Publication - Mar-08d for in 2003, the first plan year, but were not signed and the first premiums were not paid until March of 2004. The insurance carrier has confirmed that the contract was in effect in 2003, per an oral binder given by the agent to the plan.
After more than 18 months of protracted discussion, provision of voluminous documentation and detailed analyses of the legal authorities and the facts of the case, the IRS has conceded all issues except for one: was the annuity contract in effect for the first year of the plan? We have pointed out that there is nothing in the Code or the regulations that requires that the annuity contract be signed or the premium paid before the end of the first plan year. The Code simply states that the contract must commence with the date the participant enters the plan, and the carrier is prepared to certify that this was the case. The contract commences when the carrier certifies that there is coverage, not upon the signing of the contract or the payment of the premium. Indeed, the 412(i) regulation specifically provides that premiums may be paid any time before lapse of the contract and that a payment made on the first payment date under the contract still meets the requirement even if that date is after the participant enters the plan. Thus, in our view, there is no legal support for the IRS position that the policy must be signed and the premium paid before the last day of the first plan year. Nevertheless, the IRS is proposing to disallow the deduction for the first plan year, and the case is headed to Appeals.
Conclusion Our purpose in presenting these two examples is not to suggest that the IRS is entirely wrong or that it is acting unreasonably in handling this audit initiative. As we noted at the outset, there certainly are plans that fail to comply with the 412(i) requirements and there are others that were abusive. And to its credit, the IRS has developed an approach that will permit most of the audits to be settled in a way that will preserve much of the original tax deductions and plan benefits.
That said, not every case is bad, and it is unfortunate that the IRS has failed to give its agents the discretion to close cases that clearly do not fall within either category.
At one time in the late 1990s OnlineAdviserTM service received more questions otumbles. Recent 412(i) plan interest peaked in 2002 and has dropped off in 2003 as the stock market recovered.
2) A small business wants a pension-type retirement plan but balks at the cost of commercial pension services. This situation commonly arises in blue-collar family businesses where the employee/family members are not financially sophisticated and may not be well-qualified to handle their own investments. One business I advised was a father/son fish wholesaler where the son was mentally handicapped. The son did a great job running the sales counter, but his father made sure his son's pension plan was on auto-pilot before he retired. The son understood and could describe in one simple sentence what would happen when he eventually retired. "My paycheck will keep coming for the rest of my life even if I don't come to work".
3) A business owner may wish to move receivables out of the business on a tax-deductible basis. In the example used above, the father was able to ensure that cash for funding the pension would be available from future receipts on the sale of a business property under a lease-purchase agreement. The future income from installments would be offset by annual pension plan contributions. In terms of tax planning, the father effectively transferred some of his own assets (in this case long term business receivables from an installment sale that would otherwise be counted as income and taxable business assets) out of his estate and into a safe tax-deductible benefit for his son.
4) Where a supplemental income annuity is already being used. Non-qualified annuity plans are handled differently than pension plans for purposes of legal settlements (divorce and other liability settlement situations), college financial aid and other public and private accounting. The core issue is that a pension plan account is a business asset whereas a non-qualified annuity is a personal asset. In some cases, it is simple and desirable to convert this non-deductible personal account to a tax-deductible business plan.
5) An individual who does not need current income and wants to defer 100% of earned income from taxes. This might be the case for a person already finished a career who goes back to work as a consultant. Recent inquiries from semi-retired insurance agents fit this category.
Some examples of situations where 412(i) plans are not suitable or should be used with caution include:
1) The principal or key employee is under age 40. Other traditional retirement plans will generate the same tax results with lower administrative costs and lower tax risk.
2) The desired total annual contribution is less than $50,000. In these cases traditional retirement plan designs are available. Just as above, other traditional retirement plans will generate the same tax results with lower administrative costs and lower tax risk.
3) The plan will be heavily funded with life insurance. Yes, I know it irks some financial marketers when I say this but qualified retirement plans were never meant to be a way to sell a ton of life insurance and the IRS seems intent on proving this point.
4) Where income fluctuates broadly and this might be an isolated "good year" for the owner. Although I have never seen it happen, the IRS can disqualify a plan for not meeting the "permanency" requirements. If a business sets up a pension plan and then discovers that business situation has changed for the worse, the adviser should take extra care to deliberately document the plan termination and rollover to a more suitable plan. A business owner who lets a pension plan die a quiet death is probably at greater tax risk than one who takes proactive measures to terminate a pension plan that no longer fits the current situation.
