Ethics: Insider Secrets to Avoid Malpractice and Huge Penalties

1. Ethics: Insider Secretsto Avoid Malpractice and Huge Penalties Presented by Lance Wallach, CLU, CHFC, CIMC, a frequent speaker on pensions, VEBAs, financial and estate planning, practice management, and tax-oriented strategies at accounting and financial planning conventions.

2. This webinar will help you navigate some of the ethical minefields inherent in practice today,especially under Circular 230. • Understand many of the abusive insurance and annuity based products being marketed to your clients and how to alleviate IRS scrutiny. • Identify potentially abusive deductions claimed on tax returns, which include many popular retirement and welfare benefit plans. Learn about various disclosure requirements and how to avoid large penalties, both to yourself and your client. • Protect your senior clients from abusive life settlements, reverse mortgages, annuities and more. • Discover opportunities available under the Pension Protection Act and new regulations, and how to use them correctly. • This webinar will give you expertise in tax shelters, listed transactions, captive insurance, 419 and 412i plans, premium finance, and other potentially abusive products and strategies.

3. Disclaimer 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. Notice Pursuant to IRS Circular 230 Any tax advice expressed in this communication (including any attachments) is not intended to be used, and cannot be used, for the purpose of avoiding penalties imposed on the taxpayer by any governmental taxing authority or agency.

4. Insurance agents often sell ways to deduct life insurance premiums • This is usually done in 419 plans • Most of these deductions are disallowed on audit • Notice 2007-83 was issued on 10/17/2007 • It identified certain trust arrangements involving cash value life insurance as listed transactions.

5. Revenue Ruling 2007-65 was issued simultaneously • It is now clear that an employer usually cannot claim deductions for cash value life insurance inside of 419 plans, especially if the plan is a listed transaction • Persons participating in a listed transaction have disclosure obligations • They must file Form 8886 with their tax returns

6. Failure to file and disclose results in penalties of up to $200,000 • These penalties can also be imposed upon agents, advisors, and other professionals • Taxpayers who otherwise would be required to file a disclosure statement prior to Jan. 15, 2008, as a result of Notice 2007-83 had until Jan. 15, 2008, to make the disclosure • Revenue Ruling 2007-65 has the same target as Notices 2007-83 and 2007-84

7. The target is those arrangements where cash value life insurance is purchased on employees who are owners of the business • Sometimes it is also purchased on key employees • Term insurance is then purchased on the lives of other employees • These plans are currently sold as 419(e), 419A(f)(6), or 419 plans

8. Sometimes they are sold as single employer plans • It is anticipated that the plan will be terminated with the cash value policies being distributed to owners or key employees • Little if anything goes to the other employees • Promoters claim the insurance premiums are a current deduction • The ruling makes it absolutely clear that this is not the case

9. Most businesses cannot deduct the cost of premiums paid through a 419 (welfare benefit) plan for cash value life insurance • The ruling also describes arrangements that may be listed transactions • These plans are usually sold by insurance agents and financial planners • They are also sometimes sold by accountants and attorneys

10. There is an excellent chance that the accountant with a client or clients in these plans will be deemed a “material advisor” to these plans • You are a material advisor if the client participated in the plan, you gave the client tax advice with respect to the transaction, and yourself and/or a related entity received $10,000 or more in compensation

11. The material advisor must file Form 8918. As with the 8886 form (for taxpayers) failure to file or even incomplete, misleading, or inaccurate filings can lead to penalties of $100,000 for individuals or $200,000 for corporations • A filing on a protective basis is possible if the advisor believes, in good faith, either that he does not meet the income threshold or that the transaction in question is not a listed one.

