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Financial Planning > Tax Planning

Court Backs Attack On Charitable Split-Dollar Shelter

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A panel of a U.S. appeals court last week gave strong backing to federal government efforts to shut down a potentially lucrative tax shelter called charitable split-dollar.[@@]

Insurance companies and high-end insurance brokers had used charitable split-dollar strategies to sell insurance products that took great advantage of inside buildup.

The decision was an important one for the government, which moved to shut down the loophole after determining that a number of wealthy citizens were seeking to use it to shelter their income. In its opinion, the panel cited testimony by the insurance marketer who sold the policy to the petitioners “that this was the first case that we ever sold” involving the split-dollar concept. The president of the National Heritage Foundation, which had been a party to the arrangement, testified before the Tax Court that 600 to 700 of the 4,500 foundations created by taxpayers to establish a split-dollar with the National Heritage Foundation were based on similar arrangements.

In addition to challenging the charitable split-dollar business in court, the Internal Revenue Service has moved to reduce the tax benefits of split-dollar arrangements through a rule that changed the tax treatment late last year. The move was part of an effort by the Bush administration to reduce the high level of tax-free benefits given to top executives of corporations in the wake of the corporate abuses of the 1990s.

A 9th Circuit Court of Appeals panel made the decision in Addis vs. Commissioner July 8. In doing so, it supported the IRS and a law enacted in 1999 by Congress that denied a tax deduction for so-called charitable split-dollar contributions.

In denying the deduction to a farm labor contractor in California and his wife, the court refused to ignore IRS rules and the provision enacted in 1999 by rejecting the petitioner’s argument that the deduction they made for a charitable split-dollar deduction to the National Heritage Foundation qualified for an exemption from disclosure requirements for goods and services of “insubstantial value.”

Under the facts in this case, the petitioners’ would have been entitled to 44% of the initial death benefit plus the inside buildup even though the trust they were using to purchase the policy would pay only 10% of the annual premium.

The court also noted in its decision that even though they were paying only 10% of the premium, they would also retain the sole right to borrow on the policy or surrender the policy. If the petitioners’ chose to surrender the policy, then they would have owned the net cash surrender value less the National Heritage Foundation’s termination account value.

The court heard the case after the U.S. Tax Court denied the petitioners’ request for a deduction.


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