Author/Moderator: Lance Wallach, CLU, CHFC, CIMC

Publisher: AICPA
Availability: In Stock

A perfect follow-up to “Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots,” this course was created by the renowned Sid Kess. Learn the best strategies for reducing taxes and building, conserving and passing wealth to the next generation while at the same time avoiding abusive strategies.

Identify practical alternatives to abusive tax shelters
Understand how to integrate financial products as part of a retirement plan
Discover how to use innovative retirement and financial programs to improve business and personal financial wealth of your clients
Optimize your value in the planning process between your clients and their financial advisors
Prerequisite: None
Accepted for CFP® credit.

412i Plans

Because of their large required contributions, these plans work only with established, highly profitable businesses. They usually work best when the business owner is within 10 years or so of retirement and is older than most of the company’s relatively few employees. In addition, the plan cannot make policy loans. Such a loan invalidates the plan altogether. There is no flexibility in investments, because the plan is funded entirely with insurance and annuity contracts. Finally, there may be limitations to the deductions or the amount of insurance that is purchased, and there may be an income component that is recaptured by the business owner.

No Problem for REAL VEBA

 – No Problem for REAL VEBA

Counsel to REAL VEBA

As many of you are aware, we got blind-sided by PLR 200127047, 2001 WL 757790 (IRS PLR), issued July 6, 2001. The PLR was written by Jim Holland, a long-time IRS pension official and mortal enemy of those who use welfare benefit plans. The PLR evaluates a severance plan which was submitted for ruling regarding compliance under 419A(f)(6). Predictably, the PLR held that this plan did not comply. However, and more disturbing, without citing any authority, it held that the death benefit portions did not comply either.

I have read this ruling many times already. As my blood pressure drops, I see that it is basically just another attempt to chill interest in 419A(f)(6) arrangements and to deny taxpayers their constitutional right to provide benefits so as to ease the burdens of government. More importantly, however, this PLR does not impact any employer who contributes to REAL VEBA, because the structure of the plan in the PLR is strikingly different and full of problems that we identified and avoided long, long ago.

I. Description of the Plan at Issue

The Trust at issue was the "Third Amended and Restated" version of the original (dated September 15, 1997). This has led some to believe that it probably was similar in form to the Prime Financial Partners Trust, which was implicated in the Booth case. The Tax Court issued the opinion in Booth on June 30, 1997, so the amendment and restatement was most likely no co-incidence. When this author compared the attributes of the Trust at issue in the PLR with an Adoption Agreement provided by a third party, it appeared that there was a substantial resemblance to the Prime Financial Benefit Trust (“Prime II”) Multiple Employer Welfare Benefit Fund, in its form as of December 31, 1988. However, the Trust could just as easily have been a knock-off plan. The actual identity of the Plan was not provided in the PLR.

[Now, you should be aware that the operators of the new Prime plan deny they applied for the ruling. That makes sense. Therefore, we believe that the employer who took the $3 million deduction during the relevant time-frame [or another substantial contributing employer] may have applied, just to test whether it was sold a bill of goods about the compliance of the plan with §419A(f)(6).]

Like the plan at issue in Booth, the Trust by its terms provided death and severance benefits to employees who were specified in the adoption agreement signed by those employers who chose to participate in the Trust. All participants in the Trust received death benefits. Severance benefits were provided only to those participants whose employers elected in the adoption agreement to provide such benefits.

Each participating employer was declared to be a "plan administrator" and given "all discretionary and other authority to control and manage the operation and administration of the Trust." However, the Trust required each plan administrator to delegate various duties and responsibilities to a "contract administrator" specified in the Trust document. The delegated duties and responsibilities included (i) directing the Trust's trustee as to the crediting and distribution of funds, (ii) making claims decisions, and (iii) maintaining accounting records.

1. Particulars of the Death Benefit

Consistent with a common design for welfare plans, the Death benefits provided by the Trust were equal to a specified percentage of compensation (but no less than a minimum dollar amount specified in the Trust). Each employer chose the specified percentage at the time the employer adopted the Trust. The death benefit provided to each participant was based on compensation at the time the Trust is adopted by the employer (and, thus, did not become automatically adjusted for subsequent changes in compensation). Death benefits could be forfeited by participants upon a "termination of employment" or a "discharge for cause". Also, if the employer elected to provide severance benefits in addition to the death benefits, owners of a significant amount of the total combined voting power or value of all classes of stock in the employer forfeited their right to receive death benefits upon the attainment of the later of (i) age 70 1/2 or (ii) ten years of participation. The Trust gave participants the option of purchasing the insurance policy that was providing the death benefit.

2. Particulars of the Severance Benefit

a. Event of severance

Severance benefits were payable upon a "termination of employment". Under the provisions of the Trust, a termination of employment occurred when the participant became totally disabled, resigned or was discharged "without cause.” Severance benefits could be forfeited if a participant were discharged "for cause" or voluntarily terminated employment "without good cause." Severance benefits were also forfeited upon death or actual retirement. For participants who own at least 5% of the employer, severance benefits were forfeited upon the attainment of the later of (i) age 70 1/2 or (ii) ten years of participation.

II. Numerous Errors in the Ruling

A. Blatant Disregard of Case Law Regarding Deferred Compensation and Experience Rating

The integrity of the PLR as a document of legal authority is compromised by numerous, almost careless, and cavalier misstatements of law, blatant disregard of case holdings, and regurgitation of long-defeated positions. For example, the PLR still insists that the ability to terminate a death benefit plan is deferred compensation. Moreover, it says that the ability to terminate "can be considered to be a type of experience rating arrangement." Anyone who has studied the area and read Booth v. Com'r , 108 T.C. No. 25 (1997), can only be filled with emotions ranging from nausea to rage. The issue of holding plan termination as a form of de facto deferred compensation has been defeated four times [See Moser, Schneider, Greensboro Pathology and Booth]. Furthermore, Judge Laro never equated experience rating with termination in Booth, yet Mr. Holland apparently thinks the good Judge is wrong on that point, too.

