Salvaging Leveraged COLI By Using ‘Unwinds’
by James L. Hess and
Many large companies, including insurers, are paying close attention to what is happening in tax and district courts as some of their counterparts wage a battle with the Internal Revenue Service to protect their investments in leveraged COLI. Winn-Dixie, Camelot Music and AEP, the Ohio-based utility, lost their first rounds and are now in appeals. The next case is scheduled for early in 2002.
In 1996, federal legislation was enacted that phased out the deductibility of policy loan interest for corporations, with complete elimination beginning in 1999. Despite that legislation in 1996, virtually every purchaser of broad-based leveraged COLI is under IRS attack for all prior open tax years. In addition to concerns about the potential loss of historical deductions on loan interest payments by corporations, there looms large the formidable task of deciding how to manage the policies going forward.
With three wins for the IRSs position on leveraged COLI, there is also increased discussion of settlements involving partial disallowance of the loan interest. The current settlement offers now being made by the IRS generally include provisions that are designed to encourage policyholders to surrender their policies.
In some cases settlement offers even appear to be contingent on the surrender of the policies. For most policyholders, even though their policies remain heavily leveraged, the policies have been kept in force through what have been referred to as “unwinds.” Even though the policy loan interest is no longer deductible, these policies still have the valuable aspects of life insurancetax-deferred growth of the cash values and tax-free death benefits.
Unwinds are a structured approach to using standard policy provisions found in all life insurance policies, including those issued to individuals, to meet the needs of the corporate owner. The most typical approach is to elect extended term insurance, and continue paying loan interest in cash, so that the policies remain in force.