Another tax code debacle - shelter or not?

[Judge Roy Bean]

Just what our economy needs.

http://online.wsj.com/article/SB125331489168624343.html

National Taxpayer Advocate Nina Olson, an IRS employee charged with protecting taxpayers' rights, has said the fines "have the effect of bankrupting middle-class families who had no intention of entering into a tax shelter."

[Demosthenes]

Just what our economy needs.

http://online.wsj.com/article/SB125331489168624343.html

National Taxpayer Advocate Nina Olson, an IRS employee charged with protecting taxpayers' rights, has said the fines "have the effect of bankrupting middle-class families who had no intention of entering into a tax shelter."

Small business owners who rely on commission-based life insurance salesman to design and fund their pension plans with life insurance, should be suing their advisors for those fines...

[Judge Roy Bean]

The absurdity of all of this is that the authors of the code created opportunities for alleged "experts" to foist plans on ordinary business people who cannot be expected to understand the risks involved.

The more of this kind of BS that goes on the less likely we're going to work our way out of the recession.

The reality is, private investment is being punished and those who are in a position to make those investments are being scared away by this kind of thing.

We're not going to get out of 10-15% unemployment until thousands of small business people have confidence that they won't simply be raped by the socialists who are now running things.

And keep in mind, unemployed people don't pay taxes and don't add to economic activity the way they did when they were employed - but they do become more and more dependent.

The people responsible for this latest disaster work in Washington, DC, but you can bet there is no penalty for their stupidity.

[Demosthenes]

The absurdity of all of this is that the authors of the code created opportunities for alleged "experts" to foist plans on ordinary business people who cannot be expected to understand the risks involved.

Not really. Some of us have been warning consumers about 412(i) abuses for years.

[Judge Roy Bean]

The absurdity of all of this is that the authors of the code created opportunities for alleged "experts" to foist plans on ordinary business people who cannot be expected to understand the risks involved.

Not really. Some of us have been warning consumers about 412(i) abuses for years.

Please tell me that does not mean you were among the "authors of the code."

[jcolvin2]

I thought the problem was that, by design, the cash/surrender values were artificially depressed during the early years of the plan (when the policy was inside the qualified plan), and then in later years (when the policy was "purchased" by the beneficiary and held outside the qualified plan) the cash/surrender values would radically increase ("spinging cash value"). Often the tax reserve values for these policies on the books of the life insurance companies were far higher than the claimed "cash value" or "surrender value" during the early years of the policy. In effect, the policies were designed to procure large deductions for a professional's corporation during the early years of the policy, allow the professsional to purchase the policy for a fraction of its true worth, and subsequently experience significant appreciation in cash value outside the plan.

[Demosthenes]

I thought the problem was that, by design, the cash/surrender values were artificially depressed during the early years of the plan (when the policy was inside the qualified plan), and then in later years (when the policy was "purchased" by the beneficiary and held outside the qualified plan) the cash/surrender values would radically increase ("spinging cash value"). Often the tax reserve values for these policies on the books of the life insurance companies were far higher than the claimed "cash value" or "surrender value" during the early years of the policy. In effect, the policies were designed to procure large deductions for a professional's corporation during the early years of the policy, allow the professsional to purchase the policy for a fraction of its true worth, and subsequently experience significant appreciation in cash value outside the plan.

Yep. The product designers and sellers weren't taking advantage of an overly complex tax system. They were trying to take advantage of the fact that the area of the code and regs dealing with policy valuations wasn't complex enough...

I do policy valuations as part of my practice and when these plans started going south a couple of years ago, he tried to pressure me into signing off on his clients' plans. At one point, the offer was in the seven digit range. Had I bitten, I'd have been sued later, and rightfully so.

[Demosthenes]

You can claim "springing cash value" all you want, but I double dog dare you to find any place in the IRC, or any state's insurance regulations that define "springing cash values." Plus, the form of the policy is reviewed by each state it is sold in, prior to its being sold in that state.

