The generous tax breaks for multiemployer welfare benefit plans have led to an industry that puts together plans for multiple employers to help executives use them as a tax shelter. There be dragons, as a Tax Court case issued yesterday shows.
A defense industry consultant signed on the Millenium Plan, set up as a section 419A(f)(6) welfare benefit plan to provide death, medical and involuntary severance benefits to employee participants. The IRS decided that the plan looked too much like a tax-free piggybank for the consultant and assessed over $5.5 million in taxes to the contractor and his corporation.
The court found that the plan participants had ready access to their share of plan assets by "voiding" their participation:
Voiding is purportedly allowed only when the employer fails to complete the enrollment, because of mutual mistake of fact, or because of a misrepresentation by an employer's adviser regarding benefits and features of the Millennium Plan in connection with the employer's decision to participate. In addition, employers who voided their transactions were required to sign a statement that they would amend any tax returns affected by their participation in the plan, consistent with the voiding of the plan transaction.
Around 30 employers representing approximately 50 covered employees were allowed to void their transactions after they had completed the enrollment process, entered the Millennium Plan, and had their covered employees assigned to a rating group. Some employers had been participating in the Millennium Plan for years at the time their transactions were voided.
The court said that was a fatal problem:
Our decision turns on our conclusion that covered employees in the plan were able to (1) freely void their participation in the plan and have the life insurance policy distributed to them, or (2) receive life benefits at a time of their choosing by "timing" a severance event. Participating employers funneled their pretax business profits into the Millennium Plan to claim tax deductions and covered employees were able to functionally withdraw those amounts at a later time of their choosing. As a result, [the corporation's] contribution to the Millennium Plan should be considered a constructive dividend paid to [the taxpayer], rather than an ordinary and necessary business expense under section 162(a).
The result was $5.7 million in additional taxes and over $870,000 in penalties.
The moral? There is no tax fairy. There is no tax-free way to make unlimited deductible contributions to a tax-sheltered savings plan and retain access and control of the funds for yourself.
Cite: Goyak, T.C. Memo 2012-13
UPDATE: An explanation of tax issues in abusive Sec. 419 plans: Abusive Insurance and Retirement Plans, by Lance Wallach, Journal of Accountancy, September 2008
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