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Doctor Is Subject to Penalties for Failing to Report Employer Welfare Benefit Payments

(Parker Tax Publishing November 2020)

The Eleventh Circuit affirmed a district court and held that a doctor and his S corporation were liable for penalties for not reporting their involvement in an employer welfare benefit plan as required under Notice 95-34. The court concluded that the welfare benefit plan at issue was at least substantially similar to the type of plans listed under Notice 95-34, which are not exempted from the deduction limitations under Code Sec. 419 and Code Sec. 419A. Turnham v. Comm'r, 2020 PTC 348 (11th Cir. 2020).


Alan Turnham, is a doctor who practices in Alabama through his medical practice, Alan C. Turnham, M.D., P.A. For the tax years of 2009, 2010, and 2011, the medical practice was taxed as an S corporation (the S Corporation) with a single shareholder - Dr. Turnham - such that the practice passed its income, losses, etc. through to him for tax purposes. For several years, the S Corporation participated in a multi-employer welfare benefit plan designed to provide pre-retirement and post-retirement life insurance benefits to covered employees. The S Corporation took deductions relating to contributions it made to the plan which it then passed thru to Dr. Turnham.

The employer welfare plan was marketed as the PREPare Plan (the Plan). Participating employers contributed funds to the Affiliated Employers Health & Welfare Trust (the Trust), which then used these contributions to purchase and maintain group term life insurance policies and annuity products that fund the benefits. A participating employer's contributions to the Trust were divided into two parts. One portion of the contributions was forwarded by the Trust to an insurance company, which used them to pay the premiums required to maintain the group term life insurance that funded the covered employees' pre-retirement death benefits. The second, and the overwhelmingly larger, portion of the contribution was invested into an annuity contract with the insurance company. Thus, the Plan provided term life insurance coverage for participating employees until they retired, and after retirement, the Plan provided them with a certificate of insurance that was fully paid-up (meaning that no further premiums would be owed, ever). The promoters of the Plan advised that, with fully paid up certificates of insurance, a participant could make an irrevocable assignment of the beneficiary and, by doing so, move the insurance out of his estate; alternatively, he could sell the death benefit to a willing beneficiary or convert the certificate in whole or in part to a health reimbursement benefit. In other words, potential participants were told that they would be the beneficial owners of the paid-up contract and could add it to their estate planning trusts, sell the contract for cash or trade it for medical benefits. Additionally, the Plan, through an investment company, kept track of the contributions on an employer-by-employer basis, despite that it purported to aggregate employer contributions to provide group-based benefits.

Code Sec. 419 and Code Sec. 419A provide limitations on the deductions available for employer contributions to employer welfare benefit plans. However, Code Sec. 419A(f)(6) provides an exemption from those deduction limitations for certain welfare benefit funds. In general, for the exemption to apply, an employer normally cannot contribute more than 10 percent of the total contributions, and the plan must not be experience rated with respect to individual employers. The exemption is provided because the relationship of a participating employer to such a plan often is similar to the relationship of an insured to an insurer. Even if the 10 percent contribution limit is satisfied, the exemption does not apply to a plan that is experience rated with respect to individual employers, because the employer's interest with respect to such a plan is more similar to the relationship of an employer to a fund that an insured to an insurer.

In Notice 95-34, the IRS advised taxpayers that a number of promoters were offering trust arrangements that they claimed satisfied the requirements for the 10-or-more-employer plan exemption and that were being used to provide benefits such as life insurance, disability, and severance pay benefits. The IRS warned that these arrangements typically are invested in variable life or universal life insurance contracts on the lives of the covered employees, but require large employer contributions relative to the cost of the amount of term insurance that would be required to provide the death benefits under the arrangement. Under such arrangements, the trust owns the insurance contracts and the trust administrator may obtain the cash to pay benefits, other than death benefits, by such means as cashing in or withdrawing the cash value of the insurance policies. The IRS warned that these arrangements may not be eligible for favorable tax status because they may actually be providing deferred compensation or be separate plans maintained for each employer. In Notice 95-34, the IRS identified key warning signs indicating that involvement in such trust arrangements may be an issue and that such involvement is therefore a reportable transaction under Reg. Sec. 1.6011-4.

Dr. Turnham and his S Corporation gave no notice to the IRS regarding the deductions they claimed for the nearly $837,000 in contributions the S Corporation made to its multi-employer benefit plan for 2009-2011. As a result, the IRS imposed tax penalties for the failure to file the required notices. Dr. Turnham and his S Corporation sued to overturn those penalties, but a district court granted summary judgment to the IRS. An appeal was filed with the Eleventh Circuit.


The Eleventh Circuit affirmed the district court's decision and concluded that the IRS was correct to issue the penalties on the ground that the required notices were not filed. The court noted that the welfare benefit plan at issue was at least substantially similar to the type of plans that the IRS indicated did not qualify for an exemption and full deduction for amounts paid.

According to the court, while it was true that the Plan documents prohibited participants from accessing funds contributed to the Trust, it was also undisputed that the Plan Administrator withdrew funds attributed to a participating employer's covered employees from a group annuity contract and then used those funds to pay group term life insurance for the same employees. This allowed the Plan Administrator to pay an employer's current expenses from amounts that the employer had already contributed but had been invested in an annuity. The point here, the court said, is that such a set up is less like an independent (and acceptable) multi-employer benefit plan and more like the listed "reportable transactions" for which the IRS indicated would not qualify for an exemption from the deduction limitations.

The listed transactions in Notice 95-34, the court observed, typically are invested in variable life or universal life insurance on the lives of the covered employees. A universal life insurance policy is a quasi-insurance product in which the premiums partly fund death benefits and partly accumulate and earn interest to fund future benefits for the covered person. The court found that, while the investment scheme at issue did not use universal life insurance products in the literal sense, there really wasn't any difference in practical effect. The combination of a term life policy with a separate (and much larger) annuity product, the court said, provided the same generous excess of funds that a universal life policy would itself provide. And, the court noted, there was no dispute that a welfare plan using a universal life policy would likely not be exempt and the contributions thereto would likely not be fully deductible.

Another red flag, the court said, was the large size of the contributions and how they were allocated. The court noted that, for the three tax years at issue (2009-2011), only a tiny fraction (roughly 3 percent) of the nearly $837,000 in contributions was used to pay the premiums on the group life insurance policy for the S Corporation's employees. The rest was directed into the group annuity account; yet, a deduction was claimed for the entire amount. The result was a significant reduction or elimination of business income and taxes that would have been due.

For a discussion of the taxation of contributions to welfare benefit plans for 10-or-more employer plans, see Parker Tax ¶98,970.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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