Charities and Insurance: The Next Big Thing?

Charities and Insurance: The Next Big Thing?

Article posted in Intangible Personal Property on 18 May 2004| 2 comments
audience: Partnership for Philanthropic Planning, National Publication | last updated: 6 September 2011


Last week the PGDC published the first of two "white papers" commissioned by Leimberg Information Services on the subject of financed charitable life insurance programs entitled "Insurable Interest Under Siege." In this second paper, attorney Lawrence L. Bell presents the case for this technique - but lays out many issues and cautions which must be considered by charities and their advisors.

Leimberg Information Services

by Larry Bell
Edited by Steve Leimberg

Tool or Boondoggle for Vendors?

Charities and Financed Insurance, is it a tremendous endowment tool for qualifying charities or a boondoggle for venders doomed to failure ala Charitable Split Dollar?1

These questions are being asked about programs that combine donor's lives, funding vehicles, and the disconnect on mortality charges and life expectancies to provide a benefit for charities seeking endowments at a time that charitable contributions are down.2

The programs being promoted have many similar themes:

1. Charities provide donors an opportunity to "donate" their life to the charity to use their "insurability" (the amount of their available insurance coverage not yet dedicated for other purposes).

2. The ideal donors are between the ages of 78-84.

3. The charity acts as a proxy and premium financing and/or an annuity provides the source of insurance premiums to assure the continuing premium flow to maintain the policy.

4. The policy is held to maturity, the provider of premium financing is made whole, and the charity receives the remainder. Alternatively, the charity turns around after the purchase of the policy and investigates the market to find a buyer of the policy. The value of the policy may be greater than what the charity has paid in cumulative premiums. In which case the policy could be sold and the charity receives revenues to use for its exempt purposes.

This scenario raises a number of issues that bear review by charities and their advisors.

1. Does it make economic sense? If the program is good economically, does the program have any problems or pit falls?

2. Are there insurable interest issues? Can the charity have an insurable interest?

3. Does the program put the charity's exempt status at issue?

4. Does the program create unrelated business taxable income (UBTI)?3

5. Where premium financing is used, is Debt-Financed income created?4

All of these items should be satisfactorily addressed before a charity proceeds on such a program.

Description of the Program

The basic concept of the program may combine borrowing, premium financing, annuities and life insurance as follows:

Based on the life expectancy of an individual, a single premium immediate annuity or variable annuity (SPIA) to fund life insurance premium is purchased. The SPIA involves payment of a single, initial premium and generates a fixed, certain annual income until the death of the individual (annuitant). A variable annuity initially may be used if there are concerns about the two year rule and recovery under the policy.

The life insurance policy requires payment of an annual premium and produces a predetermined death benefit upon the death of the individual participant.

The annual income from the annuity payment is used to pay the annual premium on the life insurance policy.

The structure is financially beneficial if:

(1) the annual annuity payments are sufficient to pay the annual life insurance premiums and any interest charged if premium financing is used and

(2) where the death benefit of the life insurance significantly exceeds the amount of the initial single premium of the annuity and other initial costs not covered by the annuity payments (e.g., the first premium payment on the life insurance policy, service fees, etc.) the charity benefits.

The Charity identifies suitable participants (e.g., donors, participants or members of a congregation).

The structure is not designed to, and does not in fact, directly benefit the participants individually (i.e., there is no economic immediate private inurement or tax deductions). However, donors, participants or (and other charities) are generally willing to participate to establish a legacy for the charity even without a direct personal benefit.

The charity initially identifies a list of potential participants in the investment plan. The total level of endowment, the age of the participants or other factors may be used by the charity to decide which participants to place in the pool of candidates who will be considered for participation. The charity reviews its membership for participants in the investment system.

Based upon actuarial statistics and modeling, a selection is made and it will be determined what source of funds will be used.

Due to the economic and market factors relating to life insurance and annuities, participants suitable for generating a high return on the investment are typically older than seventy years of age and are more preferably in the age range of approximately seventy-eight to eighty-four years based on currently available mortality information relating to tribes.

