Captive Insurance and Section 79 Scams, 419e and 412i Producing Large IRS fines

by Lance Wallach
by Lance Wallach

Have you ever heard of captive insurance, a 419 welfare benefit plan, a 412i defined benefit insurance plan or a Section 79 scam? You may have a client in one, or be in one yourself and not even know it. You would learn quickly when the IRS disallows your tax deduction and tries to fine you lots of money. What you are about to read about below may seem impossible in America. The IRS first audits, disallows deductions, and charges interest and penalties for being in one of these abusive plans. You then think you are finished with them. Soon thereafter, you get fined hundreds of thousand of dollars for not reporting yourself to the IRS. I have been helping successful business owners and professionals with this problem for years. I have authored numerous books for the American Institute of CPAs with chapters on this problem.

I have spoken at many conventions on this topic and argued with a lot of people who didn’t think this would ever happen to them. They purchased products sold primarily by insurance agents from large well known insurance companies like Prudential, Pacific Life, Mass Mutual, Guardian, American General, etc. The plans had opinion letters from lawyers. The business owner’s accountants signed tax returns taking deductions for these plans with insurance products. Why are the business owners and professionals being fined a huge amount of money by various divisions of the IRS for doing what seemed like a legitimate thing to do? How can something like this happen in America? When many of the business owners and accountants finally take their heads out of the sand, they are usually put out of business by these fines.

Years ago, most successful insurance agents were making big money selling 419 and 412i plans. Now they are selling captive insurance and Section 79 scams to unsuspecting business owners and professionals. Most of the plans were sold to successful business owners as plans with large tax deductions where money would grow tax free until needed, whether in retirement or sooner. I frequently spoke at national accounting and other conventions talking about the problems with most of these plans. I would be attacked by some attendees who where making large insurance commissions selling the plans. I would try to warn insurance company home office executives, but they too had their heads in the sand because of all the money these plans brought in. Now they look foolish when their depositions in the lawsuits are taken. Later, the IRS got tough and started fining the unsuspecting business owners and professionals hundreds of thousands a year for not reporting on themselves for being in these plans. The agents and insurance companies would advise not to report to the IRS, “This is a good plan. We have approval.” Not only were the business owners fined under IRS Code 6707A, but the insurance agents were also fined $100,000 for not reporting on themselves. Accountants who signed tax returns are even being fined $100,000 by the IRS. Then the business owners sue the accountants, insurance agents, etc. I have been following these scenarios for a long time. In fact, I have been an expert witness in many of these cases, and my side has never lost.

Let me give you an example:

A 40-year-old doctor with four employees earns, as pre-tax take-home pay, $500,000 a year. So he was told to contribute $200,000 a year into a 419 plan, and to claim a tax deduction in that amount. The money would go into the plan, where it would grow in a tax-free manner because it was invested in cash value life insurance. After funding $1 million over five years, the policy would continue to grow tax deferred and, ultimately, would grow to some outrageous amount, which would be used by the doctor in retirement.

419 plan participant hit with penalties for not disclosing participation in a listed tax transaction .

The IRS notices and revenue rulings that came out against 419 plans stated with clarity that 419 plans using cash value life insurance are listed tax transactions. The consequence of which is that, if you use one of these plans, you have to notify the IRS that you are doing so.

Most promoters of 419 plans told clients that their plans complied with the laws and, therefore, were not listed transactions. Unfortunately, the IRS doesn’t care what a promoter of a tax-avoidance plan says; it makes its own determination and punishes those who don’t comply.

The McGehee Family Clinic, P.A. was recently hit with back taxes and a penalty under Code Sec. 6662A in conjunction with a deduction claimed under the Benistar 419 plan

Dr. McGehee’s clinic took a deduction for a 419 plan (the Benistar plan) back in 2005. Eventually, the McGhee Family Clinic was audited. After the audit, the doctor was told that the deduction would be disallowed and that back taxes were due. Additionally, Dr. McGehee was hit with a 20 percent accuracy-related penalty under Code Sec. 6662A. Finally, the tax court sustained the IRS’s determination that McGehee was subject to the increased 30 percent penalty, because its return did not include a disclosure statement indicating its participation in the Benistar Trust. I think that in addition to the aforementioned fines, IRS will now impose, both on a corporate and personal level, another $200,000 or more, under IRC 6707A, for not properly disclosing his participation in a listed transaction. There was a moratorium on those fines until June 2010 pending new legislation to reduce them. The fines had been $200,000 per year on the corporate level and $100,000 per year on the personal level. You got the fine even if you made no contributions for the year. All you had to do was to be in the plan. So Dr McGehee’s fine would be a total of $300,000 per year for every year that he and his corporation were in the plan. IRS also says the fine is not appealable. Under Section 6707A his fine would be in the million-dollar range, in addition to all the other fines.

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