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5500 Preparer's Manual for 2012 Plan Years
The premier resource in the field of Form 5500 preparation, 5500 Preparer's Manual will help you handle the required annual Form 5500 filings for both pension benefits and welfare benefit plans.
From Spencer's Benefits Reports: In two notices and a revenue ruling issued on October 18, the Internal Revenue Service has provided a series of warnings and cautions in an attempt to curtail the growing use of certain trust arrangements under IRC Sec. 419(e), which are being sold to professional corporations and other small businesses as welfare benefit funds.
According to the IRS, “There are many legitimate welfare benefit funds that provide benefits, such as health insurance and life insurance, to employees and retirees. However, the arrangements that concern the IRS primarily benefit the owners or other key employees of businesses, sometimes in the form of distributions of cash, loans, or life insurance policies.” Donald L. Korb, chief counsel for the IRS, said that the “action sends a strong signal that these abusive schemes must stop.”
In Notice 2007-83, the IRS notes that it is aware of certain trust arrangements utilizing cash value life insurance policies and purporting to provide welfare benefits to active employees. These arrangements are being promoted to small businesses and other closely held businesses as a way to provide cash and other property to the owners of the business on a tax-favored basis and to improperly claim federal income and employment tax benefits.
The arrangements are sometimes referred to by persons advocating their use as “single-employer plans” and sometimes as “419(e) plans.” According to the IRS, advocates claim that the employers’ contributions to the trust are deductible under IRC Secs. 419 and 419A as a qualified cost, but that there is not a corresponding inclusion in the owner’s income.
Notice 2007-83 informs taxpayers that the tax benefits claimed for these arrangements are not allowable for federal tax purposes. These transactions are tax avoidance transactions, and the IRS identifies certain transactions using trust arrangements involving cash value life insurance policies, and substantially similar transactions, as “listed transactions.” If a transaction is designated as a listed transaction, affected persons have disclosure obligations and might be subject to applicable penalties. Taxpayers who otherwise would be required to file a disclosure statement prior to Jan. 15, 2008, as a result of Notice 2007-83 have until Jan. 15, 2008, to make the required disclosure.
Notice 2007-84 also addresses certain trust arrangements that are being promoted to and used by small businesses to avoid federal income and employment taxes. The arrangements described in this notice involve purported welfare benefit funds that, in form, provide post-retirement medical and life insurance benefits to employees on a nondiscriminatory basis, but that, in operation, will primarily benefit the owners or other key employees of the businesses.
Notice 2007-84 notes that the tax treatment of these arrangements “may vary from the claimed tax treatment.” Furthermore, the IRS might issue further guidance to address these arrangements, and taxpayers should not assume that the guidance will be applied prospectively only.
According to the notice, “Those advocating the use of these plans usually assert that the contributions are tax-deductible, but with no corresponding inclusion by the owner or other key employee. Some of these arrangements involve plans that previously had claimed to be ten-or-more employer plans under IRC Sec. 419A(f)(6); some others were established to receive policies transferred from terminating plans that claimed to be ten-or-more employer plans.”
The rules in the notice apply whether the trust used to provide benefits under the arrangement is a taxable trust or a voluntary employees’ beneficiary association (VEBA). While the trust might have received a determination letter stating that the trust is exempt under IRC Sec. 501(c)(9), a letter of this type does not address the tax deductibility of contributions to the trust with respect to the employer, nor the income inclusion with respect to the employees.
In Rev. Rul. 2007-65, the IRS concludes in two specific situations that for purposes of allowable deductions under Sec. 419, a welfare benefit fund’s qualified direct cost does not include premium amounts for cash value life insurance policies paid by the fund, whenever the fund is directly or indirectly a beneficiary under the policy.
In the first situation, an employer-financed group term life insurance plan is provided through a taxable trust. The trustee has obtained a cash value life insurance policy on the life of each employee, where the amount of the death benefit equals the amount payable under the plan to the employee’s beneficiary and the death benefit proceeds under each policy are payable to the beneficiary designated by the employee. The trust has retained all other policy rights. During the year, the employer contributes to the trust an amount equal to the aggregate premiums due on the life insurance policies payable by the trustee.
In the second situation, the facts are the same, except that the plan provides disability benefits to the employees. The trust is the owner and the named beneficiary of the life insurance policies held by the trust, which are intended to accumulate value to pay the disability benefits.
In the first situation, the revenue ruling notes that “if the benefit provided through the fund is life insurance coverage, premiums paid on cash value life insurance policies by the fund are not included in the fund’s qualified direct cost whenever the fund is directly or indirectly a beneficiary under the policy.”
In the second situation, if the benefit provided through the fund is other than life insurance coverage, “premiums paid on cash value life insurance policies by the fund are not included in the fund’s qualified direct cost whenever the fund is directly or indirectly a beneficiary under the policy. However, the fund’s qualified direct cost includes amounts paid as welfare benefits by the fund during the taxable year for claims incurred during the year.”
This past summer, a number of benefit practitioners already were warning that the use of “419(e) plans” was likely doomed because the plans did not comply with the IRC Sec. 409A rules relative to transfers of insurance policies or cash payments other than upon death.. A newspaper article published in July by the New York State Society of Certified Public Accountants noted that “most of the so-called ‘419(e)’ plans as well as the remaining 419A(f)(6) plans are in violation of the law and subject to hefty penalties.”
The article also noted that sponsors of Sec. 419 plans had two choices: totally eliminate distributions from their plans (except medical reimbursement or death benefits), or comply with Sec. 409A and the regulations.
A simple Web search by the editors of Spencer’s Benefits Reports on the day after the IRS issued its notices and revenue ruling turned up dozens of companies still advocating the use of “419(e) plans” to provide tax advantages to small businesses.
For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.
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