Abusive Insurance and Retirement Plans

Parts of this article are from the AICPA CPE self-study course Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots, by Sid Kess, authored by Lance Wallach.

Many of the listed transactions that can get your clients into trouble with the IRS are exotic shelters that relatively few practitioners ever encounter. When was the last time you saw someone file a return as a Guamanian trust (Notice 2000-61)? On the other hand, a few listed transactions concern relatively common employee benefit plans the IRS has deemed tax-avoidance schemes or otherwise abusive. Perhaps some of the most likely to crop up, especially in small business returns, are arrangements purporting to allow deductibility of premiums paid for life insurance under a welfare benefit plan.

Some of these abusive employee benefit plans are represented as satisfying section 419 of the Code, which sets limits on purposes and balances of "qualified asset accounts" for such benefits, but purport to offer deductibility of contributions without any corresponding income. Others attempt to take advantage of exceptions to qualified asset account limits, such as sham union plans that try to exploit the exception for separate welfare benefit funds under collective-bargaining agreements provided by IRC § 419A(f)(5). Others try to take advantage of exceptions for plans serving 10 or more employers, once popular under section 419A(f)(6). More recently, one may encounter plans relying on section 419(e) and, perhaps, defined-benefit pension plans established pursuant to the former section 412(i) (still so-called, even though the subsection has since been redesignated section 412(e)(3). See sidebar "Defined-Benefit 412(i) Plans Under Fire").

Promoters and Their Best-Laid Plans
Sections 419 and 419A were added to the Code in 1984 by the Deficit Reduction Act of 1984 in an attempt to end employers’ acceleration of deductions for plan contributions. But it wasn’t long before plan promoters found an end run around the new Code sections. An industry developed in what came to be known as "10 or more employer plans." The promoters of these plans, in conjunction with life insurance companies who just wanted premiums on the books, would sell people on the idea of tax-deductible life insurance and other benefits, and especially large tax deductions. It was almost, "How much can I deduct?" with the reply, "How much do you want to?" Adverse court decisions (there were a few) and other law to the contrary were either glossed over or explained away.
The IRS steadily added these abusive plans to its designations of listed transactions. With Revenue Ruling 90-105, it warned against deducting certain plan contributions attributable to compensation earned by plan participants after the end of the taxable year. Purported exceptions to limits of sections 419 and 419A claimed by 10 or more multiple-employer benefit funds were likewise proscribed in Notice 95-34. Both positions were designated listed transactions in 2000.

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