Abusive Tax Shelters
Listed Transactions

Listed Transaction #34  (Abusive Trust Arrangements)

Utilizing Cash Value Life Insurance Policies Purportedly to Provide Welfare Benefits
IRS Notice 2007-83


Features (must have all):


·      Trust or other fund described in IRC § 419(e)(3) as a purportedly valid welfare benefit fund;


·      For determining deductible portion of contributions, employer does not rely on the IRC § 419A(f)(5)(A) exception, for collectively bargained plans;


·      Trust/fund pays premiums on one or more life insurance policies, and with respect to at least one of the policies, value is accumulated either within the policy (cash value life insurance policy) or outside the policy (side fund, or through agreement outside the policy which will, at some point, have accumulated value based on the purported premiums paid on the original policy);


·      Employer takes deduction for its contributions to the fund with respect to benefits provided under the plan that is greater than the sum of the:  (a) with respect to uninsured benefits, an amount equal to claims that were both incurred and paid during the taxable year, plus limited reserves, plus amounts paid during the year to satisfy claims incurred in a prior taxable year, but only to the extent no deduction was taken for such amounts in prior year; and amounts paid for administrative expenses with respect to uninsured benefits and that are properly allocable to the taxable year but no deduction taken in prior years for such amounts; (b) with respect to any insured benefits, insurance premiums paid that are properly allocable to the taxable year, plus insurance premiums paid in prior years properly allocable to the taxable year, and other amounts, inclusive of additional reserves under IRC § 419A(c)(6).


The IRS also has issued IRS Revenue Ruling 2007-65, concluding that for purposes of deductions allowable to an employer under IRC § 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 within the meaning of IRC § 264(a).


The IRS also has issued IRS Notice 2007-84, describing trust arrangements involving purported welfare benefit plans that, in form, provide post-retirement medical and life insurance benefits to employees on a non-descriminatory basis, but, in operation or substance, result in the owner(s) receiving all or a substantial portion of the post-retirement and other benefits, and all or a substantial portion of any assets distributed from the trust.


The IRS intends to challenge these transactions on a number of grounds, depending on the facts and circumstances of a particular arrangement.


1.   Contributions to a purported welfare benefit plan on behalf of owner/employee may be treated as dividend income to the owner, includible in owner?€?s gross income, and for which amounts are not deductible by corporation.  See, e.g., Neonatology Associates v. IRS, 299 F.3d 221 (3d Cir. 2002);


2.   Treat as deferred compensation plan, resulting in application of IRC § 404(a)(5), governing the proper timing of any deductions, see, e.g., Wellons v. IRS, 31 F.3d 569 (7th Cir. 1994), or alternatively, as a nonqualified deferred compensation plan under IRC § 409A (resulting in immediate inclusion of income to employee, and income tax withholding obligations on employer);


3.   Treat as a split-dollar life insurance arrangement, pursuant to the rules set forth in Regs. § 1.61-22, where the employee must include in income the full value of the economic benefits provided to the employee under the arrangement for the taxable year without a corresponding employer deduction;


4.   Even if properly characterized as a welfare benefit fund, under IRC § 419 and 419A, an employer?€?s deduction for contributions to the trust or other welfare benefit fund are limited, and under these rules, no deduction is allowed with respect to premiums paid for life insurance coverage provided to current employees if the welfare benefit fund or the employer is directly or indirectly a beneficiary under the life insurance policy within the meaning of IRC § 264(a).


a.    In the promoted arrangements, the trust typically retains the rights in the policies and is directly or indirectly a beneficiary under the policies, so no deduction is allowed under the rules.  See Situation 1, Rev. Ruling 2007-65;


b.   Any deduction with respect to uninsured benefits like medical, disability, or severance is not based on the premiums paid, but is generally limited to claims incurred and paid during the year.  See Situation 2, Rev. Ruling 2007-65.


c.    Bottom line:  premiums on cash value life insurance policies paid through these type of trusts or funds are not, because of such form, deductible.


5.   In appropriate cases, IRS intends on challenging the value claimed by the taxpayer on the property distributed from the trust, including the value of the cash value life insurance policies.


6.   Other listed transactions involving purportedly valid welfare benefit plans:


a.    IRS Notice 2003-24 (purportedly meeting exceptions under IRC § 419A(f)(5)), for collectively bargained plans;


b.   IRS Notice 95-34 (describes transactions that purport to meet the 10 or more employer plan exception under IRC § 419A(f)(60);


If you believe that you may have engaged in a transaction that is the same or substantially similar to the transaction described above, Federal law may require you to disclose your and other parties?€? participation in any such ?€?listed transaction?€? on IRS Form 8886. For more information about Federal disclosure law requirements, please contact us.