IRS Tax Audit Strategy

Private placement life insurance is a pre-emptive IRS audit tax strategy that transforms taxable ordinary income and capital gains into tax-free income (with no income tax reporting required under current U.S. Law). Please reference IRS Private Letter Ruling 200244001 (May 2, 2002).

For U.S. Persons with investment income, private placement life insurance provides for compliant, tax-free compounded earnings.

A private placement insurance policy is variable in nature, which allows the insurance company to invest the majority of the premium(s) in a legally separate, segregated account to be managed by either an investment manager of the client's choosing or the insurance company itself. There are no guarantees when it comes to the investment performance (as it varies, so does the death benefit but with a fixed minimum).

The income tax benefits are:

1. Assets inside a life insurance policy grow and compound income tax free.

2. Death benefit paid income tax free.

Domestically in the U.S., investors have traditionally used the tax benefits of variable life insurance policies to invest in mutual funds. In contrast, international private placement life insurance policies allow users to invest in a wider range of investments including hedge funds, private equity, derivatives, and real estate investment trusts (there are functionally no restrictions on the types of investments that can be held and managed inside the policy).

Other benefits include the following:
1. Short-term capital gains (41% Federal/California income tax): exempt from income tax.
2. Bond interest (taxed at 41% ordinary income rates Federal/California): exempt from income tax.
3. Policies in certain jurisdictions (e.g., Cayman Islands): exempt from creditor attachment.
4. IRS audit risks are minimized since assets held under a qualifying life insurance policy are neither subject to income tax, nor is there any required income tax reporting (under IRC §72(e)(5)). In addition to the substantive tax and reporting benefits, for audit purposes there would be no presumed IRS tax avoidance, due to the fact that life insurance has been granted an "angel exception" (i.e., is an IRS approved transaction) (IRS Revenue Procedure 2004-65, 2004-66, 2004-67, 2004-68).
5. Policy lifetime withdrawals may be tax-free and not subject to tax reporting (as either a return of premium/basis or a loan). The Modified Endowment Contract ("MEC") rules may or may not apply depending on policy design.

Residential Capital Gains Strategy For 2009 - Impact of New Law

If you have turned your primary residence into a rental, a second home or a vacation home and are planning to sell it, you should be aware of a new law that changes how capital gains are calculated beginning January 1, 2009. You may want to change your strategy while there is still time.

The Current Law.

Currently, the law excludes up to $250,000 ($500,000 if married filing a joint return) of gain realized on the sale or exchange of a primary residence. The sale of a home qualifies for this exclusion if the home was the primary residence of the tax payer for at least two of the five years ending on the date of sale or exchange. The exclusion applies even if the home was originally purchased as a second home.

The New Law.

Rethink your strategy because on January 1, 2009, the rules will change. President Bush signed The Housing and Economic Recovery Act of 2008 (H.R. 3221) on July 30, 2008. The tax law name of this same law is The Housing Assistance Tax Act of 2008. This law will generate tax revenue by reducing the home sale exclusion, but it also provides a friendly transition for taxpayers.

The law does not allow a taxpayer to claim exclusion for any period of time after December 31, 2008, in which the home is not the main home of the taxpayer. The available exclusion is apportioned in the ratio that the period the home was the primary residence (qualifying use) bears to the period of ownership after December 31, 2008. Any nonqualifying use that occurred prior to January 1, 2009 is ignored. The maximum excludable amount remains at $250,000 or $500,000, depending on your marital status.

An Example.

If a homeowner purchased a house in 2009 for their main home, turned it into a rental property in 2012 and sold it 2014, the property would not have been used as a primary residence for 2 years of the five years it was owned (or 40% unqualified use). Under these circumstances, 40% of the gain realized from the sale would be subject to capital gains tax. The remaining 60% of the gain would be excluded up to the maximum amount allowed.

Temporary Absences.

Being absent from the property for temporary periods of time that are not greater than two years will not threaten the status of a home as a primary residence. A home can still be the primary residence of the taxpayer when he/she is absent because of a change in employment, health conditions or other unforeseeable circumstances.

Time Remains To Do Tax Planning.

Because the new law uses a test period of January 1, 2009 to the date of sale, the highest tax advantage is gained by using the home entirely as a primary residence during this period of time. Taxpayers who are planning to sell a vacation home, a second home or a rental home, may want to discuss with their tax advisors whether to move into the home on or before January 1, 2009, to accumulate as much qualifying use as possible before the home is sold. There is still time to do some planning to gain a tax benefit from this change.
This article is intended to be a general discussion of the topic area and is not to be considered as legal or tax advice for your specific circumstance. Always seek and rely upon the advice of a reputable accountant, tax advisor or tax attorney before taking any action about your personal situation.

This article is intended to be a general discussion of the topic area and is not to be considered as legal or tax advice for your specific circumstance. Always seek and rely upon the advice of a reputable accountant, tax advisor or tax attorney before taking any action about your personal situation.