Apply to join FinanceExperts.org, the leading organization for accounting, legal, insurance, finance, and other experts in related fields. If approved by our board,you will be allowed to co author articles written by our experts which appear in 51 national publications, be quoted in best selling books that our experts author and much much more.. In addition, business owners and high income people are referred to our experts by zip code. No more than 1000 experts are accepted as members, and no more than one expert per zip code.There are currently 11 openings. You do not have to be a member to use the financeExperts.org message forum. Email your bio to lanwalla@aol.com. If approved you will be notified.All the experts share the cost of running the organization, which is about $97 per member per year. That cost will go down for renewals, as the sponsors start paying more.

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NEW JERSEY ASSOCIATION OF PUBLIC ACCOUNTANTS

Lines from Lance - Newsletter November 2009



Business Owners, Accountants, and Others Fined $200,000 by IRS and Don’t Know Why

By Lance Wallach
If you are a small business owner, accountant or insurance professional you may be in big trouble and not know it. IRS has been fining people like you $200,000. Most people that have received the fines were not aware that they had done anything wrong. What is even worse is that the fines are not appeal-able. This is not an isolated situation. This has been happening to a lot of people.

Currently, the Internal Revenue Service (“IRS”) has the discretion to assess hundreds of thousands of dollars in penalties under §6707A of the Internal Revenue Code (“Code”) in an attempt to curb tax avoidance shelters. This discretion can be applied regardless of the innocence of the taxpayer and was granted by Congress. It works so that if the IRS determines you have engaged in a listed transaction and failed to properly disclose it, you will be subject to a potentially draconian penalty regardless of any other facts and circumstances concerning the transaction. For some, this penalty has been assessed at almost a million dollars and for many it is the beginning of a long nightmare.

The following is an example: Pursuant to a settlement with the IRS, the 412(i) plan was converted into a traditional defined benefit plan. All of the contributions to the 412(i) plan would have been allowable if they had initially adopted a traditional defined benefit plan. Based on negotiations with the IRS agent, the audit of the plan resulted in no income and minimal excise taxes due. This is because as a traditional defined benefit plan, the taxpayers could have contributed and deducted the same amount as a 412(i) plan.
Towards the end of the audit the business owner received a notice from the IRS. The IRS assessed the client penalties under the §6707A of the Code in the amount of $900,000.00. This penalty was assessed because the client allegedly participated in a listed transaction and allegedly failed to file the form 8886 in a timely manner.

The IRS may call you a material advisor and fine you $200,000.00. The IRS may fine your clients over a million dollars for being in a retirement plan, 419 plan, etc. As you read this article, hundreds of unfortunate people are having their lives ruined by these fines. You may need to take action immediately. The Internal Revenue Service said it will extend until the end of 2009 a grace period granted to small business owners for collection of certain tax-shelter penalties.

But with that deadline approaching, Congress has not yet acted on the tax shelter penalty legislation. IRS Commissioner Doug Shulman said in a letter to the chairmen and ranking members of tax-writing committees that the IRS will continue to suspend its collection efforts with regard to the penalties until Dec. 31, 2009.

"Clearly, a number of taxpayers have been caught in a penalty regime that the legislation did not intend," wrote Shulman. "I understand that Congress is still considering this issue, and that a bipartisan, bicameral, bill may be in the works." The issue relates to penalties for so-called listed transactions, the kinds of tax shelters the IRS has designated most egregious. A number of small business owners that bought employee retirement plans so called 419 and 412(i) plans and others, that were listed by the IRS, and who are now facing hundreds and thousands in penalties, contend that the penalty amounts are unfair.
Leaders of tax-writing committees in the House and Senate have said they intend to pass legislation revising the penalty structure.

The IRS has suspended collection efforts in cases where the tax benefit derived from the listed transaction was less than $100,000 for individuals, or less than $200,000 for firms.

