412(i) Plan Audit from Hell (PART 2)

[RayJJohnsonJr]

We got past PROBLEM 1, thanks to this forum, which was the IRS denying the 1st year plan contribution in year 2000. They have withdrawn that from their list of problems with The Plan.

NOW, the argument is over The Plan's use of a DC to DB converssion in the Plan's 1st year. A major national actuarial firm presentd this technique at the ASPA meeting in about 1999. (copy attached)

It worked like this:

At participant age 56

$519,689 was transfered into the 412(i) DB from a terminating DC Plan.

At 8.5% projected growth, at NRA age 62 the $519,689 would grow to $844,670.

Using the 1971 GAM Male mortality and 8.5% interest, the $844,670 would result in a monthly benefit of $7,484.

The life insurance and annuity funding contracts guarantee $5.34 per $1,000 at NRA 62.

To pay the $7,484 monthly benefit the insurance contracts must generate Guaranteed Cash Value of $1,401,455.

The level premium required by the life and annuity guaranteed cash value was $149,500.04. (Rev.Rul. 74-307 was used to calculate life insurance inclusion)

When the IRS takes this technique away, we have a "listed transaction" problem with the life insurance.

ANYBODY GOT ANY IDEAS? ALL HELP APPRECIATED!

2_Pages_ASPA_handouts_regarding_DC_to_DB_conversions.pdf

[J Simmons]

Have you checked with that major national actuarial firm that presented the technique at the circa 1999 ASPA meeting to see how they are handling situations where the IRS challenges the technique? Often those that promote a novel technique have previously thought through the implications if the IRS were to disapprove, and how then to characterize for tax purposes and ameliorate the situation to minimize the taxes and penalties due.

[mbozek]

We got past PROBLEM 1, thanks to this forum, which was the IRS denying the 1st year plan contribution in year 2000. They have withdrawn that from their list of problems with The Plan.

NOW, the argument is over The Plan's use of a DC to DB converssion in the Plan's 1st year. A major national actuarial firm presentd this technique at the ASPA meeting in about 1999. (copy attached)

It worked like this:

At participant age 56

$519,689 was transfered into the 412(i) DB from a terminating DC Plan.

At 8.5% projected growth, at NRA age 62 the $519,689 would grow to $844,670.

Using the 1971 GAM Male mortality and 8.5% interest, the $844,670 would result in a monthly benefit of $7,484.

The life insurance and annuity funding contracts guarantee $5.34 per $1,000 at NRA 62.

To pay the $7,484 monthly benefit the insurance contracts must generate Guaranteed Cash Value of $1,401,455.

The level premium required by the life and annuity guaranteed cash value was $149,500.04. (Rev.Rul. 74-307 was used to calculate life insurance inclusion)

When the IRS takes this technique away, we have a "listed transaction" problem with the life insurance.

ANYBODY GOT ANY IDEAS? ALL HELP APPRECIATED!

Have you considered that guidance that is cited in the 1999 ASPA meeting may not be a governing rule because IRC 415(e) was repealed effective Jan 1, 2000. (Reg. 1.415-7 carrys a legend in CCH reg book (2007) that the reg. does not reflect the amendments made to IRC 415 after 12/30/80.) Reg 1.415-7 is titled "limitation in case of of defined benefit and defined contribution plan for same employee." Since the combined limits for DB and DC plans under IRC 415(e) was repealed for years after 1999, was not example 4 of Reg 1.415-7(e), conversion of a DC plan to a DB plan, cited in the paper, no longer authority for contributions made in 2000 because IRC 415(e) had been repealed?

[Andy the Actuary]

Has the IRS detailed chapter and verse as to why your scenario won't fly? If not, you may want to consider asking them to detail codes sections, regulations, etc. You at least then will understand their thinking and can proceed accordingly.

[RayJJohnsonJr]

We got past PROBLEM 1, thanks to this forum, which was the IRS denying the 1st year plan contribution in year 2000. They have withdrawn that from their list of problems with The Plan.

NOW, the argument is over The Plan's use of a DC to DB converssion in the Plan's 1st year. A major national actuarial firm presentd this technique at the ASPA meeting in about 1999. (copy attached)

It worked like this:

At participant age 56

$519,689 was transfered into the 412(i) DB from a terminating DC Plan.

At 8.5% projected growth, at NRA age 62 the $519,689 would grow to $844,670.

