METs Can Provide Tax Deductible Life Insurance
If the taxpayer accepts the premise that life insurance is one of the most cost- and tax- effective ways to meet business and personal financial planning objectives, the next question asked is: “How can the premiums be paid? Can they be paid with pre-tax, tax-deductible dollars?”
The ideal solution would be to pay the premiums from someone elses pocketbook. The very best scenario would allow the premium payer, typically a business owner, an income-tax deduction without a corresponding income-tax liability.
This is precisely what occurs when an employer becomes a member of a multiple employer trust (MET), structured in accordance with Internal Revenue Code Section (IRC) 419A(f)(6). This subsection of the Code permits employers to structure welfare benefit programs for a select group of employees.
The benefits are not subject to the cumbersome ERISA participation, funding and vesting requirements applicable to qualified pension and profit sharing plans. All employer contributions to a MET are deductible by the employer as ordinary and necessary business expenses under IRC Section 162. And, plan contributions are generally not taxed to participating employees.
Section 419 qualified METs can be used to meet a wide range of benefits (health, disability, education, qualified severance/separation benefits as defined in IRC Section 419(e), etc.). However, METs are often designed to allow business owners to use before-tax business dollars to meet the life insurance liquidity needs of their multimillion dollar estates.
A concomitant by-product of the MET strategy is that the business owner may potentially reduce his corporations accumulated earnings (AE) tax penalty by using any excess earnings to fund the corporations MET obligation. The AE tax is a flat 38.6% excise tax.
There are a variety of METs and each is designed to highlight a particular benefit for participating employees. The employer can choose the type of MET most desirable for his employees. The life insurance MET is the most popular since it provides a solution to the most common business, estate and financial planning needs of the business owner.
How viable are welfare benefit trusts? Have they withstood IRS scrutiny?
As is true of any established estate-planning strategy, some METs have successfully passed IRS and tax court review, while others have not. Just as there are abusive trusts and family limited partnerships, so too have there been METs that have not been structured in accordance with the letter and spirit of IRC Section 419A(f)(6). When that occurs, the IRS generally disallows any employer deductions that have been taken. It may classify those MET trust contributions as a form of non-qualified deferred compensation and thus subject to the provisions of IRC Code section 404.
Prior IRS Notices, private letter rulings and related tax court cases can provide guidance with respect to complying with tax code welfare benefit trust regulations. In 1997, the tax court in Booth vs. Commissioner stressed the importance of complying with the multiple employer trust regulations outlined in IRS Section 419A(f)(6). Two years prior to Booth, the IRS issued Notice 95-34, which delineated how an employers deductions could be lost.
It is imperative that a business owner follow the advice of his own counsel with respect to any and all business and estate-planning strategies.
A properly designed welfare benefit trust can be a most efficient tax-planning tool to meet the liquidity needs of business owners and their key employees. MET assets are insulated from potential creditor and litigation claims and can also be structured to deliver income and estate tax-free benefits to beneficiaries.
Welfare benefit trusts can be ideal strategies for employers who want to make the most of tax-deductible fringe benefit carve-out plans for themselves and key employees.
John S. Budihas, CLU, ChFC, CFP, is a business, estate and trust planning consultant for the individual life division of Hartford Life. He can be reached at john.budihas
Reproduced from National Underwriter Life & Health/Financial Services Edition, August 5, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.