Audit Lottery, Captive insurance, 419, 412i, Section 79

The audit lottery is a gambit in which taxpayers claim tax benefits to which they are not entitled in the hope that the IRS will never audit the returns or, if audited, the improper benefits will not be discovered.  The audit lottery is simply an attempt to exploit the IRS's limited resources.  The IRS has limited audit coverage.  Most taxpayers are not audited and, when audited, tax benefits may not be reviewed.  The taxpayer wins the audit lottery if the IRS does not discover the improperly claimed benefits.

With 419 and 412i plans the IRS does have special task forces who are catching the taxpayers. The fines are large and then the taxpayer gets fined again under IRS section 6707A for not telling on themselves.

Taxpayers’ positions exploiting the audit lottery often are sometimes criminal in nature.  By criminal I mean that the taxpayer voluntarily violated a known legal duty.  This is often referred to as the Cheek definition of willfulness which is the standard for most tax crimes (e.g., tax evasion in § 7201, tax perjury, in § 7206(1) and aiding and assisting in § 7206(2)).  Taxpayers’ whose conduct is criminal are playing the audit lottery.  As an aside, while most taxpayers in 419 plans, 412i plans, section 79 plans and captive insurance plans are not aware that they are doing anything wrong, some are aware. Over 50 armed IRS agents raided the offices of Benistar taking records of taxpayers in Benistar, Grist Mill Trust, Nova, and other plans affiliated with Benistar. I would think that there may be a few criminal charges. At the very least we are receiving phones calls about people in Benistar, Grist Mill Trust, Nova, etc getting audited. Very few taxpayers would engage in that conduct if they knew they would be detected; hence, their conduct is explainable only because the probability of detection is sufficiently low that the risk / reward ration is quite favorable.  For reasons, I describe below, the audit lottery is not limited to criminal misconduct. Taxpayers merely taking super aggressive positions, positions they know are not likely to prevail but are not criminal, may also play the audit lottery.  In either event, both types of taxpayers seek to exploit the IRS’s limited ability to discover, understand and correct their erroneous tax benefit claims.

I do not mean to just pick on Benistar and other 419 plans operated from the same locations. We have received thousands of phone calls from people in other plans like Niche, Sea Nine, Millennium, etc.

The significant civil tax penalties for present purposes are:

(i) the 20% accuracy related penalty (§ 6662), consisting of (a) the negligence penalty (for negligence or intentional disregard of the rules) and (b) the substantial understatement penalty for failure to pay some threshold level of tax (fairly low) from claiming positions that do not rise to a certain level of probability of being sustained; and  
(ii) the 75% civil fraud penalty (§ 6663) which is the civil counterpart to tax evasion. 
These rules create certain constructs about probability – sometimes called likelihood – that a taxpayer is entitled to the tax benefit the taxpayer claimed improperly.

These levels of probability are:

More likely than not to prevail if litigated (quantified as more than 50 percent likely)
Substantial authority (quantified as perhaps 40% likely)
Reasonable basis (quantified as perhaps 20 or 25% likely)
Frivolous (less than reasonable basis)
The last category -- frivolous -- could involve potential criminal prosecution and/or the civil fraud penalty, at least where the Government proves that, in making the frivolous claim, the taxpayer violated a known legal duty.  Many taxpayers assert frivolous claims that they really believe are available, thereby not violating a known legal duty.  Other taxpayers assert frivolous claims to mask that they intend to avoid paying the tax they know they owe.  The thinking among the practitioner community is that frivolous claims are at high risk of criminal prosecution and assertion of the civil fraud penalty because a jury could read the taxpayers’ intent either way.

The other categories – the nonfrivolous categories – represent some level of probability that the claim rises above being frivolous.  The thinking among the practitioner community is that these taxpayers claiming tax benefits with these higher levels of probability are not committing a tax crime.  These taxpayers could commit a tax crime if the tax benefit with this higher level of probability is accompanied by acts designed to impair or impede any IRS investigation, which are independent crimes regardless of the merits of the tax benefit.  Assume that the taxpayer has a reasonable basis the claimed tax benefit from transaction X is would prevail.  In the real world, that is not much of a probability (20 or 25%) that the taxpayer will actually sustain the position if it is discovered and contested by the IRS.  But, the taxpayer claiming such a position will be subject to the civil penalty regime only, and the only civil penalty that will apply is the 20% accuracy related penalty.  That taxpayer will not be subject to the civil fraud penalty or to criminal tax penalties.


The 6707A fines for not reporting on yourself can be very large. Most taxpayers, and accountants are not aware of this.


 Lance Wallach, National Society of Accountants Speaker of the Year and member of the
AICPA faculty of teaching professionals, is a frequent speaker on retirement plans, financial
and estate planning, and abusive tax shelters.  He writes about 412(i), 419, and captive
insurance plans. He speaks at more than ten conventions annually, writes for over fifty
publications, is quoted regularly in the press and has been featured on television and radio
financial talk shows including NBC, National Pubic Radio's All Things Considered, and
others. Lance has written numerous books including Protecting Clients from Fraud,
Incompetence and Scams published by John Wiley and Sons, Bisk Education's CPA's
Guide to Life Insurance and Federal Estate and Gift Taxation, as well as AICPA best-selling
books, including Avoiding Circular 230 Malpractice Traps and Common Abusive Small
Business Hot Spots. He does expert witness testimony and has never lost a case. Contact
him at 516.938.5007, wallachinc@gmail.com or visit www.taxaudit419.com or www.taxlibrary.
us.





The information provided herein is not intended as legal, accounting, financial or any
other type of advice for any specific individual or other entity.  You should contact an
appropriate professional for any such advice.





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