Cash Value Insurance and Benefit Programs – When Will It Stop?


Professionals and small business owners are often confronted with sales pitches on how they can put away large sums for retirement, get around the nondiscrimination rules and usually get a current deduction for amounts expended. These schemes are usually marketed by financial planners or other benefits professionals who are trying to sell cash value life insurance (“CVLI”). The CVLI often brings with it large front end commissions to the benefits professional.

Each new scheme comes with a new twist on a tax code section. Section 412(i) pension plans promised benefits free from funding limits and other restrictions imposed upon by the ode on pension plans. There were and still are several variations of welfare benefit plans based on supposed loopholes in the rules under Sections 419 and 419A sometimes marketed as 419(e) plans which supposedly take advantage of the exceptions to the funding limitations under Sections 419A(f)(5) for collectively bargained plans or 10 or more employer plans under 419A(f)(6). The tax consequences of these schemes are disastrous including the draconian penalties which attach to listed transactions and failure to disclose.

While the IRS has clearly stated its positions over the years (starting with Notice 95-34) with respect to the plans, they continue to be marketed as a way to sell CVLI. In Notice 2003-24the IRS summarized the tax problems raised by certain plans seeking to qualify for exceptions under 419(f)(5). In Notice 2007-83 the IRS took the position that the use of CVLI for funding welfare benefit trusts was a listed transaction. In Chief Counsel Advice CCA 200931049 the IRS deals with these same issues. In most instances these 419/419A arrangements are listed transactions – see Notice 2009-59.

Once a taxpayer is in the arrangement, it may be impossible to unwind without significant tax exposure. A recent case illustrates this point (see G.M. Cadwell Jr. v. Commissioner, 136 T.C. No. 2 (January 3, 2011). In Cadwellthe taxpayer joined a 419A(f)(6) trust with the benefit funded by CVLI and term insurance. The promoter decided to undo the multiple employer trust based on guidance in Notice 95-34 by spinning off the assets to separate single employer trusts. This method of undoing the transaction resulted inclusion in income of the cash value with no deduction for a surrender charge; inclusion in gross income of the excess contributions; inclusion of the current cost of insurance in gross income; where the fair market value of the life insurance policy had been determined using the PERC method, the taxpayer had to include in gross income the cost of the life insurance protection an amount equal to the sum of mortality charges and other expenses; and the taxpayer was liable for the accuracy penalty for understatement of income under Section 6662(a) and (b). There was nothing said about liability for failure to report a listed transaction.

Yet these variations of these arrangements continue to be sold to unwitting taxpayers!

-- Jeffrey N. Clayton
Callister Nebeker & McCullough