Like the infamous split-dollar TAM [9604001], it is clear what the IRS' intentions are. Having been defeated in the legislative process when it attempted to modify section 419 in 1999 [thanks to us], IRS has thrown down another administrative landmine to quell our victory. This is not much unlike Notice 95-34. The difference this year is that they have selectively disregarded Judge Laro's holdings in Booth and have shamelessly misconstrued the recent case of Neonatology Associates, P.A. v. Com’r, 125 T.C. No. 5 (2000).

B. Erroneous Statement of Neonatology Holding

Contrary to Mr. Holland's statements, Neonatology did not hold that amounts paid for insurance in excess of term costs are constructive dividends. The deduction for term costs was a concession, agreed to before trial by the taxpayers and the IRS. Rather, the IRS argued that the excess amounts in that case, paid into a springing cash value reserve account relating to a specious "continuous-group-term" arrangement, were not insurance at all, and therefore, not deductible. Moreover, there was no evidence of compensatory intent demonstrated by the taxpayers, so the amounts could not be considered components of compensation to qualify for any deduction. Since only shareholder-employees in Neonatology got the "coverage," the excess amounts were classified as constructive dividends." Frankly, Mr. Holland knows better. The legislative history under section 419 clearly includes "insurance premiums," not "term insurance premiums", in the definition of currently deductible qualified direct costs.

C. Erroneous Application of the Ten Percent Rule

Section 419A(f)(6) requires that no employer regularly contribute more than 10% of the total annual contributions to the Plan made by all employers. The Legislative History also gives the IRS authority to issue regulations to increase this percentage.

In the PLR, Mr. Holland noted that plan contributions were about $20 million in one year. He pointed out, however, that one employer had contributed about $3 million during that year. Therefore, according to Mr. Holland, the plan violated the Ten Percent Rule because it failed the test in a single year.

Such an interpretation disregards the plain language of the statute. The Code requires that the 10% limit be measured by reference to the regular contributions of the taxpayer and the plan. What if the plan had an average of $30 million over three successive years? It would appear that $3 million would not regularly exceed 10% of $30 million. Alternatively, what if the employer made contributions of $1.5 million in the next two years. That would total $6 million in 3 years, or an average of $2 million. The average would not exceed 10%, and contributions 2 of the 3 years would not exceed 10%.

III. Certain Parts of the PLR Are Correct Because the Plan Was Defective

A. It was virtually certain that the plan would terminate, which is a form of deferred compensation because distributions are measured by reference to time.

Upon further reflection, the PLR is right in certain respects, but for the wrong reasons. Mr. Holland never describes his conclusion that the plan had a "virtual certainty" of returning money to the contributors. The answer is between the lines.

If you look closely, and understand the history and operation of Prime and other plans like it, you realize that both the severance benefits and death benefits ended at age 70 1/2. This was necessary to prevent imposition of sec. 4976 (the 100% excise tax on postretirement benefits). Holland must have concluded [rightly] that no business person would allow this expiration. The plan, therefore, had a fixed date of distribution. It was measured by a term of years, rather than event. Therefore, it was deferred compensation under Wellons.

B. Prohibited experience-rating was probably present because the trustee had the ability to change benefits.

Holland's experience rating argument is partially correct. The unilateral ability of a trustee to adjust a benefit is experience rating. But his comment about termination being a form of experience rating is dead wrong. It also conflicts with the Treasury position at page 9 of the IRS Memorandum of Issues in Booth. In Tax Court, the IRS conceded that a fully-insured death benefit plan was not a type of self-insurance, and therefore, did not resemble an experience-rating arrangement.

C. The plan was not a “single plan” because it did not make ALL ASSETS available for the payment of all claims.

Mr. Holland’s single plan argument is arguably correct. This plan tried to get cute by limiting “risk of cross-invasion” to the balances of a few dedicated, special accounts. This is not much different that the “suspense account” found lacking in the structure of Prime I.

The draftsmen of the plan made a fundamental mistake. The essence of the single-plan analysis is this: Is there a part of the trust not available to pay a claim? Clearly, the cross-invasion potential in this trust was limited to the various special accounts. It therefore violated the single- plan rule of Reg. 1.414(l)-1(b)(1) [which the IRS asserted in Booth and Neonatology] and the very similar test Judge Laro articulated in Booth.

In fairness to Mr. Holland, the trust in question had certain very questionable plan provisions that indicated an intention to segregate plan assets from the claims of certain employees. This would be a violation of the rules. This is all he had to say, rather than engaging in a diatribe and manifesto of what he wishes the law would be -- all expressed with virtually no citations to applicable authority.

IV. Reasons for the PLR? Why Now?

Initially, you should note that this ruling was requested in 1997, just months after the Booth decision. Therefore, Jim Holland had been holding onto this for 3 1/2 years. Maybe he was waiting to determine the winds of Congressional change, or maybe there was a practical reason for not releasing the PLR until now.

It is very important that Holland mentioned the $3 million deduction taken by one of the employers. If it was taken in 1998, the statute of limitations would run as of April 15, 2002. This might have been a reason for the timing of the PLR.

Everyone close to the insurance industry knows that we were primarily responsible for beating back the Treasury’s attempts to change §419A in 1999 and 2000. Despite 14 attempts at adding their provisions to bills, they couldn't get their 419 proposal past our political ally, former Senator Bill Roth, the Finance Committee Chairman. Second, the administration has no agenda against 419 presently. Third, HR 2370 was introduced by Rep. Weller last week. That bill seeks to legitimize severance operators who run discriminatory plans. It is conceivable that Holland was beside himself about it and decided to drop a bomb.

