A Rose By Any Other Name, or
Whatever Happened to All Those 419A(f)(6)Providers?
FIRST - check out my new websites: TaxAudit419.com Lawyer4audits.com VebaPlan.org Taxlibrary.us
The IRS finally put a stop to such assertions by issuing
regulations and naming such plans as “potentially abusive tax shelters”
(or “listed transactions”) that needed to be disclosed and registered.
Enrolled Agents Journal March*April 2006
A Rose By Any Other Name, or
Whatever Happened to All Those 419A(f)(6) Providers?
By Ronald H. Snyder, JD, MAAA, EA & Lance Wallach, CLU, ChFC, CIMC
For years promoters of life insurance companies and agents have tried to find ways of
claiming that the premiums paid by business owners were tax deductible. This
allowed them to sell policies at a “discount”.
The problem became especially bad a few years ago with all of the outlandish claims
about how §§419A(f)(5) and 419A(f)(6) exempted employers from any tax deduction
limits. Many other inaccurate statements were made as well, until the IRS finally put a
stop to such assertions by issuing regulations and naming such plans as “potentially
abusive tax shelters” (or “listed transactions”) that needed to be disclosed and
registered. This appeared to put an end to the scourge of such scurrilous promoters,
as such plans began to disappear from the landscape.
And what happened to all the providers that were peddling §§419A(f)(5) and (6) life
insurance plans a couple of years ago? We recently found the answer: most of them
found a new life as promoters of so-called “419(e)” welfare benefit plans.
We recently reviewed several §419(e) plans, and it appears that many of them are
nothing more than recycled §419A(f)(5) and §419A(f)(6) plans.
The “Tax Guide” written by one vendor’s attorney is illustrative: he confuses the
difference between a “multi-employer trust” (a Taft-Hartley, collectively-bargained
plan), a “multiple-employer trust” (a plan with more than one unrelated employer) and
a “10-or-more employer trust” (a plan seeking to comply with IRC §419A(f)(6)).
Background: Section 419 of the Internal Revenue Code
Section 419 was added to the Internal Revenue Code (“IRC”) in 1984 to curb abuses in
welfare benefit plan tax deductions. §419(a) does not authorize tax deductions, but
provides as follows: “Contributions paid or accrued by an employer to a welfare
benefit fund * * * shall not be deductible under this chapter * * *.”. It simply limits the
amount that would be deductible under another IRC section to the “qualified cost for
the taxable year”. (§419(b))
Section 419(e) of the IRC defines a “welfare benefit fund” as “any fund-- (A) which is
part of a plan of an employer, and (B) through which the employer provides welfare
benefits to employees or their beneficiaries.” It also defines the term "fund", but
excludes from that definition “amounts held by an insurance company pursuant to an
insurance contract” under conditions described.
None of the vendors provides an analysis under §419(e) as to whether or not the life
insurance policies they promote are to be included or excluded from the definition of
a “fund”. In fact, such policies will be included and therefore subject to the limitations
of §§419 and 419A.
Errors Commonly Made
Materials from the various plans commonly make several mistakes in their analyses:
1. They claim not to be required to comply with IRC §505 non-discrimination
requirements. While it is true that §505 specifically lists “organizations described in
paragraph (9) or (20) of section 501(c)”, IRC §4976 imposes a 100% excise tax on any
“post-retirement medical benefit or life insurance benefit provided with respect to a
key employee” * * * “unless the plan meets the requirements of section 505(b) with
respect to such benefit (whether or not such requirements apply to such plan).”
(Italics added) Failure to comply with §505(b) means that the plan will never be able to
distribute an insurance policy to a key employee without the 100% penalty!
2. Vendors commonly assert that contributions to their plan are tax deductible
because they fall within the limitations imposed under IRC §419; however, §419 is
simply a limitation on tax deductions. Providers must cite the section of the IRC
under which contributions to their plan would be tax-deductible. Many fail to do so.
Others claim that the deductions are ordinary and necessary business expense under
§162, citing Regs. §1.162-10 in error: there is no mention in that section of life
insurance or a death benefit as a welfare benefit.
3. The reason that promoters fail to cite a section of the IRC to support a tax
deduction is because, once such section is cited, it becomes apparent that their
method of covering only selected key and highly-compensated employees for
participation in the plan fails to comply with IRC §414(t) requirements relative to
coverage of controlled groups and affiliated service groups.
4. Life insurance premiums could be treated as W-2 wages and deducted under §162
to the extent they were reasonable. Other than that, however, no section of the
Internal Revenue Code authorizes tax deductions for a discriminatory life insurance
arrangement. IRC §264(a) provides that “[n]o deduction shall be allowed for * * * [p]
remiums on any life insurance policy * * * if the taxpayer is directly or indirectly a
beneficiary under the policy.” As was made clear in the Neonatology case
(Neonatology Associates v. Commissioner, 115 TC 5, 2000), the appropriate treatment
of employer-paid life insurance premiums under a putative welfare benefit plan is
under §79, which comes with its own nondiscrimination requirements.
5. Some plans claim to impute income for current protection under the PS 58 rules.
However, PS58 treatment is available only to qualified retirement plans and split-
dollar plans. (Note: none of the 419(e) plans claim to comply with the split-dollar
regulations.) Income is imputed under Table I to participants under Group-Term Life
Insurance plans that comply with §79. This issue is addressed in footnotes 17 and 18
of the Neonatology case.
