An Expert Discusses Section 79 and Listed Transactions
The dangers of being "listed"
A warning for 419, 412i, Sec.79 and captive insurance
As published in:
AccountingToday: October 25, 2010
By: Lance Wallach
Taxpayers who previously adopted 419, 412i, captive insurance or Section 79 plans are in big trouble.
In recent years, the IRS has identified many of these arrangements as abusive devices to funnel tax deductible dollars to
shareholders and classified these arrangements as "listed transactions."
These plans were sold by insurance agents, financial planners, accountants and attorneys seeking large life insurance
commissions. In general, taxpayers who engage in a "listed transaction" must report such transaction to the IRS on Form 8886
every year that they "participate" in the transaction, and you do not necessarily have to make a contribution or claim a tax
deduction to participate. Section 6707A of the Code imposes severe penalties ($200,000 for a business and $100,000 for an
individual) for failure to file Form 8886 with respect to a listed transaction.
But you are also in trouble if you file incorrectly.
I have received numerous phone calls from business owners who filed and still got fined. Not only do you have to file Form 8886,
but it has to be prepared correctly. I only know of two people in the United States who have filed these forms properly for clients.
They tell me that was after hundreds of hours of research and over fifty phones calls to various IRS
The filing instructions for Form 8886 presume a timely filing. Most people file late and follow the directions for currently
preparing the forms. Then the IRS fines the business owner. The tax court does not have jurisdiction to abate or lower such
penalties imposed by the IRS. Many business owners adopted 412i, 419, captive insurance and Section 79 plans based
upon representations provided by insurance professionals that the plans were legitimate plans and were not informed that they
were engaging in a listed transaction. Upon audit, these taxpayers were shocked when the IRS asserted penalties under Section
6707A of the Code in the hundreds of thousands of dollars. Numerous complaints from these taxpayers caused Congress to
impose a moratorium on assessment of Section 6707A penalties.
The moratorium on IRS fines expired on June 1, 2010. The IRS immediately started sending out notices proposing the imposition
of Section 6707A penalties along with requests for lengthy extensions of the Statute of Limitations for the purpose of assessing
tax. Many of these taxpayers stopped taking deductions for contributions to these plans years ago, and are confused and upset
by the IRS's inquiry, especially when the taxpayer had previously reached a monetary settlement with the IRS regarding its
deductions. Logic and common sense dictate that a penalty should not apply if the taxpayer no longer benefits from the
Treas. Reg. Sec. 1.6011-4(c)(3)(i) provides that a taxpayer has participated in a listed transaction if the taxpayer's tax return
reflects tax consequences or a tax strategy described in the published guidance identifying the transaction as a listed transaction
or a transaction that is the same or substantially similar to a listed transaction. Clearly, the primary benefit in the participation of
these plans is the large tax deduction generated by such participation. It follows that taxpayers who no longer enjoy the benefit
of those large deductions are no longer "participating ' in the listed transaction. But that is not the end of the story.
Many taxpayers who are no longer taking current tax deductions for these plans continue to enjoy the benefit of previous tax
deductions by continuing the deferral of income from contributions and deductions taken in prior years. While the regulations do
not expand on what constitutes "reflecting the tax consequences of the strategy", it could be argued that continued benefit from
a tax deferral for a previous tax deduction is within the contemplation of a "tax consequence" of the plan strategy. Also, many
taxpayers who no longer make contributions or claim tax deductions continue to pay administrative fees. Sometimes, money is
taken from the plan to pay premiums to keep life insurance policies in force. In these ways, it could be argued that these
taxpayers are still "contributing", and thus still must file Form 8886.
It is clear that the extent to which a taxpayer benefits from the transaction depends on the purpose of a particular transaction as
described in the published guidance that caused such transaction to be a listed transaction. Revenue Ruling 2004-20 which
classifies 419(e) transactions, appears to be concerned with the employer's contribution/deduction amount rather than the
continued deferral of the income in previous years. This language may provide the taxpayer with a solid argument in the event
of an audit.