Transcript Lance Wallach - CommPartners

Ethics: Insider Secrets
to Avoid Malpractice and Huge
Penalties
Presented by Lance Wallach, CLU, CHFC, CIMC, a
frequent speaker on pensions, VEBAs, financial
and estate planning, practice management, and
tax-oriented strategies at accounting and financial
planning.
This webinar will help you navigate some of the
current ethical minefields inherent in practice today,
especially under Circular 230.
 Understand many of the abusive insurance and annuity based
products being marketed to your clients and how to alleviate
IRS scrutiny.
 Identify potentially abusive deductions claimed on tax returns,
which include many popular retirement and welfare benefit
plans. Learn about various disclosure requirements and how to
avoid large penalties, both to yourself and your client.
 Protect your senior clients from abusive life settlements, reverse
mortgages, annuities and more.
 Discover opportunities available under the Pension Protection
Act and new regulations, and how to use them correctly.
 This webinar will give you expertise in tax shelters, listed
transactions, captive insurance, 419 and 412i plans, premium
finance, and other potentially abusive products and strategies.
Disclaimer
The information provided herein is not intended as legal,
accounting, financial, or any other type of advice for any
specific individual or other entity. You should contact an
appropriate professional for any such advice.
Notice Pursuant to IRS Circular 230
Any tax advice expressed in this communication (including
any attachments) is not intended to be used, and cannot be
used, for the purpose of avoiding penalties imposed on the
taxpayer by any governmental taxing authority or agency.
 Insurance agents often sell ways to deduct
life insurance premiums
 This is usually done in 419 plans
 Most of these deductions are disallowed on
audit
 Notice 2007-83 was issued on 10/17/2007
 It identified certain trust arrangements
involving cash value life insurance as listed
transactions.
 Revenue Ruling 2007-65 was issued
simultaneously
 It is now clear that an employer cannot claim
deductions for cash value life insurance inside
of 419 plans
 Persons participating in a listed transaction
have disclosure obligations
 They must file Form 8886 with their tax
returns
 Failure to file and disclose results in penalties
of up to $200,000
 These penalties can also be imposed upon
agents, advisors, and other professionals
 Taxpayers who otherwise would be required
to file a disclosure statement prior to Jan. 15,
2008, as a result of Notice 2007-83 had until
Jan. 15, 2008, to make the disclosure
 Revenue Ruling 2007-65 has the same target
as Notices 2007-83 and 2007-84
 The target is those arrangements where cash
value life insurance is purchased on employees
who are owners of the business
 Sometimes it is also purchased on key
employees
 Term insurance is them purchased on the lives
of other employees
 These plans are currently sold as 419(e),
419A(f)(6), or 419 plans
 Sometimes they are sold as single employer
plans
 It is anticipated that the plan will be terminated
with the cash value policies being distributed to
owners or key employees
 Little if anything goes to the other employees
 Promoters claim the insurance premiums are a
current deduction
 The ruling makes it absolutely clear that this is
not the case
 Most businesses cannot deduct the cost of
premiums paid through a 419 (welfare
benefit) plan for cash value life insurance
 The ruling also describes arrangements that
may be listed transactions
 These plans are usually sold by insurance
agents and financial planners
 They are also sometimes sold by accountants
and attorneys
 There is an excellent chance that the
accountant with a client or or clients in these
plans will be deemed a “material advisor” to
these plans
 You are a material advisor if the client
participated in the plan, you gave the client tax
advice with respect to the transaction, and
yourself and/or a related entity received
$10,000 or more in compensation
 The material advisor must file Form 8918. As
with the 8886 form (for taxpayers) failure to file
or even incomplete, misleading, or inaccurate
filings can lead to penalties of $100,000 for
individuals or $200,000 for corporations
 A filing on a protective basis is possible if the
advisor believes, in good faith, either that he
does not meet the income threshold or that the
transaction in question is not a listed one.
Professional discipline is even
possible in connection with this
area, as is indirect (as a witness) or
even direct (as a defendant)
involvement in legal proceedings
 There are many reasons why the IRS may
challenge the claimed tax benefits of these
arrangements
 The Section 4976 100 percent excise tax may
disqualify benefits provided to owneremployees or key employees
 Where property, including life insurance
policies, is not properly valued, the IRS will
challenge the value
 In a proper arrangement, deductions are
limited by IRC Sections 419 and 419A
 Depending on facts and circumstances, the
rules for split-dollar arrangements may apply
 Again depending on facts and circumstances,
contributions on behalf of an owner-employee
may be characterized as dividends or as
deferred compensation pursuant to IRC
404(a)(5) or 409A, or both
 Be especially cautious should a client
approach you with any 419 plan, for both
yourself and the client
 The Government has the names of most
former 419 A(f)(6) promoters, as many
current 419 promoters were
 This leads to increased scrutiny of such
promoters, making audits far riskier and more
likely
More on listed transactions
 Listed transactions are those deemed by the
IRS to be structured for the significant
purpose of tax avoidance or evasion
 Participants in listed transactions must attach
Form 8886 to their tax returns
 There are severe penalties for failure to file
Form 8886 disclosing such participation
 There are also severe penalties for those who
aid and abet participation in listed
transactions
Abusive 412(i) and other
Retirement Plans
On Feb. 13, 2004, the Treasury Department
and Internal Revenue Service issued guidance
to shut down abusive transactions involving
specially designed life insurance policies in
retirement plans, Section “412(i) plans.” The
guidance designates certain arrangements as
“listed transactions” for tax-shelter reporting
purposes
 A “Section 412(i) plan” is a tax qualified
retirement plan that is funded entirely by a
life insurance contract or an annuity. The
employer claims tax deductions for
contributions that are used by the plan to pay
premiums on an insurance contract covering
an employee. The plan may hold the
contract until the employee dies, or it may
distribute or sell the contract to the employee
at a specific point, such as when the
employee retires.
