Abusive Tax Avoidance Transactions (ATAT) and Emerging Issues
Note - Any federal tax advice contained in this transcript is intended to apply to the specific situation described and should not be considered official guidance independent of the presentation. The tax advice and statements contained herein should not be relied upon for retirement planning purposes without first consulting a tax or retirement planning professional. This transcript has been edited for technical accuracy and may differ slightly from the audio recording of the ATAT and Emerging Issues phone forum. This information is current as of August 27, 2010. Since changes may have occurred, no guarantees are made concerning the technical accuracy after that date.
Ladies and gentlemen thank you for standing by. Welcome to the ATAT and Emerging Issues phone forum. At this time all participants are in a listen-only mode. If you should require assistance during the call, please press star then zero. As a reminder, today's conference is being recorded. I would now like to turn the conference over to your host, Mr. John Schmidt. Please go ahead.
Thanks Camile. Hi, everyone. I'm John Schmidt, the Staff Assistant for the Employee Plans Customer Education and Outreach Office at the IRS. Thanks for dialing in to our phone forum today entitled Abusive Tax Avoidance Transactions, or ATAT, and Emerging Issues. Please be advised that the following program will be recorded and maintained in accordance with federal recordkeeping laws. This recording is a work of the U.S. government and is in the public domain. A transcript and/or video recording of this program may be made publicly available on our Web site, www.irs.gov.
Today we'll be hearing from Monika Templeman, the Director of our Employee Plans Examinations Office. Monika serves as the IRS Executive Champion for 412(i) Abusive Tax Avoidance Transaction enforcement efforts.
We will also be hearing from Colleen Patton, Area Manager for the Pacific Coast Area. Colleen is the emerging issue champion and has the largest inventory of ATAT cases within employee plans.
We will e-mail a certificate of completion to everyone who registered for this session and who attends the full session. Enrolled agents and enrolled retirement plan agents, or ERPAs, are entitled to continuing professional education credit for this session. For tax professionals other than enrolled agents and ERPAs, consult with your licensing organization to see if it will provide continuing professional education credits for this session.
The retirement plans Web site at www.irs.gov/ep has information on ATAT. You can get there by going to the main IRS Web page and clicking on the Retirement Plans Community tab at the top. Once there, look to the left hand navigation bar for examination/enforcement.
You might also want to subscribe to one of our free electronic newsletters when you're there. The link for newsletters is also in the left hand navigation bar. We have two different newsletters, The Retirement News for Employers, which is directed toward employers sponsoring a retirement plan, and the Employee Plans News, which is directed at professionals who practice in the retirement area. We urge you to check out our Web page and subscribe to our newsletters.
So without further ado, here are our speakers, Monika Templeman and Colleen Patton. Monika?
M. Templeman: Thank you very much, John. It's a pleasure to be with all of you today. I'm going to share with you some of the hot issues, as will Colleen, but first I would like to start out with a little bit of an overview of our retirement plan universe and why we're so concerned about abuses, particularly in the abusive tax avoidance transactions. I want to clarify that when we're looking at abuses, we're looking at not legitimate questions as to whether or not you're taking an aggressive approach to something, but real tax avoidance schemes. As opposed to legal tax avoidance, we're talking about tax evasion.
We're also looking at emerging issues that could be questionable that could put your plans in jeopardy. Let me start out by letting you know that the retirement universe is made up of approximately one million retirement plans out there. Those are the qualified plans, that's not counting 403(b), the plans primarily that teachers and exempt organizations use. It's not counting the IRA based plans. So those are a lot of retirement plans out there and they cover roughly between 85 million and 99 million participants, and again we're looking at the private sector plans.
If you put governmental into the mix we have a lot more coverage. And yet when you look at Americans who are actually covered in the private sector by plans, workers who participate in plans that are offered are just a little over 50%. Employees in their 20s, they make up about 12% of participants in their employer's K plan. Only 66% of employees who are offered to participate in an employer's plan like a K plan actually do so. Oftentimes only 10% contribute the maximum; 90% contribute the minimum. About 60% cash out when they change jobs, and the coverage gap seems to grow.
