Often feeling like the lone voice in the wilderness, I have written about abuses involving so-called Private Placement Life Insurance (PPLI) policies for some years. These are typically very large life insurance policies not available to the unwashed masses which were originally designed for the dual purpose of eliminating commissions ― and thus putting more money to work inside the policy ― and to act as a tax-free sponge to soak up the negative tax consequences of arbitrage hedge funds that were frequently throwing off more taxes than they were making in profits. After the IRS cracked down on PPLI abuses involving the hedge funds, the PPLI policies then morphed into a slightly different type of tax shelter where they absorbed the taxes thrown off by private operating businesses while allowing the business owner to access the cash by policy loans.
As part of my writings, a couple of years ago I noted that Senate Finance had finally taken up the topic of PPLI in my article, Senator Wyden At Senate Finance Announces Investigation Of Abusive Private Placement Life Insurance (PPLI) Transactions (Aug. 23, 2022). Today we will examine the fruits of that investigation, as Senate Finance has now published its report, Private Placement Life Insurance: A Tax Shelter For The Ultra-Wealthy Masquerading As Insurance (Sen. Finance, Feb. 21, 2024), which you can read for yourself here.
The Committee’s investigation included obtaining information from major insurance company providers of PPLI policies. The Committee found that PPLI policies are now sheltering at least $40 billion from taxes, but this is not a shelter that is available to everybody. Only the wealthiest 0.1% of Americans are able to take advantage of PPLI policies. The average income of PPLI purchasers was around $7.5 million for the years 2019 through 2021, and their average net worth was between $100 million and $150 million. So, PPLI isn’t exactly something that is benefitting the average man on the street. Further, because PPLI products are usually purchased through estate planning trusts, not only do they avoid income taxes completely but also there will be no estate taxes when the PPLI policy pays out to the beneficiary at death. So, PPLI policies create a totally tax-free shelter.
But that’s not all. The Committee also found that PPLI policies were also frequently used to hide money abroad, since PPLI policies do not generate any mandatory Foreign Account Tax Compliance Act (FATCA) reporting or any other tax forms (unless the owner does something really funky, which of course the owner will avoid doing). While offshore PPLI does require a U.S. person who is the owner of such a policy to file a Report of Foreign Bank and Financial Accounts (FBAR), there really is no way for the IRS to verify that such has been done. Thus, offshore PPLI policies can be an ideal vehicle for so-called “dark money” or to facilitate other previously-recognized abusive tax shelters.
The Committee’s report then goes on to say that the Committee will next explore what legislation may be adopted to stop PPLI from being used as a tax shelter, without giving much in the way of specifics as to what that legislation would look like. The report does not that any such litigation should also address similar tax abuses by PPLI’s twin brother, which is private placement annuity (PPAPPA) contracts. Suggestions are made that some PPLI and PPA policies should not be treated as life insurance or annuities for tax purposes, reporting requirements all PPLI and PPA policies should be enhanced, and finally that there be stiff penalties for the abuse of these policies. Notably, the Committee suggests that new legislation should apply to both new and existing PPLI and PPA policies such that there is no “grandfathering” of benefits.
ANALYSIS
Welcome to Congress, where they don’t bother to close the barnyard door until several generations of horses have already escaped. Such is the case with PPLI, whose abuses were known as early as 1998 but the IRS has been forced to play whack-a-mole against this tax shelter ever since because Congress turned a blind eye to it all — doubtless because the very folks who use PPLI to dodge their taxes are of course megadonors to both parties. Taxes for thee, not for who is cutting checks to me.
Since the Committee will not give specific recommendations, let me throw in a couple of my own. The first relates to the laudable purpose of life insurance, which is to provide for families when the breadwinner passes away. As the report indicates, the folks who misuse PPLI products are already super-wealthy, the top 0.1%, and don’t really have a legitimate need for life insurance in such huge amounts. If one of these folks die, their heirs are not going be cutting coupons to buy discount pizza. For these folks, PPLI is nothing more than a tax shelter and a wealth transfer tool, nothing more, nothing less. Thus, what I would suggest is that any person may have an aggregate amount of the face value of their life insurance in some amount that is sizeable for the other 99.9% of Americans, say $20 million, index that amount to inflation, and then if they exceed that amount in life insurance, none of their policies will qualify as life insurance policies for tax purposes. I would also apply this to PPA products to the extent their death benefit exceeds this number as well.
The next problem is the ubiquitous tactic of stuffing operating businesses into PPLI policies such that their dividends and distributions are soaked up by the tax-free nature of the policy. To combat this, I would suggest that all variable life insurance (VUL) and variable annuity (VA) policies be limited in their investments to only those companies, including mutual funds and hedge funds, which have a minimum of 100 non-related investors.
These are just two obvious solutions that I came up with while shooting from the hip, but give me some more time and I could probably come up with a few more good ones, such as by tinkering with the rules for Modified Endowment Contracts (MEC rules) which require that a life insurance policy’s death benefit be X larger than the cash value of the policy, and also by restricting the amount of cash that may be borrowed tax-free from life insurance policies.
Cheaters gonna cheat. Certainly, PPLI and PPA are not the last tax shelters that we will see, but compared to the two most recent IRS program audits, being microcaptives and syndicated conservation easements, PPLI and PPA are even more abusive albeit limited to a smaller universe of purchasers. Hopefully, this time Congress will do something to crack down on these shelters, but I’m not holding my breath.
Something about taking on megadonors.
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