"Welfare Benefit Plan Tax
Schemes" Harmful to Your Health By:
Bill E. Branscum
"Welfare Benefit Plan" tax schemes are gaining
popularity among sole proprietors about like crack cocaine, and
they promise to be much more harmful to their health.
As we all know, businesses that provide benefits to
their employees, such as health care and insurance, write the costs
of those welfare benefit programs off on their taxes. Welfare Benefit
Plan tax schemes are promoted as a way for sole proprietors to do
the same thing, providing their favorite employee (themselves) with
cleverly crafted welfare benefits, writing the costs of those benefits
off as tax deductions. So, as the scheme goes, you pump massive
amounts of income into a cash value life insurance policy, deducting
those premiums as a tax deduction, while building a cash value that
you can later cash out, or borrow against, "tax free."
The promoters of these schemes generally explain (with a wink and
a nod) that when you begin to cash out, you have an obligation to
report that money as income, because insurance policy proceeds are
not generally taxable, and these withdrawals are not reportable
by the issuer of the policy.
In other words, these Welfare Benefit Plans are promoted
to be like some special IRA that you can put all the money in you
want, write the contributions off your taxes, and pull the money
out later without any notification to the IRS . . . unless you tell
Internal Revenue Code Sections 419, and 419A, define
the rules allowing employers to make tax deductible contributions
to Welfare Benefit Plans, in order to provide their employees with
medical and life insurance benefits. There is nothing inherently
wrong with these plans; the IRS acknowledges that businesses often
maintain welfare benefit funds that fully comply with the intent
of Sections 419 and 419A and, in fact, provide meaningful medical
and life insurance benefits to their employees, making substantial
contributions to those funds that the IRS accepts as fully deductible.
On the other hand, the IRS does take issue with the
Welfare Benefit Plans that are being promoted to sole proprietors
and small businesses as a way to avoid federal income taxes via
schemes that, in form, provide medical and life insurance benefits
to key employees but, in substance, primarily serve to benefit the
owner(s) of the businesses. These programs are sometimes referred
to by their promoters as “single employer plans,” or
“419 plans.” The promoters claim that the employers’
contributions are deductible under IRC Sections 419 and 419A as
ordinary and necessary business expenses.
The essence of the 419 Welfare Benefit Plan scam is the representation
that a business owner can provide life insurance for himself as
his own “favorite employee,” writing off the policy
payments as a tax deductible business expense, while enjoying the
benefit of the insurance, and accumulating cash value in the policy.
They cannot -- PERIOD!
Admittedly, the provisions of the Internal Revenue Code, and related
case law, can be very difficult to understand, but evaluating the
viability of this sort of tax scheme need not be that complicated.
With regard to the assertion that sole proprietors can fund their
own life insurance policies as a tax deductible business expense,
there is no room for interpretation, discussion or debate. IRC 264(a)(1)
says, “No deduction shall be allowed for premiums
on any life insurance policy . . . if the taxpayer is directly or
indirectly a beneficiary under the policy or contract.”
Further, the Internal Revenue Service has made every effort to
publish guidelines and abusive tax scheme warnings that are relatively
easy to understand.
In IRS Notice 2007-84, entitled, Trust Arrangements
Purporting to Provide Nondiscriminatory Post-Retirement Medical
and Life Insurance Benefits, appended hereto as Exhibit
1, the IRS cautioned taxpayers that the tax treatment of trusts
that, in form, provide postretirement medical and life insurance
benefits to owners and other key employees may vary from the treatment
claimed by those who promote them.
In IRS Notice 2007-83, entitled, Abusive Trust Arrangements
Utilizing Cash Value Life Insurance Policies Purportedly to Provide
Welfare Benefits, appended hereto as Exhibit 2, the
IRS identified schemes involving cash value life insurance policies
as being “listed transactions.” Taxpayers were put on
notice that they are problematic, and they have an affirmative obligation
to disclose their involvement in them.
With regard to the specific representations proffered
by the promoters who push these programs, the IRS published Revenue
Ruling 2007-65, Section 419 – Treatment of Funded
WelfareBenefit Plans, appended hereto as Exhibit 3.
It unequivocally states that no deduction is allowable for the premiums
paid into these plans when the taxpayer is directly, or indirectly,
a beneficiary. [See Exhibit 3, Page 6]
The deductibility issue notwithstanding, Revenue Ruling 2007-65,
Section 419 – Treatment
of Funded Welfare Benefit Plans, makes it clear that,
in addition to
disallowing the premium deductions, the value of any economic benefit
conferred by the employer to himself as an employee is taxable income.
