US Says Benefit Plan Scheme Costs Millions In Taxes

By Gavin

Law360, New York (October 11, 2013, 2:38 PM ET) -- The U.S. government sued an insurance program marketer in California federal court Wednesday in an effort to shut down a purported scheme pushing small businesses to buy into employee benefits programs it claims are structured to cheat the government out of millions of dollars in taxes.
The government’s complaint accuses KAE Insurance Services Inc. and affiliated entities of hawking voluntary employee beneficiary association plans on the misleading promise that the participating businesses can legally write off plan contributions as federal income tax deductions while still recouping the full value of those contributions down the road, according to the complaint.

The defendants have long been well aware, however, that the plans as structured violate the Internal Revenue Code and regulations promulgated by the U.S. Department of the Treasury, and their activities must be halted via a court injunction, the government argues.

“Defendants have continued to falsely claim that the VEBA plans in fact comply with the tax laws, and manage and promote them to this day despite their documented knowledge of the illegality of the plans,” the government said. “The result is significant amounts of lost tax revenue to the treasury based on erroneously claimed tax deductions.”

The complaint alleges that named defendant and California resident Kenneth Elliott has since 2001 used a network of businesses, independent certified public accountants and financial planners to sell companies on the VEBA plans on the promise they can provide “a lucrative and tax-advantaged method to accrue wealth.”

Promotion of those plans has led participating companies across the country to deduct millions in contributions, despite the fact that the IRS decided more than a decade ago — in a determination repeatedly upheld by federal courts — that massive tax write-offs under such plans are at odds with federal law, according to the complaint.

The government said one audit of some 41 customers who participated in the plans marketed by the defendants revealed a total tax deficiency of nearly $14 million, and further estimated the potential total loss to date to be over $70 million.

Elliot and his co-defendants are said to push the VEBA plans on wealthy customers with closely-held businesses such as medical practices, pitching the programs as a legal and tax-free means of providing medical or death benefits to employees, according to the complaint.

VEBA contributions are placed into a trust used to purchase insurance contracts, the premiums for which would otherwise be included as part of that employee’s gross income if purchased directly. Because such plans have in the past been used as tax shelters, federal law tightly regulates the ways in which plan contributions may be deducted, the government said.

The complaint noted that one common example of how such plans have been used as “vehicles for rampant tax abuse” involves paying excessive contributions to obtain cash value insurance policies set aside for future benefits to company owners that do not actually provide welfare benefits to employees but instead are a means of distributing excess corporate profits and softening current federal tax obligations.

The involvement of Sea Nine Associates Inc. — which sponsors the VEBA plans promoted by the instant suit defendants and is itself a named defendant — in a suit over those plans more than a decade ago serves as evidence that the defendants are well aware of the potential illegality of their enterprise, the government said.

“The core purpose and effect of the participation in a Sea Nine VEBA plan is to provide participants with a mechanism to accumulate wealth for their personal benefit, unlawfully protecting that income from federal taxation by treating it as a welfare benefit when it was that in name only,” the complaint said.

Representatives for the parties were not immediately available for comment Friday.

Counsel information for the defendants was not immediately available.

The case is United States of America v. Kenneth Elliott et al, case number 8:13-cv-01582 in the U.S. District Court for the Central District of California.