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EDUCATION MEMBERSHIP NEWS ADVOCACY RESOURCES EMAIL|PRINT| More Sharing Services SHARE Keep a Watchful Eye: Tax Avoidance Can Lurk in Employee Benefit Plans
November 1, 2008
By Lance Wallach,CLU, ChFC
As the Internal Revenue Service (IRS) continues to crack down on abusive retirement and employee benefit plans, many accountants will almost certainly, though inadvertently, land their clients and themselves in trouble.
Two particular types of arrangements top the IRS list of abusive plans: the so-called 419 insurance welfare benefit plan and the 412(i) defined benefit retirement plan. These popular plans, while ostensibly for the benefit of employees, are popular with employers mainly because they can offer large tax deductions. The IRS believes those deductions are often disproportionate to the economic realities of these transactions. Both plans are usually sold by insurance agents who are motivated principally by the large commissions that flow from the sale of the insurance policies within these plans.
Some of these plans have been designated as listed transactions by the IRS. Of particular interest is a spurt of IRS regulation in late 2007 that severely affected welfare benefit plans. Any participant in a listed transaction must file Form 8886 with the IRS to disclose participation in such a transaction. Failure to file can result in penalties of up to $100,000 for individuals and $200,000 for corporations. "Material advisors" to participants in such transactions, whom many CPAs are, must file Form 8918 to disclose their role. Failure to file leads to the same pe
Notice 2007-83 is aimed at promoted arrangements under which the fund trustee purchases cash-value insurance policies on the lives of a business’s employee/owners, and sometimes key employees, while purchasing term insurance policies on the lives of other employees covered under the plan. These plans anticipate being terminated and that the cash-value policies will be distributed to the owners or key employees, with very little distributed to other employees. The promoters claim that the insurance premiums are currently deductible by the business, and that the distributed insurance policies are virtually tax-free to the owners.
The Ruling makes it clear that going forward a business, under most circumstances, cannot deduct the cost of premiums paid through a welfare benefit plan for cash-value life insurance on the lives of its employees. The IRS may challenge the claimed tax benefits of these arrangements for various reasons:
Some or all of the benefits or distributions provided to or for the benefit of owner-employees or key employees may be disqualified benefits for purposes of the 100 percent excise tax under section 4976. The IRS stated in Notice 2007-84 that whenever the property distributed from a trust has not been properly valued by the taxpayer, the IRS will challenge its value, including life insurance policies. Under the tax benefit rule, some or all of an employer’s deductions in an earlier year may have to be included in income in a later year if an event occurs that is fundamentally inconsistent with the premise on which the deduction was based. An employer’s deductions for contributions to an arrangement that is properly characterized as a welfare benefit fund are subject to the limitations and requirements of the rules in sections 419 and 419A, including reasonable actuarial assumptions and nondiscrimination. Further, a taxpayer cannot obtain a deduction for reserves for post-retirement medical or life benefits unless the employer intends to use the contributions for that purpose. The arrangement may be subject to the rules for split-dollar arrangements, depending on the facts and circumstances. Contributions on behalf of an owner-employee may be characterized as dividends or as nonqualified deferred compensation subject to Section 404(a)(5), Section 409A or both, depending on the facts and circumstances.
My firm has received many calls for help from CPAs whose clients are being audited for deducting 419 or 412(i) plans. The CPAs were not aware that anything was wrong, and they are being accused of being material advisors and subject to a $200,000 IRS fine.
Lance Wallach, CLU, ChFC, is the author of the American Institute of CPAs (AICPA)“The Team Approach to Tax, Financial and Estate Planning” and other AICPA books. He speaks at numerous AICPA conferences and other national conventions and writes for financial publications.He can be reached at lawallach@aol.com, (516) 938-5007 orwww.vebaplan.com.
Disclaimer: The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice. Lance Wallach adapted parts of this article from the American Institute of CPAs (AICPA) CPE self-study course he wrote, “Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots,” by Sid Kess, as well as his September 2008 Journal of Accountancy article.
Reprinted with permission from the Virginia Society of CPAs.
