412(i) Audit from hell, could use some help

[RayJJohnsonJr]

IRS ISSUE 1: Disallowance of first year’s premium. The IRS actuary says "In general, a qualified plan does not exist unless a corresponding trust also exists. When a qualified plan is first established, the trust must be in existence no later than thel ast day of the initial plan year for the plan to be in existence with respect to that plan year. Within the context of a plan described under IRC section 412(i), the insurance policies and annuity contracts that are used to fund the retirement benefits function in the same manner as a trust functions with regard to a traditionally funded defined benefit plan. Therefore, if the policies are not in effect and if no premiums were actually paid until after February 28, 2000, not only does the plan fail to be a plan described under IRC section 412(i) in 1999, but also the plan itself does not exist in 1999. Therefore, the deduction for 1999 (or 2000 depending on how the tax year correlates to the plan year) should be disallowed."

The client made the 1st year contribution within 8 1/2 months of the plan anniversary. How do you argue with the IRS actuaries assertion? Funding the 1st year contribution after the 1st plan year end in a 412(i) is a very common practice. Anyway, how can they take away an eight year old deduction? What happened to the statute of limitations.

Thanks, much help needed on this one.

[AndyH]

What was signed in 1999, and when did it say the premiums for 1999 were due?

[Ron Snyder]

Let us assume that the IRS is correct that the tax deduction for 1999 was improperly claimed. The statute of limitations for 1999 ran out in 2007 (at the latest) even if the taxpayer participated in a fraud or materially misstated his taxes. Has the taxpayer signed a consent to extend the statute of limitations?

This taxpayer needs a good tax representation. I could recommend a good (but not inexpensive) attorney, or a CPA with over 30 years experience working for the IRS to handle the appeal on this matter.

Please note that the kindler, gentler IRS of the George H W Bush and Bill Clinton administrations was dismantled by the G W Bush administration. It is too early in the Obama administration for this to have changed, even if they are going to. Currently, IRS auditors are capable of making ridiculous and frivolous assertions about why taxpayers should owe big bucks as taxes. And since the office of tax shelter analysis has labeled 412(i) plans as "listed transactions", they think taxpayers are getting off light if they don't assess the $200,000 fine/penalty for participating in a listed transaction.

[RayJJohnsonJr]

Hi AndyH, The fiscal year and plan year are 3/1 to 2/28. The 412(i) adoption agreement was executed 2/25/2000 and described the 1st plan year as 3/1/99 to 2/28/00. Neither the adoption agreement nor the the plan and trust document specify when premiums are due, except to say "determined by accepted actuarial cost methods" and "premiums have to paid by the "lapse date" or by the end of the plan year in which the lapse date falls. So nothing here really applies does it?

The rule, as I have always understood it, is that the contribution must be made by the tax return due date including extensions(12/15/00), to get an income tax deductiion for fye 2/28/00, but in any event the contribution must be made within 12 months following the last day of the plan year.

Thank you for any input you can provide.

[RayJJohnsonJr]

Hi vebaguru, Yes, the taxpayer signed a consent to extend the statute of limitations for tax years ending 3/1/2005 through 2/28/06. The taxpayer filled his 2/28/00 FYE tax return on or before 12/15/2000. Has the statute of limitations run out on that?

I would like to get your recommendations for a good attorney, or a CPA. We have about 6 more issues the IRS has cited (most of them inaccurate) to overcome, as the IRS has concluded, "The Plan fails to be IRC 412(i) plan with disqualification defects."

Thank you for your input.

[JAY21]

So the plan was effective properly for the 2/28/00 plan year but since the plan document did not include a "trust" component (since it's a 412i plan) the 412i policy/contract itself "serves" as the equivalent of a trust and it was not properly adopted (apparently) by 2/28/00. Did I get that right ? Trying to follow the IRS analysis here.

[RayJJohnsonJr]

Hi JAY21,

Yes, the plan did include a "trust component." The adoption agreement which adopted the trust document was executed on 2/25/00. I think what the IRS is saying is that since there wasn't money in the trust, and there was no money in the insurance or annuities until Novemeber of 2000, the plan did not exist for the 3/1/99 to 2/28/2000 year.

Thank you, again, all help is appreciated.

[PensionPro]

Maybe this will help a little. Rev. Rul. 81-114.

The purpose of this revenue ruling is to restate the position in Rev. Rul. 57-419, 1957-2 C.B. 264, in view of the enactment of the Employee Retirement Income Security Act of 1974, Pub. L. 93-406, 1974-3 C.B. 1.

The issue is whether deductions are allowable under section 404(a) of the Internal Revenue Code for contributions made to an employees’ trust that is valid in all respects under local law except for the existence of a corpus at the close of the taxable year. Such contributions were made after the close of the taxable year, but during the time prescribed for filing the employer’s income tax return.

In order to be an allowable deduction under section 404(a) of the Code, a contribution to an employees’ trust must be made pursuant to a plan in effect and to a valid trust which is recognized under local law.

Section 404(a)(6) of the Code provides that a contribution to an employees’ trust is deemed made on the last day of the preceding taxable year if the payment is made on account of such taxable year and is paid not later than the time prescribed by law for filing the return for such taxable year (including extensions). This rule applies to cash basis as well as accrual basis taxpayers.

