trust

Is a “Trust” Really a Trust for Tax Purposes?

Taxpayer fails to report listed transaction and receives $10,000 penalty.

Interior Glass Systems, Inc. v. United States1 discusses what a trust is for tax purposes in the context of tax shelters. It reconsiders an earlier decision under a Rule 59(e) motion.2

Life Insurance Premium Deductions

The Internal Revenue Service initiated a $40,000 penalty on Interior Glass for failure to disclose two life insurance premium deduction participations: the Insured Security Program (ISP) and the Group Term Life Insurance Plan (GTLP).

The Association for Small, Closely Held Business Enterprises (ASCHBE) provided both programs. The theory was that an employer could claim life insurance premiums as deductions by paying the premiums on behalf of employees. The employees would have no income given this fringe-benefit treatment.

Interior Glass’s participation in the ISP began in 2006 and ended in 2008, while participation in the GTLP began in 2009 and continued through 2011. Under both plans, Interior Glass took annual deductions for life insurance premium payments while its employee-owner, the beneficiary, recognized nothing for income.

Notice 2007-83

In 2007, the IRS issued Notice 2007-83, “Abusive Trust[s] [emphasis added] . . . Utilizing Cash Value Life Insurance Policies Purportedly to Provide Welfare Benefits.” The Notice mentioned that promoters lure participants under the guise that employer trust contributions are deductible pursuant to Internal Revenue Code Sections 419(c)(3) and 419A, but employees don’t have a matching income inclusion.

The Notice continued by saying that abusive trusts involve trustees taking employer contributions to buy cash-value life insurance on employee-owners and term life insurance on other employees. Eventually, the employee-owners cause plan termination, getting all or substantially all the trust assets allegedly tax free.

Abusive trusts are “listed transactions” under IRC Sections 6111 and 6112 and Treasury Regulations Section 1.6011-4(b)(2). Notice 2007-83 elaborates: “Any transaction [with] all . . . the following [four] elements and any transaction that is substantially similar to such a transaction are . . . ‘listed transactions’ for required disclosure purposes:

The transaction involves a trust . . . [under] Section 419(e)(3) . . . . For determining the portion of its contributions to the trust . . . that are currently deductible, the employer does not rely on the exception in Section 419A(f)(5)(A) (. . . collectively bargained . . .). The trust . . . pays premiums . . . on . . . life insurance policies and, with respect to at least one of the policies, value is accumulated. The employer has taken a deduction for any taxable year for its contributions to the fund with respect to benefits provided under the plan . . . that is greater than the sum of the following amounts . . . .”

Listed Transaction

Treas. Regs. Section 1.6011-4(b)(2) suggests a listed transaction is “a transaction that is the same as or substantially similar to one of the types of transactions that the Internal Revenue Service has determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance as a listed transaction.” Treas. Regs. Section 1.6011-4(c)(4) remarks that “substantially similar” is “any transaction that is expected to obtain the same or similar types of tax consequences and that is either factually similar or based on the same or similar tax strategy.”

Penalties

Failure to disclose the programs to the IRS would result in IRC Section 6707A penalties. Seeing the now flawed ISP program after this Notice, ASCHBE developed the GTLP program. ASCHBE wanted the same results in GTLP as ISP. It simply changed the word “trust” in the ISP to the word “Association” in the GTLP.

The IRS imposed a $10,000 penalty on Interior Glass for each of 2008 through 2011 under IRC Section 6707A.

In August  2016, Interior Glass prevailed on the 2008 penalty refund. Nevertheless, the IRS won summary judgment for the remaining penalty years because the GTLP was considered “substantially similar” to a “listed transaction” and therein under Notice 2007-83.

Interior Glass sought remedial relief under Rule 59(e), considering the original decision to misapply the facts. It previously contended that IRC Section 6707A was unconstitutional based on “substantially similar” being too vague or overbroad. The original court believed there to be no vagueness issue and Notice 2007-83 to be capable of enforcement. 

Argument and Final Resolution

Interior Glass believed that the GTLP wasn’t under Notice 2007-83’s necessary reporting regime as it wasn’t a trust or any “other fund described in Section 419(e)(3) that is purportedly a welfare benefit fund.” That interpretation, though, would make “substantially similar” unnecessary and without meaning. GTLP was “substantially similar” to a “listed transaction.” Consequently, a requirement to report this transaction to the IRS arose. The court ruled in favor of the IRS, evidencing no manifest error under Rule 59(e).   

More specifically, Notice 2007-83 fails to define “trust.” Interior Glass believed it was involved not in a trust but instead in an established business organization, ASCHBE, which had tax exemption under IRC Section 501(c)(6). The business organization controlled the policies, disallowing any individual member control of the money. Thus, the first of the four necessary elements for a listed transaction under Notice 2007-83 was absent. The court found that what Interior Glass’s relationship with ASCHBE could be described as was “substantially similar” to a trust and thus under Notice 2007-83’s reporting requirements for “listed transactions.”

Endnotes

1. Interior Glass Systems, Inc. v. United States, Case No. 5:13-cv-05563-EJD, 2017 U.S. Dist. LEXIS 46007 (N.D. Cal. 2017).

2. Interior Glass Systems, Inc. v. United States, Case No. 5:13-cv-05563-EJD, 2016 U.S. Dist. LEXIS 107883 (N.D. Cal. 2016).

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