Bookmark and Share

Tax-Shelter Trap Threatens to Bankrupt Small Businesses

By MARK HENRICKS, AOL SMALL BUSINESS
Posted: 2009-11-05 11:27:04
Tax shelter
Corbis
If you set up certain types of employee benefits plans, you could be in big trouble with the IRS. How big? How about a million-dollar penalty?

That's the predicament of some small business owners who have unwittingly run afoul of a law intended to stop big companies from using abusive tax shelters. In 2004, Congress passed a law requiring companies to notify the IRS if they set up specific types of tax-advantaged plans. The idea was to keep large companies from escaping IRS scrutiny of possibly illegal tax shelters.

More From AOL Small Business

    However, the law also affects two types of plans small businesses often use to provide employees with retirement and other benefits. One was a defined-benefit pension plan called a 412(i) plan. Another was a health and welfare plan called a 419 plan. The plans did offer tax advantages. But the small businesses that set them were after employee benefits, not tax shelters.

    IRS Commissioner David Shulman admitted as much in a letter to the chairmen of tax committees in the House and Senate in September. "Clearly, a number of taxpayers have been caught in a penalty regime that the legislation did not intend," Shulman wrote. Shulman urged Congress to change the law to avoid catching innocent small business owners.

    The Wall Street Journal reports that the IRS has agreed to stop trying to collect the financial penalties, but only through the end of 2009. By then, it's hoped Congress will have passed a new law that will grant some relief.

    Meanwhile, small business owners are still being told they owe penalties for doing nothing more than failing to notify the IRS. That's right: Even if there's no problem with the plan itself, they can still be liable if they didn't file the required notifications.

    And the penalties are huge. They can total $300,000 for every year the plan has been in existence without notifying the IRS. The business must pay $200,000 of that. The individual business owner must pay the other $100,000.

    In the five years since the law was changed, it's easy for penalties to total more than $1 million. Many small business owners have said that would put them out of business and into personal bankruptcy. Some have sued the insurance companies and financial advisors who sold them the plans.

    Unfortunately, there's not much else they can do. Congress set the amount of the penalties in stone and also required that the fines be assessed in every case. The IRS extended a moratorium on collecting fines through December 31. Now it's time for Congress to amend the statute and shield small business owners from some or all of the penalties.

    Both Democrats and Republicans have expressed support for the idea. But with the focus in Washington almost entirely on health care reform, no bill has emerged so far. It could be a very unhappy New Year for some small business owners who were only trying to help their employees.

    2009-11-05 11:19:49
    Bookmark:

    Recent Comments

    Post Your Own  
    1 - 10 of 38
    38 comments

    bottomin45212 02:56:05 AM Nov 06 2009

    Report This!

    I cant believe they are doing nothing about it and then come the first of the year those businesses and the people are going to go bankrupt... Big business wins and the people get screwed. I would go after physically whoever sold me that plan and didnt tell me I had to inform the irs.. Shoudnt the people selling them be the ones to inform They should have the rules... If im going to lose everything because of my mistake fine but someone elses then someone is going down too.. I use to wonder why people would kill others before killing themselves now I understand it perfectly... Hope I never get to that point in my life but if I do watch out..lol

    tabrastaro 01:33:09 AM Nov 06 2009

    Report This!

    Laws are meaningless if they are vindictive. Ethics outweights any law. Hold on everyone. As an owner of a small business I have an ace up my sleeve. Small business will again become the backbone of our society. According to the publishers, my book will be out hopefully before Christmas. It has been in the making for over fifteen years and will put the country back on track. Greed has taken over this country, and the bottom line is to bring our country back to capitalism before the culprits destroy it.Entrepreneurials will enjoy the book of repetitious remedies and not the repetition of problems. You do not reward mismanagement and that's what are leaders advocated while stealing us blind. Anyone wanting to know more cantact me at TabraStaro@aol.com. The new administration preached no new taxes. What do you call raising the federal cigarette tax. They are going to tax us to death in a way unknown to mankind.

    gent88 12:57:21 AM Nov 06 2009

    Report This!

    Time for a tax reform and and the simpler the better! With such a complicated tax system, one can never get to optimize one's tax due, and every little mistake you make, you'd end up either paying too much, or underpay and risk severe penalties as this case clearly shows. The very complicated tax system is a result of our elected officials constantly trying to add new tax rules that would benefit a certain class of tax payers. Do that over the years, may be a centry, that's how we end up with such a mess.

    jamessporter 11:42:46 PM Nov 05 2009

    Report This!

    It is not safe to say what I really think but I am learning a new language.

    hlt117 11:35:19 PM Nov 05 2009

    Report This!

    small business will survive:make the government aware and tax allowances or loans will help the small guy. don't fear it's the creative link of capitalism.

    rmcfa23125 11:32:07 PM Nov 05 2009

    Report This!

    nothing new. big business uses government to get an advantage over small business. been going on for years, just put money into congressmans pocket and fair goes out the window.

    inoflx 09:22:59 PM Nov 05 2009

    Report This!

    You grow up in a 1000 sq ft house with 5 other people. Then you live in a trail er house so you can afford college. Finally get through college in six years so you can work your ass off for 20 years making pennies. Then you get a break and invent something useful. You risk everything to make it successful by working 7 days a week while living off of savings for two years. After 10 more years of hard work to finally turn the idea into a real business. The final result is that the government thinks you make too much money and should be punished. You should share your money with the less fortunate who did not have the oppurtunity to go to college. Opportunity my ass, no one wanted to trade places with me in the beginnign when I was working for free. The American dream is all but dead.

    wdavis3910 08:59:21 PM Nov 05 2009

    Report This!

    The law is not just the law, Just because those who have the power to write it, doesn't mean it right. The most powerful vote we have is the jury vote. What is really interesting is ignorance of the law has no excuses, but ignorance is acceptable of not knowing your right's, which has to be read to you before you are arrested.

    jjjameson 08:39:25 PM Nov 05 2009

    Report This!

    Sorry, but the law is the law. No matter how absurd and unjust, we MUST enforce the laws, otherwise we will descend into chaos.

    rdscottsr 08:00:32 PM Nov 05 2009

    Report This!

    All of this was done under a Republican administration. In 2004 the republicans controled the White House and the House and the Senate.

    1 - 10 of 38
    38 comments

    Add your own Comments

    Clear
    Add

    The Startup

    The Startup

    The Startup, the web's premiere online reality show for small business owners, is back for its third season! Watch as we follow four entrepreneurs to see how they're making their businesses come to life.

    1. The Startup

      Small Business Checklists

      It can be difficult to keep up with all the details involved in running a small business. Don't lose track of the details -- use a checklist to keep yourself organized.

      1. Checklist: Starting a Business
      2. Checklist: Closing a Business
      3. Index of Small Business Checklists

        Small Business Success Stories

        1. More Than Moonlighting
        2. Reality TV Leads to Small Biz Success
        3. From Couple to Business Partners
        4. Build-A-Bear's Founder Shares Her Story

          Helpful Resources

            AOL Coaches

            Jake Steinfeld

            Business Coaches
            Starting your own business can be a daunting task. With AOL's Small Business Coaches, you can get the best advice to guide you through the process.