Every year at this same time, I run headlong into the same issue for my clients – last minute Tax Scams by very persuasive promoters.
Last year, one of my tax strategy clients had found THE answer for their tax issues. They ran into a guy who had the magic answer that no one else did. (That’s always a little scary) They would invest $100,000 and get a write-off of $1,000,000. That was the short version that my tax strategy clients told me. I knew there was no way they could do that unless there was recourse debt (ie, they were on the hook for some debt) simply because one of the fundamental rules of tax law is that you can not take a loss bigger than your basis.
But, I also knew that sometimes people mis-hear what is said and so I gave the guy the benefit of the doubt and said I wanted to know more. He was very selective in what he sent. First of all there were tons of case law, revenue rulings, PLRs (Private Letter Rulings) and sites of Code and Regulations to back it up! But, I asked what was “it”? Underneath the fast talking, he was proving that beneficiaries of a simple trust would treat the distributions just the same as if they were in their own name. Okay. Sure, we agree on that. In fact, he didn’t need to show me anything to back that up. I agree with that.
But what about this $100K investment that somehow turns into a $1 mill write-off? Oh, wait, he said, there were even more cases. He sent them on – all proving that the trust could pass through a loss.
He got tired of me asking the same question and told my clients that I agreed with him (before I could tell them I did not) and got them to send him a list of all their friends who also had tax problems with the promise that he’d pay a commission to them if any of them bought.
Lesson learned there for me – don’t waste time. Ask the hard questions right up front and keep my client informed.
Since that time, DKTaxServices, a full time tax service company, has started so there are clients I work with year-round. And guess what? One just got the secret tax strategy of the century!
It was a Section 79 plan. Okay, fine, that means that a C Corporation can take a deduction for the premiums of up to $50,000 of term life insurance coverage. I think my premium on one of my policies – $100K of term in this case – is about $200 per year. So, half of that is $100. Sure, it’s nice to take it but a $100 deduction is not going to do a lot to help these people’s tax issues.
Then I heard that it was actually a $25,000 premium and it would be fully deductible. I knew he didn’t have that many employees, so that just didn’t make sense. I asked more questions and found out that there was a “savings account” built in. That sounded suspiciously like a cash value build-up. And that means whole life (aka permanent life insurance). I love whole life policies. I’ve had one for 20 years now. I don’t pay premiums anymore on it and the cash value just keeps growing. It’s a safe, tax free, liquid reserve for me. And, it’s got great asset protection. BUT whole life premiums are not deductible.
Then I got the deluge of material. (hmm….same M.O. as last year) I sorted through it and that took a few days. There was a lot of biographical information and screenshots of web pages which didn’t provide a lot of information. There were also a lot of “illustrations”, which is something that financial planners and insurance agents will use to show returns. First rule of an illustration is to know what the assumptions are. There were none listed here. Plus, the name of the insurance company wasn’t to be found anywhere. In today’s economic climate, you want to make sure you’re with a solid life insurance company. Some have closed their doors and if you had cash value in a permanent policy sitting there, you’re out of luck.
Still, though, I couldn’t figure out how they were taking a deduction. That’s when I stumbled on some suspicious words. If you’re still with me through the long drawn out story (and my soapbox du jour), there are two things to look for if you’re ever in this spot “retirement plan” and/or “benefit group.”
There were some schemes a decade ago that attempted to put life insurance into a retirement plan. That wasn’t allowed then, but there were some loose definitions back years ago that made it plausible. No more. Those definitions are clear cut now. You can’t run life insurance in a retirement plan.
They didn’t have that as their plan, so moot point anyway.
But there was a sentence at the beginning that said, “This must be done inside a benefit group.” Oops – we’ve got a red flag here.
I went to the “FAQs” which could have been retitled “why we know more than your stupid CPA does”. It was a little on the condescending side.
The first statement was that they had a patent on the strategy. Uh-oh. Those aren’t legal. The IRS has a few grandfathered in, but there are huge reporting requirements if you use one and you can count on your return being audited.
Then the questions are answered, all dealing mainly with “Is this an abusive tax shelter?” “Is this a listed transaction?” And the answer was “no” “no” and “no”.
The very last question though “Was this a 419 or 419A plan?” And the answer was a winding maze of not quite answering the question. In the end, there was the statement that I’m sure someone made them put in: It is possible that this could be considered a 419A or 419 plan.
And that’s where everything stops. A 419 or 419A plan is called a VEBA. They were very popular at one time and then there where a lot of abuses. So they went on the listed transactions list by the IRS. That meant you had to disclose the plan on your tax return or face severe penalties.
The abuses continued and the IRS moved them to the “abusive tax shelter” list. Now it’s serious. You must disclose if you use them and if you do ONE THING WRONG (by the way, this plan clearly was wrong) the penalty is $100,000 per individual and $200,000 at the corporate level. PLUS the accountant pays the penalty too. And chances are someone might go to jail as well. They are targetting the promoter for that, but if the accountant doesn’t exercise due diligence she might get that as well.
Now, here’s the deal. I have a client who is mad at me now. This seemed like such a great plan. And the promoter warned him that “small minded CPAs” wouldn’t understand it and would try to stop him. So he should just do it anyway. I don’t know if he did or not. If he did, I think I have to fire him. I can’t take the risk of signing a return that has those kind of penalties attached.
BTW, even if this had not been a 419 plan, the numbers didn’t make sense. The internal rate of return on the investment was unbelievably low. I’m guessing the promoter is taking a big commission for the deal. PLUS I still don’t know who the insurance company is. There are just screen shots of a website and illustrations with no disclaimers, no company name, nothing.
So, that is my soap box today. Be careful. The reason that my clients save so much in taxes is simply because of the process we use And we use full range of the “tools in the tool box”. We don’t ONLY use one structure or another. We use them all as applicable. It’s not even in the grey area. And we go out of our way to make sure that the way we prepare the return keeps both of us out of jail! (and reduces your chances of audit) That’s the way I want to do business.