Wyden introduces bills to close tax shelters

Senate Finance Committee ranking member Ron Wyden, D-Oregon, introduced two pieces of legislation this week aimed at cracking down on the use of grantor retained annuity trusts and private placement life insurance contracts to avoid or minimize taxes.

The Getting Rid of Abusive Trusts Act, which Wyden introduced Tuesday with Sen. Angus King, I-Maine, would modify rules dealing with grantor retained annuity trusts. Under current law, GRATs are commonly used by the ultra-wealthy to minimize or zero-out any income, gift or estate tax liability on assets worth at least tens of millions of dollars. They are neither available nor useful to middle-class Americans as a financial planning tool.

"If you want to see a clear case of ultra-wealthy tax dodgers hiding their schemes with overcomplicated tax rules and mind-numbing financial jargon, look no further than grantor retained annuity trusts," Wyden said in a statement. "This is a garden-variety tax dodge in which a billionaire signs some papers and moves some money around, and suddenly they owe little or no tax on assets worth millions and millions of dollars. Bottom line, as a matter of basic economic fairness, we've got to close loopholes like this one to make sure the ultra-rich pay a fair share."

The GRATs Act would deter the most common planning methods that grantors use to reduce the value of their estate, thereby lowering their estate tax burden, while avoiding additional income or gift tax. The GRATs Act would also modify the tax rules for grantor trusts by putting in place some downside risk on the use of GRATs so they are less likely to be used purely for tax avoidance purposes.

The bill would add a requirement that a GRAT must have a minimum term of 15 years and a maximum term of the life expectancy of the annuitant plus 10 years. This provision would prohibit any decrease in the annuity during the GRAT term. It would also add the requirement that the remainder interest in a GRAT at the time of transfer must have a minimum value for gift tax purposes. The purpose of applying additional requirements is to impose costs on the use of GRATs, so they are less likely to be used entirely for tax avoidance purposes.

Under the bill, transfers of property between a trust and the deemed owner of the trust would be treated as a sale or exchange for income tax purposes. This change aims to address tax planning strategies in which a taxpayer's appreciating assets could be transferred in and out of a GRAT without incurring income tax.

Also under the bill, any income tax paid on the GRAT's income would be designated as a gift for the purposes of the gift tax, unless the owner is reimbursed from the GRAT during the same calendar year. The gift amount could not be reduced through the use of deductions such as the charitable or marital deduction, or deductions for gifts of tuition or medical care. This change aims to combat tax strategies in which a grantor of a GRAT uses the trust to reduce the value of their estate, thereby lowering their estate tax burden while avoiding additional income or gift tax. 

"Well-off Americans shouldn't be able to move assets around on paper and make their tax bill disappear," King said in a statement. "The Getting Rid of Abusive Trusts Act brings some common sense and fairness back into the equation by adding reasonable guardrails to reduce abuse of GRATs while preserving legitimate estate planning tools. If America is going to stabilize our financial situation, the first step should simply be that people pay what they owe."

Private placement life insurance

The other piece of legislation, the Protecting Proper Life Insurance from Abuse Act, stems from a report on an 18-month investigation that Wyden and his staff released in February 2024 into the private placement life insurance industry. The Senate Finance Committee found the domestic PPLI industry includes at least $40 billion in policies held by only a few thousand individuals, who have net-worths reaching into the hundreds of millions or billions of dollars. The biggest PPLI providers promoted PPLI products as tax-free investments in private equity and hedge funds, as well as a means to dodge income, gift and estate taxes. Policyholders could borrow against those assets at extremely favorable rates.

PPLI policies are designed to mimic hedge funds and other vehicles for the benefit of highly sophisticated investors, and are exclusively available to the ultra-wealthy. There's no requirement to report PPLI contracts to the IRS, allowing wealthy investors to use them to shelter profits from lucrative investments.

PPLI contracts, which are related in name only to typical life insurance commonly held by middle class families, make up just 0.003% of all outstanding life insurance policies. 

"Life insurance is an essential source of financial security for tens of millions of middle class American families, so we cannot have a bunch of ultra-rich tax dodgers abusing its special tax treatment to set up tax-free hedge funds and shelter mountains of cash," Wyden said in a statement. "Congress has a long tradition of stepping in to prevent the abuse of the important, preferential tax rules for life insurance, and this bill is the next step in that process. Life insurance is too important to allow it to be twisted into another garden variety tax ripoff for the super-rich."

To protect the tax treatment of traditional life insurance from further abuse, the Protecting Proper Life Insurance from Abuse Act would separate PPLI policies from traditional life insurance and deem them "Private Placement Contracts." Under the legislation, a policy taken out by a wealthy investor would be considered a PPC if it's backed by an insurance company asset account that supports fewer than 25 contracts held by other individual investors. The definition would apply not only to PPLI but also to private placement annuities. 

The legislation includes rules providing that contracts owned by related parties would be aggregated to determine whether the arrangement meets or fails the 25-investor requirement, and the Treasury Department would be granted authority to prevent other circumvention. The proposal would also define contracts issued by foreign insurers to US purchasers.  

The PPLI Abuse Act stipulates that a PPC would not be treated as a life insurance or annuity contract under the Internal Revenue Code. Thus, the earnings and losses of the separate account that supports the PPC would be taxed to the contract holder as they are earned each year. The proposal would disqualify PPCs from enjoying the protected inside build-up that is a tax benefit of traditional life insurance and annuity contracts. Since the PPC is not a life insurance or annuity contract, the proposal includes a rule that the issuing insurance company would not be permitted to include the reserves related to the PPC in their life insurance reserves, it would receive no deduction for the reserve held to support the PPC, and reserves would not count as life insurance reserves for purposes of testing whether the issuing company qualifies as a life insurance company. 

The reserves instead would be subject to general accrual tax principles. The death benefit paid under a PPC would be taxed. The rules for PPCs would apply to existing contracts as well as new PPCs, with a 180-day transition rule for policies existing on the date of enactment to allow holders of PPCs to convert them to traditional insurance policies before they are subject to the new PPC rules. In addition to defining PPC and setting forth the tax consequences of owning and issuing such a contract, the draft legislation would create badly-needed reporting requirements. An information return would be required when a contract becomes a PPC, either upon issue or conversion to a PPC. 

Failure to file the return would lead to a $1 million fine for each 30 days that the report goes unfiled. Moreover, the appropriate insurance commissioner and the SEC would be informed about the failure to report. Annual reporting would be required each subsequent year, although there will be no enhanced penalties. The proposal would also make necessary modifications related to reporting requirements under the Foreign Account Tax Compliance Act to prevent the growth of foreign PPLI tax shelters. The proposal would be effective on the date of enactment and apply to PPCs issued before, on or after that date.