West Virginia farmers claim MassMutual and their accountants engaged in fraudulent conduct involving 412(i) plan

MassMutual has recently been sued in a 412(i) case in West Virginia. According to published reports, an elderly farming family in West Virginia has filed suit against MassMutual, several of it’s agents, and a West Virginia accounting firm.

In their suit, they claim that the accountants and MassMutual agents set up a 412(i) pension plan that included policies and annuities that generated hundreds of thousands dollars in commissions to the MassMutual agents and their accountants (who did not disclose that they would benefit as well). In their suit, the plaintiffs claim they were not qualified for the plan, that the agents and accountants allegedly falsified information, forged signatures on insurance and annuity documents, and fraudulently amended tax returns.

Unfortunately, this type of conduct is not uncommon. I represented a client in a single person ESOP who made similar allegations against another insurance company and broker and I am currently representing a physician with a 412(i) plan who is making similar allegations.

You can contact Chris Hellums at ChrisH@PDKHLAW.com

Are Captives the new 412, 419 and the One Man ESOP

I read recently where some believe that captive insurance companies may become the next 412 and 419 problem for unsuspecting companies. Designed under IRS Code 831(b), these captive insurance companies are designed to insure the risks of an individual business. In theory and if properly designed, the premiums are deducted when paid to a related company, and depending on claims, profits can be paid out as dividends and when liquidated, the proceeds are taxed at capital gains rates.

The problem with Captives is that the are expensive to set up and operate. When I last looked into this issue, I was told that in order to set up a captive, you needed at least $1,000,000.00 per year in premium spent to make it worth the administrative cost. Captives must be opetate as a true risk assuming entity, not simply a tax avoidance vehicle.

Reports indicate that the IRS is looking into the sale of life insurance to fund Captives. This sounds very familiar.

Chris Hellums can be contacted at Chrish@PDKHLaw.com

What is MDL and what is the status of the 412i MDL

MDL stands for Multidistrict Litigation. It was created by Congress in 1968 – 28 U.S.C. §1407.

The act created an MDL Panel of judges to determine whether civil actions pending in different federal districts involve one or more common questions of fact such that the actions should be transferred to one federal district for coordinated or consolidated pretrial proceedings. In theory, the purposes of this transfer or “centralization” process are to avoid duplication of discovery, to prevent inconsistent pretrial rulings, and to conserve the resources of the parties, their counsel and the judiciary. Transferred actions which are not resolved in the MDL are remanded (sent back) to their originating court or district by the Panel for trial.

Recently, Pacific Life, Hartford Life & Annuity moved for summary judgment in the MDL. The court granted the motions in part, and denied the motions in part. Specifically, the court dealt with the issue of the disclaimers contained within the policies and signed by various policyholders.

Applying California law in evauating the disclosures and disclaimers, the Court ruled that the California Plaintiffs failed to raise issues of material fact that they reasonably relied on representations by Hartford and Pacific Life regarding the tax and legal issues related to their 412(i) plans.

Conversely, the court ruled that pursuant to Wisconsin law, the disclaimers were unenforceable. The court came to similar conclusion when applying Texas law to the Plaintiffs claims.

Here Comes the Internal Revenue Service

The IRS's response to these 412(i) plans was predictable. The IRS had long criticized the features that characterized 412(i) plans. When the proliferation of these plans hit critical mass, the IRS honed in on these plans and gave fair warning of what was about to come.

The IRS does not make law. Its job is collection, enforcement and interpretation of existing law.

In 2002 and and early 2003 IRS officials began giving speeches at benefits conferences advising that 412(i) plans met neither the spirit nor the letter of the Code. They made it clear that the IRS would not be gentle and even indicated that potential criminal liability existed.

Insurance company representatives attended these conferences.

Neither the brokers, promoters, or Insurance companies relayed this information to their clients and insureds at this time.


On February 13, 2004, the IRS issued a press release, two revenue rulings, and proposed regulations to shut down abusive transactions involving specifically designed life insurance policies in retirement plans, section 412(i) plans. See http://www.irs.gov/pub/irs-utl/ir-04-021.pdf


In October of 2005, the IRS invited those who sponsored 412(i) plans that were treated as listed transactions to enter a settlement program in which the taxpayer would recind the plan and pay the income taxes it would have paid had it not engaged in the plan, plus interest and reduced penalties.



In late 2005, the IRS began obtaining information from advisors and actively auditing plans and more recently, levying section 6707 penalties.

Who is Richard Smith and the Bryan Cave law firm and where do they fit into the puzzle?

According to their website, Bryan Cave is a law firm with over 1100 attorneys and 19 offices worldwide. Richard C. Smith is a partner in this mega firm. His webpage states that "[h]is practice has a particular emphasis in the employee benefits area including the design, implementation and other aspects of pension, profit sharing and other qualified plans." His bio says that he graduated summa cum laude from Syracuse University College of Law.

What did Bryan Cave and Richard Smith provide Kenneth Hartstein necessary to sell his Pendulum Plan ---In one word---Credibility.