12. Professional discipline is even possible in connection with this area, as is indirect (as a witness) or even direct (as a defendant) involvement in legal proceedings

13. There are many reasons why the IRS may challenge the claimed tax benefits of these arrangements • The Section 4976 100 percent excise tax may disqualify benefits provided to owner-employees or key employees • Where property, including life insurance policies, is not properly valued, the IRS will challenge the value

14. A particular target here would be "springing cash value" life insurance • This type of insurance features temporarily artificially depressed policy values, the goal being to reduce tax owed on the value of the life insurance when said insurance is removed from the plan

15. In a proper arrangement, deductions are limited by IRC Sections 419 and 419A • Depending on facts and circumstances, the rules for split-dollar arrangements may apply • Again depending on facts and circumstances, contributions on behalf of an owner-employee may be characterized as dividends or as deferred compensation pursuant to IRC 404(a)(5) or 409A, or both

16. Be especially cautious should a client approach you with any 419 plan, for both yourself and the client • The Government has the names of most former 419 A(f)(6) promoters, as many current 419 promoters were • This leads to increased scrutiny of such promoters, making audits far riskier and more likely

17. More on listed transactions • Listed transactions are those deemed by the IRS to be structured for the significant purpose of tax avoidance or evasion • Participants in listed transactions must attach Form 8886 to their tax returns • There are severe penalties for failure to file Form 8886 disclosing such participation • There are also severe penalties for those who aid and abet participation in listed transactions

18. CPE Code Word #1 Lance For CPE, you will be asked to recall this code word in the online evaluation

19. Abusive 412(i) and other Retirement Plans On Feb. 13, 2004, the Treasury Department and Internal Revenue Service issued guidance to shut down abusive transactions involving specially designed life insurance policies in retirement plans, Section “412(i) plans.” The guidance designates certain arrangements as “listed transactions” for tax-shelter reporting purposes

20. A “Section 412(i) plan” is a tax qualified retirement plan that is funded entirely by a life insurance contract or an annuity. The employer claims tax deductions for contributions that are used by the plan to pay premiums on an insurance contract covering an employee. The plan may hold the contract until the employee dies, or it may distribute or sell the contract to the employee at a specific point, such as when the employee retires.

21. There are many legitimate Section 412(i) plans, but some push the envelope, claiming tax results for employees and employers that do not reflect the underlying economics of the arrangements,” according to the IRS. • One of the main abuses is that any life insurance contract transferred from an employer or a tax-qualified plan to an employee must be taxed at its full fair market value. Some firms have promoted an arrangement where an employer establishes a Section 412(i) plan under which the contributions made to the plan are used to purchase a specially designed life insurance contract.

22. The insurance contract is designed so that the cash surrender value is temporarily depressed • These contracts are sometimes called springing cash value insurance • These abuses also occur in other types of retirement plans

23. The 2004 regulation has led to numerous IRS audits of 412(I) plans • While many plans are substantially in compliance, the Service regards others as abusive • The ones that are regarded as abusive are listed transactions, which trigger the disclosure requirements necessitating the filing of Forms 8886 and 8918, and of course the possible penalties there

24. As for the plans themselves, plan sponsors of listed transactions (those that deemed abusive), are treated as if the plans never existed, and are forced to pay the income taxes that would have been due and owing had the plan never existed, together with interest • The Service, in conducting these audits, is critically concerned with compliance with non-discrimination rules and applicable deduction limits. Failures in either or both of these areas are more likely to lead to being regarded as abusive and therefore being denominated a listed transaction

25. Large Companies have long used captive insurers to reduce premiums paid for property and casualty insurance. • The amount of money necessary to fund self-insured risks associated with tangible and intangible assets is also reduced. • Large companies commonly establish single parent captives. • However, for small and medium sized businesses, the group captive structure and its protected cell variation can realize cost savings at a cost far less than establishing a single parent captive.

26. So it is a win-win situation – you save money while saving money • The accountant can use the group captive and captive cell structures to introduce new cost saving opportunities to business clients • These opportunities can be enhanced by income tax and succession planning techniques commonly used by estate planning professionals

27. What requirements must be met to obtain a legitimate tax deduction while using captive insurance? • Risk sharing • Risk distribution • Using group captives makes it significantly cheaper to satisfy these requirement, especially the risk distribution requirement • More on the risk distribution requirement

28. If done properly, premium finance allows large amounts of life insurance to be obtained with a small dollar outlay • Various problems occur if it is done wrong • It is not a free way to obtain life insurance, and should not be sold as such • What spread over the loan interest rate must the client earn to make this work?

