More On Legal & Compliancefrom The Advisor's Professional Library
- Conducting Due Diligence of Sub-Advisors and Third-Party Advisors Engaging in due-diligence of sub-advisors isnt just a recommended best practice it is part of the fiduciary obligation to a client. An RIA should be extremely reluctant to enter a relationship with a sub-advisor who claims the firms strategy is proprietary.
- Best Practices for Working with Senior Investors Securities examiners deal harshly with RIAs that do not fulfill their fiduciary obligations toward senior investors, as the SEC and state securities regulators view older investors as particularly vulnerable and in need of protection.
The Obama Administration’s 2012 federal budget proposal has revived two budget proposals that will touch the life insurance business – one affecting Corporate-Owned Life Insurance (COLI) and the other affecting carriers’ Dividends-Received Deduction (DRD).
In response to alarm that the proposals tamper with the tax preferred status of life insurance, the Treasury recently issued a letter clarifying that these proposals center around tax arbitrage issues, not the tax treatment of death benefits.
Corporate-Owned Life Insurance Proposal
If passed, the COLI proposal would repeal the pro rata interest expense disallowance rule, which enables business taxpayers to deduct certain interest expenses related to corporate-owned policies.
COLIis life insurance that a corporation takes out on its employees’ lives. COLI policies were originally designed to reduce the risk of unexpected death of important corporate employees, so-called ‘key man’ insurance. COLI cushions corporations from some of the costs of re-recruiting and retraining replacements for employees who serve integral employment roles.
Congress has already implemented rules applying to corporations that are perceived to abuse the COLI option, usually by taking out insurance on an overbroad range of employees – sometimes without the employees’ knowledge. The new changes would further restrict COLI by allowing deductions for premium payments only if the employee, officer, or director has a 20% minimum interest in the corporation – helping ensure the COLI option is not abused.
Dividends-Received Deduction Proposal
If passed, the DRD proposal would change the way DRDs are currently calculated by imposing limitations similar to other corporate tax-related dividend payments. Life insurance companies are currently allowed to claim DRDs, but are subject to industry specific rules. To be eligible for the DRD, a portion of the company’s dividend income must be used to fund policyholders’ tax-deductible reserves.
“Life insurance companies get a tax deduction for their increase in reserves,” explains an IRS memorandum. “Correct determination of the amount of dividends subject to the DRD ensures that a life insurance company does not realize an excess benefit by deducting part of investment earnings credited to policyholders that have already been deducted through increases in reserves.”
A DRD is a corporate tax deduction on dividends a corporation receives from other domestic corporations. The DRD reduces corporations’ tax burden by preventing triple taxation – once at the corporate level, once at the corporate
shareholder level, and then again at the individual shareholder level. The DRD eliminates the second tax hit: the tax at the corporate shareholder level.
The new calculations would require a more direct relationship between the company’s economic interests in separate account dividends before the DRD would be allowable. In short, the proposal will increase the tax burden for many carriers.
The Admininstration’s Arguments and Intent
The revival of the DRD and COLI proposals is premised on the belief that some corporate taxpayers—including insurance carriers—take unfair advantage of the tax system by engaging in tax arbitrage and by double dipping on some deductions. “We are taking the next step in creating fairness in our economy by ending loopholes that allow companies to avoid paying taxes while millions of hardworking families and small businesses pay their fair share,” said Treasury Secretary Timothy Geithner.
The Obama Administration won’t be easily swayed. The Administration’s defensive posturing in the Treasury letter remains singularly focused on attacking perceived corporate abuses of the tax system, but they continue to ignore the impact of the proposals on small business planning client. It is fighting to defend proposals that would curb many long-accepted insurance planning solutions not only for the corporate market, but the small and closely-held markets as well. Whether these proposals will eliminate unfairness or place an unfair burden on life insurance remains to be seen.
For additional coverage of this issue and similar ones, we invite you to sign up with AdvisorOne’s partner, AdvisorFX, for a free trial.
See also The Law Professor's blog at AdvisorFYI.