Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client has been approached by another financial professional, who is encouraging the client to implement a Section 419 plan funded with life insurance at his business. Is this a good idea?

Answer: Probably not.

In the past, advocates of Section 419A or Section 419 plans have touted their strategies as a way for a closely held business owner to generate in income tax deduction for certain employee benefits. Those benefits have included

• Pre-retirement death benefits
• Severance benefits
• Post-retirement death benefits
• Post-retirement health benefits

Advocates have also encouraged the business owner to fund the benefits under the 419 plan arrangement with permanent life insurance on one or more of the plan participants. In this way, the premium for the life insurance was, arguably, tax deductible to the business and not included in the employee’s personal income.

In a series of revenue rulings and announcements over the past ten years, the IRS has issued a series of rulings and announcements under which it has decided that most configurations of 419A or 419 plans using permanent life insurance are listed transactions. The IRS considers listed transactions to be tax shelters, and imposes extra reporting requirements on participants and promoters. There are severe penalties for those who fail to comply with the requirements, and the IRS will also almost certainly disallow the claimed tax benefits of the plan.

Those promoters who still advocate Section 419 plans funded with life insurance argue that their particular plan configuration is exempt from the listed transaction requirements. While an exempt design is possible, the IRS’s announcements give the Service a fair amount of discretion to decide after the fact that a 419 plan was in fact a listed transaction.

Therefore, we recommend that business owner clients avoid implementing Section 419 plans funded with permanent life insurance.

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