Different Uses of a Tax Shield

PPLI: Two Sides of One Face, Part I 

Tax Shield concepts are best understood by comparing similar Private Placement Life Insurance (PPLI) concepts.  In our specialty, PPLI structures for wealthy international families, an article caught our attention that highlights our topic–the difference between PPLI structuring for families strictly in the U.S. context, and those structures that work best for international families.

Our topic is much like the picture of this cat: two sides that have something in common, yet also something that can be very different.

The international families we work with may have ties to the U.S. like U.S. beneficiaries, real estate, or investments, but they also have substantial wealth outside the U.S.  Our firm is able to create structures for these international families that have a very robust character.  An odd phrase for international tax planning, but as you will read below, this robust character allows our firm many more possibilities than we have for our clients who are U.S. persons and just have holdings inside the U.S.

The article mentioned above is “Private Placement Life Insurance Primer, Recent tax law changes make for a particularly interesting time to explore PPLI,” by Brian Gartner and Matthew Phillips.

In the structuring process, one decision that is made early on in the process is whether to put the policy under U.S. tax and insurance rules (a so-called 953(d)) policy, or that of the country where the insurance company is domiciled, usually Bermuda or Barbados, a non-953(d) policy.  If we can use a non-953(d) policy, we have much more flexibility in the structuring process.

In the picture of the cat, the two blue eyes are blue, and contrast to the black and gray sides of the face.  For our discussion, the two blue eyes are what is similar to both 953(d) policies and non-953(d) policies.  So we will look into the eyes of our topic first, and discuss the similarities.

A key element in our two policy types is the tax deferral of the assets inside the policy.  This chart, courtesy of the article mentioned above, is an example of U.S. centric planning. It shows how powerful tax deferral can be in terms of what an investor keeps after taxes. The chart compares a  Taxable Investment vs. placing those same assets inside a properly constructed PPLI policy.

Another aspect where we look into the same pair of eyes and see something similar relates to trust planning with PPLI.  We quote from the article:

“Trustees are attracted to PPLI in the context of multi-generational trust planning for three main reasons: (1) assets within a trust allocated through PPLI grow on an income tax-deferred basis; (2) the trustee can make income tax-free distributions to trust beneficiaries from PPLI without having to consider the income tax consequences of liquidating assets; and (3) the trust will eventually receive an income tax-free insurance benefit, which will serve to effectively step-up the basis of the assets within the trust that are allocated through PPLI.”

In our next blog we will discuss how using a non-953 policy works with the investor control and diversification requirements of the U.S. tax code.

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 by Michael Malloy, CLU TEP, @ Advanced Financial Solutions, Inc

 

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Chinese + Investor Control + PPLI = Success

Part II: EWP Chinese Case Study

Expanded Worldwide Planning (EWP) with the right fact pattern can deliver a Private Placement Life Insurance Policy (PPLI) which gives clients the control they wish.  In the much discussed Webber v. Commissioner, U.S. Tax Court case, the policy issued by the offshore company had a 953(d) election, therefore, the issues of investor control and diversification were of paramount importance.  What if the PPLI policy had been a non-953(d) issued PPLI policy?

For international clients with no connection to the U.S., a non-953(d) policy suits their needs perfectly.  So where does that leave us on the investor control issue?  It eliminates it, along with the diversification requirement under the U.S. tax code.  Why?  Because, if the insurance company was domiciled in Barbados, we are using the Barbados tax and insurance code. For this jurisdiction there are no investor control and diversification requirements.

Let us use a Chinese family as a case study.  Mr. Lee’s wealth had been generated from steel manufacturing in China. Over the years he has used various offshore structures.  Mr. Lee is now concerned with CRS and the fact than these offshore structures will now be reported to Chinese tax authorities.  Using EWP and a properly structured PPLI policy, the insurance company will become the beneficial owner of the assets inside the PPLI policy.

If ties develop to the U.S. through Mr. Lee’s daughters, who are attending school in the U.S., we can also issue a 953(d) PPLI policy to benefit them and shield them from tax. By using an EWP structure, Mr. Lee and his family can keep their affairs private, tax efficient, and tax compliant.

Now back to the Webber case. The most comprehensive article on investor control, as it pertains to PPLI policies, that I have read is by Steven Horowitz. The article is impressive both in terms of the detailed analysis of investor control, and the conclusions that Mr. Horowitz reaches.  We quote one of his key points below, and invite you to read the full article,

“I truly believe that the Service should have lost the case on the issue of investor control, but not because of the fact that the investor/ Taxpayer did not exercise too much control. Rather, the case should have been decided based upon the one major point of law, namely: Jeffrey T. Webber did not own the policy. The body of case law and revenue rulings, right or wrong, provides that it is the “policyholder/ owner of the contract” (See, Rev. Rul. 82-54, 1982 C.B. 11), must be the one who has exercised the excessive control over the investments within the contract. The Code provisions and historical body of tax law which govern the tax treatment of life insurance policies and annuity contracts provides in pertinent part as follows in a very clear fashion, the relevant language is as follows: the Policy Holder and owner of the contract are the parties who may not exercise an overabundance of control over the investments within the contract. As Mr. Webber was not the owner of the policy or policyholder (without application of the grantor trust rules), then the Court could not reach the conclusion that it reached without first dealing with the issue of grantor trust status (which would have made Mr. Webber the “Owner” for all federal income tax purposes), (See Rev. Rul. 85-13, 1985-1 C.B. 184).”

Most wealth owners wish structures where they maintain control of their assets. They also wish to keep their affairs private, tax efficient, and tax compliant. Using EWP and a properly structured PPLI policy, it is possible to achieve all these aims.

Please let us know how we can assist you in using these structures.  Our experienced staff is here to serve you.

 

 by Michael Malloy, CLU TEP, @ Advanced Financial Solutions, Inc