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Obama Tax Proposal Zooms in on COLI Policies


May 26, 2009

SOURCE: InsuranceNewsNet, Inc.

The Obama administration’s new tax plans – expected to generate almost $13 billion in new tax revenue over the next decade – would restrict numerous tax breaks currently enjoyed by insurance companies and insurance purchasers.

Industry stakeholders are particularly concerned on three separate proposals in the General Explanations of the Administration’s Fiscal Year 2010 Revenue Proposals recently released by the Treasury Department.  The proposals will affect corporate-owned life insurance (COLI), life settlement transactions and tax deductions taken by life insurers for dividends received from investments in other companies' stock. Of the three, the most significant proposal on insurers involves COLI policies.

COLI is a reliable way of funding ongoing employee benefits. Executive, or key person, COLI policies cover the lives of top executives to insure against losing the expertise, knowledge and contacts of top managers that could have a significant financial impact for companies. Broad-based COLI (aka “janitors policies” or “dead peasants insurance”) insure rank-and-file workers. The investment component of these policies allows companies to earn tax-deferred returns while the employee is still alive.

Under the current law corporations are allowed to deduct interest expense on loans taken out to fund premiums of COLI policies, up to certain limitations. Companies can also take out tax-free loans on the policies. All these gains and income are used to fund operations, pay for executive compensation or boost other benefits.

The tax proposal would repeal the exception of the pro rata interest expense disallowance rule for COLI contracts covering employees, officers or directors, except for contracts on the lives of persons owning at least 20 percent of the business. According to the Treasury Department, the tax change was proposed because tax arbitrage benefits result when insurance companies invest in COLIs.  Many critics of COLI policies, including the IRS, see them as a tax dodge because ordinary investments are treated as tax-advantaged funds inside life insurance policies.

"We are taking the next step in creating fairness in our economy by ending loopholes that allow companies to avoid paying taxes while millions of hardworking families and small businesses pay their fair share," Treasury Secretary Timothy F. Geithner said in a statement.

The tax change would cover COLI contracts entered into after the date of enactment of the provision in 2010 or 2011. It is expected to bring in $8.5 billion in fresh tax revenues over the next 10 years.


Kenneth Kies, a tax lobbyist for insurers, said imposing a big penalty on companies using COLI could kill off the business. COLI sales make up more than 20 percent of the all the life insurance sold every year, according to a 2006 report.

This is not the first time COLI policies have been placed under the tax spotlight. Congress has increasingly reduced the amount of interest that can be deducted on debt incurred on COLI policies since the mid-‘80s. Before 1986 interest paid on loan proceeds on borrowing against a COLI policy was, in general, fully deductible. This was reduced by legislators through the Tax Reform Act (TRA) of 1986, the Health Insurance Portability and Accountability Act (HIPAA) in 1996 and the TRA of 1997.  

These reductions were imposed because Congress concluded that it is unfair for companies to be able to borrow funds against the tax-free "inside build up" of COLI and simultaneously be able to deduct the loan interest.

Hundreds of companies have purchased COLI policies on more than 6 million rank-and-file workers and these companies expect to receive more than $9 billion in tax breaks from these policies over the next five years, according to some news reports.

A second tax proposal concerns life settlement transactions. The Treasury noted that compliance is sometimes hampered by a lack of information reporting. In addition, current law exceptions to the transfer-for-value rule may give investors the ability to structure a transaction to avoid paying tax on the profit when the insured person dies.

The tax proposal would require a person or entity who purchases an interest in an existing life insurance contract with a death benefit equal to or exceeding $1 million to report the purchase price, the buyer's and seller's taxpayer identification numbers (TINs), and the issuer and policy number to the IRS, to the insurance company that issued the policy, and to the seller. 

A third proposal that affects life insurance industry attempts to modify dividends-received deduction (DRD) for life insurance company separate accounts. Under current law a life insurance company's separate account assets, liabilities, and income are segregated from those of the company’s general account in order to support variable life insurance and variable annuity contracts. A company’s share and policyholders’ share are computed for the company’s general account and separately for each separate account.

According to the Treasury some private accounts are being used for tax avoidance “that generates controversy between life insurance companies and the IRS.” The tax proposal requires life insurance companies to report to the IRS detailed information about separate accounts that are part of a group in which related persons own at least 10 percent of that separate account’s value. 


© Entire contents copyright 2009 by, Inc.  All rights reserved.  No part of this article may be reprinted without the expressed written consent from


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