I.R.S. Loophole Allows Wealthy to Avoid Taxes
By DAVID CAY JOHNSTON
In recent months some of the wealthiest older Americans have been buying huge life insurance policies on themselves. Curiously, these people have shopped not for the cheapest rates but for the highest rates they can find. In some cases, they delightedly pay 10 times the lowest rates for that insurance.
Why would anyone willingly pay so much?
Through a technique invented by a lawyer in New York and a chemical engineer in California, each dollar spent on this insurance can typically eliminate $9 in taxes. Spend $10 million on this insurance, avoid $90 million or more in income, gift, generation-skipping and estate taxes.
"I'm not saying this is the best thing since sliced bread, but it's really good for pushing wealth forward tax free," said Jonathan G. Blattmachr, the New York lawyer who heads the estate tax department at Milbank, Tweed, Hadley & McCloy and who explained the plan in a half-dozen interviews.
The technique is legal, blessed by the I.R.S. in 1996. But some leading estate tax lawyers, as well as some accountants and insurance agents, say it shouldn't be. They say it effectively disguises a gift to one's heirs that should be taxed like any other gift involving millions in wealth. They also say it is but one example of how a tax exemption on life insurance that was approved by Congress in 1913 to help widows and orphans has been stretched to benefit the very richest Americans.
Several thousand of these jumbo policies have been sold, according to agents who sell them, all under confidentiality agreements with the buyers and their advisors. One member of the Rockefeller family took out a policy, according to people who have seen documents in the deal.
The several billion dollars of this insurance already sold, much of it in the last 18 months, means that tens of billions of taxes will not flow into federal and state government coffers in the coming decade or so.
In recent months, policies with first-year premiums alone of $4.4 million, $10 million, $15 million, $25 million, $32 million and $40 million have been sold by New York Life Insurance, Massachusetts Mutual Life Insurance and other underwriters, according to insurance agents, accountants and tax lawyers who have worked on these deals.
The agents selling the policies find them hard to resist — they can earn millions of dollars for selling just one such policy. One of them acknowledged that his small firm's commissions this year have already reached $20 million.
The technique works this way. An older person — typically someone who does not expect to live long and who has at least $10 million and usually much more — wants to avoid estate taxes, which are 50 percent with such fortunes.
Under tax law, money from a life insurance policy goes at death to heirs tax free.
The premium paid on that life insurance is considered a gift to those heirs. Any annual premium that exceeds $11,000 is therefore subject to the gift tax of 50 percent. Only the wealthiest Americans pay such large premiums and are subject to this tax.
The new technique sidesteps the gift tax in a two-step process. First, the person who is buying the policy reports on his tax return only a small portion of what he really paid in premiums.
Wouldn't the I.R.S. say that is cheating? No. It's perfectly legal. The reason is that insurance companies offer many different rates for the same policy. And the buyer is allowed to declare on his tax return the insurance company's lowest premium for that amount of insurance, even if that person could never qualify for that rate because of his age and health, and even if no one has actually ever been sold a policy at that rate.
A low premium means a low gift tax. But in fact the buyer has really paid the very highest premium offered by that insurer for that amount of insurance. The insurer then invests the difference between the highest premium and the lowest premium. That investment grows tax free, paying for future premiums on the policy. At death, the entire face value of the policy is paid tax free to heirs.
In an example cited by one agent, a customer paid a $550,000 premium for the first year alone, the highest price offered by the insurance company, for a policy that was also offered at $50,000, the lowest price. So $550,000 can be passed on to heirs tax free. Yet the gift tax is only $25,000 — 50 percent of the lowest premium, instead of $275,000, which is 50 percent of the highest premium.
The I.R.S. would not comment officially. But an I.R.S. official who specializes in insurance matters said he had not heard that so many people were exploiting this loophole. He could not say whether the issue would be re-examined.
The deal gets better because of a second step. Under this technique, even that $25,000 tax can be avoided by shifting the gift-tax obligation to the spouse through a trust. In 1982, Congress made all transfers between spouses tax free, so the gift tax disappears.
If the policy holder continues to pay huge premiums year after year, he can pass along much or all of his fortune tax free if he lives long enough. In fact, Michael D. Brown of Spectrum Consulting in Irvine, Calif., said, many clients in their 50's and 60's, working with other agents, are now trying to do just that.
By far the biggest deals have been made by two insurance agents who work together, Mr. Brown, a former chemical engineer, and Louis P. Kreisberg of the Executive Compensation Group in Manhattan.
The technique was devised in 1995 by Mr. Blattmachr and Mr. Brown. Mr. Blattmachr has since expanded his idea and other estate tax lawyers have copied his methods.
"In 1995 I was told that this was the stupidest idea ever by a guy who is now collecting millions in commissions from selling" such insurance, Mr. Blattmachr said.
Among his peers Mr. Blattmachr is renowned for his creativity in finding ways to pass down fortunes without paying taxes and without breaking the law.
quote:wants to avoid estate taxes, which are 50 percent with such fortunes.
Read: "wants to avoid DEATH taxes, where the government takes up to 50% of every penny you or your family spent their entire life/lives working for."
Beats the hell out of me why ANYONE would be for a DEATH TAX of any kind. Where does the equal representation fall into this when the person is DEAD!!??!?!?!?!?!?!?!
The only greed I see here is on the part of the government who will surely take that money and immediately shove it down the toilet!! Hurrah for those that take every advantage of the loop-holes in the tax code, THAT is patriotic to me!!