Now, why is that so problematic? Because a lot of baby boomers are reaching retirement age, a lot of people who counted on retirement plans being there have been on their own or not really been participating and they're worried that Social Security will not sustain the type of living that they are currently used to, and it won't. So we have a lot of folks who are reaching retirement and are in jeopardy of not being able to maintain a lifestyle. That leaves a lot of susceptibility to ..., things that seem too good to be true but maybe have some kind of ... opinion and either people go into this with their eyes wide open, or they go into wanting to believe. But either way it can be highly problematic and can jeopardize one's retirement altogether, not only with compliance issues but in not having a retirement plan at all.
Now, the Employee Plans' division has regulatory responsibility that extends beyond tax collection. The goal is to ensure that the huge expenditure ... benefit, we forego about 112 billion annually to contribute to the retirement security of American workers, that's taxes that are not collected so that these can be exempt. The EP exam function is very much part of this equation, but we are very concerned that we have emerging issues and abuses that could basically corrupt the integrity of the private retirement system. So we're going to talk about that and talk about the watch out, what could be putting you and your plans in jeopardy.
Also, another piece of the equation is the emphasis on international. It's no secret that President Obama, Secretary Geithner and our IRS Commissioner, Doug Shulman are all very passionate about making sure that we curb any kind of abuses and problems in the international and high wealth arena. And in the Employee Plans arena international really runs the gamut from big multi-national plans with issues involving millions and billions and high wealth taxpayers, to SIMPLE IRAs maintained by retirees overseas and everything in between, and ... and taxpayers across the board at all economic levels and in all formats. But cross border transactions and tax havens could be source of issues that border on abuse as well. Some are very legitimate, but there are transactions that could be susceptible to promoters' gain, and so some of what we're going to be looking at will extend not just nationally but internationally as well, and I wanted to give you a heads up in this arena.
For those of you who have the slides, the second one talks about this year, we go by fiscal years of course, and so we're in 2010. In the Service, our years begin in October, unlike the regular calendar year. So our FY2010 strategies in the abusive tax avoidance transaction operating priority are to continue to address and determine abusive transactions involving retirement plans; to use promoter investigations as an enforcement strategy, in other words go after those individuals who would use retirement plans as an accommodation ... or as a way of circumventing the tax system and creating a tax evasion scheme, to increase and to stop them from doing this; to increase cross-functional collaboration; to identify complex international transactions, like I just spoke about, and that's not just working within all the functions of TE/GE, but working across the IRS. So we work with Small Business Self-employed, we work with LMSB, Large and Mid-Size Business, and W&I, Wage and Investment, and with Counsel to make sure that we cover the bases in both the national and international issues and strategies that prevent abuse.
We're developing strategies to identify and address new abusive schemes as they're percolating downward. We consider civil and criminal fraud when warranted. We utilize our Employee Plans' Compliance Unit, that's our compliance contact. They're not audits usually. They are looking at particular discrepancies or issues or compliance check questionnaires. We utilize the EPCU, which is the Employee Plans Compliance Unit and we currently have three of them, to help us to get a handle on new emerging issues and to ferret out, for example, in some schemes we see things that look really questionable and some things borderline, and we might want to look and see where we should use our resources. Is it something that really is a problem? Then we are going to share and are sharing the emerging issues with the general public as concerns are identified. This phone forum today is an example of how we're openly having a dialogue about abuses, issues and concerns.
Colleen, did you want to touch on some other investigations?
C. Patton: I'd be happy to. For those of you following the slides we have just gone to slide number four. As Monika had mentioned, we are involved in promoter investigations. It has been determined to be a much more efficient way of addressing the problems occurring in our community and rather than trying to track down each individual manifestation, though we're still addressing those, would be to go after the promoter that is ... and to ... with collaborative efforts with SBSE, LMSB as needed, with Department of Justice, with Counsel to seek to have these promotions shut down at the top, if you will.
So we are looking to deter, maybe prevent future promoters from moving into those arenas and definitely to stop any abusive schemes that are being currently marketed. As I said, we're working those investigations. We work particularly with SBSE, but we'll work across the Service and we work with Department of Justice very closely to ensure that these are properly addressed. This is a very new thing for Employee Plans. I think our awareness that promoter schemes are occurring in our backyard is still a relatively new perspective, but we are reacting to it. So we have agents identified geographically across the country that have received specialized training.
