[Post updated through 2021] More than a decade ago, so called welfare benefit plans were the rage for small business owners. Insurance agents, financial planners and even tax attorneys were all out hustling clients to invest heavily in these plans. According to the promoters, business owners could contribute and sock away hundreds of thousands of dollars into the plans, all tax free. The promoters forgot to tell their clients, however, that the IRS has steadfastly taken a much different position. Although a few plans do pass muster, most do not.
As will be explained below, there is hope to get back the IRS penalties, lost premiums and other damages but time is quickly running out.
Typically the non – qualifying plans are funded with variable annuities or life insurance. The business owner is told the contributions to the plan are tax deductible. While that is sometimes true, most promoters either do not know the limits or ignore them in hopes of high commissions. These so called 419 plans have one of the highest rates of noncompliance making them tremendously risky.
As noted above, these plans are often sold by insurance brokers. While these folks may have a good knowledge of the insurance industry, they usually have no tax background. Often shady promoters not only dupe the business owners that invest in the plans but the insurance agents too.
Without getting overly technical, in order for the contribution (premiums) to be deductible, they must qualify as “ordinary and necessary” business expenses and the total amount that can be deducted is subject to strict limitations. Of course, there are hundreds of pages of highly technical regulations and tax court opinions on these qualifications.
Business owners are often sold these plans as a way of sheltering income from taxation and for providing a large benefit for the future. Unfortunately, in practice the IRS typically disallows the deduction and the investment value of the insurance or annuity product is usually quite poor.
These plans are so problematic that the IRS deems them to be “listed transactions.” Think of it as being on the TSA’s no fly list. If you have a section 419 or 412 plan, its on the IRS list as a potential abusive tax shelter. There are huge monetary penalties for even having a plan unless you tell the IRS each year. Just for having a plan you could face penalties of $200,000 per year or more in addition to the taxes from the disallowed deductions.
If you have one of these plans, you may be able to recover damages from the person who sold you the plan as well as the insurance company that provided the annuity or life insurance product. (You may also be able to collect from the sponsor and promoter but many of these companies have long ago gone under.)
Many of these plans were purchased and funded 5 or more years ago. Each state has a statute of limitations that limits how long you can sue someone for malpractice or fraud. Typically, those cases must be brought in 2 or 3 years, although some states give you much longer. Thankfully, in many jurisdictions one can claim that the clock didn’t start running until the IRS came in and ruled the plan an abusive tax shelter. More and more cases, however, are beginning to fall outside even those time frames.
If you purchased a welfare benefit plan and were subsequently audited by the IRS and subjected to huge penalties, you must act soon. Obviously we cannot provide legal advice in a blog but as a general rule, time is not on your side.
We thought we saw the last of welfare benefit plans. Since 1995 the IRS has warned that certain of these plans are listed transactions and may be considered as abusive tax shelters. It took years for that to sink in with some accountants and insurance agents but things finally quieted down. In April 2020, however, the IRS again listed Certain Trust Arrangements Seeking to Qualify for Exemption from Section 419 as a listed transaction suggesting that some promoters are still at it.
According to the IRS,
Promoters have offered trust arrangements that are used to provide life insurance, disability, and severance pay benefits. The promoters enroll at least 10 employers in their multiple employer trusts and claim that all employer contributions are tax deductible when paid, relying on the 10-or-more-employer exemption from the limitations under IRC sections 419 and 419A. Often the trusts maintain separate accounting of the assets attributable to each subscribing employer’s contributions.
Notice 95-34 puts taxpayers on notice that deductions for contributions to these arrangements are disallowable for any one of several reasons (e.g., the arrangements may provide deferred compensation, the arrangements may be separate plans for each employer, the arrangements may be experience rated in form or operation, or the contributions may be nondeductible prepaid expenses).
The fraud and tax lawyers at Mahany Law are uniquely prepared to deal with phony welfare benefit plans. If you believe you are the victim – or if you are currently being audited – contact us immediately. All inquiries are protected by the attorney – client privilege and are kept in complete confidence. For more information, contact attorney Brian Mahany online, by email at or by telephone at (202) 800-9791.