29. Is the loan commitment reasonable? • How long is the loan renewable for? Does its term exceed life expectancy? • Is the loan secured by the cash value of the life insurance? • Is it a life expectancy program? Such a program would assume dying at the IRS life expectancy

30. Problem – if the client lives beyond that, the loan amount begins to exceed cash value, and the program unravels • If policy cash values do not grow faster than the loan amount, the design will fail • Caution – there is little IRS guidance on whether a personally owned or business owned policy falls under an investment interest situation, allowing loan interest to be deducted. In general, interest on a loan to acquire a life insurance policy is considered personal interest and is not deductible

31. Using this strategy sometimes leads to estate tax problems • Investor or stranger owned life insurance is different from premium finance and should not be confused with it • IOLI or STOLI often involve financing the purchase of a policy. The policy is then sold as an investment to a stranger • STOLI may be illegal in some jurisdictions

32. In a life settlement, an unneeded policy is sold to a third party, usually an institutional investor • They originated with the viatical settlements formerly used by AIDS patients • It is projected that the industry may ultimately grow to an annual volume of $160 billion • There are licensing and commission disclosure requirements in some jurisdictions

33. Tax considerations and other insurance issues • Surrendering a life insurance policy can result in a taxable gain, but no deduction is allowed in the event of a loss • Clients can benefit from the Section 1035 exchange and the insurance swapout process, but, depending on the situation, there can be reasons not to use these strategies

34. One reason is if the client’s health has declined, making it impossible to obtain a new policy at favorable rates • The client may have to enter a new surrender charge period, which would affect cash value liquidity. Or the client may simply be unsuitable for a new product • The accountant should be aware that sometimes the objective of transactions such as this is to generate commissions

35. New surrender charge • New suicide and contestability period • Tax consequences are possible if the existing loan is not paid off prior to the exchange • The accountant receiving compensation from the transaction should disclose that in writing, detailing any possible conflicts of interest arising from the receipt of compensation. Reasons for the transaction should also be set forth in writing • Fill out all state regulatory forms. Go the extra mile in the regulatory arena, as appropriate

36. The accountant, even if not initiating or suggesting the transaction, must be knowledgeable and well versed about the issues involved • There are abusive sales practices that have targeted and victimized seniors • One is inducing seniors into reverse mortgages. Unnecessary annuity products of questionable benefit to the senior are then sold, and purchased with the mortgage proceeds

37. These annuities tend to feature abusive high commissions and long surrender periods • But the accountant should bear in mind that not all annuities are bad, and that reverse mortgages can serve a useful purpose • The real trick is separating the good from the bad

38. CPE Code Word #2 Instructor For CPE, you will be asked to recall this code word in the online evaluation

39. What is the accountant’s role in all this? • The accountant should never engage in “dabbling”. That is accepting professional engagements that you are unable to handle competently, perhaps featuring the selling, buying, or use of products with which you are not familiar.

40. Should you consider being your client’s contractor? • Learn to use opportunities created by the Pension Protection Act wisely and correctly, notably the cash balance plan.

41. Questions? ADDITIONAL RESOURCES • www.vebaplan.com • The NSA MemberLink • NSA 63RD Annual Meeting • The NSA Tax Talk • The CPA’s Guide to Life Insurance by Lance Wallach published by Bisk cpeasy • Various published articles included with this webinar

42. I welcome your calls and emails to discuss these issues. I spend most days speaking with accountants like you anyway and I don’t have a life. No, seriously, contact me so that we can try to help you. • Lance Wallach 516-938-5007 • Fax 516-938-6330 • Email lawallach@aol.com • www.vebaplan.com