Congress moved last week to crack down even
further on tax avoidance techniques that use life insurance contracts involving
charities.
The leadership of the Senate Finance
Committee said it would introduce legislation designed to shut down writing of
so-called “stranger-owned life insurance,” as well as discouraging states from
broadening their definition of “insurable interest.”
The bill would impose a 100% excise tax on
money invested into “investor-owned life insurance” arrangements, according to
officials at the American Council of Life Insurers. In effect, for every $1
invested in such an arrangement the investor would immediately incur a $1
federal tax liability.
A statement from the committee said it
also will include a provision that imposes a reporting requirement to the IRS,
which will allow the agency to examine previous deals to “determine their
compliance with even current law.”
The legislation builds on the Bush
administration’s proposal, through the budget for fiscal year 2006, that also
sought to deal with life insurance contracts that inappropriately afforded
benefits to private investors that would not otherwise be available without the
charity’s involvement.
The insurance industry is supportive in
principle of the latest initiative. “Commoditizing the insurance business,
under the guise of a charitable purpose, needs to be closed down,” said Ken
Cohen, an associate general counsel and government relations official at
Massachusetts Mutual Life Insurance Company.
“Life insurance is designed for financial
protection,” said Frank Keating, president and CEO of the ACLI. “It is no
surprise that life insurers welcome this legislative proposal. It would
effectively put an end to arrangements designed to use life insurance for
something for which it never was intended.
“We look forward to working with the
Congress on this issue and hope that legislation to curtail IOLI arrangements
is enacted quickly,” Keating added.
But Arthur Bailey, a partner in insurance
and tax law at Steptoe & Johnson in
But, as always, Bailey said, “When
Congress gets involved, the question is whether the
members of the tax writing committees approve of a particular application
of the existing statutes. If changes are made to existing statutes, the
treatment of existing policies will undoubtedly be addressed.”
The Bush administration’s plan is to shut
down “Life Insurance and Life Annuities Based Certificates,” or LILACs. Under these programs, the investors get the benefit
of the inside buildup if they agree to give a small part of the benefits to
charities, such as colleges or affiliates of colleges.
The latest action by the Senate Finance
Committee further justifies the concern of the life insurance industry about
the practice. Several life insurance trade groups have formed a coalition to
lobby against initiatives in many states to broaden the definition of insurable
interest, fearing it could lead to curbs on inside buildup down the road.
But it is unclear how the industry will
react to the latest proposal when it is released and analyzed. That is because
the industry has voiced concern about the specific language contained in the
administration’s budget. Cohen said the industry “appreciates the idea” of
shutting down LILACs, but “does not like the
particulars.” As a result, he said, the industry is working with Congress “to
craft an alternative” that the industry would find more acceptable. The ACLI
has made similar statements.
Officials of the National Association of
Insurance and Financial Advisors were more specific. They “applauded” the
committee’s leadership for introducing the bill and supported the committee
leadership’s decision to move away from the administration’s proposal to impose
an excise tax on death benefits and toward a plan to tax funds going into these
arrangements.
“NAIFA believes theirs is a sounder
approach,” its officials said. “NAIFA has not yet determined the full extent of
the tax-exempt organizations affected by the Grassley/Baucus proposal as
contrasted with the administration’s proposal.”
Specifically, they said, “NAIFA supports
legislation that would affect a fuller range of
tax-exempt organizations than the administration’s
proposal without
curtailing the legitimate use of life insurance by
charities.”
The new Senate proposal was unveiled by
Sen. Charles Grassley, R-Iowa, and Sen. Max Baucus, D-Mont., chairman and
ranking minority member, respectively, of the committee.
“I’m very concerned about snake oil
salesmen taking advantage of tax-exempt organizations to line their own pockets
with life insurance schemes,” Grassley said. “Many states are now
considering legislation that would allow this kind of exploitation. The
bill we’re announcing today will toll the bell on this scam.”
Cohen said MassMutual,
as well as others in the industry, had so far this year persuaded Maryland not
to expand the definition of insurable interest, and for the Virginia
legislature to narrow a recent expansion of its definition. Moreover, he said, MassMutual officials “just testified before a Senate
committee in
Besides individual institutions, the ACLI,
the Association for Advanced Life Underwriting and its sister trade group, NAIFA,
have all been working to shut down LILACs and similar
products.
Cohen disclosed that MassMutual
several years ago was approached by a “major investment bank” first to
underwrite LILACs, and later to be one of the
investors who would profit from the deal, but declined. He said the company did
not want to participate “in a scheme that involves commoditizing the value of
someone’s life.”
But Bailey disagreed. “Charities have long
been encouraged by federal tax law and state insurance laws to use life insurance
as a way of encouraging individuals who have donative
intent to benefit their favored charities,” he said. “This has traditionally
been accomplished by making a charity the beneficiary of a life insurance
policy, or gifting an existing policy, or by allowing the charity to
purchase a policy and gifting the annual premium.”
Bailey said what might be upsetting
Congress and the administration is that what is different in some of the
programs offered currently is that the policy benefits may be financed
with loans or other funds provided by third parties, “and consistent
with that involvement, some portion of the policy benefits are used to repay
those third parties.”