On the hunt for more revenue, the Obama administration
is turning its attention to potential new sources lurking in the
life industry, including corporate-owned life insurance and life
settlements. However, the administration faces stiff opposition
from the Republican Party, reports Charles Davis.
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As budget woes worsen in the US, the federal government is
looking in every nook and cranny for new sources of revenue.
While Republicans currently vow to
block any new tax increases, the administration has made it clear
that it will attempt to increase tax rates on three of the life
industry’s most profitable and highest-volume products,
corporate-owned life insurance (COLI) and variable life and
variable annuities (VAs).
The life insurance industry – which
warns of dire consequences to the tax planning of small businesses
and families – is steadfastly opposed to the plan as well. The
industry’s political odds could improve.
In April, a group of 31 of the 37
members of the tax-writing House Ways and Means Committee wrote a
letter to the Obama administration asking it to abandon efforts to
impose any new taxation on COLI as well as limiting life insurers’
dividends-received deduction on variable life and VA products.
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By GlobalDataThe administration replied with a
letter of its own, defending its taxation goals by saying it was
merely trying to end the “tax arbitrage” that results when interest
expense allocable to tax-preferred inside build-up on life
insurance contracts is deductible. Specifically, this refers to the
practice of profiting from differences between the way transactions
are treated for tax purposes. For instance, in the case of VAs, it
means allowing interest expense to build up inside a VA and then
also making the contract tax deductible.
The White House proposal addresses
issues left unmentioned by the COLI best practices provision of the
2006 Pension Protection Act. That provision addressed consumer
protection issues and abuses in the use of COLI by businesses that
had been addressed by courts in the late 1990s and in the early
2000s.
In announcing the proposals in the
administration’s proposed budget for 2012 in February, Treasury
Secretary Timothy Geithner justified the new taxes by saying: “We
are taking the next step in creating fairness in our economy by
ending loopholes that allow companies to avoid paying taxes whilems
of hardworking families and small businesses pay their fair
share.”
The same provisions were included
in administration budgets for fiscal years 2010 and 2011, but each
year, Congress gave them a cold reception, Geithner said.
New tax on
business
The COLI shift would effectively be
a new tax on business, according to a joint statement from the
American Council of Life Insurers, the Association for Advanced
Life Underwriting, the National Association of Insurance and
Financial Advisors, the National Association of Independent Life
Brokerage Agencies and financial services developmental
organisation GAMA International.
In the joint statement the
organisations stated: “The COLI proposal would impose new taxes on
life insurance used by businesses small and large. Many businesses
use COLI to protect against financial or job loss stemming from the
death of owners or key employees. COLI is also used to ensure
business continuation.
“In addition, COLI is a widely used
funding mechanism for employee and retiree benefits. Congress
affirmed the benefits and tax treatment of COLI and ensured its
responsible use in bi-partisan legislation enacted in 2006.”
The administration’s spending plan
would also reduce the dividend received deduction life insurers
utilise in accounts that fund variable life insurance and VA
contracts. The deduction is estimated to be worth $2.4bn over the
next five years.
“With our economy still recovering
from the recent crisis, public policy should encourage families and
businesses to responsibly plan for their financial futures,” the
joint industry statement continued. “The administration’s budget
proposal would have the opposite effect.”
The COLI proposal would deter
companies from deducting the interest expense on the cash value of
life insurance policies they’ve taken out on executives,
effectively taxing the inside buildup of newly sold policies. The
move, proposed a number of times, would be expected to reduce the
federal deficit by $7.7bn between 2012 and 2021.
The proposed change to the
calculation of dividends-received deductions was floated last year
and has been brought back for a second chance as well. The
administration’s measure would reduce the deduction that a life
insurer received based on the proportion of its policyholder
reserves to its separate-account assets.
Life settlements
targeted
Another proposal would step up tax
reporting on life settlements, ensuring the payment of tax on the
death benefits, as well as reporting the sale of the policy to
ensure the seller paid taxes on the proceeds.
Under the new regulation, planned
for introduction in 2012, anyone who purchases an interest in an
existing life insurance contract with a death benefit of $500,000
or more would be required to report the purchase price, the buyer’s
and seller’s taxpayer identification numbers (TIN) and the issuer
and policy number to the Internal Revenue Service (IRS), to the
insurance company that issued the contract and to the seller.
Upon payment of any policy benefits
to the buyer, the insurance company would be required to report the
benefit payment and the buyer’s TIN to the IRS.
Finally, another provision would
hit banks and thrift holding companies with an accountability fee
in order to recoup cash used for the Troubled Asset Relief
Programme.
Even in their present form, if all
were enacted, a team of analysts from stock broking firm Keefe
Bruyette Woods came to the conclusion that they may still have only
a small effect on company profits.
“Although general account DRD
[dividend received deduction] is discussed, our initial reading is
that the proposal, like last year, would primarily affect separate
account DRD,” the analysts wrote.
“As a result, it appears the impact
would fall primarily on companies with material separate account
business.”
Odds are long, however, that any of
the provisions will remain intact, given the fractious politics in
Washington these days.
The Republican Party remains completely opposed to any new
revenue at all, making compromise impossible – at least until the
political will runs headlong into electoral politics.