6. Several of the plans claim to be exempt from ERISA. They appear to rely upon the
ERISA Top-Hat exemption (applicable to deferred compensation plans). However, that
only exempts a plan from certain ERISA requirements, not ERISA itself. It is instructive
that none of the plans claiming exemption from ERISA has filed the Top-Hat
notification with the Dept. of Labor.
7. Some of the plans offer severance benefits as a “welfare benefit”, which
approach has never been approved by the IRS. Other plans offer strategies for
obtaining a cash benefit by terminating a single-employer trust. The distribution of a
cash benefit is a form of deferred compensation, yet none of the plans offering such
benefit complies with the IRC §409A requirements applicable to such benefits.
8. Some vendors permit participation by employees who are self-employed, such as
sole proprietors, partners or members of an LLC or LLP taxed as a partnership. This
issue was also addressed in the Neonatology case where contributions on behalf of
such persons were deemed to be dividends or personal payments rather than welfare
benefit plan expenses.
[Note: bona fide employees of an LLC or LLP that has elected to be taxed as a
corporation may participate in a plan.]
9. Most of the plans fail under §419 itself. §419(c) limits the current tax deduction to
the “qualified cost”, which includes the “qualified direct cost” and additions to a
“qualified asset account” (subject to the limits of §419A(b)). Under Regs. §1.419-1T, A-
6, “the "qualified direct cost" of a welfare benefit fund for any taxable year * * * is the
aggregate amount which would have been allowable as a deduction to the employer
for benefits provided by such fund during such year (including insurance coverage
for such year) * * *.” “Thus, for example, if a calendar year welfare benefit fund pays
an insurance company * * * the full premium for coverage of its current employees
under a term * * * insurance policy, * * * only the portion of the premium for coverage
during [the year] will be treated as a "qualified direct cost" * * *.” (Italics added)
Most vendors pretend that the whole or universal life insurance premium is an
appropriate measurement of cost for Key Employees, and those plans that cover rank
and file employees use current term insurance premiums as the appropriate measure
of cost for such employees. This approach doesn’t meet any set of nondiscrimination
requirements applicable to such plans.
10. Some vendors claim that they are justified in providing a larger deduction than
the amount required to pay term insurance costs for the current tax year, but, as cited
above, the only justification under §419(e) itself is as additions to a qualified asset
account and is subject to the limitations imposed by §419A. In addition, §419A adds
several additional limitations to plans and contributions, including requirements that:
A. contributions be limited to a safe harbor amount or be certified by an actuary as to
the amount of such contributions (§419A(c)(5));
B. actuarial assumptions be “reasonable in the aggregate” and that the actuary use a
level annual cost method (§419A(c)(2));
C. benefits with respect to a Key Employee be segregated and their benefits can only
be paid from such account (§419A(d));
D. the rules of subsections (b), (c), (m), and (n) of IRC section 414 shall apply to such
plans (§419A(h)).
E. the plan comply with §505(b) nondiscrimination requirements (§419A(e)).
Circular 230 Issues
Circular 230 imposes many requirements on tax professionals with respect to tax
shelter transactions. A tax practitioner can get into trouble in the promotion of such
plans, in advising clients with respect to such transactions and in preparing tax
returns. IRC §§6707 and 6707A add a new concept of “reportable transactions” and
impose substantial penalties for failure to disclose participation in certain reportable
transactions (including all listed transactions).
This is a veritable minefield for tax practitioners to negotiate carefully or avoid
altogether. The advisor must exercise great caution and due diligence when
presented with any potential contemplated tax reduction or avoidance transaction.
Failure to disclose could subject taxpayers and their tax advisors to potentially
Draconian penalties.
Summary
Key points of this article include:
· Practitioners need to be able to differentiate between a legitimate §419(e) plan
and one that is legally inadequate when their client approaches them with respect to
such plan or has the practitioner to prepare his return;
· Many plans incorrectly purport to be exempt from compliance with ERISA, IRC
§§414, 505, 79, etc.
· Tax deductions must be claimed under an authorizing section of the IRC and are
limited to the qualified direct cost and additions to a qualified asset account as
certified by the plan’s actuary.
Conclusion
Irresponsible vendors such as most of the promoters who previously promoted IRC
§419A(f)(6) plans were responsible for the IRS’s issuing restrictive regulations under
that Section. Now many of the same individuals have elected simply to claim that a life
insurance plan is a welfare benefit plan and therefore tax-deductible because it uses
a single-employer trust rather than a "10-or-more-employer plan".
This is an open invitation to the IRS to issue new onerous Regulations and more
indictments and legal actions against the unscrupulous promoters who feed off of the
naivety of clients and the greed of life insurance companies who encourage and
endorse (and even own) such plans.
The last line of defense of the innocent client is the accountant or attorney who is
asked by a client to review such arrangement or prepare a tax return claiming a
deduction for contributions to such a plan. Under these circumstances accountants
and attorneys should be careful not to rely upon the materials made available by the
plan vendors, but should review any proposed plan thoroughly, or refer the review to
a specialist.
_____________________________________________________________________
Ron Snyder practices as an ERISA attorney and Enrolled Actuary in the field of
employee benefits.
Lance Wallach speaks and writes extensively about VEBAs retirement plans, and tax
reduction strategies. He speaks at more than 70 conventions annually and writes for
more than 50 publications. For more information and additional articles on these
subjects, call 516-938-5007 or visit www.vebaplan.com..
This information 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.
