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Often feeling like a lone voice in the wilderness, I have written for several years about abuses involving so-called Private Placement Life Insurance (PPLI) policies. These are usually very large life insurance policies, not available to the unwashed masses, that were originally designed for the dual purpose of eliminating commissions – and thus getting more money into the policy – and acting as a tax-free sponge to absorb negative tax implications of arbitrage hedge funds, which often threw in more taxes than they earned. After the IRS cracked down on PPLI abuses involving hedge funds, PPLI policies became a slightly different type of tax shelter, where they absorbed the taxes dumped by privately operated businesses while allowing the business owner to access the money through policy loans.
As part of my writings a few years ago, I noted that Senate Finance had finally addressed the subject of PPLI in my article, Senate Finance’s Senator Wyden Announces Investigation into Abuse of Private Placement Life Insurance (PPLI) Transactions (Aug 23 2022). Today we look at the results of that investigation, as Senate Finance has now released its report, Private Placement Life Insurance: A Tax Shelter for the Ultra-Wealthy Masquerading As Insurance (Sen. Finance, 21 February 2024), which you can read for yourself here .
The Committee’s investigation involved obtaining information from major insurance companies providing PPLI policies. The committee found that PPLI policies now protect at least $40 billion from taxes, but it is not a shelter that is available to everyone. Only the wealthiest 0.1% of Americans can take advantage of PPLI policies. The average income of PPLI buyers is about $7.5 million for the years 2019 to 2021, and their average net worth is between $100 million and $150 million. So PPLI is not exactly something that benefits the common man on the street. Also, since PPLI products are usually purchased through estate planning trusts, not only do they avoid income taxes entirely, but there will also be no estate taxes when the PPLI policy is paid out to the beneficiary on death. So, PPLI policies create a completely tax-free shelter.
But that’s not all. The committee also found that PPLI policies are also often used to stash money overseas because PPLI policies do not generate mandatory reporting under the Foreign Account Tax Compliance Act (FATCA) or other forms of taxation (unless the owner don’t do anything really weird, which of course the owner will avoid doing). Although an offshore PPLI requires a US person who owns such a policy to file a Statement of Foreign Bank and Financial Accounts (FBAR), there is really no way for the IRS to verify that this has been done. Thus, offshore PPLI policies can be an ideal vehicle for so-called “dark money” or to facilitate other previously recognized abuses of tax havens.
The committee report then said the committee would then explore what legislation could be passed to stop the use of PPLI as a tax haven, without giving much detail on what that legislation would look like. The report does not indicate that similar litigation should also concern similar tax abuses by PPLI’s twin brother, Private Placement Annuity Contracts (PPAPPA). Proposals are being 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 improved and finally there should be strict penalties for misusing these policies. Notably, the Committee proposes that the new legislation should apply to both new and existing PPLI and PPA policies so that there is no ‘obsolescence’ of benefits.
ANALYSIS
Welcome to Congress, where they don’t bother to close the yard door until several generations of horses have already escaped. Such is the case with PPLI, whose abuses were known as far back as 1998, but the IRS has been forced to play a molehill against this tax haven ever since because Congress turned a blind eye to it all—no doubt because the very people who use PPLI to avoid their taxes, of course, are megadonors for both countries. Taxes for you, not the one who cuts me checks.
Since the committee will not make specific recommendations, let me add a few of my own. The first has to do with the laudable purpose of life insurance, which is to provide for families when their dependent dies. As the report shows, the people abusing PPLI products are already ultra-rich, the top 0.1%, and don’t really have a legitimate need for life insurance in such huge amounts. If any of these people die, their heirs won’t be clipping coupons to buy discount pizza. For these people, PPLI is nothing more than a tax shelter and wealth transfer tool, nothing more, nothing less. Thus, what I would suggest is that each person can have a total of the face value of their life insurance in some amount that is significant to the other 99.9% of Americans, say $20 million, index that amount for inflation and then if they exceed that amount in life insurance, none of their policies will qualify as a life insurance policy for tax purposes. I would also apply this to PPA products as long as their death benefit exceeds that number as well.
The next problem is the ubiquitous tactic of cramming existing businesses into PPLI policies so that their dividends and distributions are absorbed 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, that have a minimum of 100 unrelated investors.
These are just two obvious solutions I came up with while shooting from the hip, but give me a little more time and I could probably come up with a few more good ones, such as messing around with the rules for modified donation contracts (the MEC rules ) that require the death benefit on a life insurance policy to be X greater than the cash value of the policy, and also by limiting the amount of cash that can be borrowed tax-free from life insurance policies.
Cheaters will cheat. Of course, PPLI and PPA are not the last tax shelters we will see, but compared to the two most recent audits of the IRS program, because they are microcaptive and syndicated conservation easements, PPLI and PPA are even more abusive, though and limited to a smaller universe of buyers. Hopefully this time Congress will do something to crack down on these shelters, but I’m not holding my breath.
Something about accepting megadonors.
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