in excess of a certain threshold amount. More on threshold soon, but the most common
    one is $10,000 for listed transactions. A “reportable transaction”, basically, is any transaction
    which has been deemed to have a potential for tax avoidance or evasion. That is pretty broad, and
    the reader should consult the regulations under section 6011 for more on this. Finally, a “listed
    transaction” is a reportable transaction which is identical or substantially similar to a transaction
    specifically identified as a tax avoidance transaction.

    As for threshold amounts, in the case of reportable transactions, it is $50,000, if substantially all
    tax benefits are provided to natural persons, and $250,000 in other cases. Natural person is
    construed most broadly, generally ignoring trusts, corporations, and other such entities. For listed
    transactions, the numbers are $10,000 (previously discussed) and $25,000.

    Lance Wallach speaks and writes about benefit plans, and has authored numerous books for the
    AICPA, Bisk Total tape, and others. He can be reached at (516) 938-5007 or For more articles on this or other subjects, feel free to visit his website

    The information contained in this article is not intended as legal, accounting, financial or any
    other type of advice for any specific individual or entity. You should seek such advice from an
    appropriate professional.