Aviva Life and Annuity Co. sued six of its agents earlier this year, claiming the agents were involved in a fraudulent sale of life insurance to 119 church members. The agents recently responded, charging that Aviva was not only complicit in the charity-owned life insurance (CHOLI) scheme, but actively “directed, ordered, approved, and in all other respects, ratified the acts and performance of” the agents.

Aviva filed the lawsuit against the agents in March of this year in the United States District Court Central District of California. According to the lawsuit, the six agents arranged for church parishioners to purchase life insurance that would be held in 119 individual life insurance trusts.

The producers are accused of violating Aviva’s “producer guidelines” by participating in the sales. The scheme outlined by Aviva’s complaint is a variation on stranger-originated life insurance (STOLI), where church members were approached about participating in an endowment program under which life insurance death benefits would be split between the church, beneficiaries and a third party.

Members who allowed policies to be purchased on their lives have told Aviva that they either did not pay premiums on their life insurance policies or paid only the initial premium.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of STOLI in Advisor’s Journal, see Court Holds that STOLI Law Is Not Retroactive (CC 11-108) & STOLI Scheme Lands Insurance Agent in Jail (CC 11-92).

Why is This Topic Important to Wealth Managers? This blogticle discusses the proper treatment of a partial exchange of an annuity contract for tax purposes. The information presented herein is useful for those wealth managers considering a tax-free exchange of annuities under Section 1035 for their clients.

The Internal Revenue Service recently released a revenue procedure addressing the tax treatment of certain tax-free exchanges of annuity contracts under Sections 72 and 1035 of the Internal Revenue Code. [1]

Generally, the Code provides that no gain or loss shall be recognized on the exchange of an annuity contract for another annuity contract. [2] The legislative history of IRC Section 1035 states that exchange treatment is appropriate for “individuals who have merely exchanged one insurance policy for another better suited to their needs.” [3]

The Income Tax Regulations provide that the exchange, without recognition of gain or loss, of an annuity contract for another annuity contract under IRC Section1035(a)(3) is limited to cases where the same person or persons are the obligee or obligees (beneficiary or beneficiaries) under the contract received in the exchange as under the original contract. [4]

If, in addition to an annuity contract, a taxpayer receives other property or money in exchange for a second annuity contract, then gain (if any) is recognized to the extent of the sum of money and the fair market value of other property received, but loss (if any) is not recognized to any extent. [5]

The Tax Court has held that the direct exchange by an insurance company of a portion of an existing annuity contract to an unrelated insurance company for a new annuity contract was a tax-free exchange under IRC Section 1035.  [6] Such a transaction is sometimes referred to as a “partial exchange.”

Notwithstanding, the IRS has determined that the receipt of a check under a nonqualified annuity contract and endorsement of the check to a second company as consideration for a second annuity contract treated as a taxable distribution rather than as a tax-free exchange under IRC Section 1035. [7]

Generally, Rev. Proc. 2008-24 set forth circumstances under which a direct transfer of a portion of the cash surrender value of an existing annuity contract for a second annuity contract would be treated as a tax-free exchange under IRC Section 1035. Under the revenue procedure, a transfer was treated as a tax-free exchange if no amount was withdrawn from, or received in surrender of, either of the contracts involved in the exchange during the 12 months beginning on the date of the transfer, or if the taxpayer demonstrated that one of the conditions described by IRC Sections 72(q)(2)(A)-(J) or any similar life event “occurred between” the date of the transfer and the date of the withdrawal or surrender.

Revenue Procedure 2011-38, in sum amends Revenue Procedure 2008-24, and recognizes that generally a partial exchange (usually of cash value) of an annuity contract for another annuity contract is treated as a tax-free exchange under section 1035 if no amount is withdrawn from, or received in surrender of, either of the contracts involved in the exchange during the 180 days beginning on the date of the transfer.

Tomorrow’s blogticle will discuss additional tax issues relating to life insurance and annuities.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

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[1] See Revenue Procedure 2011-38.