Rev. Rul. 76-28, 1976-1 C.B. 106, provides rules with respect to the application of section 404(a)(6) of the Code. These rules do not, however, change the requirement that a plan must be in existence as of the last day of the employer’s taxable year with respect to which a contribution is made.

In Dejay Stores, Inc. v. Ryan, 229 F.2d 867 (2d Cir. 1956), and Tallman Tool & Machine Corp. v. Commissioner, 27 T.C. 372 (1956), acquiescence 1957-2 C.B. 7, it was held that where trust corpus was lacking at the close of a taxable year because of the employer-taxpayer’s failure to make the initial contribution to an otherwise valid trust, such corpus was considered furnished and the trust was deemed to have been in existence for that year if the contribution was made within the time prescribed for filing the incme tax return for that year.

Accordingly, deductions are allowable under section 404(a) of the Code for contributions paid after the close of the taxable year, but within the time prescribed for filing the employer’s income tax return for the preceding year, even though the employees’ trust did not have a corpus at the close of the preceding taxable year.

Rev. Rul. 57-419 is superseded because the position stated therein is restated under current law in this revenue ruling.

[RayJJohnsonJr]

Thank you, PensionPro. Your citations are very comprehensive and greatly appreciated. I'm beginning to think the IRS has misplaced the original Adoption Agreement and Trust and may think there was not one. They have used 2 different IRS agents and 2 different actuaries in 2 different cities over a period of 16 months. My next step is to confirm that they actually have the original Adoption Agreement and Trust.

Thanks again

[JAY21]

As a side note it's interesting that a 412i plan had a trust doc component. I thought a 412i plan did not have a trust per se (just insurance contracts) so it's possible that by showing that Rev. Ruling (81-114) and showing them the trust docs that they (IRS) may say that it wasn't a true 412i plan but rather a traditional DB plan with insurance in the plan. Then they would next say where are the Schedule B's for those years and the Actuarial Valuations for this traditional DB plan with lots of insurance in it.

Not trying to make life more complicated, just noting that going down the "hey a trust was established" road might open up other areas of attack.

[RayJJohnsonJr]

Thanks, JAY21. I honestly didn't know it was common to do 412(i)'s without a Trust. What document would take the place of a trust if there was none? We have always used a trust, it's actually a Defined Benefit Trust with optional 412(i) provisions which can be elected in the adoption agreement.

[JAY21]

Rene, the adoption agreements I've seen (mostly Datairs) has a box to check whether it is a 412i plan or not and then the trust section doesn't apply. Maybe yours is the same in that if you check the box the "trust" part isn't being used. However, it does still seem to leave you in a pickle: (a) either a trust was established timely but then no vals/Bs were done since it then wouldn't be a true 412i plan (just traditional DB plan with lots of insurance), OR (b) a trust was not established because it was a 412i plan (by checking the 412i box insurance contracts are in lieu of the unused trust) but then you have your original problem of the contracts maybe not being timely adopted.

Don't mean to be doom-and-gloom just trying to understand the IRS position and also help think through the different positions the IRS might take.

[JAY21]

I guess the main point is that a 412i does not have a "trust" by definition of what a 412i plan is.

[Belgarath]

Jay - FWIW - the 412(i) (now 412(e)(3)) plans that I have seen do indeed have a trust. As with other qualified plans, the trustee is the owner and beneficiary of the policies. I actually haven't seen a "non-trust" plan such as you describe.

[RayJJohnsonJr]

JAY21, the adoption agreement and trust we use is definitely a trust whether 412(i) provisions are elected or not. There is not a place to mark "trust" or "not a trust." Everything in the adoption agreement refers to language in the trust document. Trustees are named and must execute with signatures. Seperately, a Corporate Resolution is executed resolving to establish a trust, giving the trust a name, and naming the trustees.

[JAY21]

Well that sounds like you have a better arguement then with the IRS since the plan contains a trust and the trust was effective timely. Sounds like the IRS believes (like I did) that a 412i doesn't have a trust and thus they look to the insurance contract effective dates, let us know if you are able to prevail by using the trust's effective date.

[JAY21]

Looks like you are both right that a 412i can have a trust through which the policies are purchased. Treas. Reg. 1.412(i)-1(b)(2)(i) and Treas. Reg. 1.412(i)-1©(2)(i).

I'd make sure the IRS knows this and point out the trust was adopted timely and per the prior Rev. Ruling 81-114 previously cited does not have to have a corpus (be funded) by the end of the plan year to be a valid trust.

[RayJJohnsonJr]

Which brings up an interesting question: Does a non-trusteed 412(i) enjoy the same creditor protection as a trusteed 412(i)?

[JAY21]

I would think it would enjoy the same protection. I think the bankruptcy code (revised a few years ago) references "qualfied plans" vs. whether the plan had a trust or not.

[RayJJohnsonJr]

JAY21. That makes sense. I'm curious, in a non-trusteed 412(i), who is the owner and who is the beneficiary of an annuity in the plan?

[JAY21]

I believe each separate annuity contract specifies the participant (beneficiary) to whom it belongs to and that is their actual accrued benefit with no further calculation (except a top-heavy check must be done to make sure it's greater than top-heavy if the plan is top-heavy).