Congressional tax writers and the Obama Administration continue to debate the tax treatment of corporate-owned life insurance (COLI). While upcoming congressional midterm elections will likely slow progress toward reform of the Internal Revenue Code (IRC), a proposal that would indirectly impose a tax penalty on COLI owners is being considered for inclusion in draft tax reform language.
The proposed revenue measure (“the proposal”) is an expansion for the pro rata interest expense disallowance for COLI.
The proposal has been included in the revenue provision of every presidential budget dating back to fiscal 2010. And, it is expected to reappear in Obama’s 2015 budget, which is slated for release on March 4.
Essentially, the proposal would apply the interest deductibility disallowance provisions of IRC 264(f) to the interest deductions of all corporate taxpayers, allocable to unborrowed life insurance policy cash values, regardless of any connection between the policy and a corporation’s debt.
Here’s how this could play out for a corporation: A corporation purchases COLI to secure employee benefits. Fifteen years after the purchase of the policy, the corporation borrows money, unrelated to its COLI policy, to fund a business expansion. Under this proposal, the corporation’s deduction for the interest paid on the business expansion loan would be disallowed by a ratio that reflects the extent of the unborrowed cash value of the corporation’s COLI policy to all assets of the corporation.
There are many problems with this proposal:
- It could create a detriment to life insurance ownership and the use of COLI.
- It reflects a misunderstanding and lack of recognition of past legislative and regulatory initiatives pertaining to COLI.
- It involves improper expansion of the IRC rule that imposes the existing pro-rata interest expense disallowance for select and disfavored COLI policies.
Republicans argue that the proposal could unnecessarily penalize life insurance ownership and undermine the public policy objectives fulfilled by COLI. It could cost jobs and hurt employees; discourage savings and protection; and cause unnecessary tax penalties.
As Obama’s 2015 budget is slated to be released on March 4, be sure to stay tuned and contact us for more information on how these changes may affect your corporation. We encourage you to contact Charles J. Farro. Chuck is the president and co-founder of Marsh & McLennan Agency formerly Benefits Resource Group. You can contact him by phone at 216-393-1818 or by email at firstname.lastname@example.org.