The tax benefits of making investments through private placement life insurance (“PPLI”), including investments in hedge funds, are very significant (i.e., the potential elimination of income tax and possibly estate tax as well). For information on the tax benefits and risks of PPLI click here to see the chapter written by partner Jeff Bortnick from The PPLI Solution.
The IRS has long maintained that to achieve the tax benefits of tax-free inside build-up in a life insurance policy the taxpayer must not retain sufficient control and incidents of ownership over the assets in the separate account of the insurance company so as to be treated as the owner of those assets for income tax purposes. For the last 30 years it has not been clear that the IRS has had the authority to impose this doctrine. Last week, the Tax Court in Webber v. Commissioner, a decision filed on June 30, 2015, upheld the IRS’s imposition of tax on investment returns based on the investor control doctrine, but refused to apply any penalties.
The application of the investor control doctrine is very fact specific and the Court, in a very lengthy opinion, determined that Webber effectively dictated the investments made by the insurance company separate accounts.
This case should not affect the tax benefits for properly structured PPLI or annuities. However, it increases tax risks for any policyholder who has control over the underlying investments.