Business Owners Beware of Tax Shelter Pitches

Companies considering insurance plans that offer significant tax benefits should be on their guard.  Negligent and unscrupulous tax shelter promoters could leave them – as they left a pair of Tampa small business owners — facing back taxes, fines and fees from the IRS as well as expensive and unnecessary insurance.

When properly designed and administered, Section 419 plans —so named because the law regarding them is found in Section 419 of the Internal Revenue Code — allow businesses to contribute tax-deductible funds to a trust in order to provide certain tax-free benefits for business owners and their key employees. Benefits allowable under a properly created and implemented Section 419 plan may include health insurance premiums, uninsured medical care, long-term care, and death benefits.

Retirement income is never allowed as a benefit under a 419 Plan. But insurance agents holding themselves out as “retirement planning specialists” peddling “alternative investments” often lure small business owners into buying very high-commission life insurance policies with false promises, including promises of tax-free investment income.

According to an ongoing lawsuit filed by Vernon Litigation Group on behalf of small business owners, one such Section 419 plan funneled retirement savings through a life insurance policy. These business owners were told at the time they agreed to buy the policy – from those who stood to benefit substantially from the sale — that they could reduce or even skip their annual contribution without affecting benefits. It turned out that they were, in fact, required to make a substantial minimum contribution each year or lose their entire investment.

Because of the volatility of the business they are in, the owners would never have agreed to a plan that did not allow flexibility in its contributions. But that was only the initial hardship and headache that came as a result of the advice given to them.

In addition, the premiums paid for cash value life insurance policies as part of the plan were not tax-deductible under the Internal Revenue Code since they were used to fund retirement income. That is true for Section 419 plans even if the funds are run through a so-named “welfare benefit plan,” as was the case for these business owners. So in addition to being responsible for a large annual contribution, the owners were also on the hook for the back taxes due for those contributions as well as fines and penalties from the IRS.

The tax-collecting agency has recently become more aggressive in its pursuit of fraudulent tax shelters, even when the owners of those shelters have been misled.

Vernon Litigation Group’s clients were not warned of the possibility of such a devastating scenario. In presentations made in their own offices, the business owners were led to believe that: contributions to the plan were fully tax-deductible, contribution amounts were flexible, the plan provided safety of the initial investment, the benefits were tax-free, the plan provided retirement income and the plan could be terminated at any time.

On the contrary, even after the IRS declared the plan to be an illegal tax shelter, the 419 plan administrator refused to shut it down unless the business owners paid a hefty “termination fee.”

Vernon Litigation Group is a Naples, Florida based law firm that assists clients in attempting to recover losses caused by all manner of financial fraud and negligence. It focuses its practice on complex financial litigation and arbitration as well as business and commercial litigation.

For more information, contact:

Susan Healy, attorney at law

Christopher T. Vernon, attorney at law

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