The United States Supreme Court let stand last week a lower court ruling that a broad-based corporate-owned life insurance policy lacked economic substance and thus did not qualify for an interest deduction on policy loans.
The high court, without comment, declined to hear an appeal of a Sixth Circuit Court of Appeals ruling in the case of American Electric Power Co. v. United States, in which the Internal Revenue Service disallowed $66 million in interest deductions and assessed AEP with an additional $25 million in taxes in a dispute over the companys COLI policies.
The case involves a pre-1997 COLI policy which covered more than 20,000 AEP employees. These policies, which some critics call “janitors insurance,” have not been sold since the tax code was changed in 1997.
The AEP policy dates back to 1990 and was sold by Mutual Benefit Life.
According to the Sixth Circuit Court of Appeals ruling, the COLI plan utilized an intricate funding mechanism that was designed to have zero equity and “mortality neutrality.”
In other words, the court said, the cost-of-insurance charges increased if more employees than expected died, while MBL paid AES a dividend if fewer employees than expected died.
AEP also had the option of selecting from a menu of interest rate options that MBL would pay on policy loans, the court said.
AEP, the court said, always picked one of the highest interest rate options.