September 24, 2010
Muhammad Ali: Superman don’t need no seat belt.
Flight Attendant: Superman don’t need no plane, neither.
A 412(e)(3) plan (formerly known as a 412(i) plan), or a 401(k) plan, may be the proper fit for your business and investment strategy, but the IRS will be watching carefully how you form and operate your plan. We discuss the pluses and minuses of these plans further on in the book but warn you up front that cash-hungry IRS can scrutinize the legitimacy of any of these pension planning methods. It is essential to use the tools, advice, and strategy of competent tax and investment strategists.
The odds are stacked against the average investor, it seems. The opposite is true, however—if the average investor is willing to educate himself and team up with ethical professionals who have weathered this storm, and will weather the next one, too.
One thing is certain, though; when the Government is teetering toward insolvency, it will seek to make up lost revenues. Over the next 12 months, the Small Business and Self-Employed Division (SB/SE) of the Internal Revenue Service will focus on taxpayer services and increased enforcement. SB/SE owns the majority of the tax gap: to wit, the difference between what is due and what is actually received. Enforcement is a necessary presence when you are talking about tax administration. Let us review a cautionary tale regarding the methods it can utilize.
Bruce Hink, who has given me permission to utilize his name and circumstances, is a perfect example of what the IRS is doing to unsuspecting business owners. What follows is a story about Bruce Hink and how the IRS fined him $200,000 a year for being in what they called “a listed transaction.” In addition, I believe that the accountant who signed the tax return and the insurance agent who sold the retirement plan will each be fined $200,000 as material advisors. We have received a large number of calls for help from accountants, business owners, and insurance agents in similar situations. Don’t think this will not happen to you. It is happening to a lot of accountants and business owners, because these so-called listed, abusive plans, or substantially similar plans, are currently being sold by most insurance agents.
Bruce was a small business owner facing $400,000 in IRS penalties for 2004 and 2005 for his 412(i) plan. These penalties were imposed under Section 6707A of the Internal Revenue Code, which authorizes penalties of up to $200,000 per year simply for failing to disclose participation in what the Service deems a listed transaction. Here is how the story developed.
In 2002, an insurance agent representing a century old, well-established insurance company suggested he start a pension plan. Bruce was given a portfolio of information from the insurance company, which was given to the company’s outside CPA to review and to offer an opinion. The CPA gave the plan the green light and the plan was started for tax year 2002.
Contributions were made in 2003. Then the administrator came out with amendments to the plan, based on new IRS guidelines, in October 2004.
The business owner’s agent disappeared in May 2005 before implementing the new guidelines from the administrator with the insurance company. The business owner was left with a refund check from the insurance company, a deduction claim on his 2004 tax return that had not been applied, and without an agent.
It took six months of making calls to the insurance company to get a new insurance agent assigned. By then, the IRS had started an examination of the pension plan. Bruce asked for advice from the CPA and a local attorney (who had no previous experience in such cases), which made matters worse, with a “big name” law firm being recommended and more than $30,000 in additional legal fees being billed in three months.
To make a long story short, the audit stretched on for more than two years to examine a two year old pension with four participants and $178,000 in contributions.
During the audit, no funds went to the insurance company. The company was awaiting IRS approval on restructuring the plan as a traditional defined benefit plan, which the administrator had suggested, and which IRS had indicated would be acceptable. The $90,000 2005 contribution was put into the company’s retirement bank account along with the 2004 contribution.
In March 2008, the business owner received an apology from the IRS agent that headed the examination. Even this sympathetic IRS agent thinks there is a problem with the IRS enforcement of these Draconian penalties. Below is one of her e-mails to the business owner, who was fined $400,000.
From: xxxxxxxx xxxxx
Date: Tue, Mar 4, 2008 at 7:12 AM
Subject: RE: Urgent
To: Bruce Hink
Thanks Bruce - yes - please just overnight them to the Grand Rapids address. Once again, I’m sorry about this. Basically, our Counsel told us that we needed language specific to the IRC 6707A penalty in order for that statute to be extended. I will ask the Reviewer to hold off an extra day.
I’m also very sorry that this is getting you down. Deeply sorry. It’s very difficult for me as well - before I started working this project (412(i)) I was doing audits of 401(k) and profit sharing plans. If there was an error in the plan, the employer would just fix it and the audit was over. There wasn’t anything controversial or adversarial about it - and I felt like I was helping people - employers and plan participants. I really liked my job. In two years’ time, that has completely changed. I know it’s not very “professional” to make such confessions - so forgive me. But I guess I just wanted you to know that I really sympathize with your situation - and have been doing whatever I can to help. I know that having this hanging over your head can’t be fun - but as this project goes forward - I think that the IRS is going to have to soften their position somewhat - so these delays may be to your benefit.
Also, I’m not really supposed to be sending emails to you - but when I went through the file I couldn’t find a good phone number for you. Could you just send me a note or an email with a current phone number?
Looking to receive the signed 872s on Thursday. If you have any questions at any time - please call me at xxx-xxx-xxxx. I’m usually in the office in the mornings.
The IRS subsequently denied any appeal and ruled in October 2008 that the $400,000 penalty would stand.
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