Private Placement Life Insurance or PPLI – Expect Greater Focus from U.S. Authorities

I have written about PPLI many times before.  Here’s the ultimate guide . 

Let’s take another look at the subject.  Leaked documents obtained by the International Consortium of Investigative Journalists show private placement life insurance (PPLI) structures set up in so called offshore tax havens like Belize and the Cayman Islands. Meanwhile, states like Alaska, Delaware, South Dakota, and Wyoming have been cutting taxes to lure those policies from offshore jurisdictions.

Senate Finance Committee Chair Ron Wyden, D-Ore., says PPLI is one way to leverage the strategy known as “buy, borrow, die” in which investors can limit their tax liability, grow their wealth, and pass it on tax free. The committee believes that at least $40 billion is being sheltered in 3,061 domestic PPLI policies. Critics say the strategy contributes to wealth inequality.

The investigation found that PPLI represents just 0.003 percent of all individual life insurance policies in force in the United States. The IRS is largely unable to enforce investor control rules in place to prevent the abuse of tax-advantaged financial products like PPLI. At the moment, there is no requirement to report ownership of PPLI on a tax return, allowing wealthy investors to use PPLI to shield lucrative investments in alternative assets from scrutiny by the IRS. The report on Senator Wyden’s investigation includes a framework for forthcoming legislation that will curb the use of PPLI as a tax shelter. 

The full report from the Senate Finance Committee had the following key findings: 

• The PPLI industry is now a tax shelter made up of at least $40 billion in policies held by only a few thousand wealthy Americans.
• Unlike traditional insurance policies, PPLI policies are an ultra-niche financial product that is not available to middle-class families.
• PPLI policies are actively promoted to ultra-wealthy Americans as tax-free hedge and private equity fund investments.
• PPLI policies are actively promoted to millionaires and billionaires as a way to transfer significant wealth to their heirs while bypassing income, gift and estate taxes.
• Guardrails against abuse of PPLI policies are nearly impossible for the IRS to enforce due to a lack of disclosure requirements.
• The IRS should increase scrutiny of the PPLI industry’s compliance with investor control rules.
• Legislation is needed to increase oversight of PPLI and curb abuse of these products as tax avoidance by the wealthiest 1 percent of Americans.

Some of the challenge may relate to the nature of the transactions. PPLI issues might end up in different divisions of the IRS without directly encountering anyone with the expertise needed to challenge them.

The Justice Department has prosecuted cases involving life insurance wrappers in partnership with the IRS Criminal Investigation division in which PPLI is used for tax evasion. However, the issue with PPLI “boils down to investor control”.

Investor control — a term that means a taxpayer exercises too much control over the assets in the policy’s segregated account — can be a problem for PPLI policies, making them ineligible for tax benefits that are attractive to high-net-worth individuals and families.

The Tax Court defined the investor control doctrine in 2015 in Webber v. Commissioner, which concerned a taxpayer that arranged and funded PPLI policies from an insurer based in the Cayman Islands. In that case, the court ruled that the taxpayer — who exchanged more than 70,000 emails directing specific investments (including start-ups in which he had a personal interest) for the policies — had exercised too much control over the policy assets, so he owed taxes on the accumulated gains.

Individuals who take out domestic PPLI policies aren’t required to disclose them on their tax returns, making them difficult for the IRS to see.   The IRS has no visibility into who owns a domestic PPLI policy unless it comes up in an audit.  It is believed that the audit rates are almost zero.  

Even insurance specialists at the IRS may not have been informed about how PPLI arrangements work and how to look for them. Offshore PPLI policies are subject to reporting requirements under FATCA, and policyholders are required to file FBARs with Treasury.

Although individuals must disclose their ownership of an offshore PPLI policy by filing an FBAR, the requirements are less clear for financial institutions.

Although offshore PPLI policies should be disclosed on FBARs, some taxpayers don’t report them.

Expect greater attention from both legislators and the IRS going forward.