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Keep a Watchful Eye: Tax Avoidance Can Lurk in Employee Benefit Plans
November 1, 2008
By Lance Wallach,CLU, ChFC
As the Internal Revenue Service (IRS) continues to crack down on abusive retirement and employee benefit plans, many accountants will almost certainly, though inadvertently, land their clients and themselves in trouble.
Two particular types of arrangements top the IRS list of abusive plans: the so-called 419 insurance welfare benefit plan and the 412(i) defined benefit retirement plan. These popular plans, while ostensibly for the benefit of employees, are popular with employers mainly because they can offer large tax deductions. The IRS believes those deductions are often disproportionate to the economic realities of these transactions. Both plans are usually sold by insurance agents who are motivated principally by the large commissions that flow from the sale of the insurance policies within these plans.
Some of these plans have been designated as listed transactions by the IRS. Of particular interest is a spurt of IRS regulation in late 2007 that severely affected welfare benefit plans. Any participant in a listed transaction must file Form 8886 with the IRS to disclose participation in such a transaction. Failure to file can result in penalties of up to $100,000 for individuals and $200,000 for corporations. "Material advisors" to participants in such transactions, whom many CPAs are, must file Form 8918 to disclose their role. Failure to file leads to the same pe
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ReplyDeleteNotice 2007-83 is aimed at promoted arrangements under which the fund trustee purchases cash-value insurance policies on the lives of a business’s employee/owners, and sometimes key employees, while purchasing term insurance policies on the lives of other employees covered under the plan. These plans anticipate being terminated and that the cash-value policies will be distributed to the owners or key employees, with very little distributed to other employees. The promoters claim that the insurance premiums are currently deductible by the business, and that the distributed insurance policies are virtually tax-free to the owners.
The Ruling makes it clear that going forward a business, under most circumstances, cannot deduct the cost of premiums paid through a welfare benefit plan for cash-value life insurance on the lives of its employees. The IRS may challenge the claimed tax benefits of these arrangements for various reasons:
Some or all of the benefits or distributions provided to or for the benefit of owner-employees or key employees may be disqualified benefits for purposes of the 100 percent excise tax under section 4976.
The IRS stated in Notice 2007-84 that whenever the property distributed from a trust has not been properly valued by the taxpayer, the IRS will challenge its value, including life insurance policies.
Under the tax benefit rule, some or all of an employer’s deductions in an earlier year may have to be included in income in a later year if an event occurs that is fundamentally inconsistent with the premise on which the deduction was based.
An employer’s deductions for contributions to an arrangement that is properly characterized as a welfare benefit fund are subject to the limitations and requirements of the rules in sections 419 and 419A, including reasonable actuarial assumptions and nondiscrimination. Further, a taxpayer cannot obtain a deduction for reserves for post-retirement medical or life benefits unless the employer intends to use the contributions for that purpose.
The arrangement may be subject to the rules for split-dollar arrangements, depending on the facts and circumstances.
Contributions on behalf of an owner-employee may be characterized as dividends or as nonqualified deferred compensation subject to Section 404(a)(5), Section 409A or both, depending on the facts and circumstances.
My firm has received many calls for help from CPAs whose clients are being audited for deducting 419 or 412(i) plans. The CPAs were not aware that anything was wrong, and they are being accused of being material advisors and subject to a $200,000 IRS fine.
Lance Wallach, CLU, ChFC, is the author of the American Institute of CPAs (AICPA)“The Team Approach to Tax, Financial and Estate Planning” and other AICPA books. He speaks at numerous AICPA conferences and other national conventions and writes for financial publications.He can be reached at lawallach@aol.com, (516) 938-5007 orwww.vebaplan.com.
Disclaimer: The information provided herein is not intended as legal, accounting, financial or any type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice. Lance Wallach adapted parts of this article from the American Institute of CPAs (AICPA) CPE self-study course he wrote, “Avoiding Circular 230 Malpractice Traps and Common Abusive Small Business Hot Spots,” by Sid Kess, as well as his September 2008 Journal of Accountancy article.
Reprinted with permission from the Virginia Society of CPAs.