[2] IRC Section 1035(a)(3).

[3] H.R. Rep. No. 1337, 83d Cong., 2d Sess. 81 (1954).

[4] Treas. Regs. Section 1.1035-1 of the Income Tax Regulations

[5] Section 1035(d)(1) (cross referencing § 1031(b) and (c)); § 1.1031(b)-1(a); § 1031(c)-1.

[6] Conway v. Commissioner, 111 T.C. 350 (1998), acq., 1999-2 C.B. xvi.

[7] See Rev. Rul. 2007-24, 2007-21 I.R.B. 1282.

In a merciful move, the Treasury has again extended the FBAR filing deadline for persons with only signature authority over a foreign financial account to November 1, 2011. [Notice 2011-54]. Two previous extensions had pushed the FBAR due date to June 30, 2011, but the Financial Crimes Enforcement Network (FinCEN) and the IRS recognized the difficulty signatories were having locating the information they needed to complete the form.

Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), must be filed annually by all U.S. citizens, residents, business entities, trusts, and estates with a financial interest in or signature authority over one or more foreign financial accounts (FFA) with an aggregate value greater than $10,000.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the FBAR in Advisor’s Journal, see Do Your Clients’ International Assets Create Criminal Tax Exposure? (CC 11-73) & IRS Provides FBAR Answers (CC 11-119).

Why is This Topic Important to Wealth Managers? Today we discuss one issue that is a concern to most taxpayers. The Tax Gap—The difference between the amount of taxes due and those actually paid. The blogticle provides information and facts which makes for interesting discussion among wealth managers and clients.

The Government Accountability Office (GAO) recently released a report on the tax gap and taxpayer compliance and complexity. The report summarizes that the tax code compliance issues caused by complexity resulted in an increase to the overall tax gap.

It is no surprise that the federal tax system contains complex rules. These rules may be necessary, for example, to ensure proper measurement of income, target benefits to specific taxpayers, and address areas of noncompliance. However, these complex rules also impose a wide range of recordkeeping, planning, computational, and filing requirements upon businesses and individuals.

It has been shown in the past and is also no secret that complying with these requirements costs taxpayers time and money. In 2005 GAO reported that even using the lowest available compliance cost estimates for the personal and corporate income tax, combined compliance costs would total $107 billion (roughly 1 percent of gross domestic product) per year; other studies estimate costs 1.5 times as large. In addition, economic efficiency costs, which are reductions in economic well-being caused by changes in behavior due to taxes, are estimated to be even larger.

Although many taxpayers have simple forms of income, others do not—especially those who receive income from capital gains, rents, self-employment, international and other sources—and they may be required to do complicated calculations and keep detailed records.

Tax expenditures add to tax code complexity in part because they require taxpayers to learn about, determine their eligibility for, and choose between tax expenditures that have similar purposes. Tax expenditures also complicate tax planning because taxpayers must “predict” their own future circumstances as well as future tax rules to make the best choice among provisions.

Taxpayer errors also contribute to the tax gap. For example, in 2001 taxpayers underreported $6.3 billion in net income due to misreported Individual Retirement Arrangement (IRA) distributions. In addition, taxpayers may underclaim benefits to which they are entitled. According to GAO’s past  analysis, of tax filers who appeared to be eligible for a higher-education tax  credit or tuition deduction in tax year 2005, about 19 percent, representing  about 412,000 returns, failed to claim any of them.

The Internal Revenue Service (IRS) has estimated that the gross tax gap—the difference between taxes owed and taxes paid on time—was $345 billion in 2001.

The gross tax gap is an estimate of the difference between the taxes—including individual income, corporate income, employment, estate, and excise taxes—that should have been paid voluntarily and on time and what was actually paid for a specific year.

Of the estimated $345 billion tax gap for tax year 2001, IRS estimated that it would eventually recover about $55 billion of that through late payments and enforcement actions, for a net tax gap of $290 billion.