Senator Ben Nelson (D-Nebraska) has sponsored legislation (S.765) to curtail the IRS and its nearly unlimited authority and power under Code Section 6707A. The bill seeks to scale back the scope of the Section 6707A reportable/listed transaction nondisclosure penalty to a more reasonable level. The current law provides for penalties that are Draconian by nature and offer no flexibility to the IRS to reduce or abate the imposition of the 6707A penalty. This has served as a weapon of mass destruction for the IRS and has hit many small businesses and their owners with unconscionable results.

Internal Revenue Code 6707A was enacted as part of the American Jobs Creation Act on October 22, 2004. It imposes a strict liability penalty for any person that failed to disclose either a listed transaction or reportable transaction per each occurrence. Reportable transactions usually fall within certain general types of transactions (e.g. confidential transactions, transactions with tax protection, certain loss generating transaction and transactions of interest arbitrarily so designated as by the IRS) that have the potential for tax avoidance. Listed transactions are specified transactions which have been publicly designated by the IRS, including anything that is substantially similar to such a transaction (a phrase which is given very liberal construction by the IRS). There are currently 34 listed transactions, including certain retirement plans under Code section 412(i) and certain employee welfare benefit plans funded in part with life insurance under Code sections 419A(f)(5), 419(f)(6) and 419(e). Many of these plans were implemented by small business seeking to provide retirement income or health benefits to their employees.

Strict liability requires the IRS to impose the 6707A penalty regardless of innocence of a person (i.e. whether the person knew that the transaction needed to be reported or not or whether the person made a good faith effort to report) or the level of the person’s reliance on professional advisors. A Section 6707A penalty is imposed when the transaction becomes a reportable/listed transaction. Therefore, a person has the burden to keep up to date on all transactions requiring disclosure by the IRS into perpetuity for transactions entered into the past.

Additionally, the 6707A penalty strictly penalizes nondisclosure irrespective of taxes owed. Accordingly, the penalty will be assessed even in legitimate tax planning situations when no additional tax is due but an IRS required filing was not properly and timely filed. It is worth noting that a failure to disclose in the view of the IRS encompasses both a failure to file the proper form as well as a failure to include sufficient information as to the nature and facts concerning the transaction. Hence, people may find themselves subject to the 6707A penalty if the IRS determines that a filing did not contain enough information on the transaction. A penalty is also imposed when a person does not file the required duplicate copy with a separate IRS office in addition to filing the required copy with the tax return. Lance Wallach Commentary. In our numerous talks with IRS, we were also told that improperly filling out the forms could almost be as bad as not filing the forms. We have reviewed hundreds of forms for accountants, business owners and others. We have not yet seen a form that was properly filled in. We have been retained to correct many of these forms.

For more information see www.vebaplan.com, www.lawyer4audits.com, www.irs.gov or e-mail us at lawallach@aol.com

The imposition of a 6707A penalty is not subject to judicial review regardless of whether the penalty is imposed for a listed or reportable transaction. Accordingly, the IRS’s determination is conclusive, binding and final. The next step from the IRS is sending your file to collection, where your assets may be forcibly taken, publicly recorded liens may be placed against your property, and/or garnishment of your wages or business profits may occur, amongst other measures.

The 6707A penalty amount for each listed transaction is generally $200,000 per year per each person that is not an individual and $100,000 per year per individual who failed to properly disclose each listed transaction. The 6707A penalty amount for each reportable transaction is generally $50,000 per year for each person that is not an individual and $10,000 per year per each individual who failed to properly disclose each reportable transaction. The IRS is obligated to impose the listed transaction penalty by law and cannot remove the penalty by law. The IRS is obligated to impose the reportable transaction penalty by law, as well, but may remove the penalty when the IRS determines that removal of the penalty would promote compliance and support effective tax administration.

The 6707A penalty is particularly harmful in the small business context, where many business owners operate through an S corporation or limited liability company in order to provide liability protection to the owner/operators. Numerous cases are coming to light where the IRS is imposing a $200,000 penalty at the entity level and them imposing a $100,000 penalty per individual shareholder or member per year.

