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Employee Retirement Plans

By Lance Wallach

412i, 419, Captive Insurance and
Section 79 Plans; Buyer Beware

The IRS has been attacking all 419 welfare benefit plans, many 412i retirement plans,
captive insurance plans with life insurance in them, and Section 79 plans.  IRS is
aggressively auditing various plans and calling them “listed transactions,” “abusive tax
shelters,” or “reportable transactions,” participation in any of which must be
disclosed to the Service.  The result has been IRS audits, disallowances, and huge
fines for not properly reporting under IRC 6707A.  
In a recent tax court case, Curico v. Commissioner (TC Memo 2010-115), the Tax
Court ruled that an investment in an employee welfare benefit plan marketed under the
name “Benistar” was a listed transaction.  It was substantially similar to the
transaction described in IRS Notice 95-34.  A subsequent case, McGehee Family
Clinic, largely followed Curico, though it was technically decided on other grounds.  
The parties stipulated to be bound by Curico regarding whether the amounts paid by
McGehee in connection with the Benistar 419 Plan and Trust were deductible.  
Curico did not appear to have been decided yet at the time McGehee was argued.  
The McGehee opinion (Case No. 10-102) (United States Tax Court, September 15,
2010) does contain an exhaustive analysis and discussion of virtually all of the
relevant issues.

Taxpayers and their representatives should be aware that the Service has disallowed
deductions for contributions to these arrangements.  The IRS is cracking down on
small business owners who participate in tax reduction insurance plans and the
brokers who sold them.  Some of these plans include defined benefit retirement plans,
IRAs, or even 401(k) plans with life insurance.
In order to fully grasp the severity of the situation, you have to understand Notice 95-
34.  It was issued in response to trust arrangements that were sold to companies
designed to provide deductible benefits, such as life insurance, disability and
severance pay benefits.  The promoters of these arrangements claimed that all
employer contributions were tax-deductible when paid.  They relied on the 10-or-
more-employer exemption from the IRC § 419 limits.  They claimed that the
permissible tax deductions were unlimited in amount.
In general, contributions to a welfare benefit fund are not fully deductible when paid.  
Sections 419 and 419A impose strict limits on the amount of tax-deductible
prefunding permitted for contributions to a welfare benefit fund.  Section 419(A)(F)
(6) provides an exemption from Section 419 and Section 419A for certain “10-or-
more-employers” welfare benefit funds.  In general, for this exemption to apply, the
fund must have more than one contributing employer of which no single employer
can contribute more than 10% of the total contributions.  Also, the plan must not be
experience-rated with respect to individual employers.

According to the Notice, these arrangements typically involve an investment in
variable life or universal life insurance contracts on the lives of the covered
employees.  The problem is that the employer contributions are large relative to the
cost of the amount of term insurance that would be required to provide the death
benefits under the arrangement.  Also, the trust administrator can cash in or withdraw
the cash value of the insurance policies to get cash to pay benefits other than death
benefits.  The plans are often designed to determine an employer’s contributions or its
employees’ benefits based on a way that insulates the employer to a significant extent
from the experience of other subscribing employers.  In general, the contributions
and claimed tax deductions tend to be disproportionate to the economic realities of the
Benistar advertised that enrollees should expect the same type of tax benefits as listed
in the transaction described in Notice 95-34.  The advertising packet listed the
following benefits of enrollment:
·        Virtually unlimited deductions for the employer.
·        Contributions could vary from year to year.
·        Benefits could be provided to one or more key executives on a selective basis.
·        No need to provide benefits to rank-and-file employees.
·        Contributions to the plan were not limited by qualified plan rules and would not
interfere with pension, profit sharing or 401(k) plans.
·        Funds inside the plan would accumulate tax-free.
·        Beneficiaries could receive death proceeds free of both income tax and estate
·        The program could be arranged for tax-free distribution at a later date.
·        Funds in the plan were secure from the hands of creditors.

The Court said that the Benistar Plan was factually similar to the plans described in
Notice 95-34 at all relevant times.  In rendering its decision, the court heavily cited
Curico, in which the court also ruled in favor of the IRS.  As noted in Curico, the
insurance policies, which were overwhelmingly variable or universal life policies,
required large contributions compared to the cost of the amount of term insurance
that would be required to provide the death benefits under the arrangement.  The
Benistar Plan owned the insurance contracts.
Following Curico, the Court held that the contributions to Benistar were not
deductible under section 162(a) because participants could receive the value reflected
in the underlying insurance policies purchased by Benistar.  This is despite the fact
that payment of benefits by Benistar seemed to be contingent upon an unanticipated
event (the death of the insured while employed).  As long as plan participants were
willing to abide by Benistar’s distribution policies, there was never a reason to forfeit
a policy to the plan.  In fact, in estimating life insurance rates, the taxpayers’ expert in
Curico assumed that there would be no forfeitures, even though he admitted that an
insurance company would generally assume a reasonable rate of policy lapses.

The McGehee Family Clinic had enrolled in the Benistar Plan in May 2001 andclaimed
deductions for contributions to it in 2002 and 2005.  The returns did not include a
Form 8886, Reportable Transaction Disclosure Statement, or similar disclosure.

The IRS disallowed the latter deduction and adjusted the 2005 return of shareholder
Robert Prosser and his wife to include the $50,000 payment to the plan.  The IRS
also assessed tax deficiencies and the enhanced 30% penalty totaling almost $21,000
against the clinic and $21,000 against the Prossers.  The court ruled that the Prossers
failed to prove a reasonable cause or good faith exception.

More You Should Know

·        In recent years, some section 412(i) plans have been funded with life insurance
using face amounts in excess of the maximum death benefit a qualified plan is
permitted to pay.  Ideally, the plan should limit the proceeds that could be paid as a
death benefit in the event of a participant’s death.  Excess amounts would revert to
the plan.  Effective February 13, 2004, the purchase of excessive life insurance in any
plan is considered a listed transaction if the face amount of the insurance exceeds the
amount that can be issued by $100,000 or more and the employer has deducted the
premiums for the insurance.
·        By itself, a 412(i) plan is not a listed transaction; however, the IRS has a task
force auditing 412(i) plans.
·        An employer has not engaged in a listed transaction simply because it is a 412
(i) plan.
·        Just because a 412(i) plan was audited and sanctioned for certain items, does
not necessarily mean the plan engaged in a listed transaction.  Some 412(i) plans have
been audited and sanctioned for issues not related to listed transactions.
Companies should carefully evaluate proposed investments in plans such as the
Benistar plan.  The claimed deductions will not be available and penalties will be
assessed for lack of disclosure if the investment is similar to the investments
described in Notice 95-34.  In addition, under IRC 6707A, IRS fines participants a
large amount of money for not properly disclosing their participation in listed,
reportable, or similar transactions; an issue that was not before the Tax Court in
either Curico or McGehee.  The disclosure needs to be made for every year the
participant is in a plan.  The forms need to be filed properly even for years that no
contributions are made.  I have received numerous calls from participants who did
disclose and still got fined because the forms were not filled in properly.  A plan
administrator told me that he helps hundreds of his participants file forms, and they all
still received very large IRS fines for not filling in the forms properly.

Lance Wallach is National society of Accountants Speaker of the Year and member of
the AICPA faculty of teaching professionals.  He does expert witness testimony and
has never lost a case.  Contact him at 516-938-5007,, or visit or  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.