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Lawmakers Call For STOLI Tax Warnings

By Matt Brady

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The leaders of a House Ways and Means subcommittee have called on the Treasury Department to alert seniors about the potential tax issues caused by involving themselves in stranger-originated life insurance schemes.

In a letter to Treasury Secretary Henry Paulson, Select Revenue Measures Subcommittee Chairman Richard Neal, D-Mass., and ranking minority member Phil English, R-Pa., said they were concerned that “STOLI transactions take advantage of the secondary market in life insurance settlements at the expense of elderly Americans who are left with an unexpected tax liability.”

The two said in the letter that they understand several variations on the scheme exist in the market, with some of them making use of trusts to hold the policies, but that “in each case” the insured is elderly and often with a high net worth.

“In a typical STOLI transaction, an elderly individual, on average 80 years old, is marketed a policy that claims to provide millions of dollars worth of ‘free’ insurance coverage on his or her life,” they said. “We understand that these policies are aggressively marketed, and in some cases, the individual receives an expensive dinner voucher or cruise as part of the promotion.”

Neal and English acknowledged that the state law treatment of STOLI policies is outside the jurisdiction of the Treasury Department, but argue that the tax consequences of such arrangements “have been the subject of increasing commentary and concern.” Depending on how the deal is structured, the transaction could be considered a split dollar arrangement, they noted, and the rules regarding cancellation of indebtedness may also come into play on settlement of the policy.

“In certain cases, the terms for the initial arrangement may not qualify as true indebtedness, thus exposing the insured to income inclusion,” Neal and English argued. “Also, depending upon the value of the promotional incentive or cash payment, the insured could be taxed on the value of the promotion received. Depending upon the structure of the product promoters may also be liable for information reporting.”

The congressmen said their concerns regarding STOLI are not intended to stifle the ability of policyholders to bring their life insurance policies to the secondary market. “Rather, we seek Treasury’s assistance in notifying elderly taxpayers of the adverse consequences of investing in a product that is in fact ‘too good to be true,’ ” they said, adding that they sought a notice or other guidance to outline the potential consequences of participating in STOLI arrangements. “ While we recognize that STOLI products can take various forms that potentially alter the tax treatment,” they said, “we believe that guidance could be crafted to address these variations.”

Jack Dolan, a spokesman for the American Council of Life Insurers, said the letter was “not really surprising” as the issues surrounding STOLI transactions have drawn increasing attention. “Word is getting out about the problems consumers participating in STOLI arrangements can face,” he said. “The congressmen put it well, noting the potentially adverse tax consequences associated with these arrangements, particularly for seniors.”

The Life Insurance Settlement Association, according to executive director Doug Head, welcomes the idea of increased tax guidance from the Treasury, saying “it would be helpful and we’d be supportive of that kind of initiative.”

Head said he was “a little bit puzzled” by some of the characterizations made in the letter, as an example noting that the congressmen depict those insureds in STOLI transactions as typically high net worth individuals in one paragraph and yet potentially unable to pay off a premium-financing loan in the next.

Additionally, Head expressed some confusion at a reference in the letter to seniors as “investing a product” that would be a STOLI transaction, and he noted that the problem of “promotions” or kickbacks has been raised by LISA during prior debates on STOLI. “That’s what we’ve been talking about all along,” he said.

He added, however, that the letter did raise some “interesting questions” and that the split dollar classification was an issue he hadn’t seen raised previously. Overall, he said LISA would be supportive of any tax guidance issued by the Treasury, adding “the more clarification they can offer the better.”