The individuals are generally left with one of two options:
Declare Bankruptcy
Face a $300,000 penalty per year.

Keep in mind, taxes do not need to be due nor does the transaction have to be proven illegal or illegitimate for this penalty to apply. The only proof required by the IRS is that the person did not properly and timely disclose a transaction that the IRS believes the person should have disclosed. It is important to note in this context that for non-disclosed listed transactions, the Statue of Limitations does not begin until a proper disclosure is filed with the IRS.

Many practitioners believe the scope and authority given to the IRS under 6707A, which allows the IRS to act as judge, jury and executioner, is unconstitutional. Numerous real life stories abound illustrating the punitive nature of the 6707A penalty and its application to small businesses and their owners. In one case, the IRS demanded that the business and its owner pay a 6707A total of $600,000 for his and his business’ participation in a Code section 412(i) plan. The actual taxes and interest on the transaction, assuming the IRS was correct in its determination that the tax benefits were not allowable, was $60,000. Regardless of the IRS’s ultimate determination as to the legality of the underlying 412(i) transaction, the $600,000 was due as the IRS’s determination was final and absolute with respect to the 6707A penalty. Another case involved a taxpayer who was a dentist and his wife whom the IRS determined had engaged in a listed transaction with respect to a limited liability company. The IRS determined that the couple owed taxes on the transaction of $6,812, since the tax benefits of the transactions were not allowable. In addition, the IRS determined that the taxpayers owed a $1,200,000 section 6707A penalty for both their individual nondisclosure of the transaction along with the nondisclosure by the limited liability company.

Even the IRS personnel continue to question both the legality and the fairness of the IRS’s imposition of 6707A penalties. An IRS appeals officer in an email to a senior attorney within the IRS wrote that “…I am both an attorney and CPA and in my 29 years with the IRS I have never {before} worked a case or issue that left me questioning whether in good conscience I could uphold the Government’s position even though it is supported by the language of the law.” The Taxpayers Advocate, an office within the IRS, even went so far as to publicly assert that the 6707A should be modified as it “raises significant Constitutional concerns, including possible violations of the Eighth Amendment’s prohibition against excessive government fines, and due process protection.”

Senate bill 765, the bill sponsored by Senator Nelson, seeks to alleviate some of above cited concerns. Specifically, the bill makes three major changes to the current version of Code section 6707A. The bill would allow an IRS imposed 6707A penalty for nondisclosure of a listed transaction to be rescinded if a taxpayer’s failure to file was due to reasonable cause and not willful neglect. The bill would make a 6707A penalty proportional to an understatement of any tax due.

Accordingly, non-tax paying entities such as S corporations and limited liability companies would not be subject to a 6707A penalty (individuals, C corporations and certain trusts and estates would remain subject to the 6707A penalty).

There are a number of interesting points to note about this action:
1. In the letter, the IRS acknowledges that, in certain cases, the penalty imposed by section 6707A for failure to report participation in a “listed transaction” is disproportionate to the tax benefits obtained by the transaction.
2. In the letter, the IRS says that it is taking this action because Congress has indicated its intention to amend the Code to modify the penalty provision, so that the penalty for failure to disclose will be more in line with the tax benefits resulting from a listed transaction.


