Taxation & Estate Planning

STRETCHING THE ENVELOPE TOO FAR

By Charles Rubin

Insurance professionals have an incentive to find creative tax planning opportunities that involve insurance since their compensation is based on sales of policies. Such tax planning usually makes good sense, at least in appropriate circumstances, but sometimes that planning goes too far.

A recent Tax Court decision illustrates a planning arrangement that was marketed to many professionals as a method of generating income tax deductions for life insurance premiums, but which the IRS has successfully challenged in court. The case involved a partnership of 'S' corporations, whose shareholders were employed by the corporations and engaged to provide medical services to the partnership. Under the the Severance Trust Executive Program Multiple Employer Supplemental Benefit Plan and Trust (STEP) arrangement, a purported welfare benefit fund was established to pay severance payments to doctors that ceased to be employed. To fund those payments, the fund purchase life insurance on the lives the participants, which policies had significant cash values. Their 'S' corporations sought to deduct the premium payments as Section 162 business expenses to fund termination compensation.

An excerpt from the case best summarizes the Tax Court's dim view of the arrangement:

While the STEP plan may have been cleverly designed to appear to be a welfare benefits fund and marketed as such, the facts of these cases establish that the plan was nothing more than a subterfuge through which the participating doctors, through [the partnership], used surplus cash of the PCs to purchase cash-laden whole life insurance policies primarily for the benefit of the participating doctors personally. While employers are not generally prohibited from funding term life insurance for their employees and deducting the premiums on that insurance as a business expense under section 162(a), employees are not allowed to disguise their investments in life insurance as deductible benefit-plan expenses when those investments accumulate cash value for the employees personally.

Based on this view, the Court's disallowance of deductions for the premium payments should come as no surprise.

V.R. Deangelis M.D.P.C. & R.T. Domingo M.D.P.C., V.R. Deangelis M.D.P.C., Tax Matters Partner, ET AL. v. Commissioner, TC Memo 2007-360

Full post as published by Rubin on Tax on December 11, 2007 (boomark / email).