By J. Keith Phifer, Esquire
Businesses are often approached by promoters of welfare benefit plans. Properly structured, these vehicles can effectively serve to provide certain pre- and post- retirement benefits for employees, through tax incentives offered under section 419 of the Internal Revenue Code, which allows for current tax deductions for the employer upon contributions to the plan. The permissible benefits include death benefit only, severance, and medical benefit plans. These kinds of plans are and will likely continue to be valuable tools for businesses to provide tax-advantaged benefits to its employees.
However, as with other provisions of the tax code, promoters have stretched the limits of welfare benefit plans under section 419, and have become a target of IRS scrutiny. The Internal Revenue Code states that a deduction is allowed to employers who contribute to such a plan for the current cost of benefits and expenditures that represent a reasonable reserve for future benefits payable to employees. The essence of the abuse of these kinds of plans are that promoters began selling plans that 'front loaded' or greatly accelerated the business' deductions, and began providing them, on a discriminatory basis only to highly compensated executives. A series of IRS regulations aimed at shutting down these abuses have come and gone since the late 1970's.
Most recently, aggressive promoters have argued that funding welfare benefit plans with cash value life insurance was a viable strategy for establishing the deductibility of corporate owned life insurance. Internal Revenue Code Section 264(a)(1) has long established that corporate owned life insurance premium payments are not deductible to businesses. Unscrupulous promoters of certain welfare benefit plans would have you believe otherwise. But recent IRS guidelines (Rev. Ruling 2007-65) conclusively state that the IRS will challenge potentially abusive welfare benefit plans. Specifically the ruling states that the IRS will challenge the following type of plans: (1) plans that provide death benefits only and deduct the full cash value of life insurance premiums as opposed to actual cost of providing annual death benefit protection; (2) plans that purport to provide post-retirement medical benefits to employees on a non-discriminatory basis, but in actuality only benefit the owners of the business (or highly compensated employees); (3) entering into a plan with the expectation of later terminating it and distributing cash value policies primarily for the benefit of the owners of the business (or highly compensated employees); and (4) distributing or purchasing cash value life insurance policies from the plan for significantly less that its fair market value.
If your business has a welfare benefit plan, or has been approached about implementing one, be cautious. They come in all different shapes and sizes. Many are very effective means of providing tax benefits to the business and benefits to the employees. However, you might be unknowingly subjecting your business to IRS scrutiny, so a review of your plan may be a good idea.
If you have any questions or comments, please don't hesitate to contact Attorney Keith Phifer at 781-848-5028 or kphifer@sabusinesslaw.com.