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Guest FLMaster

Illegal 412(i) Plans

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Guest FLMaster

I suggest that the discussion of tax opinion letters, marketing materials, and plan designs, be moved to this thread as it has nothing to do with case studies of traditional 412(i) plans.

For those who do not know the "bloody history" of illegal 412(i), it started when promoters of 419(a)(f)(6) plans were under attack by the IRS. They had traditionally used a surpressed cash value product to remove assets from their plans. Needing to find another code section,(which was not tainted) the Insurance Gurus discovered 412(i). They took this to several law firms who issued opinions that they were not "springing cash value" products as techincally defined. Next, they wrapped the policy with marketing materials that stated you could purchase 100% life insurance, put $500,000 into the plan and deduct it and then buy the policy out at $87,000. The policy would grow quickly to $500,000 which you could withdraw tax free. Hence, tax deductible insurance going in-tax free coming out. Only creative insurance minds would of thought of this not the green eye-shaded actuaries- While the actuaries on this board were answering hypertechincal questions, the insurance industry sold (by some estimates) $250 million of premium into these plans. In 5 years over one billion will be collected. The insurance gurus claim the actuaries just are not creative, the actuaries stated foul play and we await the IRS (and plaintiffs attorneys maybe if the IRS is sucessful). Who will end up on the short end of this? Probably the taxpayer who purchased the scam/plan. If you look at it from the taxpayers viewpoint-Major Brokerage firm sold it-respected large law firm wrote opinion-large insurnce company issued the product-and major actuairal firm administered it-How could they know it was a scam? Do the insurance companies have any liability? What about the law firms? Will the taxpayers have any money left to fight after the IRS is done with them?

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Guest FLMaster

Please post comments on the tax opinions here. :shades:

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One of the "respected" law firms that wrote an opinion letter on one of the scam 412(i) plans was Bryan Cave. They are a moderately large tax firm and I believe that they should be responsible for their work product. The opinion contained several errors. One of the most serious problems, however, was that the law firm gave an opinion about a plan that operated quite differently from the plan that they gave the opinion about. Did the law firm do this intentionally? Or did their client lie to their own attorneys about how their plan operated? I would sue the promoters as well as the law firm in such a matter.

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"I would sue the promoters as well as the law firm in such a matter."

You would? Why? Do you mean "the IRS should sue..."?

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The IRS is not a party damaged by the firm's actions, the taxpayers are.

Did the law firm describe a program that would fail to satisfy Code and/or IRS regulations?

If so, then they seem a good candidate for liability when the plan failed to meet its stated goals.

If not, then they have a good defense, and the promoters have a problem because they failed

to control the operation of the plan.

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Quick edit - it was by attorneys in a law firm named Bryan Cave - I don't know who actually wrote the article.)

Veba - I read an article by Bryan Cave on this back in 2003. They, like every other source I've seen who said it was ok to issue 100% life insurance, rely heavily on the word "or" in 1.412(i)-1(b)(2)(i). Which says, "The plan must be funded exclusively by the purchase...of individual annuity OR individual insurance contracts, or a combination thereof." And in -1(b)(ii) of that section, it starts of with, "The individual annuity OR individual insurance contracts issued under the plan..." They read the use of the word "or" to be a clear indication that the drafters of the regulation contemplated 100% to insurance.

I was asked about this argument (in general, not specific to the Bryan Cave article as the question predated the article by a year and a half) back in 2002, and here's an excerpt from my response - and please keep in mind I'm not an attorney - this response was merely to a co-worker. "Purely playing Devil's Advocate here, I could read these regs to permit investment only in life insurance if it suited my purpose to do so. I could not in good conscience make this reading as a CORRECT reading, because I simply do not believe it is correct. If a client and/or their legal counsel were to either call the IRS, or request a PLR, I suspect they would get the same answer that I would give - you can't do it!"

Not having any notion whatsoever of the twisted legal system requirements, it would nevertheless seem a bit harsh to make the law firm liable for reading the regulation in this manner. Although aggressive, and was in my opinion a wrong reading, I'm still not sure that it rises to the level of pure negligence. But maybe it does. However, it is possible that they warned their clients, for example, that it was an aggressive stance that might be challenged by the IRS, and the clients went ahead anyway. I'm a little hesitant to assume that just because someone spouts off in an article that their specific advice to individual clients is necessarily the same as what is contained in the general article.

That said, I suspect some folks will agree with you and the litigation treadmill will start at some point. Hopefully not too many people actually implemented such plans.