3. The IRS will not suspend audits or collection efforts in appropriate cases. It cannot suspend imposition of the penalty, because, at least with respect to listed transactions, it does not have the discretion to not impose the penalty. It is simply suspending collection efforts in cases where the tax benefits are below the penalty threshold in order to give Congress time to amend the penalty provision, as Congress has indicated to the IRS it intends to do.
4. The legislation does not change the penalty provisions for material advisors.
This is taken directly from the IRS website:

“Congress has enacted a series of income tax laws designed to halt the growth of abusive tax avoidance transactions. These provisions include the disclosure of reportable transactions. Each taxpayer that has participated in a reportable transaction and that is required to file a tax return must disclose information for each reportable transaction in which the taxpayer participates. Use Form 8886 to disclose information for each reportable transaction in which participation has occurred. Generally, Form 8886 must be attached to the tax return for each tax year in which participation in a reportable transaction has occurred. If a transaction is identified as a listed transaction or transaction of interest after the filing of a tax return (including amended returns), the transaction must be disclosed either within 90 days of the transaction being identified as a listed transaction or a transaction of interest or with the next filed return, depending on which version of the regulations is applicable.”

Lance Wallach, CLU, ChFC, CIMC, speaks and writes about benefit plans, tax reductions strategies, and financial plans. He has authored numerous books for the AICPA, Bisk Total tape, and others. He can be reached at (516) 938-5007 or lawallach@aol.com. For more articles on this or other subjects, feel free to visit his website at www.vebaplan.com.

Lance Wallach, the National Society of Accountants Speaker of the Year, speaks and writes extensively about retirement plans, Circular 230 problems and tax reduction strategies. He speaks at more than 40 conventions annually, writes for over 50 publications, is quoted regularly in the press, and has written numerous best-selling AICPA books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Business Hot Spots. He does extensive expert witness work and has never lost a case. Contact him at 516.938.5007 or visit www.vebaplan.com.

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.

NEW JERSEY ASSOCIATION OF PUBLIC ACCOUNTANTS

Lines from Lance - Newsletter November 2009



Business Owners, Accountants, and Others Fined $200,000 by IRS and Don’t Know Why

By Lance Wallach
If you are a small business owner, accountant or insurance professional you may be in big trouble and not know it. IRS has been fining people like you $200,000. Most people that have received the fines were not aware that they had done anything wrong. What is even worse is that the fines are not appeal-able. This is not an isolated situation. This has been happening to a lot of people.

Currently, the Internal Revenue Service (“IRS”) has the discretion to assess hundreds of thousands of dollars in penalties under §6707A of the Internal Revenue Code (“Code”) in an attempt to curb tax avoidance shelters. This discretion can be applied regardless of the innocence of the taxpayer and was granted by Congress. It works so that if the IRS determines you have engaged in a listed transaction and failed to properly disclose it, you will be subject to a potentially draconian penalty regardless of any other facts and circumstances concerning the transaction. For some, this penalty has been assessed at almost a million dollars and for many it is the beginning of a long nightmare.

The following is an example: Pursuant to a settlement with the IRS, the 412(i) plan was converted into a traditional defined benefit plan. All of the contributions to the 412(i) plan would have been allowable if they had initially adopted a traditional defined benefit plan. Based on negotiations with the IRS agent, the audit of the plan resulted in no income and minimal excise taxes due. This is because as a traditional defined benefit plan, the taxpayers could have contributed and deducted the same amount as a 412(i) plan.
Towards the end of the audit the business owner received a notice from the IRS. The IRS assessed the client penalties under the §6707A of the Code in the amount of $900,000.00. This penalty was assessed because the client allegedly participated in a listed transaction and allegedly failed to file the form 8886 in a timely manner.

The IRS may call you a material advisor and fine you $200,000.00. The IRS may fine your clients over a million dollars for being in a retirement plan, 419 plan, etc. As you read this article, hundreds of unfortunate people are having their lives ruined by these fines. You may need to take action immediately. The Internal Revenue Service said it will extend until the end of 2009 a grace period granted to small business owners for collection of certain tax-shelter penalties.

But with that deadline approaching, Congress has not yet acted on the tax shelter penalty legislation. IRS Commissioner Doug Shulman said in a letter to the chairmen and ranking members of tax-writing committees that the IRS will continue to suspend its collection efforts with regard to the penalties until Dec. 31, 2009.

