In recent months some of the wealthiest older Americans have been buying huge
life insurance policies on themselves. Curiously, these people have shopped not
for the cheapest rates but for the highest rates they can find. In some cases,
they delightedly pay 10 times the lowest rates for that insurance.
Why would anyone willingly pay so much?
Through a technique invented by a lawyer in New York and a chemical engineer
in California, each dollar spent on this insurance can typically eliminate $9
in taxes. Spend $10 million on this insurance, avoid $90 million or more in income,
gift, generation-skipping and estate taxes.
"I'm not saying this is the best thing since sliced bread, but it's really
good for pushing wealth forward tax free," said Jonathan G. Blattmachr, the New
York lawyer who heads the estate tax department at Milbank, Tweed, Hadley &
McCloy and who explained the plan in a half-dozen interviews.
The technique is legal, blessed by the I.R.S. in 1996. But some leading tax
lawyers, as well as some accountants and insurance agents, say it shouldn't be.
They say it effectively disguises a gift to one's heirs that should be taxed like
any other gift. They also say it is but one example of how a tax exemption on
life insurance that was approved by Congress in 1913 to help widows and orphans
has been stretched to benefit the very richest Americans.
Several thousand of these jumbo policies have been sold, according to agents
who sell them, all under confidentiality agreements with the buyers and their
advisors. One member of the Rockefeller family took out a policy, according to
people who have seen documents in the deal.
The several billion dollars of this insurance already sold, much of it in
the last 18 months, means that tens of billions of taxes will not flow into federal
and state government coffers in the coming decade or so.
In recent months, policies with first-year premiums alone of $4.4 million,
$10 million, $15 million, $25 million, $32 million and $40 million have been sold
by New York Life Insurance, Massachusetts Mutual Life Insurance and other underwriters,
according to insurance agents, accountants and tax lawyers who have worked on
The agents selling the policies find them hard to resist they can
earn millions of dollars for selling just one such policy.
The technique works this way. An older person typically someone who
does not expect to live long and who has at least $10 million and usually much
more wants to avoid estate taxes, which are 50 percent with such fortunes.
Under tax law, money from a life insurance policy goes at death to heirs tax
free. The premium paid on that life insurance is considered a gift to those heirs.
Any annual premium that exceeds $11,000 is therefore subject to the gift tax of
50 percent. Only the wealthiest Americans pay such large premiums and are subject
to this tax.
The new technique sidesteps the gift tax in a two-step process. First, the
person who is buying the policy reports on his tax return only a small part of
what he really paid in premiums.
Wouldn't the I.R.S. say that is cheating? No. It's perfectly legal. The reason
is that insurance companies offer many different rates for the same policy. And
the buyer is allowed to declare on his tax return the insurance company's lowest
premium for that amount of insurance, even if that person could never qualify
for that rate because of his age and health, and even if no one has actually ever
been sold a policy at that rate.
A low premium means a low gift tax. But in fact the buyer has really paid
the very highest premium offered by that insurer for that amount of insurance.
The insurer then invests the difference between the highest premium and the lowest
premium. That investment grows tax free, paying for future premiums on the policy.
At death, the entire face value of the policy is paid tax free to heirs.
In an example cited by one agent, a customer paid a $550,000 premium for the
first year alone, the highest price offered by the insurance company, for a policy
that was also offered at $50,000, the lowest price. So $550,000 can be passed
on to heirs tax free. Yet the gift tax is only $25,000 50 percent of the
lowest premium, instead of $275,000, which is 50 percent of the highest premium.
The I.R.S. would not comment officially. But an I.R.S. official who specializes
in insurance matters said he had not heard that so many people were exploiting
this loophole. He could not say whether the issue would be re-examined.
The deal gets better because of a second step. Even that $25,000 tax can be
avoided by shifting the gift-tax obligation to the spouse through a trust. In
1982, Congress made all transfers between spouses tax free, so the gift tax disappears.
If the policy holder continues to pay huge premiums year after year, he can
pass along much or all of his fortune tax free if he lives long enough. Michael
D. Brown of Spectrum Consulting in Irvine, Calif., said, many clients in their
50's and 60's, working with other agents, are now trying to do just that.
By far the biggest deals have been made by two insurance agents who work together,
Mr. Brown, a former chemical engineer, and Louis P. Kreisberg of the Executive
Compensation Group in Manhattan.