Using the 1971 GAM Male mortality and 8.5% interest, the $844,670 would result in a monthly benefit of $7,484.

The life insurance and annuity funding contracts guarantee $5.34 per $1,000 at NRA 62.

To pay the $7,484 monthly benefit the insurance contracts must generate Guaranteed Cash Value of $1,401,455.

The level premium required by the life and annuity guaranteed cash value was $149,500.04. (Rev.Rul. 74-307 was used to calculate life insurance inclusion)

When the IRS takes this technique away, we have a "listed transaction" problem with the life insurance.

ANYBODY GOT ANY IDEAS? ALL HELP APPRECIATED!

Have you considered that guidance that is cited in the 1999 ASPA meeting may not be a governing rule because IRC 415(e) was repealed effective Jan 1, 2000. (Reg. 1.415-7 carrys a legend in CCH reg book (2007) that the reg. does not reflect the amendments made to IRC 415 after 12/30/80.) Reg 1.415-7 is titled "limitation in case of of defined benefit and defined contribution plan for same employee." Since the combined limits for DB and DC plans under IRC 415(e) was repealed for years after 1999, was not example 4 of Reg 1.415-7(e), conversion of a DC plan to a DB plan, cited in the paper, no longer authority for contributions made in 2000 because IRC 415(e) had been repealed?

Hi mbozek (mjb), I'm not sure I'm posting this reply in the right place, please let me know if I'm doing this wrong. Thank you for your very thorough reply. Would it make a difference if the 1st Plan Year, that is the year the conversion took place was 3/1/99 to 2/28/00 ?

Rene

[mbozek]

Good question. It has been a while since I looked at the 415 regs, old or new, but I remember that under the old regs benefits limits were determined on "a limitation year" which could be any 12 month period designated in the plan. If no election was made the limitation year was the calendar year. Maybe one of the actuaries who are more familar with the old regs can answer your Q.

[RayJJohnsonJr]

Good question. It has been a while since I looked at the 415 regs, old or new, but I remember that under the old regs benefits limits were determined on "a limitation year" which could be any 12 month period designated in the plan. If no election was made the limitation year was the calendar year. Maybe one of the actuaries who are more familar with the old regs can answer your Q.

Thank you again mbozek, the Plan's limitation year was the same as the plan year and corporations physcal year 3/1 to 2/28.

Rene

[mbozek]

Good question. It has been a while since I looked at the 415 regs, old or new, but I remember that under the old regs benefits limits were determined on "a limitation year" which could be any 12 month period designated in the plan. If no election was made the limitation year was the calendar year. Maybe one of the actuaries who are more familar with the old regs can answer your Q.

Thank you again mbozek, the Plan's limitation year was the same as the plan year and corporations physcal year 3/1 to 2/28.

Rene

If the converson was adopted before the end of the 1999 limitation year (2/28) then it should be ok but you need to check both the old and new regs to confirm what the IRS issue is because I dont do 412i/412(e)(3).

[Belgarath]

Is the IRS asserting that this technique was not allowable at all, or that it was not valid specifically for a 412(i) plan? (I have no solution either way, I'm just curious.)

[RayJJohnsonJr]

Good question. It has been a while since I looked at the 415 regs, old or new, but I remember that under the old regs benefits limits were determined on "a limitation year" which could be any 12 month period designated in the plan. If no election was made the limitation year was the calendar year. Maybe one of the actuaries who are more familar with the old regs can answer your Q.

Thank you again mbozek, the Plan's limitation year was the same as the plan year and corporations physcal year 3/1 to 2/28.

Rene

If the converson was adopted before the end of the 1999 limitation year (2/28) then it should be ok but you need to check both the old and new regs to confirm what the IRS issue is because I dont do 412i/412(e)(3).

Thank you, I will do that. What is the easiest way to look at what the regs were in 1999/2000. I had a copy but I threw it away, wish I hadn't.

Rene

[RayJJohnsonJr]

Is the IRS asserting that this technique was not allowable at all, or that it was not valid specifically for a 412(i) plan? (I have no solution either way, I'm just curious.)

