Proposal Would Strip High-End Life Insurance of Tax Benefits
Tax advantages of private placement life insurance (PPLI) and private placement variable annuities would be eliminated under draft legislation proposed by the Senate’s top taxwriter.
Senate Finance Committee Chair Ron Wyden, D-Ore., released the text of the proposal on December 16, saying in a statement that “life insurance is an essential source of financial security for tens of millions of middle class families in America, so we cannot have a bunch of ultra-rich tax dodgers abusing its special tax treatment to set up tax-free hedge funds and shelter oodles of cash.”
The proposal is being released for discussion before being formally introduced in the Senate. Wyden has yet to reach out to Republican or Democratic senators for support, according to a Finance Committee aide.
Under the draft legislation, PPLI and private placement variable annuity contracts issued by domestic and offshore insurance carriers would no longer be treated as life insurance or annuity contracts under the IRC, and thus accumulated earnings within the policies would lose their tax benefits. The life insurance death benefits would no longer be tax free.
The proposal is “the best blueprint for PPLI reform that has been proposed” so far, Luís Carlos Calderón Gómez of Yeshiva University’s Benjamin N. Cardozo School of Law told Tax Notes.
Its focus on the types of investments made — in private companies, private equity funds, and hedge funds, for example — is a good approach “because it gets at the economic heart of the transaction and its abuse: investing tax free in significant amounts in asset classes unavailable to ordinary people,” Calderón Gómez said.
A prior proposal floated by Wyden to address PPLI abuse focused instead on the amount of income and value of assets of individual policyholders. Wyden’s office confirmed in October that new draft legislation was in development.
Both new and existing contracts would be affected by Wyden’s proposal, which would apply to all policies already in place when it is enacted. Policyholders would have 180 days to convert or liquidate their policy assets and would be subject to tax on all prior earnings inside the policies.
“The retroactive application is bold but the right way to go,” according to Calderón Gómez. Excluding existing PPLI from the law or allowing existing asset appreciation in the policies to continue to be tax free “would unjustifiably let people get away with what should have been widely understood to be an abusive transaction,” he said.
No ‘Crack in the Armor’
Life insurance industry stakeholders oppose the legislation.
Finseca CEO Marc Cadin called it “an attack on all forms of permanent life insurance.” Finseca, an industry group representing life insurance and retirement planning professionals, had met with Wyden and his staff “to emphasize the importance of preserving the core tax treatment of life insurance,” Cadin said in a statement.
“Individuals, families and businesses make financial plans based on the long-standing policy for the tax treatment of life insurance and annuities,” American Council of Life Insurers spokesperson Whit Cornman told Tax Notes. “Changing these rules would undermine the certainty they sought from the guarantees that these life insurance products provide.”
The life insurance industry is likely to oppose any change to the tax treatment of even a small subset of policies, according to Gerald Nowotny of the Law Office of Gerald R. Nowotny PLLC, a longtime practitioner in this area.
“A crack in the armor is a crack in the armor,” Nowotny said, adding that “cracks only get bigger; they don’t get smaller.”
Nowotny noted the potential for Wyden’s proposal to be expanded to affect other forms of life insurance that operate similarly to PPLI, including bank-owned life insurance and company-owned life insurance. Domestic corporations use those products to finance corporate employee benefit liabilities, and collectively they hold “tens or maybe hundreds of billions of dollars of assets,” he said.
Wrapping Investments in Insurance
PPLI is a special type of life insurance that is only available to accredited investors, meaning they must have a net worth of more than $1 million, excluding the value of their primary residence, or annual income of over $200,000 ($300,000 for couples).
Sometimes referred to as an “insurance wrapper,” a PPLI policy is structured as a private contract between the insurer and the investor and lets the investor “wrap” an investment portfolio within the life insurance, thus allowing the investor to avoid paying taxes on the buildup of income inside the policy. The arrangement can be structured to allow the policyholder to minimize their estate tax liability.
The draft legislation would separate PPLI policies from traditional life insurance and name them private placement contracts. Life insurance policies would be considered private placement contracts if they’re held in an insurance company asset account with fewer than 25 contracts held by individual investors.
Insurance companies that issue or reinsure the contracts would be required to report them within 30 days from when the contract is issued. Companies that fail to report a contract would face a $1 million penalty for each 30-day period that failure continues.
Information reporting in this area is essential for IRS enforcement, Calderón Gómez said. The nonreporting penalties “are substantial and should hopefully be enough to nudge insurers into reporting,” he said.
If the insurer fails to properly report a contract, the state or local regulator with jurisdiction over the company would be notified, along with the SEC.
The proposal follows a February report from Wyden’s staff, which estimated that at least $40 billion is being held in domestic policies issued by seven of the largest PPLI carriers.
Wyden will be replaced as chair of the Senate Finance Committee by ranking member Mike Crapo, R-Idaho, in January 2025.