New York Times Article Didn’t Print All The Facts That Fit The Case

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My office has received many inquiries from agents about the July 28 article by David Cay Johnston (“IRS Loophole Allows Wealthy to Avoid Taxes”) published on the front page of the New York Times. This article purports to describe a secret tax-saving scheme, whereby wealthy individuals avoid substantial estate and gift taxes.

The article says the technique “has been approved by the IRS.” Many financial service professionals received calls from their clients wanting to do the same thing.

We believe that important facts were left out of the Times article, which if included, would cast an entirely different light on the situation. Since attorneys, agents and customers apparently must sign a confidentiality agreement, not much is known about this technique. But, one can piece together various aspects of the article to figure out its general outlines.

The article indicates that “[t]he technique is legal, blessed by the IRS in 1996.” The article also mentions that the technique involves split-dollar. We know that in 1996 the IRS issued a private letter ruling (“PLR”) on private split-dollar (PLR 9636033). In reading the article, we believe that this is the foundation for the technique being discussed.

Unfortunately, the article does not explain that the so-called IRS approval is just a private letter ruling. Whenever we present material about a PLR, we believe it is crucial to the readers understanding to emphasize that a PLR cannot be relied on by anyone but the taxpayer to whom it is issued. That is, the PLR does not have general application to all taxpayers, and cannot be cited as precedent.

We also explain the review process through which a PLR goes, as opposed to other rulings, such as a Revenue Ruling, which has general application. A PLR does not undergo the scrutiny that the IRS applies to a Revenue Ruling, and this is a large part of the reason why a PLR cannot be cited as precedent.

In addition, the article states the plan being discussed apparently goes several steps past the 1996 PLR. In that case, a customer would truly be out on a limb.

Another omission, we believe, is that under the PLR part of the policy proceeds are included in the estate of the spouse of the insured. With large policy values involved, these amounts can be substantial.

Had the author explained these points in the article, we think that insurance customers would not have been calling their agents to get into this kind of plan.

Of greater importance we believe, is the viability of the PLR 9636033. As legal counsel to life insurers on these matters, we regularly discuss this PLR. We find it to be well reasoned and to reach a logical and supportable result.

It is not a tax panacea. Instead, it may be appropriate when gift taxes are the over-riding concern. The reason is that the insureds spouse retains ownership of the policy cash values. So, the premiums paid by the spouse are not gifts, because the spouse does not part with control over the cash values. And, as a result, the cash values, which can be substantial, are included in the spouses estate under the PLR.

A follow-up article, also by Mr. Johnston, also lacks an explanation about these gift tax issues. While this later article correctly identifies the spouses participation as a key element, it does not discuss the trade-off in estate taxes.

We believe that the failure to fully explain the foregoing concepts resulted in a tempest in a teapot. If the concepts had been explained, clients would not have been calling their agents to get into this kind of plan. Instead, they would have understood that the plan had not been approved by the IRS for the public to utilize.

Douglas I. Friedman, a partner in the Friedman, Pennington & Downey, P.C. law firm of Birmingham, Ala., is national counsel on estate and business planning for insurers. His e-mail is doug@fpdlaw.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, September 9, 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.