The first case where Employee Plans took a lead on an investigation is under way in my area, but we have several more that we're investigating where it looks like Employee Plans will take the lead, where an Employee Plan promoter is the key proponent of the scheme as opposed to having it be more structured as a deduction issue, where SBSE, for instance, would be more appropriate in the lead. We are in an ongoing discussion and review of submissions for these. We foresee that this will not be, perhaps, an enormous workload. But it's going to be an ongoing and consistent effort on the part of the Service and on the part of Employee Plans to address appropriately promoter schemes for promoter investigations.
We also need to mention that while there will be a small number where Employee Plans take the lead, we will continue to support SBSE on those that may be more deduction scheme oriented or any other kinds of instances that are out there so that we do work cross-functionally on these promoter investigations.
M. Templeman: We also wanted to share with you a little bit about 412(i), which are the deductions for excess life insurance schemes that we've seen. You may have heard about our 412(i) initiative to basically detect and deter these schemes and to stop them where they were abusive. Not that you couldn't have a good 412(i) plan, because there are perfectly good 412(i)plans, but we're talking about those that were abusive.
In the intro when you heard John Schmidt introduce the session, he mentioned that I was the executive lead for working on this initiative. We have done some very, very good work in the 412(i) arena and we have to commend our practitioner community for working very closely with us to help us in keeping the integrity of the private retirement system. But let me tell you a little bit about what the watch outs are and what we've done. Now, again, these were arrangements for employers to deduct the amounts contributed to buy excess life insurance.
The features in the 412(i) plan that the Service considers to be abusive or problematic are contracts where the annual premiums are significantly higher than the contributions that would be required in the plan using a reasonable funding method and reasonable actuarial assumptions. Now, oftentimes these premiums in egregious cases were five to times the amount that would be necessary to fund a typical defined benefit plan and contracts, where these premiums were excessive given the death benefits under the contract or the plan.
The plan document will specify the death benefit. This death benefit must meet the incidental death benefit rules, and the contracts purchased should match the death benefit from the plan. If the contract provides a death benefit of more than $100,000 than the plan's death benefit, you could be talking about a possible listed transaction, and Colleen, I think, will get into that. But there is a 6707A penalty that can be quite draconian that goes with having a listed transaction. Contracts with guaranteed cash values as intended where the data requirements bear no relationship to the required premiums under the contract can be problematic. Contracts with a cash value of the expected distribution date is significantly less than the accumulated value of the premiums paid is another warning sign.
Contracts that use surrender charges as a mechanism by which the cash value is artificially suppressed in the early policy years but increase significantly subsequent to the distribution of the contracts in the plan, that's the springing cash value, that's another trigger of an abusive feature. These surrender charges may be assessed by the insurance company, however, they're not typically assessed and thus the cash value is understated. And if it's based on the application of these surrender charges this could trigger an abuse. In other words, if the relationship between the premiums, the death benefits, and the guaranteed cash value is such that the owners of the businesses would never consider buying it themselves or selling it to a friend or relative outside of a 412(i) arrangement, then it's more than likely an abusive arrangement.
An arrangement in which the eligibility to purchase a contract is different for the owners than for the rank and file is another watch out. 412(i) arrangements are funding tools for qualified plans, thus, the plan is subject to the same qualification rules as non-412(i) arrangements. These plans must be available to a large cross-section of highly and non-highly compensated employees. This also means that participants must have the same options available. Features in a 412(i) plan that the Service does not consider abusive but is concerned about, and that means that they're just compliance issues not an abusive scheme, could include flexible premium products without a detailed, separate agreement, insurance contracts in which the cash value at retirement can be expected to be an amount greater than the limit allowed by law.
The Service is suspicious of arrangements that a participant will walk away from funds on his or her contract at any point and these cases are those in which a lump sum at retirement will be exceeding the maximum allowable under law. That's like a Section 415 violation even when they're converted into the contract rate and will result in an annuity at a level not allowed. Insurance contracts that offer settlement options that are not included in the pension plan or conversely do not include options offered under the pension plan can be another compliance problem, and insurance contracts that are associated with pension plans where the amount of the death benefit is not obvious. But those are more compliance problems. The first issues, the springing cash value and the discrimination and the abusive nature of those ones were the ones that we really targeted as far as preventing these abuses. I'm very happy to report that we're working with the practitioner community and we have done an excellent job of greatly deterring and basically stopping most of this abusive scheme.
Colleen, did you want to talk about some of the regulations that are in the 412(i) area?