And it may be semantics, but there is a difference between the cash value of a policy and the surrender value of the policy.

Also, do not forget why the surrender charge is there. Insurance companies incur a lot of costs when a policy is sold and it incurs those charges up front. Ideally, the policy owner would keep the policy for decades, allowing the issuing company to make a profit on it. However, if the owner opts to surrender the policy in the early years, the surrender charge allows the issuing company to recoup some of those up front costs.

WHy would the IRS define springing cash value policies? This was a game played by aggressive insurance companies, not the IRS.

The valuation of these specialized contracts have nothing to do with surrender charges, Captain. The internal valuation of the contract was artificially supressed through other means which have nothing to do with state insurance laws.

[Demosthenes]

Lots of people talk about "springing cash value" but without a legal definition that's all it is.

When a legal definition isn't proivded, you use the industry definition.

And yes, the policies used in 412(i) plans had rather sizeable costs associated with them - face amount charges, cost of insurance and so forth. And yet I think each and every state approved the policy types for sale in their respective states.

So what?

You stated that "The internal valuation of the contract was artificially supressed through other means which have nothing to do with state insurance laws." What were those means? Were they extra-contractual? Just curious.

The games varied from year by year depending on which whack-a-mole technique had just been shut down. These were contracts designed only for limited-use, tax avoidance games.

To be fair,not every 412(i) plan owner got raked over the coals by the IRS, some did, but I bet they were the minority.

That's true - just like the IRS doesn't go after very many building contractors or tax deniers.

This is oonly a guess, but I would bet real money a lot of these plans were sold based on greed.

Absolutely, which is why I don't feel a lot of sympathy for the business owners in the Judge's original post.

[Joey Smith]

In the defense of life insurance agents (Aaack!), these plans, 412(i), 419A(f)(6), and 419(e), are commonly used by large corporations to provide a variety of benefits. What happens is that so-called Administrators (i.e., Promoters) put together plans that take an aggressive -- but not necessarily wrong -- position as to how much life insurance can be purchased within the plan. Then, the Administrators go to the life insurance companies who "approve" the product for the program, and channel the wholesalers/national marketing organizations to sell the plans, oh, and a lot more life insurance.

So, the individual agent -- who knows very little about tax law -- shows up at one of these seminars, which features an Administrator talking about their program with the backing and opinion letter of a major tax law firm (and they all have these), and the "approval" for sales by the life insurance companies. So, they figure that somebody who does know what is going on, i.e., the law firm or the insurance company, has thoroughly vetted the program and it is kosher.

Then, of course, when the program blows up, the individual life agent gets sued, but the life insurance company says, "we were just selling the life insurance product and had nothing to do with the plan" (ignoring that they channeled their agents into it and gave it their stamp of approval). Similarly, the law firm that gave the opinion letter says, "We gave that to the Administrator and not to you and so owe you no duties".

The real culprits are the tax law firms that give the opinion letters and the life insurance companies that allow their products to be sold within these programs and channel their agents into it. But often they escape and the life insurance agent out in the field gets clobbered.

This isn't to say that the average life insurance agent wouldn't sell their mother for the commission on a $10,000 term policy ...............

[Judge Roy Bean]

...
The real culprits are the tax law firms that give the opinion letters and the life insurance companies that allow their products to be sold within these programs and channel their agents into it. But often they escape and the life insurance agent out in the field gets clobbered.

This isn't to say that the average life insurance agent wouldn't sell their mother for the commission on a $10,000 term policy ...............

Sorry, Joey, I call BS. The code would not have been written the way it was without the influence of the entities who wanted it that way; the House staff members who wrote them (or cut and paste them from lobbyist submissions) and their bosses have to be ultimately responsible.

I just don't get the idea that elected representatives get a free pass for this kind of crap.