 There are many legitimate Section 412(i) plans,
but some push the envelope, claiming tax
results for employees and employers that do
not reflect the underlying economics of the
arrangements,” according to the IRS.
 One of the main abuses is that any life
insurance contract transferred from an
employer or a tax-qualified plan to an employee
must be taxed at its full fair market value.
Some firms have promoted an arrangement
where an employer establishes a Section 412(i)
plan under which the contributions made to the
plan are used to purchase a specially designed
life insurance contract.
 The insurance contract is designed so that
the cash surrender value is temporarily
depressed
 These contracts are sometimes called
springing cash value insurance
 These abuses also occur in other types of
retirement plans
 Large Companies have long used captive
insurers to reduce premiums paid for property
and casualty insurance
 The amount of money necessary to fund selfinsured visits associated with tangible and
intangible assets is also reduced.
 Large companies commonly establish single
parent captives
 However, for small and medium sized
businesses, the group captive structure and its
protected cell variation can realize cost savings
at a cost far less than establishing a single
parent captive.
 So it is a win-win situation – you save money
while saving money
 The accountant can use the group captive and
captive cell structures to introduce new cost
saving opportunities to business clients
 These opportunities can be enhanced by income
tax and succession planning techniques
commonly used by estate planning professionals
What requirements must be met to
obtain a legitimate tax deduction
while using captive insurance?
 Risk sharing
 Risk distribution
 Using group captives makes it significantly
cheaper to satisfy these requirement,
especially the risk distribution requirement
 More on the risk distribution requirement
 If done properly, premium finance allows large
amounts of life insurance to be obtained with a
small dollar outlay
 Various problems occur if it is done wrong
 It is not a free way to obtain life insurance, and
should not be sold as such
 What spread over the loan interest rate must the
client earn to make this work?
 Is the loan commitment reasonable?
 How long is the loan renewable for? Does its
term exceed life expectancy?
 Is the loan secured by the cash value of the
life insurance?
 Is it a life expectancy program? Such a
program would assume dying at the IRS life
expectancy
 Problem – if the client lives beyond that, the
loan amount begins to exceed cash value,
and the program unravels
 If policy cash values do not grow faster than
the loan amount, the design will fail
 Caution – there is little IRS guidance on
whether a personally owned or business
owned policy falls under an investment
interest situation, allowing loan interest to be
deducted. In general, interest on a loan to
acquire a life insurance policy is considered
personal interest and is not deductible
 Using this strategy sometimes leads to estate
tax problems
 Investor or stranger owned life insurance is
different from premium finance and should
not be confused with it
 IOLI or STOLI often involve financing the
purchase of a policy. The policy is then sold
as an investment to a stranger
 STOLI may be illegal in some jurisdictions
 In a life settlement, an unneeded policy is sold
to a third party, usually an institutional investor
 They originated with the viatical settlements
formerly used by AIDS patients
 It is projected that the industry may ultimately
grow to an annual volume of $160 billion
 There are licensing and commission disclosure
requirements in some jurisdictions
Tax considerations and other
insurance issues
• Surrendering a life insurance policy can result
in a taxable gain, but no deduction is allowed
in the event of a loss
• Clients can benefit from the Section 1035
exchange and the insurance swapout process,
but, depending on the situation, there can be
reasons not to use these strategies
 One reason is if the client’s health has
declined, making it impossible to obtain a
new policy at favorable rates
 The client may have to enter a new surrender
charge period, which would affect cash value
liquidity. Or the client may simply be
unsuitable for a new product
 The accountant should be aware that
sometimes the objective of transactions such
as this is to generate commissions
 New surrender charge
 New suicide and contestability period
 Tax consequences are possible if the existing
loan is not paid off prior to the exchange
 The accountant receiving compensation from
the transaction should disclose that in writing,
detailing any possible conflicts of interest
arising from the receipt of compensation.
Reasons for the transaction should also be set
forth in writing
 Fill out all state regulatory forms. Go the extra
mile in the regulatory arena, as appropriate
 The accountant, even if not initiating or
suggesting the transaction, must be
knowledgeable and well versed about the issues
involved
 There are abusive sales practices that have
targeted and victimized seniors
 One is inducing seniors into reverse mortgages.
Unnecessary annuity products of questionable
benefit to the senior are the sold, and purchased
with the mortgage proceeds
 These annuities tend to feature abusive high
commissions and long surrender periods
 But the accountant should bear in mind that not
all annuities are bad, and that reverse
mortgages can serve a useful purpose
 The real trick is separating the good from the
bad
What is the accountant’s
role in all this?
 The accountant should never engage in
“dabbling”. That is accepting professional
engagements that you are unable to handle
competently, perhaps featuring the selling,
buying, or use of products which you are not
familiar
 Should you consider being your client’s
contractor? The accountant should be
familiar with the legal ramifications of
independent contractor vs. employee, and
tax aspects as well
 Learn to use opportunities created by the
Pension Protection Act wisely and correctly,
notably the cash balance plan
Questions?
ADDITIONAL RESOURCES
 www.vebaplan.com
The NSA MemberLink
NSA 63RD Annual Meeting
The NSA Tax Talk
The CPA’s Guide to Life Insurance by Lance
Wallach published by Bisk cpeasy
Various published articles included with this
webinar
I welcome your calls and emails to discuss
these issues. I spend most days speaking
with accountants like you anyway and I
don’t have a life. No, seriously, contact
me so that we can try to help you.
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Lance Wallach 516-938-5007
Fax 516-938-6330
Email [email protected]
www.vebaplan.com