C. Patton: Yes. I'm going to take just a bit of a left turn first, though, Monika. I know that we within the Service get so accustomed to our jargon that sometimes we forget that folks from outside don't always understand what we're talking about. And even though we try to be aware of that, there are some things to us that are just so obvious that we forget to define our terms.
Within the IRS we have four main operating divisions that are set up to deal with different types of taxpayers. We have the W&I division, which stands for Wage and Investment, SBSE stands for Small Business and Self-Employed; LMSB is Large and Mid-Size Businesses; and then we have the TEGE, Tax Exempt and Government Entities, which includes our Employee Plans' folks. ... that is so easy for us to slip into that and please let us know if we're using terms that are not clear.
When we talk about working with our SBSE or LMSB counterparts we're dealing with the income tax folks that address the small business and the large business community, dealing with such things as the deduction issues there.
Monika, we can get back to our slide presentation, and as she had said we've been very, very successful in shutting down the appearance of abuses in the insurance arena. And I'll tell you, there have been insurance concerns going back since the time I was first hired, some 20 years ago, when there were questions about exactly how much insurance you could carry on a plan and where there was a concern. But I think we've been very successful in being able to address this issue, and that has a lot to do with the amount of guidance that has been made available in the last few years. It gave us the foundation for moving forward with our project to address these issues, but it also, I believe, clarifies the point for the practitioner and the sponsor communities.
As noted on the PowerPoint, we have two Revenue Rulings, the 2004-20 and 2004-21 that address what happens when an insurance exceeds the plan amount, indicates when you could become a listed transaction if the amount of the excess crosses a certain threshold. We talked about how insurance availability must be non-discriminatory; it can't be available just for the highly compensated participants. Under Revenue Procedure 2005-25 we have the valuation rules for insurance in a plan, really clarifying how to go about doing that, and for the regulation for IRC 402 we have valuation for life insurance in a plan.
We think that we work together, with Employee Plans doing enforcement and our Rulings & Agreements side of the house providing timely and appropriate guidance to clarify what the rules are. And that's the most efficient way to ensure we're not all about just going out and doing a gotcha on enforcement, that we really have a commitment, through mechanisms such as today's phone forum, of trying to share information with the practitioner community to enable people to do things correct up front.
I'm going to go into a series of slides now. We're going to talk about some of the examples sort of general flavors or themes that we've seen marketed around the country recently or things that we're looking into, and the first of these is known as our Gulf Coast Preparer Project. I think what is interesting here is that what we have is one promoter that was very successful, and as you can see, we opened 500 project cases since 2006 that are tied back to this original promoter. And there are slight variations in how this worked, but it tends to be something outside of a qualified plan, a mechanism set up where we're approving the sponsor to take deductions beyond what they should to shield income that would otherwise be taxable.
What we've seen is that in the cases that we've looked at with this promoter there were significant issues found in more than 83% of the cases. We have wrapped up this particular promoter but the results have been very interesting, and I think it's worthwhile to note what the consequences can be, not only as I noted earlier could we seek a promoter investigation that may end up enjoining you from marketing that current theme, but we had in this case where the chief promoter was jailed and two associated professionals had been barred from practice before the IRS.
Monika, do you want to move into ROBS?
M. Templeman: Yes, why don't we do that? As Colleen was saying, with the Gulf Coast Preparer Project it was one that was a little bit analogous or close to the insurance type scheme, but it was a tailored project regionally and those abuses actually had consequences that we not only shut down the promotion but shut down the promoter. So that was excellent.
The next area I'm going to go into is slide eight and it deals with Rollovers as Business Startups or the acronym ROBS. Now, I know there have been a lot of pre- submitted questions about this particular arrangement and we will talk about that later. But I'm going to basically deal here with the overall concept of what a ROBS is and what some of the watch out areas are. It is a concern. Now, ROBS are not an abuse per se. ROBS is an arrangement that can lend itself to problems. So I wanted you to take that in that context. It is not something that we consider a listed transaction or an abusive scheme per se.
Rollovers as Business Startup arrangements were basically created to secure available funds held in a tax deferred savings, usually under a prior employer's plan, and an aspiring entrepreneur will want to use this without incurring resulting tax liabilities that ordinarily apply when you have a distribution. So ROBS is an arrangement that allows you to do an end run around that tax liability.
While the form of ROBS transactions is not abusive per se, as I stated at the onset, we are concerned in the IRS about these transactions because of compliance issues that do arise. These transactions are accomplished without any imposition of taxes that ordinarily happen when distributions from retirement plan savings accounts are involved.