[Demosthenes]

Demo please. You should know that the life insurance industry has no definition of, nor has it ever sold a life insurance policy with alleged "springing cash values." Where do you get such silly notions young lady?

Huh? Springing cash value policies have been aroud for at least 15 years. They were originally used to "sponge" moneys from qualified retirement plans, and were later adapted for the 419 and 412(i) marketplace. They're even used in some estate tax schemes when you want to artificially depress an assets value prior to gifting or sale.

[Demosthenes]

In the defense of life insurance agents (Aaack!), these plans, 412(i), 419A(f)(6), and 419(e), are commonly used by large corporations to provide a variety of benefits. What happens is that so-called Administrators (i.e., Promoters) put together plans that take an aggressive -- but not necessarily wrong -- position as to how much life insurance can be purchased within the plan. Then, the Administrators go to the life insurance companies who "approve" the product for the program, and channel the wholesalers/national marketing organizations to sell the plans, oh, and a lot more life insurance.

So, the individual agent -- who knows very little about tax law -- shows up at one of these seminars, which features an Administrator talking about their program with the backing and opinion letter of a major tax law firm (and they all have these), and the "approval" for sales by the life insurance companies. So, they figure that somebody who does know what is going on, i.e., the law firm or the insurance company, has thoroughly vetted the program and it is kosher.

Then, of course, when the program blows up, the individual life agent gets sued, but the life insurance company says, "we were just selling the life insurance product and had nothing to do with the plan" (ignoring that they channeled their agents into it and gave it their stamp of approval). Similarly, the law firm that gave the opinion letter says, "We gave that to the Administrator and not to you and so owe you no duties".

The real culprits are the tax law firms that give the opinion letters and the life insurance companies that allow their products to be sold within these programs and channel their agents into it. But often they escape and the life insurance agent out in the field gets clobbered.

This isn't to say that the average life insurance agent wouldn't sell their mother for the commission on a $10,000 term policy ...............

Dead on, right.

I'd like to add, however, that despite what the life insurance company says about not having any culpability for the plan, that argument doesn't fare well in civil litigation. A life insurance agent is the agent of the insurance company, after all, not an agent of the client.

A handful of states do have a "life insurance broker" license, but I've never once seen a case where a broker pushed these plans on a client, simply because he wouldn't be able to receive any commission from the deal.

[Demosthenes]

...
The real culprits are the tax law firms that give the opinion letters and the life insurance companies that allow their products to be sold within these programs and channel their agents into it. But often they escape and the life insurance agent out in the field gets clobbered.

This isn't to say that the average life insurance agent wouldn't sell their mother for the commission on a $10,000 term policy ...............

Sorry, Joey, I call BS. The code would not have been written the way it was without the influence of the entities who wanted it that way; the House staff members who wrote them (or cut and paste them from lobbyist submissions) and their bosses have to be ultimately responsible.

I just don't get the idea that elected representatives get a free pass for this kind of crap.

The 412 laws were written decades ago. Do you believe that the insurance lobby paid Congress to write the laws that way, and then waited decades to find a way to abuse a loophole they paid to have inserted?

Having worked in the life insurance world since the mid 80s, I have watched from the inside as salesmen and their managers have scrambled to find a way to make their sales bigger and sexier. Thanks to the personal computer, agents went from being old guys in cheap suits to young aggressive lions with sophisticated software and a drive to present the newest and hottest plan to their clients.

There's a ton of money to be made in life insurance sales, with commissions as high as 140% of the first year premium. The agents have had minimal training and yet they believe that they know more than any attorney or accountant ever could. The holy grail in the sales world is finding a way to sell large amounts of insurance in a tax-free environment.

Contrary to your theory, Congress has been far from accomodating the life insurance industry in finding that grail. As each new scheme popped up, the government has taken steps to shut it down. Unfortunately, just like in the tax denier world, abuses have to get pretty bad before legislative or regulatory fixes become a priority.

[Demosthenes]

Argh. I seriously need to take less cold medication.