Captive Insurance and Section 79 Scams, 419e and 412i Producing Large IRS fines

October 11, 2010

By Lance Wallach

Have you ever heard of captive insurance, a 419 welfare benefit plan, a 412i defined benefit insurance plan or a Section 79 scam? You may have a client in one, or be in one yourself and not even know it. You would learn quickly when the IRS disallows your tax deduction and tries to fine you lots of money. What you are about to read about below may seem impossible in America. The IRS first audits,  disallows deductions, and charges interest and penalties for being in one of these abusive plans. You then think you are finished with them. Soon thereafter, you get fined hundreds of thousand of dollars for not reporting yourself to the IRS. I have been helping successful business owners and professionals with this problem for years. I have authored numerous books for the American Institute of CPAs with chapters on this problem.

I have spoken at many conventions on this topic and argued with a lot of people who didn’t think this would ever happen to them. They purchased products sold primarily by insurance agents from large well known insurance companies like Prudential, Pacific Life, Mass Mutual, Guardian, American General, etc. The plans had opinion letters from lawyers. The business owner’s accountants signed tax returns taking deductions for these plans with insurance products. Why are the business owners and professionals being fined a huge amount of money by various divisions of the IRS for doing what seemed like a legitimate thing to do? How can something like this happen in America? When many of the business owners and accountants finally take their heads out of the sand, they are usually put out of business by these fines.

Years ago, most successful insurance agents were making big money selling 419 and 412i plans. Now they are selling captive insurance and Section 79 scams to unsuspecting business owners and professionals. Most of the plans were sold to successful business owners as plans with large tax deductions where money would grow tax free until needed, whether in retirement or sooner. I frequently spoke at national accounting and other conventions talking about the problems with most of these plans. I would be attacked by some attendees who where making large insurance commissions selling the plans. I would try to warn insurance company home office executives, but they too had their heads in the sand because of all the money these plans brought in. Now they look foolish when their depositions in the lawsuits are taken. Later, the IRS got tough and started fining the unsuspecting business owners and professionals hundreds of thousands a year for not reporting on themselves for being in these plans. The agents and insurance companies would advise not to report to the IRS, “This is a good plan. We have approval.” Not only were the business owners fined under IRS Code 6707A, but the insurance agents were also fined $100,000 for not reporting on themselves. Accountants who signed tax returns are even being fined $100,000 by the IRS.  Then the business owners sue the accountants, insurance agents, etc. I have been following these scenarios for a long time. In fact, I have been an expert witness in many of these cases, and my side has never lost.

Let me give you an example:

A 40-year-old doctor with four employees earns, as pre-tax take-home pay, $500,000 a year. So he was told to contribute $200,000 a year into a 419 plan, and to claim a tax deduction in that amount. The money would go into the plan, where it would grow in a tax-free manner because it was invested in cash value life insurance. After funding $1 million over five years, the policy would continue to grow tax deferred and, ultimately, would grow to some outrageous amount, which would be used by the doctor in retirement.

419 plan participant hit with penalties for not disclosing participation in a listed tax transaction .

The IRS notices and revenue rulings that came out against 419 plans stated with clarity that 419 plans using cash value life insurance are listed tax transactions. The consequence of which is that, if you use one of these plans, you have to notify the IRS that you are doing so.

Most promoters of 419 plans told clients that their plans complied with the laws and, therefore, were not listed transactions. Unfortunately, the IRS doesn’t care what a promoter of a tax-avoidance plan says; it makes its own determination and punishes those who don’t comply.

The McGehee Family Clinic, P.A. was recently hit with back taxes and a penalty under Code Sec. 6662A in conjunction with a deduction claimed under the Benistar 419 plan

Dr. McGehee’s clinic took a deduction for a 419 plan (the Benistar plan) back in 2005. Eventually, the McGhee Family Clinic was audited. After the audit, the doctor was told that the deduction would be disallowed and that back taxes were due. Additionally, Dr. McGehee was hit with a 20 percent accuracy-related penalty under Code Sec. 6662A. Finally, the tax court sustained the IRS’s determination that McGehee was subject to the increased 30 percent penalty, because its return did not include a disclosure statement indicating its participation in the Benistar Trust. I think that in addition to the aforementioned fines, IRS will now impose, both on a corporate and personal level, another $200,000 or more, under IRC 6707A, for not properly disclosing his participation in a listed transaction. There was a moratorium on those fines until June 2010 pending new legislation to reduce them. The fines had been $200,000 per year on the corporate level and $100,000 per year on the personal level. You got the fine even if you made no contributions for the year. All you had to do was to be in the plan. So Dr McGehee’s fine would be a total of $300,000 per year for every year that he and his corporation were in the plan. IRS also says the fine is not appealable. Under Section 6707A his fine would be in the million-dollar range, in addition to all the other fines.