V. Regardless, the PLR Does Not Apply To REAL VEBA

It may sound self-fulfilling, but the PLR actually contains some good news. The PLR confirms each and every fundamental of §419A(f)(6) we have been preaching and writing about for almost a decade.

A. The structure of REAL VEBA does not compel termination

This ruling cannot apply to nondiscriminatory plans, like VEBAs, because there is no virtual certainty of termination. Employers who provide benefits through REAL VEBA face no adverse consequences by not terminating. We preach the gospel of conversion-- let the cash value build up convert to other benefits, like medical, disability or long-term care. It's crazy to terminate and force ordinary income taxation, unless the alternative is the 100% excise tax of §4976. Fortunately, §4976 does not apply to a VEBA, because a VEBA complies with the nondiscrimination rules of §505(b) and a VEBA prohibits any reversion to a contributing employer.

B. REAL VEBA does not permit a trustee to unilaterally adjust benefits, so there is no experience-rating

The Plan in the PLR tried to get cute again by trying to segregate liabilities. They didn't learn the first time around in Booth. The trustee cannot have the unilateral ability to reduce benefits.

In contrast, the trustee of REAL VEBA has no authority to unilaterally adjust benefits because of the contributions to the plan. The only thing the Trustee can do is declare an involuntary termination, similar to the way an insurance company cancels a policy, if a required contribution is not made. On page 9 of the IRS’ Memorandum of Issues filed in the Tax Court in the Booth case, the IRS admitted that this power does not constitute prohibited experience rating. In fact, the trustee would be compelled under ERISA to exercise its fiduciary duty to plan participants by such an expulsion.

C. REAL VEBA puts all assets available for all claims

The Treasury Regulations, §1.414(l)-1(b)(1), governing multiple employer pension plans state clearly that a plan will not be considered a single plan unless ALL ASSETS ARE AVAILABLE FOR ALL CLAIMS. Those regulations also state that separate accounting does not impair single plan treatment, so long as the method of accounting does not operate to impact the legal duties of the plan to pay participants’ benefits in the amounts promised by the plan. In General Counsel Memorandum 39284, the IRS said that this Regulation should be applied to multiple-employer welfare plans.

The REAL VEBA plan and trust documents specifically incorporate the language of the Regulations, and done so since 1992. All assets in REAL VEBA are available for all claims.

VI. Conclusion: What else is new?

This PLR confirms my observation that, in the mind of IRS, there is no plan that they will say conforms with section 419A(f)(6). It also invites the question of why IRS relies on a PLR [issued 3 years after receipt] or a single Notice [like Notice 95-34] to chill interest in §419A(f)(6), but refuses to promulgate regulations or revenue rulings for 17 years.

As the Service is so quick to say, a PLR is among the lowest levels of authority, applicable only to the taxpayer requesting the ruling and the facts in question. The Supreme Court has repeatedly said that arbitrary and capricious interpretations of statutes are void and entitled to no deference. We are not going to overreact, but the message is clear. If we do not get legislative relief, we will apparently not get any administrative compromise on long-defeated positions. We can also expect the Service to continue to assert the legally

Lance Wallach notes that John is still fighting the IRS and I hope that one day he wins. This is an old artilce of his. I disagree with some of it.


Should you file for Bankruptcy to avoid IRS/State problems?

The IRS/State does not like to talk about the use of Bankruptcy to reduce tax liabilities, but the reality is that many IRS/State taxes, penalties and interest do qualify for complete discharge in Bankruptcy. 


You must use caution when considering whether bankruptcy will eliminate IRS/State tax debt.


  • Even when bankruptcy can help, most clients want to avoid bankruptcy if possible.
  • While certain IRS/State tax debts are eliminated by bankruptcy, NOT all tax debts can be eliminated.

An Offer in Compromise is often a much better alternative than bankruptcy, and the OIC can erase ALL your tax debts-even when bankruptcy won’t.


  • In order for a taxpayer to benefit from the Bankruptcy laws and avoid paying income taxes, the taxpayer’s income tax liabilities must qualify.
  • Many taxpayers and bankruptcy attorneys file bankruptcy without understanding whether the taxpayer’s income tax liabilities qualify for forgiveness. This often results in not discharging IRS/State income taxes that could have been discharged if the taxpayer had understood the bankruptcy laws.
  • The most common types of taxes eligible for discharge in bankruptcy are old individual income taxes.

Taxes, which are not eligible for discharge in bankruptcy, are Civil Penalties for payroll taxes.

For more information on Bankruptcy and IRS/State tax laws


Section 419

If your clients who are business owners are thinking about setting up a 419(e) single-employer welfare benefit arrangement plan, beware: It must be airtight to escape the tentacles of the Internal Revenue Service.

A 419(e) plan is a funded, welfare benefit that allows for employer-provided benefits covering sickness, accidents, disability, death or unemployment. Some plans offer benefits both before and after retirement.

If structured properly, these arrangements may allow for tax-deductible employer contributions.

But, be careful: Welfare benefits are not pension or retirement benefits. Internal Revenue Code Section 419 allows employers to take deductions, within certain limits, for contributions generally made to a trust to fund welfare benefits for employees, such as benefits paid in the event of sickness, accident, disability, death or, in some cases, unemployment. The trust can own life insurance. Yet under no circumstances can plan assets revert to the employer.

To be considered a 419(e) plan, it must be funded and offer benefits to all employees. This means that the employer must set aside assets specifically dedicated to paying benefits, often in a trust, for employees or their beneficiaries.

The typical company that uses a 419(e) plan has one or more owners in their 50s, with long-time, key employees. The typical company also has 10 employees or less.

Kurt Fasen, senior vice president of ING, in Minneapolis, says professional groups and small business operations with strong cash flows are attractive candidates for this type of program. For a medical office with two doctors and four employees, for example, contributions to this type of plan may range from $50,000 to about $250,000 annually.