"Clearly, a number of taxpayers have been caught in a penalty regime that the legislation did not intend," wrote Shulman. "I understand that Congress is still considering this issue, and that a bipartisan, bicameral, bill may be in the works." The issue relates to penalties for so-called listed transactions, the kinds of tax shelters the IRS has designated most egregious. A number of small business owners that bought employee retirement plans so called 419 and 412(i) plans and others, that were listed by the IRS, and who are now facing hundreds and thousands in penalties, contend that the penalty amounts are unfair.
Leaders of tax-writing committees in the House and Senate have said they intend to pass legislation revising the penalty structure.

The IRS has suspended collection efforts in cases where the tax benefit derived from the listed transaction was less than $100,000 for individuals, or less than $200,000 for firms.

Senator Ben Nelson (D-Nebraska) has sponsored legislation (S.765) to curtail the IRS and its nearly unlimited authority and power under Code Section 6707A. The bill seeks to scale back the scope of the Section 6707A reportable/listed transaction nondisclosure penalty to a more reasonable level. The current law provides for penalties that are Draconian by nature and offer no flexibility to the IRS to reduce or abate the imposition of the 6707A penalty. This has served as a weapon of mass destruction for the IRS and has hit many small businesses and their owners with unconscionable results.

Internal Revenue Code 6707A was enacted as part of the American Jobs Creation Act on October 22, 2004. It imposes a strict liability penalty for any person that failed to disclose either a listed transaction or reportable transaction per each occurrence. Reportable transactions usually fall within certain general types of transactions (e.g. confidential transactions, transactions with tax protection, certain loss generating transaction and transactions of interest arbitrarily so designated as by the IRS) that have the potential for tax avoidance. Listed transactions are specified transactions which have been publicly designated by the IRS, including anything that is substantially similar to such a transaction (a phrase which is given very liberal construction by the IRS). There are currently 34 listed transactions, including certain retirement plans under Code section 412(i) and certain employee welfare benefit plans funded in part with life insurance under Code sections 419A(f)(5), 419(f)(6) and 419(e). Many of these plans were implemented by small business seeking to provide retirement income or health benefits to their employees.

Strict liability requires the IRS to impose the 6707A penalty regardless of innocence of a person (i.e. whether the person knew that the transaction needed to be reported or not or whether the person made a good faith effort to report) or the level of the person’s reliance on professional advisors. A Section 6707A penalty is imposed when the transaction becomes a reportable/listed transaction. Therefore, a person has the burden to keep up to date on all transactions requiring disclosure by the IRS into perpetuity for transactions entered into the past.

Additionally, the 6707A penalty strictly penalizes nondisclosure irrespective of taxes owed. Accordingly, the penalty will be assessed even in legitimate tax planning situations when no additional tax is due but an IRS required filing was not properly and timely filed. It is worth noting that a failure to disclose in the view of the IRS encompasses both a failure to file the proper form as well as a failure to include sufficient information as to the nature and facts concerning the transaction. Hence, people may find themselves subject to the 6707A penalty if the IRS determines that a filing did not contain enough information on the transaction. A penalty is also imposed when a person does not file the required duplicate copy with a separate IRS office in addition to filing the required copy with the tax return. Lance Wallach Commentary. In our numerous talks with IRS, we were also told that improperly filling out the forms could almost be as bad as not filing the forms. We have reviewed hundreds of forms for accountants, business owners and others. We have not yet seen a form that was properly filled in. We have been retained to correct many of these forms.

For more information see www.vebaplan.com, www.lawyer4audits.com, www.irs.gov or e-mail us at lawallach@aol.com

The imposition of a 6707A penalty is not subject to judicial review regardless of whether the penalty is imposed for a listed or reportable transaction. Accordingly, the IRS’s determination is conclusive, binding and final. The next step from the IRS is sending your file to collection, where your assets may be forcibly taken, publicly recorded liens may be placed against your property, and/or garnishment of your wages or business profits may occur, amongst other measures.

