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IRS officials warned taxpayers to be aware of abusive tax-avoidance transactions (ATATs) that the IRS is currently investigating and that threaten individuals' retirement plans. IRS officials discussed potential abusive schemes that can threaten retirement savings, including insurance-funded plans, schemes involving defined benefit plans, employee stock ownership plan (ESOP) abuses and rollover as business start-ups (ROBS) compliance issues, among others, during an August 27, 2010 IRS teleconference.
According to Monika Templeman, director, Employee Plans (EP) Examinations, these transactions in many cases are "real tax-avoidance schemes, as opposed to legal tax avoidance...and simply being aggressive about your position." As part of EP Examinations' priorities, the IRS is also developing strategies to identify and address new abusive schemes "as they're trickling downward," said Templeman.
The IRS intends to deter future promoters from moving into the employee retirement plan arena, as well as to stop currently marketed abusive schemes, said Colleen Patton, area manager, Pacific Coast, EP Examinations. Patton added that the IRS is working with the Department of Justice and divisions across the IRS, especially the Small Business/Self-Employed (SB/SE) Division. EP agents are leading and/or supporting various investigations of promoters whose schemes involve employee plans, Patton added.
Templeman and Patton discussed a number of ATATs that are currently under EP scrutiny, including ROBS and others. ROBS are not an abuse, per se; they are arrangements that can lend themselves to problems. The IRS is concerned about ROBS transactions because they are accomplished without any imposition of taxes that ordinarily attach to distributions from retirement plan savings accounts, Templeman said. ROBS arrangements were created to secure available funds held in tax-deferred savings, typically an employer's plan, for an aspiring entrepreneur without incurring tax liabilities that would ordinarily apply to a distribution, Templeman explained.
The IRS is concerned about these transactions because distributions would normally be subject to treatment as ordinary income, with possible additions to tax in the form of early distribution penalties. Moreover, the transaction is one that has a lot of compliance issues the IRS has seen when doing exams, said Templeman. Of "significant" concern, she continued, is that stock is exchanged in a ROBS transaction and no independent effort is made to determine the value of the stock.
Invalid collectively bargained plans
Templeman also revealed that a number of practitioners have brought to the IRS's attention a scheme involving invalid collectively bargained plans. Typically, these are associated with professional offices such as doctors and lawyers who set up their own union with the office employees as members. However, "employees are completely unaware of the fact they are union employees." Moreover, in many cases, "employees' wages are grossed up to account for union dues the employer is paying on their behalf," Templeman explained. The "motivation" behind this plan, she said, is to put employees of a business that is not otherwise typically unionized into a union plan for purposes of exempting them from coverage for benefits provided by employers' plans.
The IRS has received leads from Service Determination Specialists involving potential issues regarding ESOPs adopted by limited liability companies (LLCs). However, the IRS has only identified two cases where the practitioner has submitted a determination letter request and the IRS is in the process of determining if the transaction has merit.
One-person DB plans
EP Examinations received from the IRS Emerging Issues team reports of a scheme involving a "one-person defined benefit plan." According to Templeman, this transaction involves little or no income on the related sponsor's income tax return. However, Templeman said that, although EP determined there were not a significant number of cases that fell into this category, questions did remain regarding whether this was a legitimate plan. Templeman explained that the IRS sees many schemes involving defined benefit plans, "especially because individuals can contribute more to a defined benefit plan."
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