Distributions would normally be subject to the treatment as ordinary income, taxable at the individual's personal tax rate, with possible additional taxes in the form of early distribution penalties. That penalty is totally avoided, as are any of the tax liabilities, when you use the ROBS setup. The Service became concerned with these transactions for several reasons; one, because they purport to facilitate the transaction, as I said, without the imposition of taxes; and two, because the transaction is one that has a lot of compliance issues that we've seen when we have been doing the examination.
Colleen, why don't you talk about some of what we've found when we analyzed these?
C. Patton: Again, as Monika said, ROBS are not inherently wrong. However, the majority that we have looked at upon examination have had issues involved with them. For instance, that the stock that's contributed to the plan ends up being allocated only ... entrepreneur, a highly compensated individual, the person for whose behalf the stock was moved as their prior benefit, and that it is set up in such a way that no current or future employees will ever have an opportunity to share in an allocation in employee stock. That's a possible violation of our non-discrimination rule.
The other item of fairly significant concern is that the stock is exchanged and there's never any independent effort made to determine the value of the stock. The stock is deemed to be valued at whatever it is exchanged for. There's no independent appraisal done to determine an accurate valuation, and that could lead to a potential for a prohibited transaction.
M. Templeman: I wanted to add one thing, Colleen, before we go on to the next topic under ROBS, and that's that Michael Julianelle, who's the Director of the Employee Plans, issued examination guidelines that were posted to the Web on the compliance issues that we're finding in ROBS, and that was dated October 1, 2008. They're still viable and still valid and still on the Web site, so you may want to check those out.
Again, while we do not find these transactions abusive per se and you can have a textbook ROBS that is pretty much problem-free, we're not basically seeing that when we're looking at our examination look at these cases. And once there are employees involved then there are inherent problems seen to arise compliance wise, and though we judge them on a case by case basis, there are a lot of issues, including a lot of these plans going belly up and not doing well. So there are concerns, definite concerns, in the ROBS arena, and we'll address those a little bit later as well.
Colleen, did you want to go to the next topic?
C. Patton: I was going to just add what you said and I'm glad you brought that up because it's not a disqualifying feature of a ROBS, but the reality is the vast majority of ROBS ... my area, what I've heard back from my agents and from my front line managers is that in most circumstances by the time they get out there the enterprise is in bankruptcy. Now, it may be in bankruptcy in the year under audit. In some cases it is not. When that occurs it's normally because the audit is being conducted on one of the initial years that the operation has been in effect, but they're in bankruptcy by the time we conduct the audit.
So it is very troubling. We know small businesses don't have a tremendous rate of success, and so we're seeing people losing their retirement savings because they don't have the skills to manage a business. It's very long odds to make a small business successful, and that, though it is not a qualification issue of a ROBS, has to be troubling when you look at the ability of people to have benefits for their retirement.
Moving on now to, for those of you following, to what would be page 11, on invalid collectively bargained plans. This was an issue that was raised to the emerging issues team from people in examination. It has, interestingly enough, also been mentioned to us by a number of practitioners around the country that they're aware that these items are being promoted. We looked at it and we determined that there is a need for guidance and training for our employees, we developed some audit tools, and we conducted a CENTRA session to make our agents more aware of this issue.
It can assume one of two slightly different manifestations, and we'll use the example, let's say, of a physician's practice, a doctor's office, to illustrate what this might look like. You could have a physician who determines on their own that their employees, their office staff, their nurses, and whatever employees they have, will be part of a union covered plan.
Now, they can do that in one of two ways. Dr. Smith could set up the Dr. Smith Union and have their employees covered under that union. Or, Dr. Smith could decide that their employees may participate in an otherwise legitimate union and the teamsters have been used fairly often and they will decide to pay dues to the teamsters so that their office staff is now a member of the teamsters' union. Some of the earmarks of this for us that cause it to be troubling is that in many, if not most cases, the employees are completely unaware of the fact that they are now unionized ..., so it was really not a legitimate collectively bargained agreement as you would look to see under the rules for the Department of Labor. It's something that the employer decided would occur on behalf of their employees and was done without their awareness.