Fasen notes that 419(e) plans use lower-cost term insurance to fund death-benefit-only benefits. Universal life insurance, which offers flexible premium rates and payments, frequently is used for post-retirement medical, disability and unemployment benefits. Loans against the cash value or cash withdrawals are also used to pay for welfare benefits.

For 419(e) plans, ING provides only the insurance products, says Fasen. But often the company will review a plan provided by a vendor or third-party administrator to double check to see if the plan complies with the law. Fasen stresses that it's important for business owners to hire a third party to design a plan that strictly adheres to IRS regulations.

At first blush, 419(e) plans look like a good way for a small business to attract and keep key employees, while getting a tax deduction for the company's 419(e) contributions into the insurance policy. In addition, assets in the life insurance trust are sheltered from creditors.

But experts warn that 419(e) plans have complex rules that dictate the need for a third-party administrator. The amount of the deductions must be actuarially certified. And if the company offers post-retirement benefits, they must offer them to all the company's employees.
The above well written article fails to mention the IRS audits all of these plans.
Lance Wallach

National Society of Accountants Speaker of The Year

The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.

Insurance Companies Are in Big Trouble and Most Do Not Know It

     By Lance Wallach, CLU, CHFC Abusive Tax Shelter, Listed Transaction, Reportable Transaction Expert Witness

PhoneCall Lance Wallach at (516) 938-5007

Many life insurance companies are using captive insurance to alter their books and look better. This could lead to another taxpayer bailout and insurance companies being taken over. This would put benefits in policies at risk for some policyholders.
By using a captive many insurance companies allow the companies to describe themselves as richer and stronger. This misleads regulators, the ratings agency and consumers who rely on rating. The NY insurance dept. said the insurance based in New York had burnished their books by $48 billion using captive insurance companies, often owned by the insurers.

I have been writing about some problems with captives for years, and this is one of the problems. The use of a captive to mislead people is not what captives are for, but some of them do this.

Insurance regulation is based on solvency. Because the transactions of using captives make companies look richer than they normally would be, so insurance companies are diverting reserves to other uses like executive compensation and stockholder dividends to try to raise the price of their stock. This is not a problem with mutual insurance companies where the insured’s are the stockholders.

By using a captive and trying to hide the fact, some insurance companies artificially increase their risk based capital ratios. These ratios are an important measurement of solvency.

Life insurer’s use of captive to shift obligations from their balance sheets has nearly doubled over the last few years. My concern is that the transactions of using captives do not accomplish the stated goal of transferring risk. Of course the insurance companies argue the opposite.

Some of the largest life insurance groups are MetLife, ING, Prudential, A.I.G., AEGON, Hartford, Manulife, Lincoln National, and ASA.

Insurance companies have been playing games for years. To sell more insurance many insurance companies have sold 419 and other plans that the IRS has called abusive transactions. Even after the IRS went after the buyers with large fines the insurance companies continued to sell life insurance inside of these plans. The also sold abusive 412i policies in the past with the same result. Now they are selling so called sections 79 plans which the IRS is looking at. As an expert witness in these types of cases my side has never lost a case.

Using captives is just the latest plan that many insurance companies are now using to look better. The state of NY is trying to do something about this. Most other states have not yet taken notice.

The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.

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, abusive tax shelters, financial, international tax, and estate planning. He writes about 412(i), 419, Section79, FBAR, 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.

While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.

Excise Disaster

Bulls and Bears Prefer VEBAs:

The Discriminatory “419 Plan”

Excise Tax Disaster

By: John

The most conservative of the welfare benefit plans is the VEBA (Voluntary Employees’ Beneficiary Association). It can be adopted by a single employer, or it can be of the multiple employer variety. If ten or more employers adopt the plan, no employer puts in more than 10% of the plan’s total annual contributions, and it is not experience-rated, the VEBA is a type of “419 plan.” Such plans appear to avoid severe deduction limitations which generally apply to other VEBAs and welfare plans.

The principal distinction between a trust commonly known as a VEBA and the plans colloquially referred to as “419 Plans” is taxability of the entity. The plans share in common their purpose and benefits (life insurance). In fact, in Notice 95-34 and elsewhere, the IRS refers to all welfare plans that provide life insurance benefits as VEBAs. Congress has provided in § 419A(h) that non-VEBA welfare plans calculate taxes on participating employers as if they were VEBAs. Still, the hallmark of a VEBA is that it has obtained exemption from taxation pursuant to IRC § 501(c)(9). In order to get such a ruling, a VEBA must be non-discriminatory; that is, it must comply with the nondiscrimination standards of § 505. In addition, the plan cannot display features of deferred compensation. Although a determination letter is not a guaranty of a deduction, it is a form of substantial authority for the deduction which has helped in actual audit settings to eliminate the prospect of accuracy-related penalties.

There are many myths about VEBAs being circulated presently by questionable sources. For example, one myth says that a VEBA can only operate within a three-state region. This requirement was stricken by the Water Quality Association case, decided in 1988 by the 7th Circuit Court of Appeals. Another myth states that a VEBA is subject to ERISA, but a “non-VEBA 419 Plan” is not. Rest assured that § 3(1) of ERISA includes within its scope all plans which provide life insurance benefits, whether funded by life insurance or not. This means that all welfare plans are subject to the reporting and fiduciary duty provisions of ERISA, if a non-owner employee is covered. The reach of ERISA was evident in Reich v. Lancaster, where insurance agents were held to be fiduciaries of a welfare plan and surcharged $750,000 in damages for recommending inappropriate, high commission, cash value insurance. A third myth is that VEBAs are subject to affiliated service group rules while other welfare plans are not. This is untrue, as § 414(m) of the Code contains no statutory link to § 505. In the summer of 1995, the IRS admitted publicly in writing that it could not combat the use of management companies by firms who wish to provide VEBA benefits only for a limited employee group.