The technique was devised in 1995 by Mr. Blattmachr and Mr. Brown. Mr. Blattmachr
has since expanded his idea and other estate tax lawyers have copied his methods.
"In 1995 I was told that this was the stupidest idea ever by a guy who is
now collecting millions in commissions from selling" such insurance, Mr. Blattmachr
Among his peers Mr. Blattmachr is renowned for his creativity in finding ways
to pass down fortunes without paying taxes and without breaking the law.
He is a busy man. Recently he set off to counsel clients in eight cities over
three days a trip made possible by a client who provided him with a private
jet. Afterward he spent the weekend fishing with his brother, Douglas, whose company,
Alaska Trust, helps wealthy Americans set up perpetual trusts, some of them using
Mr. Blattmachr's insurance plan.
One buyer of an insurance plan like Mr. Blattmachr's paid $32 million in the
first year for a policy that will pay $127 million tax free to the grandchildren,
according to a lawyer who worked on the deal and spoke on condition of not being
identified. No gift taxes were paid.
Sales of such insurance soared after the Internal Revenue Service announced
18 months ago that it was considering restrictions on similar techniques, which
are known as split-dollar plans.
In Alaska, premiums for such insurance totaled just $1.1 million in 1999,
but ballooned to more than $80 million last year, state records show.
This month, when the I.R.S. issued its proposed restrictions, it did nothing
to stop Mr. Blattmachr's plan.
Indeed, the proposed I.R.S. rules can be read as strengthening the validity
of his plan, Mr. Blattmachr and some other estate tax lawyers say.
Mr. Brown said that in some cases, when the policy holder dies quickly, both
the government and the heirs come out winners, at the expense of the insurance
"This is a good deal because both the government and the heirs get 90 percent
of what they could have gotten," he said.
He added: "We think it is good policy to allow this because it discourages
games like renouncing your citizenship or investing offshore."
But many estate tax lawyers and insurance experts think that because Mr. Blattmachr's
plan is similar to the plans the I.R.S. moved to stop on July 3, it should be
ended as well.
While the I.R.S. in 1996 approved the outlines of the Blattmachr plan, these
opponents argue that the plan as sold by agents like Mr. Brown and Mr. Kreisberg
stretches that ruling so far that it no longer provides protection in an I.R.S.
Some of them say it is the huge fees involved that are blinding their competitors
to aspects of the Blattmachr plan that make it vulnerable to being banned as an
abusive tax shelter.
Commissions for the insurance agents run between 70 percent and 200 percent
of the first-year premium when it is $1 million or so, while on the jumbo policies
commissions are typically 9 percent to 11 percent, or up to $4.4 million on a
policy with a $40 million first-year premium, Mr. Kreisberg said.
He acknowledged that many peers in the estate tax world say that he earned
$100 million in gross commissions last year, but said, "I wish it were half that."
Mr. Kreisberg did not dispute a statement by someone with knowledge of payment
records that his small firm's commissions this year have already reached $20 million.
Lawyers who opine on the validity of the deals can also earn big fees. Mr.
Blattmachr gets $100,000 for his basic opinion letter and is reported to have
charged as much as $250,000.
Sanford J. Schlesinger of the law firm Kaye Scholer said he passed up a chance
to collect a six-figure fee for advising on one of these deals because he thinks
the deals should not pass muster with the I.R.S. "My mother taught me that if
something seems too good to be true, it isn't true," he said.
Other leading estate tax lawyers, as well as some accountants and insurance
agents, say Mr. Blattmachr's insurance technique should fail because it is wholly
outside the intent of Congress in giving tax breaks for life insurance, the I.R.S.
ruling on the plan notwithstanding.
"If the I.R.S. understood this they would say that it relies on a disguised
gift and if you have to pay gift taxes, then Jonathan's insurance deal
does not work," said an estate partner at a tax firm in New York, who like others,
said they could not be identified because they have signed confidentiality agreements
that are part of all such insurance deals.
Another legal expert said paying 10 times too much for insurance in a plan
like this reminds him of a matriarch selling the family business to her granddaughter
for $10 million when it was actually worth 10 times that amount. "The I.R.S. wouldn't
let a family get away with selling the business for a dime on the dollar," this
lawyer said, "and they should not allow it to work in reverse through insurance."
Copyright 2002 The New York Times Company