In many cases the employee's wages are grossed up to account for the union dues that the employer is paying on their behalf. So the employees are very much unaware of it, or if they're being told about it they don't understand what the ramifications are of that. The motivation is very clearly because collectively bargained employees can be excluded for coverage is to put the employees of businesses you would not otherwise see as being unionized, typically professionals' offices such as physicians, such as law offices, into a union plan for purposes of being able to exempt them from coverage for the benefits provided by the employer's plan. Monika?
M. Templeman: Let's talk about another issue now that we're seeing as well. It's an ESOP adopted by an LLC, or Employee Stock Ownership Plan, which ESOP is the acronym for. We received a lead from a determination specialist and we work hand-in-hand, let me stop here and tell you that our determination function, which is in Rulings & Agreements ... works ... with EP examinations, seamlessly together with our CE&O to try and get the word out, and is also the eyes and ears of what might be a problem when things are submitted for determination letter requests and they see that the form of that plan could be problematic. Sometimes that gives us a heads up that we have a potential promotion or potential scheme, if you will, to use a type of plan for some kind of purpose for which it's not intended. And here we had a lead from a determination specialist about a potential issue involving an ESOP adopted by this LLC, and we identified a couple of cases for the practitioner who submitted this determination request, and then we used one of those cases for EP exam to learn more about the transaction, and we're still in the process of seeing if that transaction has merit.
Now that takes us to what we do with some of these cases. That's why we might use what we call our Learn, Educate, Self-Correct Enforce, or LESE type project. If we see that we have a problem or a potential issue and we want to test it out, rather than starting an audit initiative on it then we might end up doing some judgment samples, testing out to see if things really are problems, and then if they are seeing what's the best way to address them.
Another way we might do is having our Employee Plans Compliance Unit do some compliance checks on a particular issue that we find may be trending to see whether or not it really is abusive, or maybe just problematic, or maybe not an issue at all when it actually is looked at. So we have different ways of looking at these and seeing what is the best way to address them. But what I wanted you to know is that sometimes some of the potential problematic schemes out there or problematic arrangements are found first when things come in to the determination application program.
Colleen, did you want to talk about Slide 13, the one person DB plans?
C. Patton: This is another item that has come out of the emerging issues team that we have, and I'll mention that just a bit. It's a cross-functional team. We have members, representatives from Determinations, from Voluntary Compliance, from Exams, from Counsel, where we work together to look at and give consideration to issues that are raised from within the organization, sometimes externally but more often from within the organization, like Monika said, with a determination specialist raising the S-CORP ESOP issue. We have a number of employees that submit suggestions, things that they've seen, and they can be national in potential and they can be regional in potential, and this represents one where an agent had noted that it appeared that they were seeing some defined benefits ... that had been established in a particular area of the country where there were deductions taken and contributions made where the sponsor's return did not show incomes that would have supported the maintenance of that kind of plan.
So there were some questions about that, as to whether that would be, in fact, a potential issue. We used our return reporting system to research the issues, see what kinds of plans filed had the characteristics of this particular issue, and we noted that there were not a significant number. However, for planning purposes, we are looking for plans that appear to comply with that to see if it would perhaps be indicative of a problem, perhaps the tip of an iceberg of a promotion scheme that is being marketed out there, and this would be one way that we would be able to detect it.
Monika, we have a similar situation on slide number 14. Would you like to discuss that?
M. Templeman: Here we have plans for an insurance salesman, and the insurance salesman's participating in the insurance company corporate pension plan. There's a second pension plan based on Schedule C income, and that's used for the same compensation that was used for the corporate pension plan. We have a Return Inventory Classification System which is basically our way of classifying and selecting our returns for audit, and we programmed in to identify plans with similar characteristics so we could examine a small sample to see if this is an issue that is widespread and how problematic it is. Again, we don't just rush headlong into issues. We try to test them out. So let me give you a little bit on the basis of what could happen.
Now, if we see issues that are problematic, if they're not a listed transaction what can you do if you have a plan that is a problem. If it is not an abuse per se and not a listed transaction it still has options of coming in under our Voluntary Compliance Program or if it is something that lends itself to self-correction you could even fix it. If you have a listed transaction, something that is abusive per se, it will not be allowed under our Voluntary Compliance Program and therefore 2008-50, which is our current VC program, which will soon be updated, but it does not ... listed transactions. So the only way to correct it is to work through the Service but not through the voluntary compliance process.
