As the legislative session came to a close, outgoing Senate Finance Committee Chair Ron Wyden (D-OR) unveiled a draft proposal to end preferential tax treatment for private placement life insurance policies and annuities. Wyden points to use of private placement contracts by the ultra-wealthy to evade income and gift and estate taxes.
The legislative proposal follows a February 2024 Senate Finance Committee report that found life insurance policies are being promoted to ultra-high net wealth individuals as tax-free hedge and private equity fund investments. Under a private placement life insurance arrangement, an individual buys a life insurance policy, borrows against the policy at a favorable rate — then after the policyholder’s death, wealth is passed to heirs tax-free.
Legislative proposal.
The draft Protecting Proper Life Insurance from Abuse Act would add a new Tax Code section defining private placement contracts as life insurance contracts under Code Sec. 7702, annuity contracts under Code Sec. 72, and variable contracts as defined under Code Sec. 817(d) where the holder meets certain minimum income, education, or license requirements. These contracts would no longer receive the favorable tax treatment provided for life insurance and annuity contracts.
However, an exemption from treatment as a private placement contract would be available where the issuing insurance company supports at least 25 other private placement contracts, and the value of the contract is supported by each asset in the account on a pro rata basis. To avoid a further loophole, the bill calls for treating all private placement contracts held, directly or indirectly, by one holder as a single contract.
Private placement contract holders would be treated, for tax purposes, as having received or accrued any net income, regardless of whether that amount is actually distributed. In addition, any excess distribution would be treated as ordinary income.
Traditional life insurance tax treatment unchanged.
Wyden said life insurance contracts that would fall under the definition of private placement contract constitute just 0.003% of current life insurance policies. He emphasized that the bill would make no change in the tax treatment of traditional life insurance, adding that “[l]ife insurance is an essential source of financial security for tens of millions of middle class families in America.”
The February Senate Finance Committee report looked at the seven top private placement contract carriers and found that just 3,000 Americans hold these types of policies. Meanwhile, of private placement contracts issued by these seven companies, the average death benefit was almost $13 million. For one of those carriers, the average death benefit was $38 million. And in total, the report found that at least $40 billion in private placement policies are held by just a few thousand Americans.
The report also notes that the IRS has an audit campaign targeting private placement insurance policy abuse — specifically, violations of the “investor control doctrine” that requires policyholders to relinquish control over investment decisions related to assets held in a private placement contract to receive favorable tax treatment. However, because interests in a private placement policy don’t need to be disclosed on individuals’ tax returns, the IRS has faced challenges in “simply identifying the individuals” with these policies.
Wyden critiqued private placement life insurance at a September hearing on tax shelters — hinting at the forthcoming proposal. He called private placement policies a “tax shelter that really has nothing to do with life insurance at all.”
He also has spoke out against grantor retained annuity trusts (GRATs), “mega-IRAs,” and the pass-through loophole.
Wyden, along with several other Democrats, is focused on doing away with Tax Code provisions he says disproportionately favor the ultra-wealthy. Outgoing Senate Budget Committee Chair Sheldon Whitehouse (D-RI) has said that loopholes throughout the Tax Code are costing the U.S. “literally trillions of dollars in available revenue.”
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