Persons who eschew using a VEBA for welfare benefits generally believe that they can better skew benefits toward highly compensated employees (HCEs) and reduce or eliminate benefit costs for non-HCEs. This may be true, but the savings are often minimal. For example, suppose Dr. A has a professional corporation with two employees, X and Y. He desires a deduction of $100,000 and a death benefit of $3,000,000. Based upon the salaries noted below, the approximate insurance costs would be calculated as follows if the plan were discriminatory, that is, not a VEBA:

Employee Salary Multiple Death Benefit Cost

Dr A $300,000 10 $3,000,000 $99,400

X 40,000 10 400,000 400

Y 20,000 10 200,000 200

If instead, the Plan were a VEBA, Dr. A’s salary would be limited to $150,000 (plus inflation) for purposes of computing the benefits. In order to get a death benefit of $3,000,000, Dr. A’s benefit multiple must be 20 instead of 10. Accordingly, the multiple (and probably the cost) would double for the other employees. In this example, it would cost Dr. A $600 additional per year to use a VEBA. Is the non-VEBA really a bargain? Maybe not, if you consider the risks.

Excise Tax Issues:

First, most people are not aware of a tax case called Grant-Jacoby v. Commissioner which held that a discriminatory welfare plan can be recharacterized as a plan of deferred compensation. Secondly, and most importantly, failing to adhere to the nondiscrimination rules exposes the plan to a possible excise tax under § 4976 if the IRS determines that the intentional over-funding of the plan (let’s not kid ourselves) constitutes provision of a contemplated (although unstated) post-retirement benefit. This excise tax is not deductible, but its potential is disastrous. Regardless of the language of plan documents, if a plan looks like it could be a vehicle for provision of benefits beyond the ERISA normal retirement age (age 65 or 5 years of service), and in fact operates that way, § 4976 exposure looms large. Because there have been no cases on § 4976 it is difficult to predict how it will be applied, but the potential for application is too serious for the prudent practitioner to ignore.

It is highly doubtful that any operator of a non-VEBA taxable 419 welfare plan will give an absolute warranty against application of § 4976. Is the risk of a 100% excise tax worth the present savings of a few hundred dollars per year in term insurance premium? More pointedly, should a client who is worried about a few hundred (or few thousand dollars) per year in additional costs be considering a welfare plan in the first place? Notwithstanding, in groups where the costs for non-HCEs would be prohibitive, there is always available a legal way to reduce costs through proper structure of a management company. At least we know the IRS has publicly doubted its ability to defeat this strategy. Management companies are also great vehicles to use to accomplish other estate planning goals.

There is much to be said for conservatism. A wise man once said: “Bulls and bears make money. Pigs get slaughtered.” Just ask Mr. and Mrs. Robert Booth, Dr. Harry Wellons, and thousands of other famous and anonymous tax casualties who have tried the easier, rosier-looking path.
Lance Wallach opines about this well written article. John is very smart and while I do not agree with some of this older article, I wish John luck in his ongoing fight with the IRS.

412(i)/419 Litigation

  Lance Wallach


What is it?


A 412(i) plan is a “defined benefit plan” – a retirement plan, a pension plan that claims to offer very large tax deductions. It is funded with annuity and life insurance products.


A 419 plan is a “welfare benefit plan” – typically used for medical expenses, severance benefits, death benefits and the like. They started as 419af6 and then when the IRS went after them changed and were called 419e, single employer plans, or other names that promoters gave them. IRS calls most of them listed transactions.




Late 1990s/early 2000s, agents sold life insurance, and annuities policies to fund such plans.

Type of policy typically had high surrender charges, depressed cash value in early years - premiums paid by employer

After premiums funded for a few years, employee purchases policy for the current depressed cash surrender value

After policy purchased, surrender charges dramatically reduced, cash value “springs” to a high level

Employee could then borrow from high value policy for tax-free cash flow. They were called springing cash value policies.




In 1995 IRS issued IRS notice 9534 warning that they would come after 419 plans. In 2004/2005, IRS began investigating and issued regulations deeming such plans as abusive tax shelters - began nationwide audits of such plans.

Plaintiffs in these matters are typically professional groups (doctors, dentists, small business owners) audited by the IRS - plans deemed abusive tax shelters – subject to substantial fees and penalties. Participants must file under IRS 6707A to avoid additional large fines. Material advisors, people that sold the plans and accountants that gave tax advice and got paid also get fined a minimum of $100,000 if they do not properly file and tell on their client.

Professionals then file suit against insurance companies and agents claiming they were misled in the sale of these plans and policies.

Allegations typically:

Defendants represented that policies used to fund plans would be valid and subject to favorable future tax consequences

 To Date - Mixed Results for Carriers:


1. Breach of contract


Claim dismissed - contract never promised to satisfy § 412 requirements, specifically stated that it did not guarantee any future tax consequences. Zarrella v. Pacific Life, 755 F. Supp. 2d 1231 (S.D. FL March 29, 2011) (Florida law)

Claim allowed to precede - allegations pled existence of written and oral contracts promising tax benefits. Chau v. Aviva Life, 2011 U.S. Dist. LEXIS 54828 (N.D. Tex May 20, 2011) (applying Washington law).


2. Negligence

Claim dismissed because carrier is under no duty to advise its insured’s regarding tax consequences of transactions. Zarrella v. Pacific Life, (S.D. FL March 29, 2011).

 3. Fraud/Misrepresentation

A. Future statements:

Alleged misrepresentations made before the IRS pronouncements calling into question tax benefits of the various plans generally dismissed on grounds:

(i) Statements were not false when made, or

(ii) Statements were mere opinions or predictions that are not actionable.