And if you're under audit, if you have any kind of agreement it would not be what we call a regular audit closing agreement, it would be one that would require you to get rid of the part that's abusive and would be far more costly than a regular kind of closing agreement that lets you have a win-win situation of correcting things to keep a qualified plan qualified. Because the bottom line is we really are passionate about keeping qualified plans qualified so they're there for the retirement of the folks who will depend on them. We are also equally passionate about stopping abuse, and if a plan was never set up as an intended retirement vehicle but rather a tax evasion scheme, then we don't have the same kind of desire to keep that plan going and we have no compunction about blowing it up as opposed to saving a legitimate retirement plan.
So I just wanted to give you some of that background. I know Colleen has another theme that she wanted to talk about that's on slide 15.
C. Patton: I think there's a number of themes that relate to this one. But this one is such a common occurrence. In fact, the scenario that we're going to discuss here was actually found in many of our ... ESOP plans and our 412(i) plans. It is a very common occurrence. And what you have is an operating company that is going about doing business with some numbers of employees, they may or may not have a retirement plan of their own, it's typically a 401(k) plan, if they have one. And somewhere during the life of that company they set up a management services company of some sort. Now that management services company does business and provides management services only to the operating company typically, and the operating company pays over to the management services company an amount that is just about equivalent to what their taxable income would be, so the operating company then is put in a position where they have minimal taxable income.
The management company typically has few employees, sometimes it is set up to be only one or two owners of the business, sometimes a very small number of additional employees are found, but it is a fraction of the total employees of the operating company and then very significantly the management company establishes a plan that covers employees of the management company and that would typically be a defined benefit plan with a generous benefit structure.
Our concern with that is coverage, in that the operating company and the plan that they maintain, the 401(k) plan typically, as I said, will typically be fine on its own. However, the management company plan will not be able to satisfy coverage and the benefit there is substantially greater than that provided in the operating company, so that we would say you could correct it by fixing the coverage issue and bringing other employees into the management company plan, or we would disqualify the management company plan. That's very, very common.
There are a number of schemes, if you will, that involve the defined benefit plans, and that becomes obvious because you're allowed to contribute more to a defined benefit plan. So we see many variations on that particular theme.
Some of the current promotions that we've been working in my area involve so-called defined benefit plans where the employer, the sponsor maybe sold the idea that they're going to supposedly establish, and I say supposedly and that will become obvious, establish a defined benefit plan where there's really no substantial intent to provide a retirement benefit, but they will secure a plan document.
Operationally then, they may never file a Form 5500, they may never have an actuarial valuation done to determine the appropriate amount of the contribution to the plan, and they may never set up a trust. But they will have a plan document and they will take deductions for alleged contributions to the defined benefit plan, and those contributions will be determined to be whatever the employer sponsor believes they can afford. So that we look at the plan as being basically a deduction scheme, there was never really an intent, there are oft times coverage issues associated with it as well, and there really does not seem to be an intent to have a plan, there was never any other actions taken other than the adoption of a plan document. And typically the plan documents are good, but the plan itself is more smoke than mirrors.
Monika, did you have anything you wanted to add to that?
M. Templeman: Well, actually, I think you summarized it pretty well, Colleen. We are really concerned when we're looking at plans that are set up that really are not meant as true retirement vehicles. And I think you'll see a trend in the examples of emerging issues that shows in each of these cases that these were set up to benefit highly compensated or set up to evade taxes but not set up to provide true retirement for oneself and one's employees the way qualified retirement plans are meant. Therefore, that gives them the problem as far as we're concerned with being true retirement plans worthy of the treatments to try to keep them in compliance, and where we're concerned about making sure that that scheme is not continued and doesn't grow.
I think we've been really blessed with our relationship with our practitioner community, that in the EP arena we see eye-to-eye on trying to preserve and enhance the private retirement system and keep qualified plans qualified and provide for genuine retirement by protecting the integrity of the system as a whole. I think we're going to have to work vigilantly together, the private and public sectors, to be able to make sure that our private retirement system continues and is viable and therefore people will have a chance to experience the golden in their golden years. When they think about retirement it's not at what age but at what income and they have the liberty of retiring and still sustaining a lifestyle that is enjoyable, that they've earned by years of work. So I think you'll see a commonality in all of this where rank-and-file are either overlooked or in no way given any comparative type of benefit. And in some cases there's no retirement plan desire at all, it's just a scheme to avoid taxes.
