by Brian Mahany
A decision last week may mean the end of any hope for relief by holders of welfare benefit plans.
In April of last year, we reported on the Curcio decision in which the U.S. Tax Court ruled against 4 people that had purchased welfare benefit plans marketed by Benistar 419 Plan Services. The decision in that case was just upheld this month by the 2nd Circuit Court of Appeals. Unless the U.S. Supreme Court steps in, the holders of these plans are in serious trouble.
Welfare benefit plans, often called “419 Plans” after a section of the Internal Revenue Code, were marketed widely by insurance agents to small businesses. Proponents claimed that small business owners could invest pretax profits into cash laden life insurance policies over which they maintained effective control. The desired result was the ability to shield pretax profits by calling them business expenses.
The tax court last year said “no”. In the words of the court, “[the]Benistar Plan is a thinly disguised vehicle for unlimited tax-deductible investments.”
Benistar was not the only company marketing these plans. There were several others, many of whom are now out of business.
After last year’s tax court defeat, the holders of the Benistar plan appealed and took the case to the 2nd Circuit Court of Appeals in Manhattan. On August 9th, a three judge panel affirmed the tax court’s decision meaning the IRS won and the taxpayers lost. This means that the Curcios will have to pay tax on the money they invested in the plan and pay large penalties. Penalties for investing in these types of plans can be $100,000 to $200,000 per year!
The IRS has long warned against these plans. As early as 1995, practitioners were warned that these plans could be considered abusive tax shelters subject to huge penalties. Like many similar plans, the promoters in this case claimed “virtual unlimited deductions” for the business and that funds inside the plan “accumulate tax free.” Unfortunately, the insurance agents selling these plans were often not very sophisticated. We are familiar with many insurance agents selling these plans with little or no knowledge of the tax code. Even some good accountants and lawyers sold or approved these plans for their clients.
The rejection of many of these welfare benefit / 419 plans by the IRS comes as no surprise.
The Curcios had also hoped to convince the court that they should not pay penalties because they had relied on professional advice in setting up their plan. In other words, they didn’t just stumble upon the plan through a late night infomercial, they consulted with a CPA before investing. Often reasonable reliance on the advice of a professional is enough to get the IRS to waive penalties. Not in this case.
The court acknowledged that reliance on professional advice can be grounds to abate penalties but noted that it is not an absolute defense. We were a bit surprised, however, to see that the appeals court ruled that the taxpayers’ had little reason to believe that their accountants were experts on welfare benefit plans or that they had sufficiently researched the issue. At trial, the accountants provided a legal opinion from a reputable law firm which suggested the plan was valid.
In summary, we expected the Court of Appeals to reject the tax deductability of these plans. The IRS has been on record for over a decade warning of the dangers of these plans. We were surprised that the court upheld the penalties, however. The message to taxpayers from the court is that if you engage in a listed transaction (one that the IRS has labeled as potentially abusive), expect little relief from the IRS even if you hired a CPA and received a legal opinion. That decision will certainly have a chilling effect on lawyers and CPAs as well.
If you have purchased one of these plans and were assessed or audited by the IRS, you may have recourse against the person selling or marketing the plan. (As noted above, many of the original promoters are out of business or judgment proof but the insurance sales reps are still around and often insured.) If your plan was funded through life insurance, you may have a claim against the carrier as well.
Time is running out on most of these claims. State laws vary from state to state but typically only give taxpayers a very short period to file suit. This is especially true for plans sold years ago that are just now being audited by the IRS. If you were the victim of one of these schemes, give us a call immediately.
Mahany & Ertl – America’s Tax and Fraud Lawyers. Offices in Milwaukee, Wisconsin; Detroit, Michigan; Portland, Maine; Minneapolis, Minnesota and coming soon, San Francisco, California (tax only). Services available in many states.