Small Businesses Fined by the IRS Initiating Lawsuits Against Benefit Plan Advisors

Written by: Financial, Estate Planning and Retirement Expert Witness No. 3306
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Advisors and insurance brokers, for many years, beginning in the 1990s, have sold the 412(i) plan, a type of defined-benefit pension plan, and the 419 plan, a health and welfare benefit plan, to small businesses as a way of providing certain benefits to their employees, while also, and much more importantly receiving large tax deductions. Some of these plans were structured in a way that has subsequently been deemed as an abusive tax shelter.

Via legislation enacted in October 2004, Congress changed the law to address these certain tax shelters which were considered abusive and required that these companies file with the Internal Revenue Service if they had these plans in place.  Contributions to these plans were described by advisors as fully tax deductible and, it was claimed, large contributions could be sheltered, especially in the early years of the plan’s life, so a significant amount of income was sheltered, possibly forever, if rolled into annuities and similar financial products.  It was actually sometimes claimed that money could be contributed, as well as withdrawn, tax free.  Another outrageous claim was that the amount of tax deductions was unlimited.

Until recently, the IRS had instituted a moratorium on collecting these fines. However, the moratorium ended on June 1, 2010.  Many companies and financial advisors were not aware that this was a cause for concern. However, according to experts, the author of this article included, employers are now receiving heavy scrutiny from the Federal Government, as the IRS has been aggressive in auditing these plans. The fines for failing to notify the agency about them are $200,000 annually for businesses and $100,000 annually for individuals, for every year of participation in whatever plan is in question.

The IRS increasingly is issuing penalty notifications to businesses, as well as to advisors who sold these plans to small businesses or who recommended plan participation, in addition to accountants who prepared and/or signed tax returns claiming deductions for participation in such a plan. Not surprisingly, the businesses affected by these fines often resort to litigation against the advisors who persuaded them to adopt these plans, or who sold them.  The situation for the businesses is bad enough, and they sue to recover, among other things, the expenses of these penalties.  But it could be even worse for the advisors involved, who face not only litigation but IRS penalties as well, and perhaps even having action taken against professional licenses.

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Tags: insurance, brokers, IRS, tax, planning