Pension Plans Funded With Cash-Value Life Ins Policies Could Wipe Out Small Businesses

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Jeffrey Johnson is a legal writer with a focus on personal injury. He has worked on personal injury and sovereign immunity litigation in addition to experience in family, estate, and criminal law. He earned a J.D. from the University of Baltimore and has worked in legal offices and non-profits in Maryland, Texas, and North Carolina. He has also earned an MFA in screenwriting from Chapman Univer...

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UPDATED: Jul 14, 2021

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Many small business owners across the nation are worried that they won’t be able to pay the huge fines assessed by the Internal Revenue Service (IRS) on pension plans funded with cash-value life insurance policies. In most cases, the plans were created by insurance companies and their sales representatives as illegal tax shelters – much to the surprise of hard working, small business owners who simply wanted to provide for their futures and those of their employees.

Illegal 412i & 419 tax shelters

There have been many scams and schemes surrounding illegal 412(i) pension plans and illegal 419 welfare benefit plans. Insurance experts say that small business owners in high tax brackets were told by insurance agents and insurance companies that they could contribute up to ten times more funds into an employee retirement plan and withdraw up to 80% of those funds on a pre-tax basis. Insurance agents were collecting huge commissions and insurance companies were making big money, but the small business owners soon realized that the plan they’d been told was legal – was anything but.

The IRS started imposing penalties of $100,000 per year on individual participants and $200,000 per year on corporate participants – which exposes many small business owners to $300,000 per year in penalties.

Real life examples

The Wall Street Journal recently ran an article on the issue. It featured the following small business owners and described the serious tax consequences they’re now facing – which are threatening to wipe them out:

  • Car wash owner. A Houston Texas man who owns 19 coin operated car washes was assessed IRS fines of nearly $1.5 million – even though he relied on three financial advisers and a CPA (Certified Public Accountant) to set up the plan.
  • Doctor. A Baltimore Maryland doctor faces a $400,000 penalty for not disclosing the financial transaction in his individual return, even though he did include it in his business return.
  • Orthopedic surgeon. An Idaho Falls Idaho orthopedic surgeon faces over $1.8 million in penalties after he and his partner set up a plan to provide for their retirement and those of their eight employees.
  • Steel fabrication firm owner. A Salina, Kansas man who owns a steel fabrication firm with 10 employees set up a pension plan and is now facing IRS penalties of up to $900,000 because he didn’t file a particular form.

Who’s to blame?

Pension fraud attorneys say that many small business owners simply relied on experts to create the best plan available for their companies and had no idea that what they were getting into would be construed as an illegal tax shelter. Insurance companies such as American General Life Insurance Co., Indianapolis Life Insurance Co., Pacific Life Insurance Co. and Hartford Life & Annuity Insurance Co., along with their insurance agents who received hefty commissions, are being blamed and insurance experts say that they may be willing to settle instead of litigating the matters.

Although the Senate Finance Committee and the IRS have agreed to hold off enforcing the penalties until they can conduct further investigations, that time limit expires on September 30th. It is yet unknown whether that deadline will be extended further.

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