Attorney Comments on New Exempt Organization Reporting Requirements

You may recall that we spoke briefly at the recent ALI-ABA conference following your very informative presentation. You asked me to share with you my concerns in regard to IRC section 6050V.

Section 6050V should be viewed in the context of criticisms of various life insurance plans that in recent years have been marketed to charities. Annuity Arbitrage, Financed or Leveraged Life, Charity Owned Life Insurance (CHOLI), Foundation Owned Life Insurance (FOLI), Life Insurance and Life Annuity Based Contracts (LILAC), and Investor Owned Life Insurance (IOLI) are some of the names that have been given to these plans.

The most common criticism is the charity is selling or "leasing" its "insurable interest" in order to generate profit for investors in a transaction that has little economic benefit for charities. Critics have seized on the issue of the charity assigning an ownership interest to equity investors through "securitized pools." This enables third parties, who otherwise could not own an "insurable interest," to acquire life insurance interests.¹

The section 6050V concepts of "pool of such contracts" and "structured transaction" appear to have emerged from the programs described above. However, because these terms are undefined, section 6050V may impose a reporting burden on charities that use conventional loans to finance insurance premiums. The instructions from the IRS should alleviate this burden by narrowing the scope of the ill-defined terms in section 6050V.

Section 6050V requires the "applicable exempt organization" that makes a "reportable acquisition" within the two year period, August 17, 2006 - August 17, 2008, in regard to an applicable insurance contract, to file an information return.

Section 6050V does not adequately define "reportable acquisition." This concept suffers from vagueness that the IRS should correct in the instructions to the reporting form.

There is no guidance as to what constitutes a "direct or indirect interest in a contract." It is impossible to determine whether "interest" refers only to an investment or equity interest or also includes a collateral interest to secure a loan to the charity. For example, if a church borrowed funds from a local bank to finance the cost of single-premium policy on the lives of the six members of the vestry, would that be an "interest" within the meaning of 6050V?

The meanings of "structured transaction" and "pool of such contracts" similarly are open to speculation.

Neither Code section 6050V nor the Report explains how an acquisition of an "applicable insurance contract" occurs in connection with a "structured transaction involving a pool of such contracts." It is not clear what constitutes a "structured transaction" or a "pool of such contracts." Does a "pool" exist if a charity takes out a half-dozen loans from the same lender to fund the purchase of six independent life insurance contracts? Does a "pool" occur if a charity borrows funds from six different lenders? Is a "pool" created if an institutional lender, as part of an ongoing program, makes numerous loans to charities of the type described above? If a lender makes more than one loan to the same charity in connection with a "program" for the financing of life insurance premiums, is this ipso facto a "pool"? Or part of a "structured transaction"?

Additionally, is the use of a trust, partnership or similar vehicle a "structured transaction?" Does a contract between a charity and a lender constitute a "structured transaction?" Does an ongoing program of sales by the lender of loans (arbitrage) give rise to a "structured transaction"?

I do not believe Congress seeks to compel reports by churches and charities if all they are doing is taking out conventional loans to finance the premiums of life insurance policies on their leaders, e.g., members of the vestry, trustees, directors, or key donors. As noted above, it should not make any difference if a church takes out one loan or six loans to finance the premiums on life insurance policies on the lives of the six members of its vestry. The six should not be regarded as a "pool" or part of a "structured transaction."

"Pool" and "structured transaction" should be defined as elements of commercially marketed plans that are not designed to protect the interest of the charity but, rather, primarily serve the interests of investors. These are the so-called "dead pools" where a number of "insured lives" of numerous 501(c)(3) organizations are "securitized" and "packaged" for sale to hedge funds and other investors.

Compare this to conventional loans by a regulated financial institution to a college to enable it to pay premiums on life insurance policies taken out by the college as to six members of the Board of Directors. The lender may retain a collateral or security interest in the policy to secure the loan. If the loan is not sold to third party investors, the "dead pool" concern that led to 6050V is not present. It is simply a conventional loan at market-rate interest. The loan is not part of an "arbitrage plan."

I appreciate the interest you have shown in this issue. I encourage Treasury and the IRS to tailor narrowly the definitions of 6050V so the statute will not have the unintended effect of triggering reporting requirements for many churches and charities that are merely insuring the lives of their leaders and benefactors --a practice that has gone on for decades. In short, the reporting requirements should be restricted to participation by the exempt organization in the "dead pool" type of arrangement.