Taxpayer Fails to Prove Plan Met Requirements to Be a §419A Plan Exempt from Qualified Cost Limits

One of the more aggressively promoted types of shelters pushed onto small businesses related to purported 10 or more employer welfare benefit plans established pursuant to IRC §419A(f)(6).  In the case of Schechter v. Commissioner, TC Memo 2016-174 the Tax Court found that, regardless of the possible propriety of the plan, the taxpayer simply failed to produce evidence necessary to show compliance with the requirements that provision.

The issue involved a $450,000 payment made by the S corporation in which Mr. Schechter held a 100% interest for the year in question.  The $450,000 was paid to the company’s “Sickness, Accident & Disability Indemnity Trust 2007” of which $427,500 was used to purchase a single premium life insurance policy on Mr. Schechter’s life.

The plan was intended to qualify under IRC §419A(f)(6) as a ten or more employer plan on which does not maintain an experience rating with respect to individual employees.  If that qualification is met, the deduction for amounts paid to fund the plan are not limited to the plan’s “qualified cost” under IRC §419(b), though the payment would generally need to meet the “ordinary and necessary” test under IRC §162.

The IRS contended that this plan was not a more than 10 employer plan, that the plan maintained experience ratings and, regardless of any of those facts, the payment made was so vastly in excess of the benefits made available that it was not an ordinary and necessary business expense.

The taxpayer agreed that the “qualified expense” amount under §419(b) for the year would compute to zero, so if the plan did not meet the requirements of IRC §419A(f)(6) that the entire deduction would be disallowed.  The Tax Court decided the case based solely on this issue, not needing to look at the “ordinary and necessary” expense issue.

The Tax Court noted that the plan provided that the plan sponsor had the right to obtain records from the plan administrator to provide information on the participants—but the taxpayer did not request that information or provide it to the Court.  The taxpayer countered that the administrator had agreed to insure more than 10 employers were always participating in the plan, but the Court found that showing there is an agreement by someone to do something is not the same as showing that party actually did it.

Thus the Court found that the taxpayer had not carried its burden to show that the plan had more than 10 employers participating in the plan, so the §419(b) limitation applied—and no deduction was allowed.

The Court also found that a provision in the plan that would reduce any death benefit paid to a participant by the amount of any disability payments received amounted to proscribed experience rating in the plan—a second reason why the plan failed to qualify as a §419A(f)(6) plan exempt from the qualified expense limits of IRC §419(b).

This result is in line with a series of such cases over the years.  Certainly the experiences of small employers adopting such a plan and then using the “unlimited” funds to primarily buy life insurance on the owner of the sponsor has generally not been good ones at trial.EKZ