Congress moved last week to crack down even further on tax avoidance techniques that use life insurance contracts involving charities.
The leadership of the Senate Finance Committee said it would introduce legislation designed to shut down writing of so-called “stranger-owned life insurance,” as well as discouraging states from broadening their definition of “insurable interest.”
The bill would impose a 100% excise tax on money invested into “investor-owned life insurance” arrangements, according to officials at the American Council of Life Insurers. In effect, for every $1 invested in such an arrangement the investor would immediately incur a $1 federal tax liability.
A statement from the committee said it also will include a provision that imposes a reporting requirement to the IRS, which will allow the agency to examine previous deals to “determine their compliance with even current law.”
The legislation builds on the Bush administration’s proposal, through the budget for fiscal year 2006, that also sought to deal with life insurance contracts that inappropriately afforded benefits to private investors that would not otherwise be available without the charity’s involvement.
The insurance industry is supportive in principle of the latest initiative. “Commoditizing the insurance business, under the guise of a charitable purpose, needs to be closed down,” said Ken Cohen, an associate general counsel and government relations official at Massachusetts Mutual Life Insurance Company.
“Life insurance is designed for financial protection,” said Frank Keating, president and CEO of the ACLI. “It is no surprise that life insurers welcome this legislative proposal. It would effectively put an end to arrangements designed to use life insurance for something for which it never was intended.
“We look forward to working with the Congress on this issue and hope that legislation to curtail IOLI arrangements is enacted quickly,” Keating added.
But Arthur Bailey, a partner in insurance and tax law at Steptoe & Johnson in Washington, D.C., defended the programs. “Most tax experts believe as a technical matter that many of these programs satisfy the basic requirements of existing statutes, assuming the charity has a valid insurable interest [which varies with state laws] and that the program otherwise has validating tax characteristics such as economic substance.”
But, as always, Bailey said, “When Congress gets involved, the question is whether the members of the tax writing committees approve of a particular application of the existing statutes. If changes are made to existing statutes, the treatment of existing policies will undoubtedly be addressed.”
The Bush administration’s plan is to shut down “Life Insurance and Life Annuities Based Certificates,” or LILACs. Under these programs, the investors get the benefit of the inside buildup if they agree to give a small part of the benefits to charities, such as colleges or affiliates of colleges.
The latest action by the Senate Finance Committee further justifies the concern of the life insurance industry about the practice. Several life insurance trade groups have formed a coalition to lobby against initiatives in many states to broaden the definition of insurable interest, fearing it could lead to curbs on inside buildup down the road.