Berry v. Indianapolis Life, 608 F. Supp. 2d 785 (N.D. Tex. 2009, August 26, 2010)

Zarrella v. Pacific Life, 755 F. Supp. 2d 1231 (S.D. FL March 29, 2011)

Chau v. Aviva Life, 2011 U.S. Dist. LEXIS 54828 (N.D. Tex May 20, 2011)

Courts generally determine that statements made by agents prior to 2004/2005 are “forward-looking” statements or “opinions” and that “as a matter of law, any representation or prediction by any alleged agent as to how the IRS would treat the 412(i) plans and finding thereof in the future is either an unsanctionable opinion or was unjustifiably relied upon.” Berry v. Indianapolis Life


To Date - Mixed Results for Carriers:

 B. “Disclaimer of Reliance” defense – results mixed

Typically, in the plan documents, participant agrees he is not relying on carrier’s representations regarding the validity of the plan or its tax benefits - instead relying on own independent tax advisor

Cal. law – signed disclosure statements by plaintiffs preclude reasonable reliance on representations as a matter of law - claim dismissed.

Berry v. Indianapolis Life

Omni Home v. Hartford Life, 2008 Dist. LEXIS 35259 (S.D. Cal. April 29, 2008).

Texas and Wisconsin law – disclosure documents do not preclude reliance as a matter of law. Berry v. Indianapolis Life

 To date, success in dismissing claims depends upon the different courts, and applicable governing law.

Note: If alleged misrepresentations made after applicable IRS pronouncement, then representations are not predictions or opinions, but rather statements regarding the existing state of the law – probably allowed to proceed.

 Most attorneys will lose these cases. As an expert witness Lance Wallach’s side has NEVER lost a case. To win you need to mitigate the damages.  You need to properly file under IRS code 6707A. As an aside there is no IRS statute of limitations on fines etc. unless you PROPERLY file under IRS 6707A. It is very hard to properly file after the fact, as the IRS directions are not very helpful. Lance Wallach has received hundreds of phone calls from people seeking help on IRS fines etc. First IRS audits and denies the deductions with interest and penalties. Then, sometimes years later IRS comes back again to access very large fines under 6707A for not filing or not properly filing. Accountants tell their clients, after the first audit, you are done with the IRS. THIS is NOT TRUE. IRS comes back a second time if the forms are not properly filed, or not filed at all.


To win you need to show that the disclaimers were fraudulent because they did not include the facts that IRS was looking into these plans.


Lance Wallach spoke at the American Society of Pension Actuary’s national convention in 2002 about these plans. The IRS chief actuary also spoke about the IRS looking at these plans. IRS gave notice in 1995 under 9534 warning of these plans. Lance Wallach has been authoring articles for various accounting publications and books since the 90s warning of these plans. Insurance companies, promoters of these abusive tax shelters accountant and attorneys were on notice of the problems.



Lance Wallach, CLU, ChFC, CIMC, speaks and writes extensively about financial planning, retirement plans, and tax reduction strategies. He is an American Institute of CPA’s course developer and instructor and has authored numerous bestselling books about abusive tax shelters, IRS crackdowns and attacks and other tax matters. He speaks at more than 20 national conventions annually and writes for more than 50 national publications. For more information and additional articles on these subjects, call 516-938-5007.

The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.




IRS Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations.

Pursuant to the Regulatory Flexibility Act (5.U.S.C. chapter 6), it is hereby certified that the regulations will not have a significant economic impact on a substantial number of small entities. The regulations require that series and series organizations file a statement to provide the IRS with certain identifying information to ensure the proper assessment and collection of tax. The regulations affect domestic series LLCs, domestic cell companies, and foreign series and cells that conduct insurance businesses, and their owners. Based on information available at this time, the IRS and the Treasury Department believe that many series and series organizations are large insurance companies or investment firms and, thus, are not small entities. Although a number of small entities may be subject to the information reporting requirement of the new statement, any economic impact will be minimal. The information that the IRS and the Treasury Department are considering requiring on the proposed statement should be known by or readily available to the series or the series organization. Therefore, it should take minimal time and expense to collect and report this information. For example, the IRS and the Treasury Department are considering requiring the following information: (1) The name, address, and taxpayer identification number of the series organization and each of its series and status of each as a series of a series organization or as the series organization; (2) The jurisdiction in which the series organization was formed; and (3) An indication of whether the series holds title to its assets or whether title is held by another series or the series organization and, if held by another series or the series organization, the name, address, and taxpayer identification number of the series organization and each series holding title to any of its assets. The IRS and the Treasury Department request comments on the accuracy of the statement that the regulations in this document will not have a significant economic impact on a substantial number of small entities. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses.

Comments and Requests for a Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments (a signed original and eight (8) copies) that are submitted timely to the IRS. Alternatively, taxpayers may submit comments electronically directly to the Federal eRulemaking portal at www.regulations.gov.

The IRS and the Treasury Department request comments on the proposed regulations. In addition, the IRS and the Treasury Department request comments on the following issues:

(1) Whether a series organization should be recognized as a separate entity for Federal tax purposes if it has no assets and engages in no activities independent of its series;

(2) The appropriate treatment of a series that does not terminate for local law purposes when it has no members associated with it;

(3) The entity status for Federal tax purposes of foreign cells that do not conduct insurance businesses and other tax consequences of establishing, operating, and terminating all foreign cells;

(4) How the Federal employment tax issues discussed and similar technical issues should be resolved;

(5) How series and series organizations will be treated for state employment tax purposes and other state employment-related purposes and how that treatment should affect the Federal employment tax treatment of series and series organizations (comments from the states would be particularly helpful);

(6) What issues could arise with respect to the provision of employee benefits by a series organization or series; and

(7) The requirement for the series organization and each series of the series organization to file a statement and what information should be included on the statement.

