Anonymous Writer Criticizes Charity-Owned Life Insurance

Anonymous Writer Criticizes Charity-Owned Life Insurance

Story posted in Intangible Personal Property on 19 May 2004
audience: PGDC Network | last updated: 15 June 2011

Full Text:

Date: Dec. 2, 2003

Susan Brown
Associate Tax Legislative Counsel
Office of Tax Policy
U.S. Department of the Treasury

Ms. Brown --

I know Steve Leimberg, Esq., is planning to offer an editorial on this topic publicly in one of his newsletters, but in my opinion, it needs to be addressed sooner, rather than later.

Although it doesn't seem as egregious as the charitable split dollar concepts, I think it's gaining steam and is also taking advantage of the opportunity to sell big ticket life insurance contracts with the promise of an income tax deduction for what will produce little, if any, return to charity.

This latest trend of "financed life insurance" is being pitched to naive charitable organizations with the promise of "free money", and thus is very attractive to cash-strapped nonprofits. Sometimes it's marketed as CHOLI or FOLI, which is a little like COLI (corporate owned life insurance instead of charity or foundation owned life insurance), but it generally takes on one of two forms.

1. Wealthy donor pledges personal assets; insurance company or bank then loans the donor enough money to buy life insurance with charity as beneficiary, and the loan is subsequently repaid from death benefits, assuming the proceeds are adequate to repay the loan.

2. Charity pledges its assets and borrows money from lenders to purchase life insurance on any number of the charity's donors (sort of like a dead pool), with debt repaid by death benefits.

In short, noncharitable businesses are generating income with what's being called a deductible charitable planning tool. From my perspective, it looks like:

1. the charity is selling its exclusive insurable interest in order to generate profit for commercial lenders in a transaction that has little economic benefit other than to churn money around and generate large premium payments, so private inurement or personal benefit seems to be the problem here.

2. if the charity is receiving income from borrowed money, that looks like debt financed income/UBIT.

3. life insurance has, as a risk management tool, its special tax treatment because it serves the public good, but this program amounts to wagering since the lender benefits from selling a larger than average policy that has no relationship to economic risk, and the charity is left with little, or nothing, after all expenses are paid.

Should the IRS issue a warning about these abuses, rather than some cryptic comments about economic substance, it might derail some of the promotional efforts.

The following note (in italics) is from a colleague yesterday asking for some ideas on this concept; he's uncomfortable with the ethics of the deal, so he asked me for an opinion on the legitimacy of the planning.

I had a question from someone today about the ins and outs of FOLI/CHOLI. They have been approached by someone from * * * with a plan to finance 1,000 life policies for $250K apiece. They are looking for a competing organization to play one against the other. Do you know of any groups that are marketing this?

"Competing organization" is code speak for a gullible charity to front the program to benefit the insurance company. It figures that the ethical lapses at * * *, would spill over to their insurance line. I had hoped that i could kick some dust up at the IRS and get someone to look at this stuff before it gets out of hand.

* * *


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