Colleen, before I talk about our CE&O and where to find out more, any comments that you wanted to make?
C. Patton: I would. I'd like to say that it is something I think we should all celebrate. There was an announcement this week that the Department of Labor and the IRS has filed suit in federal court in Los Angeles against an alleged promoter of an Employee Plans retirement scheme. I think we should all celebrate that. The IRS celebrates it, but I think the legitimate practitioner community should celebrate that as well, that we are all better off if our interests are having a really viable private retirement system, that we should all be happy when those that have chosen to abuse the system are held accountable for that.
So I would challenge you to go and do some research and find out about that and see some of the specifics of what this alleged theme actually involves. It is a good example of some of the kinds of things that one might want to avoid. And the old axiom, If it sounds too good to be true it probably is would apply very much to clients of this particular promoter.
Unfortunately, this has led to a lot of pain, I think, for the clients that were motivated to participate in this scheme, because fixing it is a painful activity involving not only paying the taxes but paying penalties. It just would have been much better for them in the long run had they really chosen to have a retirement vehicle to have put assets in there and done it legitimately and had the benefit of such.
I would say just as another example of a real life situation going on in my area, we are very, very close to signing a final agreement on one of these schemes that came along the line of what I was talking about was set up to exclude the rank-and-file participants. This company decided that what they would like to do was bring their employees in and provide them the retirement benefits. We will not be disqualifying the plan. This is definitely a win for the Service and for the taxpayer. We will be able to obtain retroactive retirement benefits, we're going to correct the coverage issue back to the point at which these employees should have been allowed to participate in the plan. Some of these folks will be receiving six figure account balances as a result of that, but the employer had decided it was definitely worth their while to be able to preserve the deductions they take and to be able to preserve their own retirement benefit.
So that it's just such a good example of how we can work with you. You've done something that the IRS is not really in support of, but we have an overall interest in securing retirement benefits for everyone. It is socially desirable. It's the reason that the law is here that allows us to do that. And so we were able to work something out with this taxpayer that is good for the taxpayer, it is good for their employees, it is a good thing for the Service, and it's a good thing for the country because people that would not have otherwise had a retirement benefit are now going to have one.
M. Templeman: Thank you, Colleen. I wanted to mention also before I'll do what I consider my infomercial on our wonderful, wonderful tool set we have in Customer Education and Outreach and where you can find out more, a little bit about our three agencies that deal in the pension plan arena. We work very closely with the Department of Labor and Pension Guaranty Corporation, or PBGC, to make sure that we coordinate on issues and trends, and we have agreements with those agencies on the discussion of information.
While they can share more with us than we can share with them because we have very tight disclosure laws about individuals and cases, we definitely look to see that where there are abuses in the pension arena that we try to protect the IRS from a tax perspective and the DoL from a participant rights' perspective, to make sure that we are really trying to work proactively to detect and deter abuse and to ... it and to keep the integrity overall of the private retirement system. So there is that three agency cooperation and all of the three agencies deal with the Form 5500, so I did want to mention that.
Now, I'd like to talk about where you can find out more information. If you go to www.irs.gov/ep, and you have this on slide 16, you will find a whole host of wonderful customer education and outreach products, including newsletters that you can subscribe to electronically and they have all types of hot issues, including the watch outs, what's not to do to put your plans in jeopardy. Our newsletter subscription I would highly recommend if you're not currently a subscriber, because it's electronic, it's free, and it really keeps you in touch on what's happening with the Employee Plans' arena. We also have newsletters for employers, so we have tailored products, we have a navigator that helps folks to look at the options to maintain a plan and good choices for plans.
And we have our wonderful fix-it guide, how to find, fix and avoid mistakes. These are actual mistakes, legitimate mistakes made in plans. Abuses you avoid by not engaging in abuse, but how to find, fix, and avoid mistakes, those are in our fix-it guides. Currently we have fix-it guides for 401(k) plans and the IRA-based plans, the ... SEPs and the SIMPLEs. And there will be more to come, so definitely check out our CE&O Web site, and subscribe to our newsletters if you haven't done so already. This is a good source for information. You'll be on the pulse point of what's happening in the EP arena, again, www.irs.gov/ep.
With that, that concludes our formal remarks and that's the part of the session that is the actual presentation for credit of the session that we just shared with you on our emerging issues and abuses. So thank you for joining us.