All comments will be available for public inspection and copying. A public hearing may be scheduled if requested in writing by a person who timely submits comments. If a public hearing is scheduled, notice of the date, time and place for the hearing will be published in the Federal Register.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 301 is proposed to be amended as follows:


Paragraph 1. The authority citation for part 301 is amended by adding entries in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Section 301.6011-6 also issued under 26 U.S.C. 6011(a). * * *

Section 301.6071-2 also issued under 26 U.S.C. 6071(a). * * *

Par. 2. Section 301.6011-6 is added to read as follows:

§301.6011-6 Statements of series and series organizations.

(a) Statement required. Each series and series organization (as defined in paragraph (b) of this section) shall file a statement for each taxable year containing the identifying information with respect to the series or series organization as prescribed by the Internal Revenue Service for this purpose and shall include the information required by the statement and its instructions.

(b) Definitions—(1) Series. The term series has the same meaning as in §301.7701-1(a)(5)(viii)(C).

(2) Series organization. The term series organization has the same meaning as in §301.7701-1(a)(5)(viii)(A).

(c) Effective/applicability date. This section applies to taxable years beginning after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register.

Par. 3. Section 301.6071-2 is added to read as follows:

§301.6071-2 Time for filing statements of series and series organizations.

(a) In general. Statements required by §301.6011-6 must be filed on or before March 15 of the year following the period for which the return is made.

(b) Effective/applicability date. This section applies to taxable years beginning after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register.

Par. 4. Section 301.7701-1 is amended by:

1. Adding paragraph (a)(5).

2. Revising paragraphs (e) and (f).

The additions and revisions read as follows:

§301.7701-1 Classification of organizations for Federal tax purposes.

(a) * * *

(5) Series and series organizations—(i) Entity status of a domestic series. For Federal tax purposes, except as provided in paragraph (a)(5)(ix) of this section, a series (as defined in paragraph (a)(5)(viii)(C) of this section) organized or established under the laws of the United States or of any State, whether or not a juridical person for local law purposes, is treated as an entity formed under local law.

(ii) Certain foreign series conducting an insurance business. For Federal tax purposes, except as provided in paragraph (a)(5)(ix) of this section, a series organized or established under the laws of a foreign jurisdiction is treated as an entity formed under local law if the arrangements and other activities of the series, if conducted by a domestic company, would result in classification as an insurance company within the meaning of section 816(a) or section 831(c).

(iii) Recognition of entity status. Whether a series that is treated as a local law entity under paragraph (a)(5)(i) or (ii) of this section is recognized as a separate entity for Federal tax purposes is determined under this section and general tax principles.

(iv) Classification of series. The classification of a series that is recognized as a separate entity for Federal tax purposes is determined under paragraph (b) of this section.

(v) Jurisdiction in which series is organized or established. A series is treated as created or organized under the laws of a State or foreign jurisdiction if the series is established under the laws of such jurisdiction. See §301.7701-5 for rules that determine whether a business entity is domestic or foreign.

(vi) Ownership of series and the assets of series. For Federal tax purposes, the ownership of interests in a series and of the assets associated with a series is determined under general tax principles. A series organization is not treated as the owner for Federal tax purposes of a series or of the assets associated with a series merely because the series organization holds legal title to the assets associated with the series.

(vii) Effect of Federal and local law treatment. To the extent that, pursuant to the provisions of this paragraph (a)(5), a series is a taxpayer against whom tax may be assessed under Chapter 63 of Title 26, then any tax assessed against the series may be collected by the Internal Revenue Service from the series in the same manner the assessment could be collected by the Internal Revenue Service from any other taxpayer. In addition, to the extent Federal or local law permits a debt attributable to the series to be collected from the series organization or other series of the series organization, then, notwithstanding any other provision of this paragraph (a)(5), and consistent with the provisions of Federal or local law, the series organization and other series of the series organization may also be considered the taxpayer from whom the tax assessed against the series may be administratively or judicially collected. Further, when a creditor is permitted to collect a liability attributable to a series organization from any series of the series organization, a tax liability assessed against the series organization may be collected directly from a series of the series organization by administrative or judicial means.

(viii) Definitions—(A) Series organization. A series organization is a juridical entity that establishes and maintains, or under which is established and maintained, a series (as defined in paragraph (a)(5)(viii)(C) of this section). A series organization includes a series limited liability company, series partnership, series trust, protected cell company, segregated cell company, segregated portfolio company, or segregated account company.

( Series statute. A series statute is a statute of a State or foreign jurisdiction that explicitly provides for the organization or establishment of a series of a juridical person and explicitly permits—

(1) Members or participants of a series organization to have rights, powers, or duties with respect to the series;

(2) A series to have separate rights, powers, or duties with respect to specified property or obligations; and

(3) The segregation of assets and liabilities such that none of the debts and liabilities of the series organization (other than liabilities to the State or foreign jurisdiction related to the organization or operation of the series organization, such as franchise fees or administrative costs) or of any other series of the series organization are enforceable against the assets of a particular series of the series organization.

(C) Series. A series is a segregated group of assets and liabilities that is established pursuant to a series statute (as defined in paragraph (a)(5)(viii)( of this section) by agreement of a series organization (as defined in paragraph (a)(5)(viii)(A) of this section). A series includes a series, cell, segregated account, or segregated portfolio, including a cell, segregated account, or segregated portfolio that is formed under the insurance code of a jurisdiction or is engaged in an insurance business. However, the term series does not include a segregated asset account of a life insurance company. See section 817(d)(1); §1.817-5(e). An election, agreement, or other arrangement that permits debts and liabilities of other series or the series organization to be enforceable against the assets of a particular series, or a failure to comply with the record keeping requirements for the limitation on liability available under the relevant series statute, will be disregarded for purposes of this paragraph (a)(5)(viii)(C).

