Overview
In the Soundtrack of Our Lives, one of the songs that I still get to hear from time to time on Sirius XM, is “Still the One” which was recorded and released by the band Orleans in 1976. I was in the tenth grade just to be clear.
In the last four years the Senate Finance Committee under Senator Wyden’s leadership targeted Private Placement Life Insurance (“PPLI”) as a tax avoidance tool of the rich and famous. Numerous life insurers received summons and subpoenas to appear before the committee. Senator Wyden released a proposal to change the tax treatment of private placement life insurance for wealthy taxpayers in December 2024.
As expected, the American Council of Life Insurers (“ACLI”), the life insurance company lobby and NAIFA, the agents, responded with strong negative criticism of the proposal. I was even quoted in Tax Notes with a great Churchillian-lie quote that a “Crack in the Armor, is a Crack in the Armor.” Of course, I say this in jest. The Democrats lost control of the House of Representatives and Senate, and Senator Wyden lost his control over the Senate Finance Committee. PPLI lives to fight another day or at least another four years.
After it is all said and done, PPLI is “Still the One.” PPLI is arguably the most tax-advantaged investment product in the history of investment products. A big claim, but probably true! The inside buildup of the policy cash value accrues tax-free; policy loans from the policy are income tax-free up to ninety percent of the policy account value. The policy death benefit is income tax-free, and the policy proceeds may also be structured to be estate tax-free.
This article focuses on the benefits of PPLI and introduces a new planning attorney to trial lawyers to defer their contingency fees. Heretofore, trial attorneys have not aggressively deferred income.
Attorney Fee Deferrals
Attorneys can defer contingency fees in either qualified assignment for non-qualified assignment cases. The seminal case recognizing an attorney’s ability to defer contingency fees before there is constructive receipt is Childs v. Commissioner, 103 T.C. 634 (1994), aff’d without opinion, 89 F.3d 856 (11th Cir. 1996). Fee deferrals in qualified assignments are usually structured in structured settlement annuities or in qualified settlement funds. Non-qualified assignments are usually structured through foreign assignment companies in jurisdictions that have favorable tax treaties with the United States.
In my view, trial attorneys have under-utilized fee deferrals of any sort. Nevertheless, any deferred compensation ultimately has several problems. First, the deferred fee compensation is subject to federal and state income taxation. Second, the deferred fee income is included in the attorney’s taxable estate. Third, some attorneys are so wealthy that they have enough income for one hundred lifetimes and do not need any more deferred income. The combination of taxes can result in a 70-80 percent erosion in the amount of the deferred fee income. The situation is “Pay now, or pay letter but in all cases, the taxpayer pays. Structured Settlement Life Insurance (“SSLI”) is a more tax efficient than the existing tax deferral solutions in the marketplace.
Structured Settlement Life Insurance
SSLI is a combination of several different strategies to produce a superior tax planning result. The first step in the planning process is the deferral of the contingency fee either to a qualified settlement fund (“QSF”) or an offshore assignment company. The next step is the reinvestment of the deferred fees in a special purpose vehicle (“SPV”) structured as a single member limited liability which is wholly owned by the QSF or assignment company. The SPV is the sponsor of a split dollar arrangement between the SPV, and the lawyer’s irrevocable trust established for estate planning purposes. The trust is the applicant, owner, and beneficiary of a new PPLI policy.
Split dollar a contractual arrangement between the SPV and the Trust to share the benefits and rights of the PPLI policy. The SPV will receive a collateral assignment interest in the policy death benefit and account value equal to its premium payments. This collateral assignment interest is restricted until the earlier of the death of the insured, termination of the split dollar agreement or policy surrender. The split dollar rules allow the use of the economic benefit method or loan method of split dollar.
Following the Supreme Court’s decision in Loper Bright Loper Bright Enterprises v. Raimondo, 603 U.S. 369, there is a strong legal argument that the decision invalidates the split dollar regulations found in Treasury regulation 1.61-22. These regulations were added without congressional approval even though split dollar had over forty five years of case law and rulings. If this is the case, the use of equity split dollar life insurance would be revived to the great benefit of taxpayers.
The next step after funding the PPLI policy on a non-modified endowment contract basis would be the transfer of the split dollar receivable through an arms-length sale to a second family trust owned by the lawyer. The split dollar receivable subject to the restriction would be valued by a third-party valuation specialist who would most likely discount the split receivable by 65-90 percent. Following the sale of the split dollar receivable, the QSF deferred fees would be reduced by 65-90 percent. Those funds would continue to accrue tax-free inside of the PPLI policy outside of the lawyer’s taxable estate.
The remaining fees inside the QSF will be received as deferred payments in the future by the lawyer. The deferred income could then be offset through charitable tax planning using a Charitable Lead Annuity Trust (“CLAT”) or Pooled Income Fund (“PIF”) which would provide a substantial income tax deduction to the lawyer.
Summary
Existing attorney deferred fee arrangements have been underutilized. In the beginning, lawyers were forced fed fixed deferred annuity contracts in a low interest environment. Offshore assignment companies in Ireland and Barbados offered tax deferral and investment flexibility along with the ability to borrow a portion of the deferred fees, tax free. After all is said and done, the deferred fees are ultimately taxed as ordinary income along with being subject to estate taxation. The combined tax erosion effect is 70-80 percent of the deferred income.
Structured Settlement Life Insurance combines the magic of life insurance taxation with the pricing and flexibility of PPLI. The thread that allows the camel to pass through the eye of a needle is split dollar life insurance. Tax deferred dollars are transformed into tax-free dollars using split dollar and PPLI. The combination produces a dramatically different result – income tax free accumulation; income tax-free loans; an income and estate tax free death benefit and asset protection from personal and business creditors. PPLI is still the one!