The 6707A penalty amount for each listed transaction is generally $200,000 per year per each person that is not an individual and $100,000 per year per individual who failed to properly disclose each listed transaction. The 6707A penalty amount for each reportable transaction is generally $50,000 per year for each person that is not an individual and $10,000 per year per each individual who failed to properly disclose each reportable transaction. The IRS is obligated to impose the listed transaction penalty by law and cannot remove the penalty by law. The IRS is obligated to impose the reportable transaction penalty by law, as well, but may remove the penalty when the IRS determines that removal of the penalty would promote compliance and support effective tax administration.

The 6707A penalty is particularly harmful in the small business context, where many business owners operate through an S corporation or limited liability company in order to provide liability protection to the owner/operators. Numerous cases are coming to light where the IRS is imposing a $200,000 penalty at the entity level and them imposing a $100,000 penalty per individual shareholder or member per year.

The individuals are generally left with one of two options:
Declare Bankruptcy
Face a $300,000 penalty per year.

Keep in mind, taxes do not need to be due nor does the transaction have to be proven illegal or illegitimate for this penalty to apply. The only proof required by the IRS is that the person did not properly and timely disclose a transaction that the IRS believes the person should have disclosed. It is important to note in this context that for non-disclosed listed transactions, the Statue of Limitations does not begin until a proper disclosure is filed with the IRS.

Many practitioners believe the scope and authority given to the IRS under 6707A, which allows the IRS to act as judge, jury and executioner, is unconstitutional. Numerous real life stories abound illustrating the punitive nature of the 6707A penalty and its application to small businesses and their owners. In one case, the IRS demanded that the business and its owner pay a 6707A total of $600,000 for his and his business’ participation in a Code section 412(i) plan. The actual taxes and interest on the transaction, assuming the IRS was correct in its determination that the tax benefits were not allowable, was $60,000. Regardless of the IRS’s ultimate determination as to the legality of the underlying 412(i) transaction, the $600,000 was due as the IRS’s determination was final and absolute with respect to the 6707A penalty. Another case involved a taxpayer who was a dentist and his wife whom the IRS determined had engaged in a listed transaction with respect to a limited liability company. The IRS determined that the couple owed taxes on the transaction of $6,812, since the tax benefits of the transactions were not allowable. In addition, the IRS determined that the taxpayers owed a $1,200,000 section 6707A penalty for both their individual nondisclosure of the transaction along with the nondisclosure by the limited liability company.

Even the IRS personnel continue to question both the legality and the fairness of the IRS’s imposition of 6707A penalties. An IRS appeals officer in an email to a senior attorney within the IRS wrote that “…I am both an attorney and CPA and in my 29 years with the IRS I have never {before} worked a case or issue that left me questioning whether in good conscience I could uphold the Government’s position even though it is supported by the language of the law.” The Taxpayers Advocate, an office within the IRS, even went so far as to publicly assert that the 6707A should be modified as it “raises significant Constitutional concerns, including possible violations of the Eighth Amendment’s prohibition against excessive government fines, and due process protection.”

Senate bill 765, the bill sponsored by Senator Nelson, seeks to alleviate some of above cited concerns. Specifically, the bill makes three major changes to the current version of Code section 6707A. The bill would allow an IRS imposed 6707A penalty for nondisclosure of a listed transaction to be rescinded if a taxpayer’s failure to file was due to reasonable cause and not willful neglect. The bill would make a 6707A penalty proportional to an understatement of any tax due.

Accordingly, non-tax paying entities such as S corporations and limited liability companies would not be subject to a 6707A penalty (individuals, C corporations and certain trusts and estates would remain subject to the 6707A penalty).

There are a number of interesting points to note about this action:
1. In the letter, the IRS acknowledges that, in certain cases, the penalty imposed by section 6707A for failure to report participation in a “listed transaction” is disproportionate to the tax benefits obtained by the transaction.
2. In the letter, the IRS says that it is taking this action because Congress has indicated its intention to amend the Code to modify the penalty provision, so that the penalty for failure to disclose will be more in line with the tax benefits resulting from a listed transaction.


