A plan sponsor implemented a 412i insurance funded defined benefit plan.
The IRS disqualifies the plan and recommends the plan be unwound.
The IRS disqualified the plan for failure to meet the coverage tests and for excessive death benefits and excessive deductions.
For purposes of t his thread let's assume it is a one participant plan with an annual life insurance premium of $100,000 per year for the past five (2003 through 2007) years for total premiums of $500,000.
Regarding the unwinding of the plan, the IRS makes the following settlement proposal:
1. The IRS says the unwinding of the plan will involve treating the plan as if it were always a non qualified plan.
2. corporation retains income of 100k per year for the years in question (2003 through 2007)
3. in 2008 the plan is disqualified and the individual shall receive $500,00 of income and the corporation can take an associated deduction of 500k for 2008.
The plan sponsor does not like the above proposal as they consider it double taxation, followed by an extremely high corporate deduction that will create a Net Operating Loss that can never be utilized.
As I said the IRS position is that the unwinding of the plan shall be to treat it as if it were a non qualified plan all along.
So the question is:
Is the above recommendation in conformance with the tax laws related to non qualified plans?
Or should (or could) the taxation involve treating each premium as compensation to the participant in the year it was paid and thus result in a corresponding corporate deduction for each year?
Please include references in your responses if possible.
Thank you.