For many insurance agents and promoters the “Holy Grail of insurance schemes”* is finding a product that allows the insured to deduct life insurance premiums. (Hat Tip to Professor Beckett Cantley for the quote.) To date, we haven’t seen any that pass IRS muster.
Let me repeat that statement. We haven’t seen any such schemes that the IRS approves. To the contrary, the IRS considers most to be “listed transactions” meaning huge civil penalties if you get caught.
We are tax fraud lawyers meaning that by the nature of our business, the plans we see are problematic. That means that there might be some legitimate plans out there. We have no doubt that this post will generate a fair amount of comments both negative and positive. That’s good. Our goal is to educate people so they don’t become victims. This means if someone tries to sell you on a life insurance scheme in which the premiums are deductible, consult a good accountant or IRS tax attorney before plunking down your hard – earned cash.
There are some great tax benefits of life insurance. Death benefits, for example, are not taxable to beneficiaries. Another example is the increase in value (growth) of certain policies that can remain tax deferred until retirement. Deductibility of premiums, however, generally isn’t one of them.
Congress has drawn a hard line with premiums. That hasn’t stopped a steady stream of Internet promoters and scam artists from peddling nonsense to uninformed taxpayers. Many of those taxpayers are small businesses.
One of the earliest schemes (and unfortunately still alive and well) are the so-called welfare benefit plans loosely based on section 419 of the Internal Revenue Code. As early as 1995, the IRS began warning practitioners that these plans were often nothing more than abusive tax shelters.
If you are or were a small business owner and have a plan that is funded by life insurance and claims to be set up under section 419A(f) or 419(e), seek counsel! Even if not funded with life insurance, these plans may still be problematic if you deducted employer contributions.
There were many promoters armed with slick marketing materials and questionable legal opinions that claimed these plans were legitimate, safe and tax compliant. They were anything but.
Worse, we have found several 419 plans that were “converted” and the money invested in PIWM, Maven and other Ponzi schemes. Not only is the investor potentially liable for huge IRS civil penalties but frequently the underlying investment is simply gone.
Closely allied with the 419 plans were the 412(e) plans. Although there are legitimate 412 plans, the ones we typically see involve excessive insurance coverage for key employees. The reason for he excess insurance, of course, is to inflate the deduction.
Once again, as quickly as the promoters claim a new loophole, the IRS issues formal notices declaring these schemes to be listed transactions and abusive tax shelters.
Undeterred, promoters concocted PORCs, Producer Owned Reinsurance Companies. Although named “PORCs,” these plans were more like pigs in a poke.
The latest battleground is being waged over captive insurance companies and once again, some very bad promoters have lined up to exploit small business owners. We know of one individual who sold his business, created a captive (also called a CIC) and promptly lost his entire investment. Almost $1 million. Worse, he paid a questionable lawyer $100,000 to construct his captive.
Many of the captive frauds we have investigated or prosecuted are based in the Caribbean. Before anyone comments, we are again not suggesting that all offshore captives are bad. But they certainly warrant careful investigation and thorough due diligence. (Presently we are investigating captives involving Fidelity Insurance located in the British West Indies.)
The promoters of these plans often use very tortured reasoning in arguing their legitimacy. Section 264 of the Tax Code says, however, that life insurance premiums are not deductible if the taxpayer is a direct or indirect beneficiary under the policy.
As noted in the beginning of this article, the IRS seems to constantly be playing catch up. Every year promoters come up with new ideas, new names and new contorted interpretations of tax law. Don’t think that you are safe if you act before the IRS issues a formal notice. The recent notices from the IRS say that all transactions that resemble previously prohibited transactions are also prohibited. In other words, “if it looks like a duck and quacks like a duck, the IRS considers it a duck” no matter what some insurance agent or promoter claims.
Think you may have a problem? Seek legal help quickly. The IRS generally treats taxpayers much better if they come forward on their own and voluntarily fix the problem. Another reason to seek assistance is that many of the plans and schemes are simply scams.
The tax fraud lawyers at Mahany & Ertl have prosecuted a wide variety of abusive tax shelter products. We are unique in our ability to represent you before the IRS and to recover your losses from the people selling and promoting these products.
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