IRS Says 412(i) Pension Plans Must Be Reported; Co’s Filing For Bankruptcy

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Jeffrey Johnson is a legal writer with a focus on personal injury. He has worked on personal injury and sovereign immunity litigation in addition to experience in family, estate, and criminal law. He earned a J.D. from the University of Baltimore and has worked in legal offices and non-profits in Maryland, Texas, and North Carolina. He has also earned an MFA in screenwriting from Chapman Univer...

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UPDATED: Jul 15, 2021

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The Internal Revenue Service (IRS) says that 412(i) pension plans are reportable transactions and participants must file Form 8886 or face hundreds of thousands of dollars in fines. Unfortunately, it’s forced many of the small companies in high tax brackets who unknowingly participated in these tax shelter retirement plan schemes to file for bankruptcy.

IRS says report it – or else

Steve Burgess, an insurance expert on 412(i) pension and 419 welfare benefit plans, says that in 2004, the IRS came out and said that these were reportable transactions and that if you were involved in them, you must report it by filing a specific form – IRS Form 8886. So, where does the “or else” fit it? Burgess explained:

If you don’t file that form, then the penalty for not reporting the transaction to the individual participant is $100,000 a year for every year you don’t file. Corporations pay an additional $200,000 penalty per year for not reporting the transaction.

I’ve spoken with people that had put $50,000 a year into these plans through their corporation. They didn’t report the transaction for three years, so now they owe in $900,000 in penalties to the IRS for a tax deduction that was only $150,000 total. I know of several business owners that have had to file for bankruptcy because the penalties are so large that there’s no way that they could pay them.

IRS Code Section 412(i) replaced & rewritten

The IRS rewrote code section 412(i), which effectively doesn’t exist any more, according to Burgess, who says that code section 412(e) has taken its place, contains very specific language about what you can and can’t do and that the IRS has re-written the way that a life insurance policy is valued. He explained:

That was the big issue with how people were getting money out of these plans without paying any taxes on them is claiming a much lower value than the actual policy. So the IRS effectively wiped out that tax loophole.

The big impact, though, is that once you identify that you’re in one of these plans to the IRS, you can almost guarantee that you’re going to be audited. The IRS has audited probably thousands of companies that were in these plans. Employers have had to restate earnings and pay back taxes, penalties and interest for their participation in the plan because the plans were not set up correctly – and then they got hit with these huge penalties for not reporting the plan.

Senate Finance Committee asks IRS not to enforce penalties – yet

The penalties involved with 412(i) pension plans are such a hot item that the Senate Finance Committee actually went to the IRS a few months ago and asked them not to enforce those penalties until they could investigate it further and come up with a more fair assessment of penalties to match the transaction.

While that may be good news, Burgess says that, nonetheless, people are sitting in limbo right now with hundreds of thousands of dollars of penalties over their heads, waiting to see what the outcome is going to be. At this time, the IRS has not said when it will rule on the matter.

We asked him how he thinks the IRS will rule on the Senate’s request to stop assessing fees against these plans. Here’s what he told us:

I think they’re going to amend the law as it is right now. The penalty is assessed under code section 6707A for any kind of reportable transaction that doesn’t initially get reported. It didn’t become a big issue until it hit the 412(i) marketplace because these are such small businesses.

In 2008, the taxpayer advocate made that her number one priority in her report back to the IRS that these penalties are egregious for many of the situations because it doesn’t matter if you put $50,000 or $5 million into a plan; you still get the same penalty. What I think is going to happen is that they’re going to keep the penalty, but make it a percentage of the participation in the plan.

If you’ve been the victim of a fraudulent or abusive tax shelter scheme, contact an experienced pension fraud attorney to discuss your situation and evaluate what remedies may be available to you.

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