Questionable Tax Scheme Costs Taxpayer $295k in Taxes
The English proverb, "A fool and his money are soon parted" is particularly applicable in the context of tax schemes and bogus asset protection plans. Sometimes half the battle is pointing out the bogus plans and scams and why those plans not only do not work, but subject the client to even greater losses.
The recent Tax Court case of Matthies v. Commissioner is such a case. From the Tax Court's perspective, here is what happened and what went wrong.
Mr. Matthies was the sole owner of a s-corporation. The company had a profit-sharing plan ("PPS"). Mr. Matthies had an IRA as well. Mr. Matthies was the sole trustee of the PPS.
Mr. Matthies was "sold" a "Pension Asset Transfer" plan, which claimed it could "transfer qualified pension assets or IRA dollars to the participant or the participant's family without significant taxation."
Mr. Matthies made two transfers of $1,250,000 from his IRA to the PPS. The PPS purchased life insurance on Mr. Matthies inside the PPS, with the premiums paid by the PPS. The PPS transferred the policy to Mr. Matthies for the policy's cash surrender value of $315,023, net of a $1,062,461 surrender charge. Mr. Matthies valued the policy at the cash value, net of the surrender charge, and reported no gain. The IRS assessed a deficiency for the surrender charge amount and sought an accuracy related penalty.
The Tax Court ruled that under the regulation in effect at the time, the value of the policy was the entire cash value, inclusive of the surrender charge. As a result, Mr. Matthies had to recognize the bargain element, i.e. the surrender charge of $1,053,304 he did not pay, as income. The Tax Court declined to impose an accuracy related penalty because it was an issue of first impression.
As Paul Harvey said, "And now for the rest of the story."
Through an insurance agent, Mr. Matthies was put in touch with GSL Advisory Service who marketed a "Pension Asset Transfer" (PAT) plan. Among other things, GSL represented that it:
- had "an IRS nationally approved prototype plan, the only plan with specific language to support this kind of purchase"
- its product would deliver 25% better results than comparable products (I thought it was the only one)
- a positive IRS determination letter is provided on each and every case (where was it in this case)
In his article, Court Orders Walnut Creek - Lafayette Man, Edwin Lichtig III, to Stop Peddling Unlawful Tax Schemes Tom Dunn reports that a federal court in San Francisco ordered one of GSL principal's Ed Lichtig, to stop promoting unlawful tax schemes including the PAT plan as well as the FROCO (Financed Roth Conversion Strategy), which "allegedly helped customers use annuities to transfer funds from their traditional IRAs to Roth IRAs without paying the proper amount of tax that is imposed on such transfers."
Beware tax schemes and asset protection plans that make too-good-to-be-true promises. GSL's representations were classic red flags. The next time you or your client is approached by someone peddling such a plan, look closely. Ask competent tax counsel to review the deal before you leap.