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Guest mjb

I am always amused when tax advisors are questioned for issuing opinions that are based on the literal language of a statute or regulation issued by the IRS since the law/regulation is a defense to a violation of the tax law. I have never heard of a tax opinion being termed aggressive when it relies on the literal wording of a regulation. Aggressive opinions are those that don't have any substanital authority under the tax law for their conclusions, such as PLRs or ct cases. While the IRS prohibits excessive LI in a 412(i) plan, see Rev Rul 2004-20, I havent seen any rulings that prohibit a 412i plan from being funded solely with LI as permitted under the Reg. I am interested in any statements to the contrary. I thought 412i was enacted for a certain type of LI policy called a retirement income policy in which the cash reserve for retirement income could exceed the face value of the death benefit. As any tax advisor will tell you oral or informal opinions of the IRS are not binding on the taxpayer so I dont see what is the need to call the IRS. Besides IRS opinions that contradict the regs are not enforceable against a taxpayer (and the IRS cannot issue a PLR that disagrees with a reg.)

The ability of the IRS to declare certain transactions which are not explicitly prohibited under the IRC or regs to be illegal tax shelters subject to criminal prosecution will get its day in court when the KPMG tax shelter case is tried. The multiple defendents including attorneys have challenged their prosecution with a defense that there has been no ct decision that the tax shelters they promoted and rendered opinions on, and which IRS declared to be illegal, violate the IRC.

Note: My post expresses no opinion on whether springing cash values policies can be used under 412i.

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Guest FLMaster

We know that the last word will rest with the Courts.It is clear these opinion letters were flawed as case law and rulings existed at that time that would tell law firms not to "game" a policy. The game is surpressing the cash values in the early years and expand the cash values in the later years after the policy is purchased out of the plan. Why would anyone purchase an insurance policy (or any investment) that after $500,000.00 in contributions is worth $87,000.00???? Well, the next 5 years a miracle will occur. Your investment will grow 50% each year and be worth $500,000++(after you took the policy out of the plan of course at $87,000 and paid the income tax). The Third Circuit said (in Neonatology) we will not allow the taxpayer to engage in "financial fanatsies" by making investments which have no economic substance and is designed for the sole purpose of avoiding/evading taxes. Our legal brethern (in spite of this) :shades: issued tax opinions that supported this transaction. Why should we be upset? It is an insult to every actuary who reads the rules, test plans, follows the law, and ask and answer hypertechincal questions on these boards to keep plans in compliance while the insurance gurus live in an epideictic world.

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Guest FLMaster

MPreston: A penny for your thoughts on the tax opinion letters. :shades:

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There is a lot of material there. I probably won't have time to read them until after 4/15. Thank you for forwarding the material.

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Pax- If I were the taxpayer losing his tax deduction I would sue the law firm as well as the promoter.

Belgarath-Of course Bryan Cave was the firm I referred to earlier. The history of 412i didn't start in 2000, or with the issuance of the Regs. There was no excuse for the intentional misapplication of the language of the law or Regs.

MJB-You are correct that 412i plans could be funded 100% into retirement income policies (a form of insured annuity), but those policies don't exist anymore. The problem came when aggressive practitioners decided not only to use UL contracts and then phantom cash value contracts for such plans. I'm probably the only one old enough to remember retirement income policies: before ERISA, defined benefit plans were commonly funded with them.

As an attorney I was recently sued for something a client did that I supposedly advised him (I orally advised him NOT to proceed, but got sued anyway). I received a total of about $8,000 of fees for the matter. By the end my E&O carrier had spent about $60,000 in legal fees and settlement costs, plus my $10,000. Attorneys should be getting the message (as I did): there are consequences for giving opinions.

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Guest FLMaster

I agree with VEBAGURU, law firms should exercise "some" social responsibility. MPreston has the opinions and after April 15th I will be interested in his opinions. The problem I have with these illegal 412(i) plans is it gives the legitimate providers a bad name, and there are legitimate providers in the market. The other problem I have is illegal promoters enriched themselves at the expense of legitimate providers like Blinky, MPreston, and AndyH, etc. who even though I argue with(I am also an attorney and like to argue anyway) I still believe they should be handling these plans not the illegal 412(i) promoters, and I am sure that they would show other plans than a 412(i) which may not be appropriate for the sponsors. :shades:

Why should the "illegal" 412(i) promoters be allowed to purchase big homes in the Virgin islands with their ill-gotten forunes when the legit guys like MPreston that does tradional plans slave away doing ADP/ACP testing at tax time and doesn't have the time to read the bogus opinions until after April 15th!