[See Exhibit 3, Page 6-7]
An IRS Newswire Article IR-2007-170, published October 17, 2007,
and entitled, IRS Warns Taxpayers About Certain Trust
Arrangements Sold As Welfare Benefit Funds, is appended
hereto as Exhibit 4. It warns that the arrangements that the IRS
defined as abusive are those programs that, “primarily benefit
the owners, or other key employees of the business, sometimes in
the form of cash, loans, or life insurance policies.” [See
Exhibit 4, Page 1]
Abusive “Welfare Benefit Plan” tax schemes are not a
new thing. Prior to the enactment of IRC 419, similar plans were
based upon IRC 501I(9). This provision of the tax code allowed for
tax exemption for Voluntary Employee Benefit Associations (VEBA’s),
which provide life, health, and other benefits to members, their
dependents, or their designated beneficiaries.
Once VEBA related patterns of abuse emerged, the IRS published
various warnings and decisions. Congress ultimately acted, and IRC
501I(9) was displaced by IRC 419 which was intended to narrow things
down substantially, and eliminate the abuses.
The IRC is not a code of exclusions – unlike a penal code
that tells you what you cannot do, the IRC tells you what you must
do, and what you can do. As we see over and over again, tax scheme
promoters make their livings by twisting the “what’s
allowed” into what was never intended, playing the audit lottery
until the tax “strategy” systems that they create for
their clients are ultimately scrutinized and collapse.
IRC 419(e) offers nothing like the provisions that these tax scheme
promoters purport to be able to make possible; in fact, as explicated
above, section 419 of the code was established in an effort to curb
the very abuses that these people are actively pushing. The Internal
Revenue Service has done everything that they could reasonably be
expected to do to get the word out, and the IRS, Criminal Investigation
Division, is actively pursuing these cases.
In defending one of these cases, or any other case
where your client has been persuaded to buy into a tax scheme, bear
in mind that the tax scheme promoters often represent a sort of
“double edged sword” to their
victims. First, they sell them snake oil tax remedies that seem
to work wonderfully well, until one of their clients is selected
for an audit. Later, when they are prosecuted, they have a self-serving
incentive to blame their victims, and they often do, thereby victimizing
This generally manifests itself in one of two ways.
Either the promoter claims to have given their client legitimate,
viable advice, which they claim that the client misused and abused
unbeknownst to them, or they admit that their tax programs were
abusive tax schemes, and testify that their clients were knowing,
willful participants in tax evasion. Unfortunately, by the time
that they are making these sorts of claims, it is too late to record
their "pitch" as it was originally presented [clue].
I have seen notorious tax scheme promoters like Wayne
Rebuck and Michael Maricle do Jimmy Swaggart routines on the witness
stand, piously denouncing their own personal transgressions, while
dragging everyone else they could into the mire with them in the
interest of “substantial assistance.” Both testified
that the “clients” who had relied on them knew that
they were involved in tax evasion all along, and like all professional
con men, they were persuasive liars.
People who choose to make their living lying to, and
misguiding hapless Clients, and setting them up with expensive,
bogus tax programs that amount to economic suicide, while bleeding
them for every dime they can get, cannot be expected to suffer pangs
of conscience at selling those same people down the river when it
serves their interests. If you get involved in the case early enough,
you may be in a position to preempt that.
When your client has been victimized, rather than
close ranks with the scam promoter, and try to defend the indefensible,
it may be in your client's best interest to get cleaned up, and
throw the mutt who got them into the mess under the government bus.
While everyone is still getting along with each other, you have
an opportunity to generate evidence that you will not be able to
obtain once the promoter "lawyers up." An indepth background
investigation, and a couple of hours of under cover video documenting
the hype that the promoter is preaching, can be a very valuable
thing at the US Attorney's trading table.
Again, while everyone is still getting along with
each other, you have an opportunity to generate evidence that will
be lost to you forever once the finger pointing begins. If you handle
it right, you may find that the government is not necessarily "the
enemy," and justice is not an anathema to our profession.
In our most recent case, we recognized our opportunities,
we seized them, and our client received the, "You are no longer
the subject of a criminal investigation" letter appended hereto
as Exhibit 5. At the end of the day, our client got a "walk," and the
promoter, whose life turned out to be a convoluted history of fraud and failure,
including fake academic degrees, two bankruptcies, a series of IRS Tax Liens,
two NASD non-performance terminations, and a litany of law suits, did not fare
It was a beautiful thing.
I hope to be able to publish a Case Study, and provide
more specific information as to how we worked with an unusually
aggressive law firm to orchestrate this spectacular outcome, in
the near future.
I have appended the above referenced Exhibits for