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PREPare PLAN SUBJECT TO FORM 8886 AS SUBSTANTIALLY SIMILAR TO NOTICE 95-34

05 / 30 / 2019

Turnham v. U.S., 2019 U.S. Dist. LEXIS 89354 (M.D.Ala. 5-29-19)

As the Federal Court in Alabama duly notes, this case is one about a tax form.  That Form is IRS Form 8886.

Seems as though Dr. Turnham, operating through his wholly owned S corporation medical practice for the years 2009-2011, made substantial contributions to the Affiliated Employers Health and Welfare Trust Plan (called the PREPare Plan).  The court notes how this plan was one that was marketed by CJA & Associates as a 10-or-more employer welfare benefit plan that enjoyed special tax benefits.  

The U.S. government determined that Dr. Turnham was required to file IRS Form 8886.  He did not do so.  Neither did his medical practice.  Accordingly, it assessed him a $10,000 penalty for each of the tax years.  He paid the penalty and sought a refund of these penalties under 28 USC Section 1346(a)(1) and 26 U>S.C. SEction 7422(a).

In other proceedings, the IRS challenges the deductibility of those contributions.  

The court held that there was no genuine dispute of fact that the PREPare Plan is the same or substantially similar to the arrangement described by the IRS in IRS Notice 95-34, Tax Problems Raised by Certain Trust Arrangement Seeking to Qualify for Exemption from Section 419, 1995-1 CB 309, 1995 IRB Lexis 197, 1995-23 I.R.B. 10, Notice 95-34.  Therefore, the claim for refund of these penalties was denied.

The PREPare Plan was touted as offering to his medical practice deductible contributions, with the plan assets protected from creditors, and with covered employees also enjoying death benefits that were not subject to income tax and may be excluded from estate tax.  The death benefits were expected to be fully paid up at retirement and projected to increase substantially.  The marketed materials also described the arrangement as comprised of 2 parts, a (1) term life insurance contract; and (2) an annuity with residual value.  After administrative fees were deducted, the plan administrator conveyed the contributions to Fidelity Security Life Insurance Company and directed them to pay annual premiums for the covered employees under a group term life insurance policy and invest the remainder in a group annuity contract.  After administrative fees, 97 percent of the money Dr. Turnham paid into the plan was invested in the group annuity, and 3 percent was used to purchase group term life insurance.  Fidelity designated a witness who testified that the objective was for the trust to utilize accumulated value that was allocated to a specific individual so that when that individual retired, the build-up of funds could then be used to purchase a paid-up whole life insurance policy having immediate forfeiture value--which is essentially the same thing as cash value.

Fidelity assigned tracking numbers to the practice and the P.A.'s employees.  This allowed Fidelity to identify the portions of the "group" annuity contract attributable to each participating employer.  Fidelity also generated a report to the plan administrator with amounts attributed to individual employees, with interest on their respective share of the group annuity contract.  

The plan administrator advised covered employees who terminated their employment that they could sell a portion of all of their post-retirement coverage to an independent settlement company in exchange for a lump sum or stream of income payment.  

Essentially, as the court noted, the IRS had warned in Notice 95-34 that certain arrangements may not be eligible for favorable tax treatment  because they may actually be providing deferred compensation or be separate plans maintained for each employer.  The court noted that other courts had found payment to the PREPare Plan to be a reportable transaction, citing to Vee's Marketing, Inc. v. U.S., 816 F.3d 499 (7th Cir. 2016), and found that case "highly persuasive." Duly noting that only a fraction of the contributions paid for group term insurance, with the remainder operating as a sort of reserve account or an accumulation account invested in the annuity.  By these combined features, the court viewed the arrangements as a de facto universal life insurance contract.  Dr. Turnham's effort to claim that he relied on advice from professionals to make these tax deductible contributions was rejected.  While Dr. Turnham attempted to note how "his" plan was distinct from the one described in Notice 95-34 or Vee's Marketing, the court found that it was "substantially similar" evidenced n part by the uncontested evidence that it was advertised as essentially a universal life contract.The receipt of an opinion regarding the tax consequences of the transaction is NOT relevant to the determination whether the transaction is reportable.  Regs. 1.6011-4(c)(4)(definition of "substantially similar").

The court thus granted the government's motion for summary judgment and dismissed the case with prejudice, with costs of the proceedings taxed against the Plaintiff.