Dec 6, 2016
The election results from last month have created a number of questions relative to the taxation of life insurance, and more specifically the taxation of bank-owned life insurance
(BOLI) and corporate owned life insurance
(COLI). Much of the discussion around tax law changes has been focused on various tax reform proposals.
The Republicans have messaged the need for tax law changes for the past couple of years including:
- Former Congressman and House Ways and Means Chairman Dave Camp’s 2014 Draft Tax Reform Proposal (Camp Proposal)
- Current House Majority Leader Paul Ryan’s A Better Way Proposal (Ryan Blueprint)
- President Elect Donald Trump’s Tax Reform that Will Make America Great Again (Trump Plan)
Only the Camp Plan represents full tax reform as it seeks to overhaul much of the Internal Revenue Code of 1986. The Ryan Blueprint is less specific than the Camp Plan and focuses on why tax law changes are needed and a few overriding themes including lowering corporate tax rates. The Trump plan provides even less detail than the Ryan Blueprint and again focusses on overriding themes including the lowering corporate tax rate.
For informational purposes only.
Newport Group Securities, Inc. ("NGS") is both a FINRA-registered broker-dealer and an SEC-registered investment adviser. All securities transactions are provided by the broker-dealer, while all investment advisory services are provided through the registered investment adviser. When offering variable insurance products, Newport Group Securities, Inc. acts solely in its capacity as a broker-dealer. Other insurance products may be offered by Newport Group, Inc. NGS is an affiliated entity of Newport Group, Inc. No guarantee as to investment results. All investments in securities involve risks including possible loss of principal.
With Republican control of both the House and Senate as well as the Presidency, we feel like some form of tax law change is likely to occur during the next two years. Given the plans noted above, much of the work towards making those tax law changes has been completed.
Implications for COLI and BOLI
In order to pay for other tax cuts, the Camp Proposal would eliminate the exception in IRC Section 264(f) which allows BOLI/COLI earnings to grow tax deferred and death benefits to be received tax free. Under the Camp Proposal, earnings on most BOLI and COLI policies would be subject to an interest expense disallowance, which can be particularly punitive to banks.
The Ryan Blueprint makes no mention of life insurance. Although the Trump plan makes no mention of BOLI or COLI, the Plan would phase-out the tax exemption on life insurance for high-income earners, so it is possible BOLI/COLI earnings could be phased out as well. The Trump plan would use the earnings from such phase-out to pay for other tax cuts.
Implications for Corporate Tax Rates
A key theme to each of the plans noted above is a reduction of corporate tax rates, with ultimate corporate tax rates lowering from 35% to 25%, 20% and 15% under the Camp Proposal, Ryan Blueprint and Trump Plan respectively.
Considerations for BOLI Owners and Prospective Purchasers
We feel the likelihood of tax law changes directly impacting the taxation of BOLI/COLI is still remote. Each of President Clinton’s and President Obama’s budget proposals have included language that would repeal/change IRC Section 264(f) and subject BOLI/COLI earnings to interest expense disallowance, but only once during the Clinton Administration did that language even make its way into a Bill. Total ownership of BOLI now exceeds $170 billion and a majority of US banks of all sizes own BOLI. Its use as an employee benefits funding tool are well documented in both banking regulation (Interagency Statement on the Purchase and Risk Management of Life Insurance) and tax law (IRC Section 101(j)). In the unlikely event of a tax law change directly impacting the taxation of BOLI/COLI, we would expect existing policies to be grandfathered.
As lowering the corporate tax rate is a key goal of each plan, we believe some decrease is likely. Given the Republicans desire to present their plans as revenue neutral, we feel a reduction to a 25% corporate tax rate is much more likely than 20% or 15%. Also, the likelihood of any plan’s passage will be dependent on the lowering of middle income individual income tax rates, which will weigh on the overall cost of the plan as well and likely limit the reduction in the corporate tax rate.
COLI and BOLI are purchased with the intent of holding for many decades. Any reduction in corporate tax rates may only be temporary until such time new tax law changes are made based on new leadership or revenue needs. BOLI and COLI are proven assets, with steady earnings growth, low volatility and high credit, and are purchased and owned for long term benefit funding, liability matching, executive benefits and other business reasons beyond any tax advantages.