Katt & Company is a national
fee-only life insurance advising firm. The June 2002 Forbes magazine,
and a July 16, 2003 Wall Street Journal article, name Peter Katt as one
of only four nationally recognized advisors. The Forbes article states
that, "…advisers are well worth the money… These savants
are working for no one but you…" For references please contact
us.
Market and Sell Tax Scam = Hard Time
"Perhaps Mr. Lawyer's story will be
a lesson for others. Stop using tax skills and the complex tax code to
put together tax scams for huge profits while putting unsuspecting clients
at risk."
Ah, typical American story. Man finishes
law school, becomes a member of the bar, is elevated to partner-in-charge
at a mega law firm's satellite office, participates in the marketing and
selling of a slick tax-avoidance scheme while enjoying huge profits (and
perhaps commissions) and GOES TO PRISON FOR 5 YEARS. Mr. Lawyer
was also ordered to pay $50,000 for conspiring to defraud the US. Four
co-conspirators have been convicted. Sentenced along with Mr. Lawyer was
one of his clients. The client received one year probation and fined $320,000
following repayment of $1,600,000 in taxes. (I had an opportunity to review
this scheme or one very similar, called PEP, in 2004. My December 2004
Perspectives [reprinted below] details the PEP plan).
The dazzle of fraudulent deductions has been used
in combination with life insurance for several decades. The sales pitch
is usually accompanied by a legal opinion letter. (See my April
2008 Perspectives). The willingness to create and market such fraudulent
schemes places professionally prudent tax advisors and life insurance
agents in a difficult and often defensive position regarding such schemes
and the kind of planning they are willing to offer. As the convoluted
details of PEP show, without expending a good deal of time and having
access to insider knowledge, a prudent tax advisor can't offer much insight
and runs the risk of losing a client because of it. Professional life
insurance agents lose legitimate sales to these kinds of schemes.
Tax advisors and life insurance agents don't need
to strain to figure out whether this or that version of these schemes
is finally able to square the circle because the simple fact is there
are no deductible life insurance premiums nor are there deductible non-qualified
retirement plans. You don't need to get trapped into fuzzy form over substance.
It is always the substance. The claim that these tax scams are loopholes
is false. When the phony form is uncovered we discover that the tax code
has never permitted such maneuvers. A loophole is something that is completely
legitimate but the outcome wasn't intended by tax writers. An example
is the ability to take tax-free loans from life insurance policy cash
values for retirement income.
Another fact is that even if deductions were legitimate
the plans have dubious value. This is the dazzle of the deduction part
of the equation. The magician gets the prospect so excited about a deduction
that a basic evaluation of what is to be obtained is not done.
Perhaps Mr. Lawyer's story will be a lesson for
others. Stop using tax skills and the complex tax code to put together
tax scams for huge profits while putting unsuspecting clients at risk.
December 2004 Life Insurance Perspectives
PEP Plan
I have written often about tax avoidance schemes
that promise non-qualified tax-deductible contributions and tax-free benefits.
Life insurance is almost always used in such schemes because its complications
make certain items hard to see and the hidden compensation is huge. I
have run into the Personal Equity Plan (PEP) several times in the past
couple of years. Unlike abusive VEBA, 419 and 412(i) plans that have really
caught the IRS' attention, I'm not sure PEP has been picked up by the
IRS. None of the PEP participants I have worked with have run into trouble
with the IRS, yet. PEP involves split-dollar, but I am ignoring how the
new split-dollar regulations affect it. I know PEP is an ongoing program
for those already in it, but I don't know if PEP is still being marketed.
My main purpose here isn't PEP per se but how schemes like this expose
the difference between professional cleverness and decency.
My comments about PEP only apply to those I have
reviewed and they may not be completely representative of other PEPs.
Dr. Smith became a participant in a PEP in 1995
through his employer, Doctors, Inc., The employer was solicited to purchase
PEP from its corporate attorney who is with a very prestigious firm
that has a large presence in the state. Doctors, Inc. paid $14,000 for
what appear to be pure boilerplate documents by this law firm who also
offered to render a tax opinion for an additional fee. I recently learned
from another client that this law firm is listed as co-counsel on PEP.
PEP promises: tax-free retirement income / pre-tax
funding / no plan contribution limits / not subject to ERISA / extremely
safe. The tax-free retirement income is in the form of life insurance
policy loans - nothing controversial with that. It is the pre-tax funding
that is either a very clever tax loophole or catch-us-if-you-can tax
avoidance. It appears that considerable effort has gone into papering
over the actual transaction, but if my understanding of PEP is correct
the critical transaction is simply goofy.
The critical transaction consists of Doctors,
Inc. taking three annual loans from what the PEP folks claim is a third
party lender. Doctors, Inc. borrowed $125,181 a year for three years
for Dr. Smith's PEP. There is very serious appearing documents transmitted
to a third party lender each year requesting these loans, but Doctors,
Inc. received no money. Instead the insurance company notifies Dr. Smith
that his unscheduled premium in the amount of the requested loan has
been received. Doctors, Inc. pays tax deductible 12 percent interest
on the loan. Here is the goofy part. The loan interest payment is made
to the insurance company. The claimed third party lender receives nada,
zero, zilch, NOTHING. And with a wink-wink the after-tax cost of this
loan interest payment is subtracted from Dr. Smith's compensation. The
tax-deductible interest payment (sic) paid to the insurance company
for Dr. Smith is $15,022 the first year, $30,046 the second year and
$45,065 each year thereafter. Dr. Smith also makes an annual premium
payment with his after-tax money of $34,935.
After seven years in PEP the insurance company
has received from Doctors, Inc. and Dr. Smith $521,938. But because
the loan interest (sic) was deductible, the net cost is $427,300
for a policy with a surrender value of $411,514. This PEP scheme saved
Dr. Smith $175,755 in taxes that he was able to apply to the life insurance
policy.
In 2003 Dr. Smith decided to end his PEP participation
so the PEP and split dollar agreements were terminated. Impressive security
release documents were circulated between the insurance company, Dr.
Smith and Doctors Inc., but no checks went to anyone. Doctors, Inc.
didn't owe anyone for the, ahem, loans, and Dr. Smith didn't owe Doctors,
Inc. anything for its split-dollar contributions.
PEP appears to be very much like a leveraged
split-dollar plan that was smashed in the Tax Court ruling Lowery R.
Young, Jr., et ux., et al. v. Commissioner (T.C. Memo, 1995-379, Tax
Ct. Dkt. No. 2861-94). Dr. Young's loan interest payments were
treated as constructive dividends.
The amount of the PEP life insurance was $4,627,833.
Based on Dr. Smith's family protection goals and other life insurance
he was over-insured by about $3,100,000. The irony is that the additional
costs associated with this over-insuring were more than his tax savings.
In other words Dr. Smith was induced to take tax-avoidance risks without
any demonstrable advantage.
Background information I received claims
that 122 law firms and 300 CPA firms have advised clients to implement
PEP. No doubt the documents that support PEP are impressive, but these
claimed 422 professional firms really have little chance of uncovering
the clever PEP trick because it is only obvious if you can see how the
supposed loan is really handled, or know how to do life insurance math
to realize from the beginning that no bona fide loan interest is being
paid to a third party lender, it is going to the insurance company as
part of the premium. What I need help in understanding is, whether the
firms that put together the documents really know about the subterfuge
or are simply ignorant of how the loan really works. What I have no
doubt about is their knowledge of how huge their fees are in churning
out documents.
