U.S. Bans a Scheme to Avoid Estate Tax
August 17, 2002
By DAVID CAY JOHNSTON
The Treasury Department banned a technique yesterday that
thousands of the wealthiest Americans have used to escape
billions of dollars in gift and estate taxes. The technique
involves buying expensive life insurance that will be
passed on to heirs, but declaring a far lower price on
gift-tax returns.
The department said the technique was not valid and never
had been, leading experts on taxes and insurance to predict
that people who have bought these policies will be drawn
into years of litigation with the government and with their
advisers.
The technique, described in an article in The New York
Times last month, "is not permitted in any published
guidance," the Treasury Department and the Internal Revenue
Service said in a formal notice. Before now, the
technique's creators said it was legal under a 1996 I.R.S.
ruling.
Pamela F. Olson, the chief tax policy official at the
Treasury Department, said that under the regulations issued
yesterday, "any scheme to understate the value of benefits
for income or gift-tax purposes won't be respected" in
audits.
Several tax experts said her remarks made it clear that the
government was going beyond shutting down the specific
technique described in The Times and was declaring that all
tax avoidance techniques that rely on using two different
insurance rates are invalid.
Critics of the technique said it effectively disguised a
gift to heirs that should be taxed like any other gift. The
new technique sidestepped gift taxes in a two-step process
that was designed to put wealth into a trust for children
or grandchildren and then to wrap the wealth inside an
insurance policy so that when the insured person died, the
money would pass without gift, estate or income taxes.
First, someone buys insurance for one price, say $550,000,
that could have been purchased for as little as $50,000.
Only the lower figure is reported for gift-tax purposes, in
this case lowering the tax due for wealthy people to
$25,000 from $275,000.
Then, in the second step, this gift- tax obligation is
shifted to a spouse. Because there is never a tax on gifts
between spouses, the $25,000 tax vanishes.
The insurer 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.
Wealthy Americans, including a Rockefeller, paid first-year
premiums of as much as $40 million for the policies. Each
dollar spent on the premiums could typically eliminate the
equivalent of $9 in taxes.
An I.R.S. official said last month that he had not been
aware that so many people were exploiting the loophole.
But with yesterday's announcement, "I think Treasury has
made it clear that they will not countenance games," said
Stephan Leimberg, chairman of Leimberg Information Services
in Bryn Mawr, Pa., which provides commentaries that help
tax lawyers, accountants and financial planning consultants
understand tax policy.
"I think a lot of people will be in deep yogurt," Mr.
Leimberg said, predicting years of audits and litigation
for those who bought the policies, as well as for their tax
advisers.
An estate tax lawyer who had been critical of the
technique, Sanford J. Schlesinger of the Kaye Scholer firm
in New York, said the notice seemed to rule out all tax
avoidance techniques based on using two different insurance
premiums, one that is actually paid and another that is
declared for tax purposes.
"Those who bought these policies will be embroiled for
years in litigation," he said, with the I.R.S., with their
lawyers and with the insurance agents who sold them the
policies. He and others said it was less likely that the
insurance companies that sold the policies, primarily New
York Life and Massachusetts Mutual Life Insurance, would be
drawn into the litigation.
Treasury officials declined to detail their strategy for
making those who used the techniques pay the taxes and
interest they did not pay. "We will treat this like we
treat other situations where we find taxpayers taking
incorrect positions on their tax returns," said Tara
Bradshaw, a Treasury spokeswoman. "We plan to enforce the
law and administer it appropriately."
The techniques were devised seven years ago by a prominent
New York estate tax lawyer and a former chemical engineer
who now sells insurance.
The lawyer, Jonathan G. Blattmachr of Milbank, Tweed,
Hadley & McCloy, is known for his skill at devising
techniques to reduce or eliminate gift, estate and income
taxes for wealthy people.
Mr. Blattmachr was on an airplane last night and his
cellphone connection was disrupted before he could comment.
In an e-mail message received last night, he declined to
comment.
The other developer of the technique, Michael Brown of
Spectrum Consulting in Irvine, Calif., was on vacation and
did not respond to calls to his office.
The technique grew out of a ruling that Mr. Blattmachr
obtained from the I.R.S. in 1996 allowing a form of tax
avoidance called "family reverse split-dollar" life
insurance. But critics argued that his technique went far
beyond the intent of the ruling. The Treasury, which
oversees the I.R.S., effectively endorsed that view
yesterday.
The Treasury acted after a copy of the Times article was
sent to Ms. Olson by Representative Lloyd Doggett, a Texas
Democrat who has for years introduced bills to close tax
shelters and loopholes. Yesterday Mr. Doggett said: "I am
encouraged that this particular tax shelter has been shut
down, but for every narrow loophole that is closed, there
are dozens if not hundreds more tax shelter schemes that
remain available to be exploited by those who choose not to
pay their fair share for necessities like national
security."
Several lawyers said it was significant that the Treasury
notice did not describe the device as a tax shelter. If it
were held to be a tax shelter then Mr. Blattmachr and
others would be required to turn over lists of clients who
used the techniques.
Donald C. Alexander, a Washington tax lawyer and former
I.R.S. commissioner, said, "The tax shelter law doesn't
apply to gift and estate taxes," only to income taxes. "I
think the Capitol Hill people are already thinking about
remedying that."
Copyright 2002 The New York Times Company. |