To sell this plan to wealthy individuals and their advisors, Hartstein had to have more than a fancy sale pitch and marketing materials. He had to have credibility. That is exactly what Richard Smith and Bryan Cave delivered. These plans were more complicated than most could comprehend. In fact, most accountants and even tax attorneys don't have the expertise to understand the nuances of these plans and whether they past muster with the IRS. Who would challenge a partner in a thousand plus member law firm that specializes in the design, implementation and other aspects of pension plans!

This is not the first time I have come across the Bryan Cave law firm. Several years ago, I represented a client who purchased a "One Man ESOP." It was a similar type tax shelter--hatched where---Phoenix---and guess who provided the tax opinion letter to the promoters of that plan---you guessed it---Bryan Cave attorneys.

The Bryan Cave tax opinion letter issued in September of 1999 opined that pursuant to Section 412(i) of the code, the Pendulum Plan would "more likely than not" be considered a qualified plan and "should not be considered a tax shelter." As we now know, this turned out to be dead wrong---just as they were wrong on the "One Man ESOP." How could Richard Smith and Bryan Cave been so wrong? Any research would have indicated that the characteristics of these plans were contrary to federal tax laws and regulations. What was their incentive? A complaint filed in Federal Court in Texas, which lists Bryan Cave as a "related party", alleges that they conspired with insurance companies and consultants to design 412(i) plans. I suspect when individuals are required raise their hands and testify under oath, we will find out much more about the involvement of Bryan Cave and their incentives to promote and defend these plans.

If that was not enough, Richard Smith was directly challenged by IRS officials who advised him that these plans were abusive tax shelters. In writings believed to be created in the early part of 2003, Richard Smith acknowledged that Richard J. Wickersham, who was a representative of the Tax Exempt/Government Entities Division of the Service, warned sponsors and administrators of 412(i) plans and indicated that the Service had assigned a high priority to plans that misused section 412(i) of the code.

Stay tuned for more postings on Bryan Cave.

What did Indianapolis Life know and when did they know it?

For Hartstein and Economic Concepts to sell their Pendulum Plan, they had to have specially designed policy. Enter Indianapolis Life. Upon information and belief, in early 1999 Hartstein contacted representatives of Indianapolis Life. Indy Life had a product that they believed would work. It was the Executive VIP. It was developed in the early to mid 1990’s to allow the transfer of money from pension plans or corporations with excess retained earnings.

What made the Executive VIP policy a perfect fit for the Pendulum Plan was the blooming of the cash value as the surrender charge burned off. The problem with these policies was the position the IRS had been taking back to the 80’s on springing cash value policies. In fact, the Executive VIP policy had originally been marketed to fund multiple employer welfare plans under 419A(f)(6) of the Code. These plans worked much like the Pendulum Plan. The IRS targeted these plans in the mid 90’s and designated plans with the characteristics outlined in Notice 95-34 a “listed transactions” in 2000.

It has been reported that Indianapolis Life had internally discussed the springing cash value risk associated with its Executive VIP policies throughout the 90’s and was concerned that the IRS could successfully challenge the policies and create “adverse tax consequences” for the pension plans and individual policyholders.

With 419A(f)(6) effectively shut down, enter Hartstein, his 412(i) plan, and the lure of money.

In late March 1999, Hartstein proposes to Indy Life that the Executive VIP policy be the exclusive product for his Pendulum Plan. In return, Hartstein wanted to control the distribution of the plan for which he promised millions of dollars of new commissionable premium. The policy was renamed the PenPro to co-brand with Hartstein’s Pendulum Plan.

In June of 1999, Hartstein meets with Indy Life representatives. At this meeting, they discussed the springing cash value risks of the policy. Knowing these risks, it is believed that Indy Life agreed to marked the Pendulum Plan through its agents and represent that the Pendulum Plan as a qualified 412(i) plan, that the premiums were fully deductable, and that the insured could purchase the policy after a few years for it's suppressed value.

At no time did they agree to disclose the tax risks.

Hartstein then presents the plan to Bryan Cave attorneys, requesting a tax opinion letter to be used for marketing purposes. More on Bryan Cave in future postings.

Indy Life, on the other hand, seeks an opinion from Robert G. Thurlow, a nationally recognized expert in the pension industry. In early December of 1999, Mr. Thurlow warned Indy Life that the Pendulum Plan would not qualify and the premiums would not be deductible. It is also believed that internally, there were serious reservations about these plans.
Despite these warnings, the lure of money was just too great, and Indy Life dispatched its agents and producers out to sell--not insurance, but a tax deductible plan loaded not only with excessive fees, loads, and expenses, but also a known risk of audit to its policyholders.

Not surprisingly, these plans were enormously successful. So successful, in fact, that other insurance companies began looking to take advantage of this niche market. More on other insurance companies in future postings.

Is there any hope in sight for taxpayers facing § 6707 penalties

As anyone who is currently facing 6707 penalties knows, those penalties are $100,000 per year for the individual and $200,000 per year for the corporation. These penalties are stackable, which means that S-corporations are often hit with the penalties at both the individual and corporate level simultaneously.


