The Internal Revenue Service is trying to get some users of 412(i) defined benefit pension plans and 20 other tax-cutting vehicles to come to it before it goes after them.
Eligible taxpayers can make peace with the IRS by giving up on what the IRS says are “improperly claimed tax benefits” and, in some cases, paying a penalty, according to Joe Spires, author of the document describing the settlement program, IRS Announcement 2005-80.
Spire predicts in the announcement that the program will affect about 500 taxpayers.
Laurie Lewis, a senior vice president at the American Council of Life Insurers, Washington, says taxpayers who are eligible for the settlement program should talk to experienced tax advisors before deciding to participate.
The IRS has not obtained court rulings indicating that some the categories of tax-saving vehicles included in the settlement program, such as certain types of 412(i) plans, are necessarily abusive, Lewis says.
In the case of the 412(i) plans affected, before a 2002 ruling came out, “there was never any guidance that [taxpayers] shouldn’t be doing this,” Lewis says.
Lewis says she is not sure whether all of the 412(i) plans whose sponsors would be eligible for the settlement program really have abusive plans.
Most of the categories of tax-saving vehicles included in the settlement program, such as “common trust fund straddle tax shelters,” have no connection with the insurance industry.
But the IRS settlement program announcement does refer to several tax-saving strategies involving use of Roth individual retirement arrangement transactions, charitable remainder trust distributions and employee stock ownership plans.
The inclusion of 412(i) plans in the settlement program seems to have the clearest relevance to the life insurance industry.
Older, high-income owners of small businesses, such as medical practices and dental practices, often set up 412(i) plans and use annuity contracts or life insurance policies with guaranteed returns to fund defined benefit pension plans.
Because sponsors use funding vehicles with guaranteed returns, they escape from many of the reporting requirements that normally plague sponsors of defined benefit pension plans.
Moreover, because products with a guaranteed return usually offer yields of less than 3%, older, high-income business owners may be able to deduct annual contributions of $100,000 or even $300,000 from taxable income in the process of meeting funding goals.
The IRS has been looking hard at efforts to cut taxes through the use of complicated life insurance and annuity funding arrangements in 412(i) plans. The IRS says it is including 412(i) plans in the new settlement program if accumulated plan assets exceed the benefits payable; if life insurance policies built into the plan would pay more death benefits than the plan documents say the plan offers; or if the value of some participants’ rights to buy life insurance contracts from the plan is much higher than other participants’ contract purchase rights.
The IRS will be imposing 10% penalties on users of some tax-saving vehicles, but the penalties for use of affected 412(i), ESOP, charitable remainder trust and Roth IRA arrangements will be 5%, Spires writes.
Spires says the IRS might reduce a settling taxpayer’s total bill if the taxpayer is unable to pay all of the back taxes that the IRS says the taxpayer owes.
The IRS will waive requirements for the payment of penalties for taxpayers who relied on favorable written opinions from independent tax advisors who were not involved in efforts to promote the tax shelters, Spires writes.
A copy of the tax settlement announcement is on the Web at http://www.irs.gov/pub/irs-drop/a-05-80.pdf