The IRS actuary is not accepting it because she's never heard of it. I cited the regs, but she would not even look them up. So now I guess I have to prove it to her. I can tell by her questions and statements that she is not well trained or experienced. She has it in for this Plan, and probably a lot of other 412(i)'s. Her assertions suggest that she is going to disqualify the Plan no mater what we say or prove. Thank you,

Rene

[RayJJohnsonJr]

I think I found it. Attached is 1.415-7 Limitation in case of defined benefit and defined contribution plan for same employee, Example 4 is highlighted. Example 4 is an exact description of the participants circumstances and what The Plan did.

Anybody see anything wrong with this?

Thank you,

Rene

1.415_7___Limitation_in_case_of_defined_benefit_and_defined_contribution_plan_for_same_employee.pdf

[Mike Preston]

Of course the example is fine, it is from the regs. This concept has been discussed at many meetings. At various ASPPA conferences it has been referred to as the "DB UP" method. The regs make it seem that the method is perfectly acceptable. However, I know of no citation or even any PLR that specifically addresses it. In a purely theoretical world, your client should consider standing their ground and let the IRS rule against them, knowing that when it gets to Tax Court, there is a good chance the Court can be convinced that the Secretary should be held to the letter of the regulations. It isn't a purely theoretical world, however, so the client needs to consider the whole audit and the cost of compliance, in total, and, most importantly, with ERISA counsel guiding the whole process.

[mbozek]

Of course the example is fine, it is from the regs. This concept has been discussed at many meetings. At various ASPPA conferences it has been referred to as the "DB UP" method. The regs make it seem that the method is perfectly acceptable. However, I know of no citation or even any PLR that specifically addresses it. In a purely theoretical world, your client should consider standing their ground and let the IRS rule against them, knowing that when it gets to Tax Court, there is a good chance the Court can be convinced that the Secretary should be held to the letter of the regulations. It isn't a purely theoretical world, however, so the client needs to consider the whole audit and the cost of compliance, in total, and, most importantly, with ERISA counsel guiding the whole process.

Why would it be necessary to have a citation or a PLR to provide proof that the DB UP conversion is perfectly acceptable since the regs are deemed to be the law the same as the IRC? Are you saying that unless a taxpayer pays for a PLR to validate something that is expressly permitted unded the Regs then an IRS agent can deny the tax benefit? If so then why bother having a reg which states what is permitted?

I think what the client needs to do retain counsel with the requisite advocacy skills who will ask the agent for a letter stating what are the reasons why the conversion fails and the citations to the appropriate authority under the code and regulations which form the basis for the answer.

[Mike Preston]

This may not be the only issue on the table. Of course the IRS agent should not be attempting to obviate a regulation. But once your plan is in one of these 412(i) audits, the issues can get "complicated." Litigation guidance is critical.

[RayJJohnsonJr]

Thank you. Counsel has been retained and participated in the a 1.5 hour conference call with the IRS agent and IRS actuary. Counsel (who wrote the part of the adoption agreement permitting the "DB UP" conversion) was blown away by the IRS actuaries determination to disqualify The Plan. No matter what we we said, no matter what we proved, the actuary continued to assert her intention to disqualify the "412(i) funding technique" she calls it. The IRS actuary wants the entire plan recalculated as regular DB and the DC to DB cvonversion treated as a plain old rollover and accounted for seperately.

Rene

[Andy the Actuary]

Who is the IRS Actuary?

What basis did the IRS Actuary assert for the disqualification? She would have had to state that is violated the code or regulation. Given (from earlier in the thread) that you believe she is going to disqualify the plan no matter what, presumably there is an appeals process other than going to tax court?

[RayJJohnsonJr]

This articlele may explain it all. A MUST READ!

Rene

Article___Accountants__Ins._Agents__Business_Owners_Fined__200_000_by_IRS.pdf

[movedon]

Wait for it... this is gonna be awesome.

[Andy the Actuary]

This articlele may explain it all. A MUST READ!

Rene

This article sounds like a good ploy to market services. Somewhere in between no doubt rests the true story.

[WDIK]

Here are the possibilities as first came to mind. (certainly not to preclude other possibilities)

1) Rene is covertly associated with Lance Wallach and intentionally put forth this story to allow for the opportunity to post Lance's materials.

2) An astounding coincidence has ocurred.

3) Rene has a very subtle sense of humor.

[RayJJohnsonJr]

Wait for it... this is gonna be awesome.

What did you mean by that, Lippy?