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Guest mjb

FL: As an attorney you are aware that the canon of ethics for attorneys requires the zealous representation of the client's interest, not the public's interest. An attorney who provides merely adequate or prefunctory advice that does not solely represent the client's interest to the best of his ability or has a conflict with another client interest violates the Canon of Ethics. A few years ago I was asked by a client to represent him in a RE transaction but not provide any advice or review documents because he only wanted to fulfil the requirement of being represented by counsel. I refused to represent him because it would not permit me to exercise proper representation.

Attorneys are free to decline to represent a client on matters they personally disaprove of, e.g., criminal cases, but once they agree to represent the client they must zealously represent the client's interest, not the public's interest.

As for suing law firms for losing a deduction you really need to read the opinion for all of the disclaimers and caveats which note the likelhood for a denial of deductions. Most opinion letters prior to the change in the tax law in 2004 only protected the client from having to pay the penalities for substantial underpayment of taxes in the event the IRS prevailed so as to make claiming the deduction no worse than not engaging in the transaction. I once reviewed a 60+ page opinion on a multiple employer veba which stated in a paragraph buried at the end that the opinion of counsel was subject to the contrary view of the IRS but noted that the opinion would prevent the imposition of tax penalities because it was based on substantial authority, e.g., cases and rev. rulings discussed in most of the opinion.

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Guest FLMaster

First: In regards to the canon of ethics for attorneys. The ethical rules are different from state to state. In some states for example in Florida, if you place an adverisment in a newspaper it is subject to review or you are subject to disciplineary action. In other states, this is not true. In some states it is unethical to give out a business card unless solicited, in other states this is not true. Ethicical rules differ from state to state. The interpretation will also differ as well.

Second: In regards to liability. It is clear that attorneys and law firms are very good at shielding themselves from liability by creating tax opinions etc. and stating this is to only be used by the person who hired me etc. etc. Next, de-facto they give their permission for the user to spread the gospel among the hoi palloi knowing it would be used to create sales and the reader would ignore the fine print or not understand it. What I say to you is ....someday a trial judge will overlook the fine print and allow these facts to go to a jury. As you well know law 101 is when the law says, law 102 is what the judge says the law says which may have nothing to do with 101. (of course this could all be overturned by appeals-law 103). Hope this is helpful. :shades:

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Guest FLMaster

Well the action has started in Kennard v. Indianapolis Life 2006 WL 616014 in illegal 412(i) plans. Law 102 is in effeect as the motion to dismiss was denied by Judge Fish in the Northern District of Texas. The defendants are Indianapolis Life, Xelan and ...the insurance agent (the law firm slipped out the back door).

Xelan filed bankruptcy, so all we have left is the agent and the insurancce company. The lawsuit refers to violations of State Insurance Codes and triple damages! Another interesting issue is that the policy was not approved by the state as a 412(i) policy. Only in Amerika! :D

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FLMaster

I was not aware that any state approved policies for specific uses. Which states have approved what policies for use as 412(i) policies?

As for the law firm slipping out the back door, that should only be temporary and I wait to see what action will eventually be taken against them. KPMG etc and the law firms that supported those tax shelters certainly are not escaping the consequencies of their opinion letters as yet and neither should this one.

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Guest mjb

GB: What makes you think the law firm will be liable for the opinion. Law firms are famous for giving clients opinions that provide no protection from the IRS. The best opinions for the law firm are those that state that they are subject to the contrary interpretation by the IRS because the law firm has not guaranteed the tax deduction will be upheld. As for KMPG, the question will be whether there can be a criminal conspiracy to violate the tax law in a transaction that has never been ruled to be an evasion of income taxes.

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Guest Harry O

I think the portion of the government's prosecution of KPMG relating to the "selling" of the tax shelters is a disgrace. They are attempting to criminalize an interpretation of the tax law where reasonable people may differ (and, as mjb points out, where the IRS's interpretation has yet to be endorsed by any court). KPMG's actions were in no way like some looney tax protestor who "interprets" some section of the Internal Revenue Code to exempt wage income from tax. The government is threatening these guys with personal bankruptcy by forcing KPMG to cut off their indemnification of legal expenses or have the firm indicted. KPMG obviously did what it had to in order to protect itself. This squeezes the former KPMG partners and employees since they can either capitulate or spend every last cent they have defending themselves. This should terrify anyone working for an organization that has promised to indemnify you against legal costs you incur that arise out of the performance of your job.

