Many small business owners or doctors have lost money in a 419 plan. The IRS considers most of these plans to be abusive tax shelters. Unfortunately, quite an industry developed over the last decade selling these plans to unwary consumers. The promoters claim that the plan is a legitimate way to invest money without paying taxes. These plans were often marketed through seminars and sometimes by insurance agents and accountants.
The “lucky” participants simply made a lousy investment in unneeded insurance. The rest, however, either received a huge tax bill from the IRS or found they were unable to get back their money when needed. The really unlucky both lost their money and had to pay the IRS. A recent case from the United States Tax Court once again points out the perils in 419 welfare benefit plans. (If you have invested in a similar tax shelter such as a Chapter 79 captive insurance company, 412 plan or shark finned CLATs, keep reading. The same advice probably pertains to you as well.)
The newest decision involves Dr. Jerald White, a physician from Tennessee. He and his wife contributed $200,000 a year to a so-called xelan 419 plan. When xélan pulled the plug on their plan, he converted his plan to one operated by Millennium.
xélan was a membership organization for physicians. It’s stated mission was to offer insurance products to its members. One of their offerings was a “Tax Reduction Program.” Dr. White and his wife signed up and invested $200,000 per year of pre tax dollars. Unlike some of the 419 plans, which involved outright theft, the xelan plan required a significant amount of paperwork and a legal opinion to even join. In other words, it appeared legitimate.
It was not. How the Whites got scammed and how they lost their battle with the IRS is a story worth repeating. There are plenty of lessons to be learned for anyone stuck in one of these or similar plans.
Like many similar welfare benefit plan participants, an insurance agent originally recruited Dr. White after attending an informational seminar. Most participants are very educated and sophisticated. To get folks to part with hundreds of thousands of dollars, the promoters have to put on their “A game.” Most seminars are accompanied by slick marketing materials containing legal and accounting opinions from legitimate lawyers and CPAs.
The xélan plan was funded through life insurance. Their “Tax Reduction Program” 419 plan claimed ability to shelter income by treating the premiums as a necessary business expense. Your money goes in tax-free and after just a couple years you can get your money back without a big tax bill. Of course, the IRS says otherwise.
Relying on the information from xelan’s program materials and accountants, the Whites deducted the $200,000 annual plan premiums from their tax returns.
Ultimately, the IRS disallowed the large deductions claimed by the Whites. The IRS claimed that the Whites’ annual contribution of $200,000 to the 419 plans were not valid business expenses and thus could not be deducted. Hurting the Whites even more, the IRS claimed that in 2003, the Whites should have declared an extra $643,000 in income because that was the value of their policies at the time the xelan plan was ended and technically they became distributable.
A common thread in most of these cases is the attempt to sell huge insurance policies to people that don’t really need the coverage. In order to sweeten the deal, participants are told they can shelter their income from tax and deduct the cost of the premiums as an ordinary and necessary business expense.
No one wins in these cases except the promoter (who charges a fee), insurance companies and agents.
Dr. White took his battle to U.S. Tax Court where he lost. The court ruled that a taxpayer is negligent if he puts his faith in a scheme that on its face offers an improbable result without obtaining an objective, independent opinion as to the scheme’s validity.
Of course, the Whites claimed that they had obtained such opinions and had the right to rely on the legal and opinion and accounting work provided by xelan. Because the accountants and lawyer providing the opinions were paid by xelan, the court ruled they did not qualify as independent. In the words of the court, “A promoter’s self interest makes such ‘advice’ inherently unreliable.”
As noted before, there are many similarities in these cases. Frequently these plans are accompanied by legal opinions from reputable law firms. Unfortunately, the opinions were not drafted to protect the taxpayer. In the case of the xelan plan, the fine print says the opinion was only to be relied upon by the promoter and not the taxpayer.
There is some good news in this story. It is often possible to get back one’s money and recover substantial damages. Although the promoters are usually long out-of-business and have no assets, the insurance agents selling these plans and the insurance companies may be liable. Sometimes accountants and lawyers that truly provide independent reviews and opinions can also be held liable
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