Legislation just passed slightly reducing those fines, but you still have to properly file to start the Statute of Limitations running and to avoid the fines. The IRS is fining people who report on themselves, but mistakenly prepare the forms incorrectly.  Now that the moratorium on the fines has passed, and so has the new legislation, IRS has aggressively moved to fine unsuspecting business owners hundreds of thousands. This is usually after they get audited, and sometimes reach agreement with IRS. Then another section of the IRS fines them under 6707A. I am receiving a lot of phone calls from business owners who this is happening to. Unfortunately, some of these people already had called me. I warned them to properly file under 6707A. Either they did not believe me – it is unbelievable – or their accountant or tax attorney filed incorrectly. Then they called again after being fined.

Recent raid on the Benistar office included turning over client names to the IRS

Recently, IRS raided Benistar. IRS attacked the Benistar 419 plan, and one of its tactics was to demand the names of all the clients Benistar worked with — so they could be audited by the IRS, Benistar refused to give the names and appealed the decision to turn over the names. The appeal was unsuccessful, but Benistar officials still refused to give up the names. Recently, the IRS raided the Benistar office and took hundreds of boxes of information, which included information on clients who were in their 419 plan. In documents filed by Benistar itself, they stated that 35 to 50 armed IRS agents descended upon their office to seize documents.

IRS has visited, and is still visiting, most of the other plans and obtaining names of participants, selling insurance agents, accountants, etc. They have a whole task force devoted to auditing 419, 412i and other abusive plans.

It is important to understand what could happen to unsuspecting business owners who become  involved in plans that are not above board. Their names could be turned over to the IRS, where audits could ensue, and where the outcome could be the repayment of back taxes and significant penalties. Then they would be fined another time under Section 6707A for not properly reporting on themselves. The combination of these taxes and penalties almost invariably threatens the very existence of the business.

If you were involved with one of these abusive plans there are still steps that you can take to minimize IRS problems. I know of a CPA who left the IRS after more than 37 years to help business owners with these problems. He has successfully, after the fact, filed for clients the delinquent Forms 8886.  In addition, he has assisted business owners who were being assessed accuracy-related penalties under 6662a, and they have had these penalties abated or substantially reduced. With some clients he has made large IRS fines become smaller.

It’s not worth it!

Stay away from 419 and similar plans like Section 79 plans. Be very careful with 412i plans. Avoid most captive insurance plans.

It’s getting closer to the end of the year. This is when every scammer known to man/woman comes out of the woodwork to sell some fly-by-night tax-deductible plan to clients. Sometimes they come in the form of an accountant, insurance agent-financial planner, or even an attorney. I see this in all of my expert witness cases and when I speak at conventions. I have seen this since the 1990s. I wanted to remind readers that, if it sounds too good to be true, it probably is.

Lance Wallach speaks at more than 20 conventions annually and writes for more than fifty publications about tax reduction ideas, abusive welfare benefit and retirement plans, captive insurance companies, cash balance plans, life settlements, premium finance, etc.He has written or collaborated on numerous books, including, The Team Approach to Tax and Financial Planning; Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hotspots; Alternatives to Commonly Misused Tax Strategies: Ensuring Your Client’s Future, all published by the American Institute of CPAs; The CPA’s Guide to Life Insurance, and The CPA’s Guide to Trusts and Estates, both published by Bisk Education, and his latest book,  Protecting Clients from Fraud, Incompetence, and Scams, published by Wiley. In addition, Mr. Wallach writes for various national business associations that sell his books to their members and others. He has been an expert witness on some of the above issues, and to date his side has never lost a case.

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

We have many more Life Insurance Help Articles Now Available.