3. The IRS will not suspend audits or collection efforts in appropriate cases. It cannot suspend imposition of the penalty, because, at least with respect to listed transactions, it does not have the discretion to not impose the penalty. It is simply suspending collection efforts in cases where the tax benefits are below the penalty threshold in order to give Congress time to amend the penalty provision, as Congress has indicated to the IRS it intends to do.
4. The legislation does not change the penalty provisions for material advisors.
This is taken directly from the IRS website:

“Congress has enacted a series of income tax laws designed to halt the growth of abusive tax avoidance transactions. These provisions include the disclosure of reportable transactions. Each taxpayer that has participated in a reportable transaction and that is required to file a tax return must disclose information for each reportable transaction in which the taxpayer participates. Use Form 8886 to disclose information for each reportable transaction in which participation has occurred. Generally, Form 8886 must be attached to the tax return for each tax year in which participation in a reportable transaction has occurred. If a transaction is identified as a listed transaction or transaction of interest after the filing of a tax return (including amended returns), the transaction must be disclosed either within 90 days of the transaction being identified as a listed transaction or a transaction of interest or with the next filed return, depending on which version of the regulations is applicable.”

Lance Wallach, CLU, ChFC, CIMC, speaks and writes about benefit plans, tax reductions strategies, and financial plans. He has authored numerous books for the AICPA, Bisk Total tape, and others. He can be reached at (516) 938-5007 or lawallach@aol.com. For more articles on this or other subjects, feel free to visit his website at www.vebaplan.com.

Lance Wallach, the National Society of Accountants Speaker of the Year, speaks and writes extensively about retirement plans, Circular 230 problems and tax reduction strategies. He speaks at more than 40 conventions annually, writes for over 50 publications, is quoted regularly in the press, and has written numerous best-selling AICPA books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Business Hot Spots. He does extensive expert witness work and has never lost a case. Contact him at 516.938.5007 or visit www.vebaplan.com.

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.

Dolan Media Newswires 01/22/2010
Small Business Retirement Plans Fuel Litigation
Small businesses facing audits and potentially huge tax penalties over certain types of retirement plans are filing lawsuits against those who marketed, designed and sold the plans. The 412(i) and 419(e) plans were marketed in the past several years as a way for small business owners to set up retirement or welfare benefits plans while leveraging huge tax savings, but the IRS put them on a list of abusive tax shelters and has more recently focused audits on them.
The penalties for such transactions are extremely high and can pile up quickly - $100,000 per individual and $200,000 per entity per tax year for each failure to disclose the transaction - often exceeding the disallowed taxes.
There are business owners who owe $6,000 in taxes but have been assessed $1.2 million in penalties. The existing cases involve many types of businesses, including doctors' offices, dental practices, grocery store owners, mortgage companies and restaurant owners. Some are trying to negotiate with the IRS. Others are not waiting. A class action has been filed and cases in several states are ongoing. The business owners claim that they were targeted by insurance companies; and their agents to purchase the plans without any disclosure that the IRS viewed the plans as abusive tax shelters. Other defendants include financial advisors who recommended the plans, accountants who failed to fill out required tax forms and law firms that drafted opinion letters legitimizing the plans, which were used as marketing tools.
A 412(i) plan is a form of defined benefit pension plan. A 419(e) plan is a similar type of health and benefits plan. Typically, these were sold to small, privately held businesses with fewer than 20 employees and several million dollars in gross revenues. What distinguished a legitimate plan from the plans at issue were the life insurance policies used to fund them. The employer would make large cash contributions in the form of insurance premiums, deducting the entire amounts. The insurance policy was designed to have a "springing cash value," meaning that for the first 5-7 years it would have a near-zero cash value, and then spring up in value.
Just before it sprung, the owner would purchase the policy from the trust at the low cash value, thus making a tax-free transaction. After the cash value shot up, the owner could take tax-free loans against it. Meanwhile, the insurance agents collected exorbitant commissions on the premiums - 80 to 110 percent of the first year's premium, which could exceed $1 million.
Technically, the IRS's problems with the plans were that the "springing cash" structure disqualified them from being 412(i) plans and that the premiums, which dwarfed any payout to a beneficiary, violated incidental death benefit rules.
Under §6707A of the Internal Revenue Code, once the IRS flags something as an abusive tax shelter, or "listed transaction," penalties are imposed per year for each failure to disclose it. Another allegation is that businesses weren't told that they had to file Form 8886, which discloses a listed transaction.
According to Lance Wallach of Plainview, N.Y. (516-938-5007), who testifies as an expert in cases involving the plans, the vast majority of accountants either did not file the forms for their clients or did not fill them out correctly.
Because the IRS did not begin to focus audits on these types of plans until some years after they became listed transactions, the penalties have already stacked up by the time of the audits.
Another reason plaintiffs are going to court is that there are few alternatives - the penalties are not appealable and must be paid before filing an administrative claim for a refund.

