Volume 5 #4
IRS to Target Dealer’s Welfare Benefit Plans
The Internal Revenue Service (IRS) is changing certain trust arrangements claiming to be welfare benefit funds and involving cash value life insurance policies that are being promoted to and used by taxpayers to improperly claim federal income and employment tax benefits. They are also examining trust arrangements claiming to provide nondiscriminatory post-retirement medical benefits and post-retirement life insurance benefits.
Trust arrangements utilizing cash value life insurance policies and purporting to provide welfare benefits to active employees are being promoted as a way to provide cash and other property to the owners of the business on a tax-favored basis. The arrangements are sometimes referred to as “single employer plans” and sometimes as “419(e) plans.” Advocates of these plans claim that the employers’ contributions to the trust are deductible under §§ 419 and 419A as qualified cost but that there is not a corresponding inclusion in the owner’s income.
A promoted trust arrangement may be structured either as a taxable trust or a tax-exempt trust; i.e., a voluntary employees’ beneficiary association (VEBA) that has received a determination letter from the IRS. The plan and the trust documents indicate that the plan provides benefits such as death benefit protection, self-insured disability benefits, and/or self-insured severance benefits to covered employees (including those employees who are also owners of the business). The benefits are payable while the employee is actively employed by the employer. The employer’s contributions are often based on premiums charged for cash value life insurance policies. For example, contributions may be based on premiums that would be charged for whole life policies. As a result, the arrangements often require large employer contributions relative to the actual cost of the benefits currently provided under the plan.
Under these arrangements, the trustee uses the employer’s contributions to the trust to purchase life insurance policies. The trustee typically purchases cash value life insurance policies on the lives of the employees who are owners of the business (and sometimes other key employees), while purchasing term life insurance policies on the lives of the other employees covered under the plan.
It is anticipated that after a number of years, the plan will be terminated and the cash value life insurance policies, cash or other property held by the trust will be distributed to the employees who are plan participants at the time of the termination. While a small amount may be distributed to employees who are not owners of the business, the timing of the plan termination and the methods used to allocate the remaining assets are structured so that the business owners and other key employees will receive, directly or indirectly, all or a substantial portion of the assets held by the trust.
Those advocating the use of these plans often claim that the employer is allowed a deduction under § 419(c)(3) for its contributions when the trustee uses those contributions to pay premiums on the cash value life insurance policies, while at the same time claiming that nothing is includible in the owner’s gross income as a result of the contributions. If amounts are includible, they are significantly less than the premiums paid on the cash value life insurance policies. They may also claim that nothing is includible in the income of the business owner or other key employee as a result of the transfer of a cash value life insurance policy from the trust to the employee, asserting that the employee has purchased the policy; when, in fact, any amounts the owner or other key employee paid for the policy may be significantly less than the fair market value of the policy. Some of the plans are structured so that the owner or other key employee is the named owner of the life insurance policy from the plan’s inception, with the employee assigning all or a portion of the death proceeds to the trust. Advocates of these arrangements may claim that no income inclusion is required because there is no transfer of the policy itself from the trust to the employees.
You should be aware that the IRS intends to challenge the claimed tax benefits for the above-described transactions for various reasons. We work with dealers in a myriad of ways to ensure that their compensation systems are deferred compensation plans which will pass IRS challenges. If you would like to learn more about our services to dealerships and their owners, please call our offices today.
2008 Inflation Adjustments Widen Tax Brackets
For 2008, personal exemptions and standard deductions will rise, tax brackets will widen and workers will be able to save more for retirement, thanks to inflation adjustments.
By law, the dollar amounts for a variety of tax provisions must be revised each year to keep pace with inflation. As a result, more than three dozen tax benefits, affecting virtually every taxpayer, are being adjusted for 2008. Key changes affecting 2008 returns, include the following:
The value of each personal and dependent exemption, available to most taxpayers, is $3,500, up $100 from 2007.
The new standard deduction is $10,900 for married couples filing a joint return (up $200), $5,450 for singles and married individuals filing separately (up $100) and $8,000 for heads of household (up $150).
Tax-bracket thresholds increase for each filing status. For a married couple filing a joint return, for example, the taxable-income threshold separating the 15 percent bracket from the 25 percent bracket is $65,100, up $1,400 from 2007.
The maximum Hope credit, available for the first two years of post secondary education, is $1,800, up from $1,650 in 2007.
The contribution amount allowed for Roth IRAs begin to phase out for joint filers with incomes exceeding $159,000 (up from $156,000) and $101,000 (up from $99,000) for singles and heads of household.
For contributions to a traditional IRA, the deduction phase-out range for an individual covered by a retirement plan at work begins at an income of $85,000 for joint filers (up from $83,000) and $53,000 for a single person or head of household (up from $52,000).
Participants in most employer-sponsored 401(k) plans can contribute up to $15,500, unchanged from 2007. Individuals, age 50 or over, can make an additional contribution of up to $5,000, also unchanged from 2007.
Individuals participating in SIMPLE retirement plans can contribute $10,500, unchanged from 2007. Those, age 50 or older, can make an additional contribution of up to $2,500, also unchanged from 2007.
The annual contribution limit for most defined contribution plans rises to $46,000, up from $45,000 in 2007.
For more information about the pension and retirement plan-related changes, please contact us.
Auto Demonstration Vehicles
In addition to the normal employment tax requirements applicable to auto dealerships, there are other employment tax considerations unique to the auto industry.
In December 2001, the IRS issued Revenue Procedure 2001-56. This revenue procedure provides guidance for the taxation of the personal use of an auto demonstrator vehicle provided by automotive dealers to their employees. This revenue procedure allows the dealer, instead of the salesperson, to determine the taxability of a demonstrator vehicle. An auto dealership may use any of the methods in the revenue procedure OR may use the existing rules as defined in Internal Revenue Code section 132(j)(3) and Reg. 1.132-5(o)(4).
Rev. Proc. 2001-56, and Publication 4230 for taxpayers, provides four methods to determine the amount taxable to the employees:
Full Exclusion Method - clarifies the existing rules under current law. This method provides complete exclusion from taxation for the use of a demonstrator vehicle.
Simplified Out/In Method - provides simplified record keeping requirements for the Full Exclusion Method.
Partial Exclusion Method - allows for partial taxation of an auto demonstrator vehicle with limited record keeping requirements. Most auto dealerships are expected to adopt this method.
Full Inclusion Method - allows a dealership to use the Annual Lease Value tables, as defined in Treas. Reg. 1.61-21(d)(2)(iii), to determine the taxable value of a demonstrator.
If the auto dealer cannot qualify for one method, the dealer may qualify for one of the other three methods.
In order to use any of the first three methods, the driver of the demonstrator vehicle must qualify as a full-time salesperson and the dealership must have a written policy.
The rules to qualify as a full-time salesperson are:
Must be a full-time employee of an automobile dealership
Must spend at least half of a normal business day performing the functions of a floor salesperson or sales manager
Must directly engage in substantial promotion and negotiation of sales to customers
Must derive 25% of his or her gross income directly as a result of sales activities
The written demonstrator agreement must contain the following:
Prohibit the use of the vehicle outside of normal business hours by individuals other than full-time salespeople
Prohibit the use of the vehicle for personal vacation trips
Prohibit use outside of the sales area in which the dealership's sales office is located
Prohibit storage of personal possessions in the vehicle
Employer must reasonably believe that the salesperson complies with the written policy
We can provide extensive materials and advice to assist you in determining which type of method to use in your dealership.