The estimate is an aggregate of estimates for the three primary types of noncompliance: (1) underreporting of tax liabilities on tax returns; (2) underpayment of taxes due from filed returns; and (3) nonfiling, which refers to the failure to file a required tax return altogether or on time.

Tomorrow’s blogticle will discuss issues related to life insurance.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

The Foreign Account Tax Compliance Act (FATCA) was enacted as a comprehensive measure to combat offshore tax evasion—a noble enough goal. But FATCA’s comprehensiveness is also a sore point for many in the financial services industry, especially insurance carriers and producers. In comments to regulators, one foreign life insurance trade organization, the Association of International Life Offices (AILO), recently called FATCA’s requirements “onerous and disproportionate to the risk involved.”

Passed as part of H.R. 2847, the Hiring Incentives to Restore Employment Act (HIRE Act) on March 18, 2010, FATCA combats tax evasion by requiring disclosure from foreign institutions about accounts held by individuals, including U.S. citizens, and institutions that may be subject to U.S. tax. Many life insurance and annuity contracts are considered “accounts” under the Act, although FATCA doesn’t generally apply to property, casualty, and term life insurance contracts.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of FATCA in Advisor’s Journal, see IRS Proposed FATCA Guidance Expands Offshore Compliance Initiatives (CC 10-52) & Offshore’s Limited Shelf Life (CC 10-47).

Why is This Topic Important to Wealth Managers? This blogticle discusses one area that is well known to many wealth managers. However, this reexamination of a topic is designed to provide a refresher to wealth managers. Here we discuss the three year bring-back rule.

With certain exceptions, there is a general rule with respect to estates which requires that any property transferred by gift within three years prior to the transferor’s death has to be included in the gross estate of the deceased transferor, at its date-of-death value (even though the transferor may have had no ownership interest or retained rights of any kind when she died). [1] This rule is sometimes referred to as the “three year rule” or the “bring-back rule”.

The 3-year “bring-back” rule is applicable with respect to dispositions of retained interests in property which otherwise would have been includable in the gross estate.[2] All of these sections involve transfers of property as to which the transferor retained some form of continuing interest or right, which, if still retained when the transferor dies, is deemed sufficient to require the inclusion of the property in the gross estate of the transferor:

• §2036 -  Transfers with certain life interests retained
• §2037 -  Transfers with a reversionary interest retained
• §2038 -  Transfers with a right retained to alter, amend or revoke the transferee’s beneficial interest
• §2042 -  Transfers of life insurance policies with an incident of ownership retained

Under I.R.C §2035, if an insured individual transfers an insurance policy to a trust or another individual, even though the insured may no longer retain any incidents of ownership, if he dies within the 3-year period following the transfer, the entire policy proceeds will be includable in the insured’s gross estate, effectively defeating the major objective of the having the death benefits payable outside the estate.

For the most part, this problem can be eliminated by establishing a trust with a new policy (i.e., never owned by the insured). This, of course, may not be a viable alternative when an existing policy is involved. While consideration might be given to cancellation of an existing policy and replacement with a new one, such a course of action should be based more upon the non-tax aspects of a policy change (e.g., premium costs, contractual terms, quality of carrier, etc.) than purely the tax risk of §2035, the 3-year bring back rule.

In situations where a decision is made to establish an irrevocable life insurance trust with a policy to be newly issued, the §2035 problem (the 3-year rule) can usually be avoided by simply having the policy applied for by, and initially issued to, the trust as owner. If this is properly accomplished, the insurance proceeds will not be includable in the insured’s gross estate even if he should have the misfortune of living less than three years thereafter.

The critical factor in assuring the inapplicability of I.R.C. §2035 (the 3-year rule) is that the grantor/insured not have possessed at any time anything that might be deemed an incident of ownership with respect to the policy.