The suits allege misrepresentation, fraud and other consumer claims. "In street language, they lied," said Peter Losavio, a plaintiffs' attorney in Baton Rouge, La., who is investigating several cases. So far they have had mixed results. Losavio said that the strength of an individual case would depend on the disclosures made and what the sellers knew or should have known about the risks.
In 2004, the IRS issued notices and revenue rulings indicating that the plans were listed transactions. But plaintiffs' lawyers allege that there were earlier signs that the plans ran afoul of the tax laws, evidenced by the fact that the IRS is auditing plans that existed before 2004.
"Insurance companies were aware this was dancing a tightrope," said William Noll, a tax attorney in Malvern, Pa. "These plans were being scrutinized by the IRS at the same time they were being promoted, but there wasn't any disclosure of the scrutiny to unwitting customers."
A defense attorney, who represents benefits professionals in pending lawsuits, said the main defense is that the plans complied with the regulations at the time and that "nobody can predict the future."
An employee benefits attorney who has settled several cases against insurance companies, said that although the lost tax benefit is not recoverable, other damages include the hefty commissions - which in one of his cases amounted to $860,000 the first year - as well as the costs of handling the audit and filing amended tax returns.
Defying the individualized approach an attorney filed a class action in federal court against four insurance companies claiming that they were aware that since the 1980s the IRS had been calling the policies potentially abusive and that in 2002 the IRS gave lectures calling the plans not just abusive but "criminal." A judge dismissed the case against one of the insurers that sold 412(i) plans.
The court said that the plaintiffs failed to show the statements made by the insurance companies were fraudulent at the time they were made, because IRS statements prior to the revenue rulings indicated that the agency may or may not take the position that the plans were abusive. The attorney, whose suit also names law firm for its opinion letters approving the plans, will appeal the dismissal to the 5th Circuit.
In a case that survived a similar motion to dismiss, a small business owner is suing Hartford Insurance to recover a "seven-figure" sum in penalties and fees paid to the IRS. A trial is expected in August.
Last July, in response to a letter from members of Congress, the IRS put a moratorium on collection of §6707A penalties, but only in cases where the tax benefits were less than $100,000 per year for individuals and $200,000 for entities. That moratorium was recently extended until March 1, 2010.

But tax experts say the audits and penalties continue. "There's a bit of a disconnect between what members of Congress thought they meant by suspending collection and what is happening in practice. Clients are still getting bills and threats of liens," Wallach said.

"Thousands of business owners are being hit with million-dollar-plus fines. ... The audits are continuing and escalating. I just got four calls today," he said. A bill has been introduced in Congress to make the penalties less draconian, but nobody is expecting a magic bullet.

"From what we know, Congress is looking to make the penalties more proportionate to the tax benefit received instead of a fixed amount."