Publication - Mar-08d for in 2003, the first plan year, but were not signed and the first premiums were not paid until March of 2004. The insurance carrier has confirmed that the contract was in effect in 2003, per an oral binder given by the agent to the plan.
ReplyDeleteAfter more than 18 months of protracted discussion, provision of voluminous documentation and detailed analyses of the legal authorities and the facts of the case, the IRS has conceded all issues except for one: was the annuity contract in effect for the first year of the plan? We have pointed out that there is nothing in the Code or the regulations that requires that the annuity contract be signed or the premium paid before the end of the first plan year. The Code simply states that the contract must commence with the date the participant enters the plan, and the carrier is prepared to certify that this was the case. The contract commences when the carrier certifies that there is coverage, not upon the signing of the contract or the payment of the premium. Indeed, the 412(i) regulation specifically provides that premiums may be paid any time before lapse of the contract and that a payment made on the first payment date under the contract still meets the requirement even if that date is after the participant enters the plan. Thus, in our view, there is no legal support for the IRS position that the policy must be signed and the premium paid before the last day of the first plan year. Nevertheless, the IRS is proposing to disallow the deduction for the first plan year, and the case is headed to Appeals.
Conclusion
Our purpose in presenting these two examples is not to suggest that the IRS is entirely wrong or that it is acting unreasonably in handling this audit initiative. As we noted at the outset, there certainly are plans that fail to comply with the 412(i) requirements and there are others that were abusive. And to its credit, the IRS has developed an approach that will permit most of the audits to be settled in a way that will preserve much of the original tax deductions and plan benefits.
That said, not every case is bad, and it is unfortunate that the IRS has failed to give its agents the discretion to close cases that clearly do not fall within either category.
At one time in the late 1990s OnlineAdviserTM service received more questions otumbles. Recent 412(i) plan interest peaked in 2002 and has dropped off in 2003 as the stock market recovered.
ReplyDelete2) A small business wants a pension-type retirement plan but balks at the cost of commercial pension services. This situation commonly arises in blue-collar family businesses where the employee/family members are not financially sophisticated and may not be well-qualified to handle their own investments. One business I advised was a father/son fish wholesaler where the son was mentally handicapped. The son did a great job running the sales counter, but his father made sure his son's pension plan was on auto-pilot before he retired. The son understood and could describe in one simple sentence what would happen when he eventually retired. "My paycheck will keep coming for the rest of my life even if I don't come to work".
3) A business owner may wish to move receivables out of the business on a tax-deductible basis. In the example used above, the father was able to ensure that cash for funding the pension would be available from future receipts on the sale of a business property under a lease-purchase agreement. The future income from installments would be offset by annual pension plan contributions. In terms of tax planning, the father effectively transferred some of his own assets (in this case long term business receivables from an installment sale that would otherwise be counted as income and taxable business assets) out of his estate and into a safe tax-deductible benefit for his son.
4) Where a supplemental income annuity is already being used. Non-qualified annuity plans are handled differently than pension plans for purposes of legal settlements (divorce and other liability settlement situations), college financial aid and other public and private accounting. The core issue is that a pension plan account is a business asset whereas a non-qualified annuity is a personal asset. In some cases, it is simple and desirable to convert this non-deductible personal account to a tax-deductible business plan.
5) An individual who does not need current income and wants to defer 100% of earned income from taxes. This might be the case for a person already finished a career who goes back to work as a consultant. Recent inquiries from semi-retired insurance agents fit this category.
Some examples of situations where 412(i) plans are not suitable or should be used with caution include:
1) The principal or key employee is under age 40. Other traditional retirement plans will generate the same tax results with lower administrative costs and lower tax risk.
2) The desired total annual contribution is less than $50,000. In these cases traditional retirement plan designs are available. Just as above, other traditional retirement plans will generate the same tax results with lower administrative costs and lower tax risk.
3) The plan will be heavily funded with life insurance. Yes, I know it irks some financial marketers when I say this but qualified retirement plans were never meant to be a way to sell a ton of life insurance and the IRS seems intent on proving this point.
4) Where income fluctuates broadly and this might be an isolated "good year" for the owner. Although I have never seen it happen, the IRS can disqualify a plan for not meeting the "permanency" requirements. If a business sets up a pension plan and then discovers that business situation has changed for the worse, the adviser should take extra care to deliberately document the plan termination and rollover to a more suitable plan. A business owner who lets a pension plan die a quiet death is probably at greater tax risk than one who takes proactive measures to terminate a pension plan that no longer fits the current situation.