In preparation for the coming debate on tax reform, the industry is now marshaling arguments to defend the long-standing tax-favored treatment of its products. High among its talking points is this one: that life insurance does not belong on Congress’ list of tax expenditures because the product does not meet the definition of one.
This position, which is to figure prominently in industry lobbying on tax reform this year – including visits to Capitol Hill this week by members of the Association for Advanced Life Underwriting – was revealed during a general session on Tuesday at the AALU’s annual meeting. A highlight of the conference, the “AALU Washington Report” brought together members of the organization’s Government Affairs team and affiliated attorneys to outline the legislative challenges ahead for the industry.
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“If we can persuasively argue, as I believe we can, that the inside build-up of life insurance is not a tax expenditure, then we set ourselves apart from other exposed industries,” said Kenneth Kies, managing director of the Federal Policy Group LLC and an outside counsel to the AALU. “Because present law relating to the tax treatment of insurance policies’ inside build-up is consistent with generally applicable tax law, it’s not a tax expenditure.”
Marc Cadin, AALU’s senior vice president of government affairs, agreed, adding: “Your message on Capitol Hill needs to be that life insurance and annuities are now taxed appropriately and deliver strong public policy benefits. This message is not merely self-serving; it also advances our common vision: that the promises you make to your clients today will still be good tomorrow.”
The Congressional Budget Act of 1974 defined a tax expenditure as “a revenue loss attributable to provisions of the federal tax laws, which allow a special exclusion, exemption or deduction for gross income, or which provide a special credit for a preferential rate of tax.” Kies said that life insurance falls outside the definition because not taxing permanent policies inside build-up – the cash value or savings component – is consistent with “generally applicable tax law” pertaining to investment income.
Translation: The IRS doesn’t tax investment earnings until income is “recognized” or received as cash. This policy, Kies noted, makes sense, because without the investment income, taxpayers might have difficulty paying the tax. He added that, unlike other recognized tax expenditures, the Internal Revenue Code has no provision establishing an exception to the tax rules for life insurance.
Indeed, life insurance has never been classified as a tax expenditure meriting special treatment since Congress enacted the federal income tax in 1913. Nor has the inside build-up ever been taxed.
Over the decades, tax courts have also upheld the long-standing tax treatment of life insurance. Kies cited two cases, the first from 1961 and the second from 1963, in which the courts ruled that, because of substantial restrictions on policyholders’ access to the inside build-up, constructive receipt does not apply under the IRC definition.
Yet life insurance remains in Congress’ crosshairs: First eyed as a tax expenditure by Congress’ Joint Committee on Taxation in 1972, the tax-favored treatment of life insurance would yield an estimated $157.6 billion in revenue for the U.S. Treasury if policyholders no longer enjoyed income tax-deferral of policy earnings. Given still large federal budget deficits, many tax reform proponents are tempted to secure the revenue windfall.