Generally it is the IRS’ position that reapplication by third party owner after decedent initially applied for the insurance within three years of death does not present a three year rule problem. Central to the position is the notion that an application for insurance (as long as money is not submitted with the application) is only an offer to contract. There being no contract between the parties, decedent never held any incidents of ownership.[3]

Tomorrow’s blogticle will continue to discuss issues surrounding wealth management.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

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[1] I.R.C. §2035.

[2] For example, under I.R.C. §§ 2036, 2037, 2038, or 2042.

[3] See Technical Advice Memorandum (TAM) 9323002.

Despite initial calls for private creditors to absorb some of the cost of another round of Greek bailouts, German Chancellor Angela Merkel has backed down. Merkel met with French President Nicolas Sarkozy in Berlin on June 17, 2011 to discuss the role of private investors in the bailout. Following the meeting, the leaders announced a unified plan to deal with the Greek crisis. Chancellor Merkel is still asking private creditors to voluntarily participate in the bailout.

The Greek debt crisis spans back to early 2010, when a group of European governments—including Greece—faced funding crises that threatened European stability as a whole.  At the time, Greece had €300 billion in debt, bigger than its economy.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For coverage of the U.S. debt crisis in Advisor’s Journal, see Debt Limit Standoff Boils Over (CC 11-115) & Debt Ceiling Approaching: Prepare for Impact (CC 11-100).

Why is This Topic Important to Wealth Managers? This blogticle discusses one avenue for retirement planning solutions for small businesses. Wealth managers who have small business clients may consider a discussion on the automatic payroll deduction IRAs as one simple way to help employees save for retirement.

A payroll deduction individual retirement account (IRA) is one simple way for businesses to give employees an opportunity to save for retirement. The program is easy to implement; the employer sets up the payroll deduction IRA program with a bank, insurance company or other financial institution, and then the employees choose whether and how much they want deducted from their paychecks and deposited into the IRA. Depending on the IRA service provider, some employees may also have a choice of investments depending on the IRA provider. Wealth managers can add value to employees and employers by, not only establishing a plan, but by also working with employees to help them manage their IRAs.

Under a payroll deduction IRA, the employee makes all of the contributions, thus there are no employer contributions. By making regular payroll deductions, employees are able to contribute smaller amounts each pay period to their IRAs, rather than having to come up with a larger amount all at once.

One advantage of these accounts is that there is little administrative cost and no annual filings with the government. Moreover, businesses of any size can participate as there is no requirement that an employer have a certain number of employees to set up a payroll deduction IRA.

Another element that makes the program attractive to some small businesses is that the program will not be considered an employer retirement plan subject to Federal requirements for reporting and fiduciary responsibilities as long as the employer keeps its involvement to a minimum.

Here’s how the IRAs generally work: The employer sets up the payroll deduction IRA program with a financial institution, such as a bank, mutual fund or insurance company. The employee establishes either a traditional or a Roth IRA (based on the employee’s eligibility and personal choice) with the financial institution and authorizes the payroll deductions. The employer withholds the payroll deduction amounts that the employee has authorized and promptly transmits the funds to the financial institution. After doing so, the employee and the financial institution are responsible for the amounts contributed.

Generally however, the employer needs to remain neutral with respect to the IRA provider. It cannot negotiate with an IRA provider to obtain special terms for its employees, exercise any influence over the investments made or permitted by the IRA provider, or receive any compensation in connection with the IRA program except reimbursement for the actual cost of forwarding the payroll deductions.

Commonly, any employee who performs services for the business (or “employer”) can be eligible to participate. The decision to participate is left exclusively up to the employee. The employees should understand that they have the same opportunity to contribute to an IRA outside the payroll deduction program and that the employer is not providing any additional benefit to employees who participate.

Employees’ tax-deferred contributions are generally limited to $5,000 for 2011. Additional “catch-up” contributions are permitted for employees age 50 or over. This special catch-up amount is currently limited to $1,000 per year.

Tomorrow’s blogticle will continue to discuss simple wealth management solutions.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

A new academic study on the effect of increased life-spans on savings rates confirms old suspicions and raises some interesting new questions.