[RayJJohnsonJr]

Here are the possibilities as first came to mind. (certainly not to preclude other possibilities)

1) Rene is covertly associated with Lance Wallach and intentionally put forth this story to allow for the opportunity to post Lance's materials.

2) An astounding coincidence has ocurred.

3) Rene has a very subtle sense of humor.

A CPA emailed the article to me this morning. I've never heard of the author. This is happening to one of my clients right now.

Rene

[WDIK]

Number 2 it is.

[RayJJohnsonJr]

Who is the IRS Actuary?

What basis did the IRS Actuary assert for the disqualification? She would have had to state that is violated the code or regulation. Given (from earlier in the thread) that you believe she is going to disqualify the plan no matter what, presumably there is an appeals process other than going to tax court?

By refusing to recognize the DC to DB conversion, it makes the contributions excessive, the benefits distributed exceed 415, and the life insurance fails the 74-307 test causing a listed transaction.

[RayJJohnsonJr]

Number 2 it is.

I'm sorry, I'm not seeing the coincidence. Where is it?

[J Simmons]

The coincidence is that Lance Wallach uses this board to advertise the fear mongering and there has been a recent flurry by him in such posts here, and rene having such an issue--right now. Quite the coincidence.

[WDIK]

Mr. Wallach has posted and reposted this same article scores of times on nearly every forum of BenefitsLink to the aggravation, irritation, annoyance and consternation of many forum members and in violation of forum rules and administrator requests.

I'm surprised you missed it, Rene.

[RayJJohnsonJr]

Mr. Wallach has posted and reposted this same article scores of times on nearly every forum of BenefitsLink to the aggravation, irritation, annoyance and consternation of many forum members and in violation of forum rules and administrator requests.

I'm surprised you missed it, Rene.

I formally apologize for reposting it. I am sorry I had not previously seen it. I guess my question is, if it's true, can enough people read it? Is anyone taking action? People are being steamnrolled. Is he wrong or is this not an outrage?

[J Simmons]

The IRS has been very clear about what the abusive tax shelters are. The IRS has made clear what uses of 412i are abusive. The IRS has made clear what uses of 419A are abusive. That there are advisors that continue, in the face of these warnings, to promote to employers, unsuspecting and otherwise, these abusive tax shelters is in my opinion the outrage. These charlatans have left a slash-and-burn wake out of which employers fear legitimate employee benefit plans, sometimes terminating their legitimate 401a and 401k plans, 125 cafeteria plans, etc. Other charlatans, for their own gain, then engender fear among legitimate advisors.

[Ron Snyder]

rene-

On the assumption that you may be exactly who you appear to be, I will answer that there are several good tax litigation firms who represent similarly situated clients. They are likely to prevail in cases that are not egregious. However, IRS is likely to prevail where a plan is clearly abusive.

j simmons-

Since 412(i) plans necessarily involve at lease 1 life insurance company, one can hardly accuse them of "slash-and-burn" tactics. They do not have the privilege of hiding from the actions of their agents/brokers who are likely to say almost anything to make a good insurance sale. But the carrier inevitably ends up making the client whole after the IRS is through with its own abusive treatment. Just get a good plaintiff's attorney.

[J Simmons]

j simmons-

Since 412(i) plans necessarily involve at lease 1 life insurance company, one can hardly accuse them of "slash-and-burn" tactics. They do not have the privilege of hiding from the actions of their agents/brokers who are likely to say almost anything to make a good insurance sale. But the carrier inevitably ends up making the client whole after the IRS is through with its own abusive treatment. Just get a good plaintiff's attorney.

I agree ... if the life insurance company is yet in business. I've been asked to help a couple of 412i victims and when we investigated, found that the insurance companies were no longer in business. In other instances where the insurance company is yet in business, with some legal pushing they have, like you said, 'made the client whole'.

[RayJJohnsonJr]

OK, here's where we are now: The IRS Actuary says(maybe conceding that DC to DB conversions are allowable): if you did a DC to DB conversion of $500,000, which created a new DB benefit, and the DB is a 412(i), the transfer flunks the 412(i)(2) requirement of level premiums. I think that is an inexperienced, uneducated position. But what code or regulation prooves that it does not violate the 412(i)(2) level premium requirement(other than common sense)?

Thanks Everybody,

Rene

[Mike Preston]

Interesting. I think I'd just respond that the premiums paid by the plan with respect to the transferred benefit are level: $0 and that it therefore satisfies the regulation.