How to Get Fined $100,000 by the IRS and Lose Your License – Accountants, Insurance Agents

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 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.

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