Parts of this article are from book published by BISK Education CPEasy: CPAs Guide To Life Insurance authored by Lance Wallach
IRC Sections 419(e) and 419A(f)(6) Plans
For years life insurance agents and others have been selling ways to deduct life insurance in welfare benefit plans. For years the IRS has been disallowing most of these plans on audit.
In Notice 2007-83, the IRS identified certain trust arrangements involving cash value life insurance policies, and substantially similar arrangements, as listed transactions. The IRS also issued related Revenue Ruling 2007-65 to address situations where an arrangement is considered a welfare benefit fund but the employer’s deduction for its contributions to the fund is denied in whole or in part for premiums paid by the trust on cash value life insurance policies.
The IRS ruled in Revenue Ruling 2007-65 that a welfare benefit fund’s qualified direct cost under IRC §419 does not include premium amounts paid by the fund for cash value life insurance policies if the fund is directly or indirectly a beneficiary under the policy as determined under IRC §264(a).
If a transaction is designated as a listed transaction, affected persons have disclosure obligations and may be subject to applicable penalties.
Like Notice 2007-83 and Notice 2007-84, Revenue Ruling 2007-65 is aimed at promoted arrangements under which the fund trustee purchases cash value life insurance policies on the lives of the employees who are owners of the business (and sometimes key employees), while purchasing term insurance policies on the lives of other employees covered under the plan. They are currently sold as an IRC §419(e), IRC §419A(f)(6) or IRC §419 plans. These are sometimes sold as single employer plans. These plans anticipate that the plan will be terminated and the cash value policies will be distributed to the owners or key employees with very little distributed to other employees. The promoters claim the insurance premiums are currently deductible by the business, and that the distributed insurance policies are virtually tax-free to the owners. The ruling makes clear that, going forward, a business cannot deduct the cost of premiums paid through a welfare benefit plan for cash value life insurance on the lives of its employees. Some arrangements described by this ruling may qualify as listed transactions.
The IRS may challenge the claimed tax benefits of these arrangements for various reasons:
- Some or all of the benefits or distributions provided to or for the benefit of owner-employees or key employees may be disqualified benefits for purposes of the 100-percent excise tax under IRC §4976.
- Whenever the property distributed from a trust has not been properly valued by the taxpayer, the IRS intends to challenge the value of the distributed property, including life insurance policies.
- Under the tax benefit rule, some or all of an employer’s deductions in an earlier year may have to be included in income in a later year if an event occurs that is fundamentally inconsistent with the premise on which the deduction was based.
- An employer’s deductions for contributions to an arrangement that is properly characterized as a welfare benefit fund are subject to the limitations and requirements of the rules in IRC §§419 and 419A, including the use of reasonable actuarial assumptions and the satisfaction of nondiscrimination requirements. Further, a taxpayer cannot obtain a deduction for reserves for post-retirement medical or life benefits unless the employer actually intends to use the contributions for that purpose.
- The arrangement may be subject to the rules for split-dollar arrangements, depending on the facts and circumstances.
- Contributions on behalf of an owner-employee may be characterized as dividends or as nonqualified deferred compensation subject to IRC §404(a)(5) or IRC §409A or both, depending on the facts and circumstances.
If a client approaches you with one of these plans, be especially cautious, for both of you. Advise your client to check the promoter very carefully. Make it clear that the government has the names of all former 419A(f)(6) promoters and, therefore, will be scrutinizing the promoter carefully if the promoter was once active in that area, as many current 419(e) (welfare benefit fund or plan) promoters were, thereby making an audit of your client far riskier and more likely.
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 Pubic 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, firstname.lastname@example.org or visit www.taxadvisorexperts.org or www.taxaudit419.com.
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.
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