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Industry Hopeful IOLI Provision Will Be Removed From Tax Bill

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The life insurance industry is cautiously optimistic that its efforts to point out serious flaws in a provision in the Senate version of tax cut legislation, which would impose punitive taxes on investor-owned life insurance transactions involving charities, are having an effect. The industry also is hopeful the provision will be removed pending further study.

The bill, the Tax Relief Act of 2005, has been tied up in Congress since last December as the House and Senate try to reconcile different versions.

Industry observers hope that work on some sort of compromise will resume when Congress returns April 24 and that an updated version of the bill can be enacted in May.

The controversial provision dealing with investor-owned life insurance is contained in the Senate version of the bill, which passed there last December. It would impose a 100% excise tax on the acquisition cost of any “taxable acquisition” of an interest in an “applicable insurance contract.” The provision is estimated to raise $264 million over a 10-year period.

Congress, the National Association of Insurance Commissioners and individual states all are wrestling with the issue of those without insurable interest directly or indirectly purchasing life insurance products. The IOLI provision of concern in the Senate bill deals with the involvement of charities in arrangements where unrelated third parties take out interests in life insurance policies.

A concern of life insurers, agents and their trade associations is that circumvention of the purpose of “insurable interest” rules may increase the possibility some legislators will want to revisit the historical tax treatment of life insurance products.

Negotiations on the overall bill have been contentious. In the House, Republican moderates are concerned about provisions extending the 15% rate on capital gains and dividends first enacted in 2003. Without an extension, the provisions expire in 2008.

There apparently has been some progress on the issue, although a deal in the House to extend the cuts on capital gains and dividends fell apart at the last minute before Congress departed for a two-week recess April 7.

Industry officials are cautiously optimistic the controversial IOLI provision will be left out of the compromise being crafted to enact the bill.

Marc Cadin, vice president of legislative affairs for the Association for Advanced Life Underwriting, said an agreement appears to be near that will call for a two-year extension of the cut in capital gains and dividends.

“It appears that the deal that was nearly reached before the Easter recess did not include section 312, the so-called ‘IOLI’ provision,” Cadin said. “This would be consistent with the historical precedent of the House not taking action on provisions until they have been properly considered by the Ways and Means Committee.”

But, he cautioned, “We intend to watch this issue until the final deal is completed and signed into law.”

Cadin said that while the AALU, most other national insurance companies, agents and their trade groups support the purpose of the IOLI provision, “it is AALU’s strong view, and that of the broader industry, that it should not be included as part of the tax reconciliation bill.

“The current version would harm legitimate uses of life insurance and it may not effectively address techniques that evade the spirit of insurable interest laws,” Cadin said. “More attention and study are needed to assess what should be done and to get this right.”

A key issue is language in the IOLI provision on how the excise tax could be triggered where the insured gets a loan secured by his interest in the policy.

In a note to members last November, AALU officials said that based on the language contained in the Senate Finance Committee’s summary of the provision, “it seems that a secured creditor’s position (i.e., a loan secured by the policy) constitutes an interest with respect to which the excise tax may be imposed.”

AALU cites examples where it believes the tax would be triggered inadvertently. One is a case where the insured borrows money to purchase a life insurance policy (borrowing secured by policy) and makes a family member the beneficiary for 90% of the proceeds and a charity the beneficiary for the other 10%.

Another case is where the insured borrows money to purchase a life insurance policy (borrowing secured by policy) that is needed for purely personal reasons. “Years later, the insured no longer needs the policy for the original personal reasons and gifts the policy to a charity,” the AALU officials said, thereby triggering the tax.



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