That said, the government can prosecute away as far as I am concerned regarding how certain members of KPMG may have reacted to government subpoenas, etc. once the government started investigating. If documents were withheld then anyone involved in that aspect deserves what is coming to them.

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Guest mjb

It is very difficult for the Govt to prove that a business transaction violates the tax law. A few years ago Black and Decker prevailed against the IRS after B & D set up a free standing off shore subsidiary into which they transferred all of their retiree health care liability in which the only assets were B & D pref. stock for which B &D took a deduction for the dividends. The IRS said it was tax scam because there was no legitimate business purpose for the sub but the Fed ct said that B & D had a legitimate business motive in setting up the sub because it was intended to provide for health care expenses.

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Guest FLMaster

To GBurns: Yes, the states do require that if a product is submitted as use in a 412(i) plan it must be approved by the State Insurancce commissioner to be sold in a 412(i) plan. I personally know of several carriers who had their annuity products declined for 412(i) by ceratin states as the guaranteed interest rate was too low. The illegal 412(i) providers did not run these products through state compliance-now what a surprise. :ph34r:

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Guest FLMaster

The law firm is liable for the tax opinion to the person they wrote the opinion, which is not the taxpayer who used the opinion, but the promoter.

Basically, here is how tax scam 101 works.

Step 1.Tax promoter receives scam opinion from law firm.

Step 2.Tax promoter gets insurance company to sell product into the scam.

Next:The IRS audits taxpayer. The IRS takes away all money from taxpayer. The taxpayer now sues promoter and insurance company and law firm. Insurance company says-we just sold a product, Law firm says we issued the opinion to the promoter not to you, the promoter flees to the virgin islands. The taxpayer is broke and cannot pursue the promoters or pay any more legal fees.

End result: Promoter is living well in the virgin island, the law firm made payroll, the insurance company has the money and the taxpayer is bankrupt....only in Amerika!

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Guest mjb

There are different grades of tax opinions- there are tax opinions that are issued by prominent firms to corporate clients who need a tax benefit to make a $5+B deal work where the firm will strive to find enough "substantial authority" to justify a more likely than not opinion necessary to claim the tax benefit and avoid penalities and puts the firm at risk. At the other end of the spectrum are "cold comfort" opinions that do not provide any opinion that a taxpayer will prevail against the IRS but only describe the risks of taking a position under the tax law. These opinions were frequently marketed to promoters selling vebas, split $ or 412(i) plans because the prospectrive clients did not read the opinion letters to identify the risk (and did not pay the LF for the opinion). In some states the client cannot sue the firm for the opinion it rendered to the promoter because their is no privity of contract between the firm and the client. In other cases the lack of a representation that the taxpayer would prevail against the IRS absolves the LF of any liability. Under C230 all tax opinions to promoters will be marketed opinions with the disclaimers that it cannot be relied on by a taxpayer to avoid tax penalties unless the client is willing to pay big bucks for the firm to perform the necessary due dilligence for a reliance opinion that doesnt contain disclaimers. Bottom line on LF opinions is caveat emptor.

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Guest FLMaster

I concur with MJB. It is too bad that clients do not consult with a qualified advisor before they make their decisions. I did have one prospective client who was warned if entered into an illegal 412(i) he may not have the deduction upheld. The prospective client was a doctor from the midwest area and he said, if it was not upheld he would just sue the agent and insurance company and his adviosr from Xelan.....wish granted..... :rolleyes:

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Harry O and mjb - the recent reports of the KPMG prosecutions indicate that the KPMG promoters didn't bother to complete some of the off-shore transactions that were part of the overall transaction that resulted in the tax benefits. [since the transactions apparently didn't have any substance anyway, why go to the extra expense and bother of completing them?] Doesn't this, plus the way the transactions were promoted (confidentiality agreements), plus the active steps to hide what was being done (didn't report them as tax shelters, use of tiered limited partnerships, offshore transactions), plus the tremendous fees made by the promoters (based on tax savings), plus the tremendous amount of loss to the Treasury, at least give the appearance of something wrong? How do you get to these issues, unless you go after the promoters? And finally, isn't this why KPMG got the big fees, because of these risks - shouldn't KPMG bear some of the risk - indeed most of the risk, since they are the promoters, the experts, and licensed to practice before the IRS (and therefore in my opinion with some professional responsibility to the tax system - perhaps an old-fashioned view on my part)?

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Ditto

Will add due respect to HarryO, and I do mean that, the confession that I read in the newspaper yesterday from a former KPMG executive seemed awful thorough and damning. It left no impression of ambiguity or room for interpretation whatsoever.

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