Under a bill passed by Congress in 2004, the IRS does not have the ability to waive the fines for listed tax shelters.


Currently, there is legislation pending both in the House and Senate which would lessen penalties and give the IRS discretion in handing down those penalties. The bill introducted last year by Sens. Nelson (D., Neb.) and Evan Bayh (D., Ind.), would allow the Treasury Secretary to waive the current mandatory penalties if the taxpayer acted in good faith. Many taxpayers, caught by these penalties, never knew they were purchasing a tax shelter, and were advised by financial planners not to file a form 8886 after the revenue ruling in 2004.

To read more on the status of the legislation, see:


http://news.morningstar.com/newsnet/ViewNews.aspx?article=/DJ/200904281511DOWJONESDJONLINE000765_univ.xml


http://online.wsj.com/article/SB123311144767422917.html

If you have any questions or comments, please free to contact Chris Hellums at Chrish@PDKHLaw.com

What are participants in 412(i) plans saying!

Participants in these plans generally report the same story.



No one told me I was purchasing a tax shelter. I was making good money at the time and looking to supplement my 401(k). I was told this was the perfect plan. I was told that I could fund the plan over a 5 year period of time, and then have flexability to take money out of the plan as I needed it.



I was told (or provided) with a tax opinion letter which said the plan was in compliance with IRS regulations.



I was provided with an IRS letter of Determination which I was told indicated that the IRS had blessed the plan. What they were not told was that the letter of determination only applied to the plan documents, not the operation of the plan.



I was told in 2004 that the IRS had issued guidance but that my plan was not an abusive plan and that I should continue to fund the plan.



I was told that since my plan was not an abusive plan, I was not required to file a form 8886 on my tax return, and that if I did, I was asking for an audit by the IRS.



I have been audited by the IRS.



I have been assessed or will be assessed section 6707 penalties.

Is there any recourse against the people who sold me the plan?

What is 412(i) and what are the problems with these plans

412(i) is a provision of the tax code. A 412(i) plan is a defined pension plan. A 412(i) plan differs from other defined benefit pension plans in that it must be funded exclusively by the purchase of individual life insurance products (insurance and annuities). It provides specific retirement benefits to participants once they reach retirement and must contain assets sufficient to pay those benefits. To create a 412(i) plan, there must be a plan to hold the assets. The employer funds the plan by making cash contributions to the plan, and the Code allows the employer to take a tax deduction in the amount of the contributions, i.e. the entire amount.

The plan uses the contributed funds to purchase some combination of life insurance products (insurance or annuities) for the plan. As the plan participants retire, the plan will usually sell the policies for their present cash value and purchase annuities with the proceeds. The revenue stream from the annuities pays the specified retirement benefit to plan participants.

Where did the problems start?

In the late 1990's brokers and promoters such as Kenneth Hartstein, Dennis Cunning, and others began selling 412(i) plans designed with policies created and sold through agents of Pacific Life, Hartford, Indianapolis life, and American General. These plans were sold or administered through companies such as Economic Concepts, Inc., Pension Professionals of America, Pension Strategies, L.L.C. and others.

These plans were very lucrative for the brokers, promoters, agents, and insurance companies. In addition to the costs associated with adminstering the plans, the policies of insurance had high commissions and high surrender charges.

These plans were often described as Pendulum Plans, or other similar names. In theory, the plans would work as follows. After the defined pension plan was set up, the plan would purchase a life insurance policy insuring the life of an individual. The plan would have no cash value (and high surrender charges) for 5 or more years. The Corporation would pay the premium on the policy and take a deduction for the entire amount. In year 5, when the policy had little or no cash value, the plan would transfer the policy to the individual, who would take it at a greatly reduced basis. Subsequently, the policy would bloom like a rose, and the individual would have a policy with significant cash value which he or she could withdraw tax free.

Who signed off on the plan?

Attorney Richard Smith at the law firm of Bryan Cave issued tax opinion letters opinion which stated that the design of many of the plans met the requirements of section 412(i) of the tax code.


So what is the problem?

In the early 2000s, IRS officials began questioning the insurance representatives, brokers, promoters, and their attorneys and giving speeches at benefits conferences wherein they took the position that these plans were in violation of both the letter and spirit of the Internal Revenue Code.

In February 2004, the IRS issued guidance on 412(i) and began the process of making plans "listed transactions." Taxpayers involved in listed transaction are required to report them to the IRS. These transactions are to be reported using a form 8886. The failure to file a form 8886 subjects individual to penalties of $100,000 per year, and corporations $200,000 per year. These penalties are often referred to as section 6707 penalties. Advisors of these plans are required to maintain records regarding these plans and turn them over to the IRS, upon demand.

In October of 2005, the IRS invited those who sponsored 412(i) plans that were treated as listed transactions to enter a settlement program in which the taxpayer would recind the plan and pay the income taxes it would have paid had it not engaged in the plan, plus interest and reduced penalties.

In late 2005, the IRS began obtaining information from advisors and actively auditing plans and more recently, levying section 6707 penalties.

Please return for more information. You may contact Chris Hellums at Chrish@pdkhlaw.com