28 JULY 2002: [SIGH]
New York Times:
I.R.S. Loophole Allows Wealthy to Avoid
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.
anyone willingly pay so much?
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.
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.
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.
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.
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.
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.
selling the policies find them hard to resist they can earn millions
of dollars for selling just one such policy. One of them said that his
small firm’s commissions this year have already reached $20 million.
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.
tax law, money from a life insurance policy goes at death to heirs tax
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.
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.
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.
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.
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.
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.
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 transfers between spouses tax free, so
the gift tax disappears.
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
the biggest insurance 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.
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.
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.
his peers Mr. Blattmachr is renowned for his creativity in finding ways
to pass down fortunes without paying taxes and without breaking the law.
a busy man. Recently he set off to counsel clients in eight cities over
three days a trip made possible by a client who provided him with a private
jet. Afterward he spent the weekend fishing with his brother, Douglas,
whose company, Alaska Trust, helps wealthy Americans set up perpetual trusts,
some of them using Mr. Blattmachr’s insurance plan.
of an insurance plan like Mr. Blattmachr’s paid $32 million in the first
year for a policy that will pay $127 million tax free to the grandchildren,
according to a lawyer who worked on the deal and spoke on condition of
not being identified. No gift taxes were paid.
of such insurance soared after the Internal Revenue Service announced 18
months ago that it was considering restrictions on similar techniques,
which are known as equity split-dollar plans.
premiums for such insurance totaled just $1.1 million in 1999, but ballooned
to more than $80 million last year, state tax records show.
month, when the I.R.S. issued its proposed restrictions, it did nothing
to stop Mr. Blattmachr’s plan.
the proposed I.R.S. regulations can be read as strengthening the validity
of his plan, Mr. Blattmachr and some other estate tax lawyers say.
said that in some cases, when the policy holder dies quickly, both the
government and the heirs come out winners, at the expense of the insurance
is a good deal because both the government and the heirs get 90 percent
of what they could have gotten,” he said.
“We think it is good policy to allow this because it discourages games
like renouncing your citizenship or investing offshore.”
estate tax lawyers and insurance experts think that because Mr. Blattmachr’s
plan is similar to the plans the I.R.S. moved to stop on July 3, it should
be ended as well.
the I.R.S. in 1996 approved the outlines of the Blattmachr plan, these
opponents argue that the plan as sold by agents like Mr. Brown and Mr.
Kreisberg stretches that ruling so far that it no longer provides protection
in an I.R.S. audit.
of them say it is the huge fees for everyone involved that are blinding
their competitors to aspects of the Blattmachr plan that make it vulnerable
to being banned as an abusive tax shelter.
for the insurance agents run between 70 percent and 200 percent of the
first-year premium when it is $1 million or so, while on the jumbo policies
commissions are typically 9 percent to 11 percent, or up to $4.4 million
on a policy with a $40 million first-year premium, Mr. Kreisberg said.
that many peers in the estate tax world say that he earned $100 million
in gross commissions last year, but said, “I wish it were half that.” Mr.
Kreisberg did not dispute a statement by someone with knowledge of payment
records that his small firm’s commissions this year have already reached
who opine on the validity of the deals can also earn big fees. Mr. Blattmachr
gets $100,000 for his basic opinion letter and reportedly has charged as
much as $250,000.
J. Schlesinger of the law firm Kaye Scholer said he passed up a chance
to collect a six-figure fee for advising on one of these deals because
he thinks the deals should not pass muster with the I.R.S. “My mother taught
me that if something seems too good to be true, it isn’t true,” he said.
leading estate tax lawyers, as well as some accountants and insurance agents,
say Mr. Blattmachr’s insurance technique should fail because it is wholly
outside the intent of Congress in giving tax breaks for life insurance,
the I.R.S. ruling on the plan notwithstanding.
I.R.S. understood this they would say that it relies on a disguised gift
and if you have to pay gift taxes, then Jonathan’s insurance deal does
not work,” said an estate partner at a tax firm in New York, who like others,
said they could not be identified because they have signed confidentiality
agreements that are part of all such insurance deals.
legal expert said paying 10 times too much for insurance in a plan like
this reminds him of a matriarch selling the family business to her granddaughter
for $10 million when it was actually worth 10 times that amount. “The I.R.S.
wouldn’t let a family get away with selling the business for a dime on
the dollar,” this lawyer said, “and they should not allow it to work in
reverse through insurance.”