The conclusions reached by Optimal Retirement and Saving with Increasing Longevity, by David E. Bloom, David Canning, and Michael Moore are simple enough but need some unpacking: “[A] higher level of wages leads to earlier retirement and increasing savings rates. On the other hand an increase in life expectancy leads to an increase [in] the retirement age, but less than proportionately, while reducing savings rates.”

This result emphasizes the importance of planning for middle-income families. Without a solid plan, many will be stuck working many more years than they hoped or planned.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of retirement values in Advisor’s Journal, see Appealing to Your Affluent Clients’ Retirement Planning Values (CC-11-42).

For in-depth analysis of investment planning for affluent clients, see Advisor’s Main Library: Investment Planning.

Why is This Topic Important to Wealth Managers? Today’s blogticle is presented as part of our casual Friday series. Here we present interesting topics that may or may not be directly related to wealth management but have some interesting element worth discussing with this audience. Our discussion in this blogticle focuses on the patentability of tax motivated transactions and strategies.

On Thursday, Congress passed by a vote of 304-117, the America Invests Act (H.R. 1249). One particular provision of the law addresses concerns relating to patenting tax transactions. The proposed law states under Section 14 that for purposes of evaluating an invention for patent issuance purposes, any strategy for reducing, avoiding, or deferring tax liability, shall be deemed insufficient to differentiate a claimed invention from the prior art.  In other words, the score may finally be settled as to whether or not tax motivated transaction can be patented under U.S. law.  As one commentator notes, it “looks as though the time has come for comprehensive patent reform, which includes the banning of tax strategy patents.” [1]

For purposes of the new law the term ‘‘tax liability’’ generally refers to any liability for a tax under any Federal, State, or local law, or the law of any foreign jurisdiction, including any statute, rule, regulation, or ordinance that levies, imposes, or assesses such tax liability.

The patenting of tax motivated transactions as type of business method has been the topic of discussion “ever since the Federal Circuit Court of Appeals determined that business methods could be patented in State St. Bank & Trust v. Signature Fin. Group.” [2] Since then, the Journal of Accountancy Reports “the U.S. Patent and Trademark Office has granted approximately 140 patents on tax strategies.” [3]

Some professional trade associations such as the AICPA have opposed the issuance of tax motivated transaction patents. The AICPA has in the past noted is discontent with the issuing of such patents. Reasons for some of the concerns are that these patents:

• Limit taxpayers’ ability to use fully tax law interpretations intended by Congress;
• May cause some taxpayers to pay more tax than Congress intended or more than others similarly situated;
• Complicates the provision of tax advice by professionals;
• Hinder compliance by taxpayers;
• Mislead taxpayers into believing that a patented strategy is valid under the tax law; and
• Preclude tax professionals from challenging the validity of a patented strategy. [4]

A similar version of the bill with the same name has already been passed in the Senate in March. [5] Now the two houses will work together to reconcile the provisions so that an acceptable version could be signed into law by the White House.

Next week’s bloticles will discuss tools being used by professionals this year related to wealth management.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

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[1] Rodger Russell. Accounting Today. “AICPA Opposes Grandfathering of Pending Tax Strategy Patents”. June 24, 2011. http://www.accountingtoday.com/news/AICPA-Opposes-Grandfathering-Pending-Tax-Strategy-Patents-58943-1.html. Last Accessed 6/24/2011.

[2] Id.; State St. Bank & Trust v. Signature Fin. Group 149 F.3d 1368 (Fed. Cir. 1998).

[3] See Journal of Accountancy. “House Passes Bill With Tax Patent Provision, Sends Back to Senate.” June 23, 2011. http://www.journalofaccountancy.com/Web/20114248.htm. Last Accessed 6/24/2011.

[4] Id.

[5] See generally, Tax Analysts. “House Approves Bill Banning Tax Strategy Patents”. 2011 TNT 122-3. June 24, 2011, Citing S. 23.