A business owner wants legitimate tax planning ideas. One solution sometimes offered today is a 419(e) plan (419 Welfare Benefit Plan). The local insurance agent or the company’s CPA who may have an insurance sales license, may suggest that the 419 Welfare Benefit Plan will provide shelter from taxes today, the costs of the plan are tax deductible and the plan will provide tax free benefits for the owner when he or she is ready to retire. The concept seems too good to be true.
Watch out because the IRS is watching, and it often says that the plan is too good to be true. A 419 Welfare Benefit Plan is generally a plan set up in the form of a trust to provide certain benefits to the employees of a company. You will notice that the term trust is used because the large whole life insurance policies that the owner is instructed to buy go into a trust where neither the company nor the business owner actually owns them. The trust owns the policies.
The insurance agent or CPA wants you to set up a 419(e) plan because you are agreeing to buy high dollar life insurance with premiums payable until you retire. That can generate fees of up to 125% of the first year premium as a commission – that’s right; you read that correctly – 125%.
The plan is sold as a win-win for everyone. It is for the insurance company because it locks the business owner into long-term, expensive insurance. It is for the trust administrator (remember: the insurance policies must be put into a trust to make the plan work) because the business owner has to pay a fee every year to administer the plan. But for the business owner? Maybe not so much!
The big sales pitch often is that the contributions are tax deductible to the business and the business can exclude employees. Moreover, the seller promises that the big insurance policies that are paid for with tax free money can be cashed out or transferred from the trust to the business owner at some later date without paying taxes. It is all so easy: no taxes in and no taxes out. Good right?
Unfortunately, it is often too good to be true. The IRS has been actively attacking such 419 Welfare Benefit Plans as TAX SHELTERS. If a transaction is classified as a tax shelter then the salesperson and your CPA are supposed to tell you to file an 8886 form which highlights tax shelters to the IRS. Think of it as a beacon so that the IRS knows who to come pursue for taxes, penalties, interest and listed transaction charges.
The IRS focus on 419(e) plans came up in a case identified as Curcio v. Commissioner of Internal Revenue, T.C. Memo 2010-115.