Abusive "Welfare Benefit Plan" Tax Schemes

Generally, contributions to a welfare benefit fund are deductible when paid, but only to the extent that they qualify as ordinary and necessary business expenses of the taxpayer and only to the extent allowable under the Internal Revenue Code. The Code imposes strict limitations on the amount of tax-deductible pre-funding permitted for contributions to a welfare benefit fund.

The Internal Revenue Services has found that unscrupulous promoters are selling abusive welfare benefit plan tax schemes to the owner-employees of small, profitable, closely-held businesses. The schemes promise to reduce corporate earnings that would normally be paid to the owner as salary. These promoters are offering trust arrangements with unlimited business deductions for employee benefits on the ground that they satisfy the rules exempting certain plans from the deductibility limitations. The arrangements purport to offer insurance-type programs through a welfare benefit fund for death benefits, severance pay, disability pay, long-term care, medical expense reimbursement, or other benefits.

The IRS has disallowed many of these business deductions and has required the business owners to include income from the arrangements. These abusive schemes do not satisfy the statutory requirements for an exemption from limitations. In fact, the arrangements may be actually providing deferred compensation, which is only deductible as a business expense if included in the employee's income.

Another reason for disallowing unlimited deductions under these arrangements is that many do not qualify for the 10-or-more-employer plan exemption established under the Code. Instead, the IRS has found that the arrangements may be separate plans maintained for each employer rather one plan for multiple employers. In addition, the arrangements may be experience rated with respect to the individual employers, which disqualifies them from the limitation exemption.

In many cases, the IRS has concluded that even if the arrangements qualify for the limitation exemption, employer contributions to the plans may represent prepaid expenses that are not deducible under other sections of the Code.