(ix) Treatment of series and series organizations under Subtitle C — Employment Taxes and Collection of Income Tax (Chapters 21, 22, 23, 23A, 24 and 25 of the Internal Revenue Code). [Reserved.]

(x) Examples. The following examples illustrate the principles of this paragraph (a)(5):

Example 1. Domestic Series LLC. (i) Facts. Series LLC is a series organization (within the meaning of paragraph (a)(5)(viii)(A) of this section). Series LLC has three members (1, 2, and 3). Series LLC establishes two series (A and pursuant to the LLC statute of state Y, a series statute within the meaning of paragraph (a)(5)(viii)( of this section. Under general tax principles, Members 1 and 2 are the owners of Series A, and Member 3 is the owner of Series B. Series A and B are not described in §301.7701-2(b) or paragraph (a)(3) of this section and are not trusts within the meaning of §301.7701-4.

(ii) Analysis. Under paragraph (a)(5)(i) of this section, Series A and Series B are each treated as an entity formed under local law. The classification of Series A and Series B is determined under paragraph (b) of this section. The default classification under §301.7701-3 of Series A is a partnership and of Series B is a disregarded entity.

Example 2. Foreign Insurance Cell. (i) Facts. Insurance CellCo is a series organization (within the meaning of paragraph (a)(5)(viii)(A) of this section) organized under the laws of foreign Country X. Insurance CellCo has established one cell, Cell A, pursuant to a Country X law that is a series statute (within the meaning of paragraph (a)(5)(viii)( of this section). More than half the business of Cell A during the taxable year is the issuing of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies. If the activities of Cell A were conducted by a domestic company, that company would qualify as an insurance company within the meaning of sections 816(a) and 831(c).

(ii) Analysis. Under paragraph (a)(5)(ii) of this section, Cell A is treated as an entity formed under local law. Because Cell A is an insurance company, it is classified as a corporation under §301.7701-2(b)(4).

* * * * *

(e) State. For purposes of this section and §§301.7701-2 and 301.7701-4, the term State includes the District of Columbia.

(f) Effective/applicability dates—(1) In general. Except as provided in paragraphs (f)(2) and (f)(3) of this section, the rules of this section are applicable as of January 1, 1997.

(2) Cost sharing arrangements. The rules of paragraph (c) of this section are applicable on January 5, 2009.

(3) Series and series organizations—(i) In general. Except as otherwise provided in this paragraph (f)(3), paragraph (a)(5) of this section applies on and after the date final regulations are published in the Federal Register.

(ii) Transition rule—(A) In general. Except as provided in paragraph (f)(3)(ii)( of this section, a taxpayer’s treatment of a series in a manner inconsistent with the final regulations will be respected on and after the date final regulations are published in the Federal Register, provided that—

(1) The series was established prior to September 14, 2010;

(2) The series (independent of the series organization or other series of the series organization) conducted business or investment activity, or, in the case of a series established pursuant to a foreign statute, more than half the business of the series was the issuing of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies, on and prior to September 14, 2010;

(3) If the series was established pursuant to a foreign statute, the series’ classification was relevant (as defined in §301.7701-3(d)), and more than half the business of the series was the issuing of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies for all taxable years beginning with the taxable year that includes September 14, 2010;

(4) No owner of the series treats the series as an entity separate from any other series of the series organization or from the series organization for purposes of filing any Federal income tax returns, information returns, or withholding documents in any taxable year;

(5) The series and series organization had a reasonable basis (within the meaning of section 6662) for their claimed classification; and

(6) Neither the series nor any owner of the series nor the series organization was notified in writing on or before the date final regulations are published in the Federal Register that classification of the series was under examination (in which case the series’ classification will be determined in the examination).

( Exception to transition rule. Paragraph (f)(3)(ii)(A) of this section will not apply on and after the date any person or persons who were not owners of the series organization (or series) prior to September 14, 2010, own, in the aggregate, a fifty percent or greater interest in the series organization (or series). For purposes of the preceding sentence, the term interest means—

(1) In the case of a partnership, a capital or profits interest; and

(2) In the case of a corporation, an equity interest measured by vote or value.

Steven T. Miller,
Deputy Commissioner for
Services and Enforcement.


(Filed by the Office of the Federal Register on September 13, 2010, 8:45 a.m., and published in the issue of the Federal Register for September 14, 2010, 75 F.R. 55699)

Drafting Information

The principal author of these proposed regulations is Joy Spies, IRS Office of the Associate Chief Counsel (Passthroughs and Special Industries). However, other personnel from the IRS and the Treasury Department participated in their development.


The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.



The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.

Taxpayers Who Previously Adopted 419, 412i, Captive Insurance or Section 79 Plans are in Big Trouble

June 15, 2011     By Lance Wallach, CLU, CHFC 

PhoneCall (516) 938-5007

In recent years, the IRS has identified many of these arrangements as abusive devices to funnel tax deductible dollars to shareholders and classified these arrangements as listed transactions." Insurance agents, financial planners, accountants and attorneys seeking large life insurance commissions sold these plans.

In general, taxpayers who engage in a “listed transaction” must report such transaction to the IRS on Form 8886 every year that they “participate” in the transaction, and you do not necessarily have to make a contribution or claim a tax deduction to participate. Section 6707A of the Code imposes severe penalties for failure to file Form 8886 with respect to a listed transaction. But you are also in trouble if you file incorrectly. I have received numerous phone calls from business owners who filed and still got fined. Not only do you have to file Form 8886, but it also has to be prepared correctly. I only know of two people in the U.S. who have filed these forms properly for clients. They tell me that was after hundreds of hours of research and over 50 phones calls to various IRS personnel. The filing instructions for Form 8886 presume a timely filling. Most people file late and follow the directions for currently preparing the forms. Then the IRS fines the business owner. The tax court does not have jurisdiction to abate or lower such penalties imposed by the IRS.
To Read More:


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