The trustee submits the trial applications of all the potential participants to a group of life insurance and annuity companies. Preferably, a significant number of potential participants will meet the medical and financial underwriting qualifications required by both the life insurance companies and the annuity companies.

The decision as to whether certain individuals are selected for participation may be based in part on investment data, including the costs of loans, the terms of the annuity, the mortality cost of insurance, the endowment goal, the expiration date of the investments, the participant's age and other relevant data.

The value of the annuities may be determined or projected. The charity uses these funds to purchase a series of annuity contracts and life insurance policies. Specifically, for each qualified participant (the "insured"), the charity purchases one or more annuity contracts and one or more life insurance policies on the life of the insured.

If the insureds are the owners of the policy, upon completion of the purchase of all of the annuities and all of the policies on the lives of the insureds, all of the participants (including all of the insureds and all of the other potential participants on whose lives annuities and policies were not purchased) are solicited by the charity to transfer their annuities and policies to the charity.

Alternatively, the charities can and probably should own the policies from the inception. This approach should satisfy the State's insurable interest rules and transfer for value issues of section 101 of the IRC. As stated earlier, these items reflect why qualified counsel should be involved in the planning and execution of such a program.

When the life insurance policy is purchased, an endowment agreement is executed by the participant that gives the charity the right to receive the death benefit associated with the life insurance policy. Any surplus after the payment of the policy premiums necessary to pay costs of the life insurance protection under the life insurance policy will be the sole and exclusive property of the charity to provide additional endowment. If premium financing is used the provider would be made whole and the remainder would inure to the benefit of the charity.

Each annuity contract could be purchased with a single premium and generates a series of immediate fixed and substantially equal annual payments (e.g., a SPIA), beginning with an initial payment no later than one year from the date of the purchase of the annuity.

The annuity does not provide for a residual payment upon the death of the insured.

The life insurance policy includes a fixed death benefit and may have an additional amount with a reflection of the interest accrued payable upon the death of the insured.

The charity's purchase of the annuity and life insurance contracts can be completed at a single closing or a series of related closings completed within a short period of time.

To comply with most insurable interest rules, the insured should pay the first premium for the life insurance policy. Thereafter, the annual payments from the annuity may cover subsequent annual premiums for the life insurance policy on the insured.

For each insured, each year, if the insured is alive, the investment trust receives the annual annuity payment and pays the annual life insurance premium with funds from the annuity payment.

The charity must provide sufficient funds to pay each year the portion of the annual policy premium equal to the cost of the life insurance protection provided under the life insurance policy.

As described above, the charity will purchase the annuities, administer receipt of the annuity payments, pay the life insurance premiums, and distribute the death benefits.

Since the charity owns the annuity policies, the exempt organization receives allocations of annual income representing annuity payments. The allocation of annuity income is offset by the interest expense if money is borrowed to buy the SPIA. The structure may involve an investor that may obtain financing for the premiums.

The Economics

A charity and its advisors should consider whether the program makes economic sense for the charity where insurance is being used. The program is adaptable for either the charity providing the premium (A) (see Figure 1), or the charity buying a SPIA to assure the premium stream (B) (see Figure 2),or the charity using a premium financing (C) (see Figure 3).

The Figures (1-3) are summaries that compare financial performance and returns on investments, through life expectancy out to age 99.

The (A) program provides a return of 1,988.34% in year one reducing to .41% at age 97.

The (B) program will provide a return of 29,838.65% in year one to .16% at age 97.

The (C) program will provide a return of 2,983% in year one and 0% at age 97.

Tax Issues Overview

Charities should be concerned about whether their fund-generating activities can be construed as income subject to taxation.

Unrelated Business Taxable Income

An organization described in Code Sections 501(c), 7871 and 7701(a)(40) is generally exempt from federal income tax.

However, such an organization is nonetheless subject to tax, at corporate tax rates, on its "unrelated business taxable income" (UBTI) in excess of $1,000 per taxable year.

Section 511(a) imposes a tax on the unrelated business taxable income (as defined in Section 512) of every organization otherwise exempt under Section 501(a), which includes organizations described in Section 501(c).

Section 512 defines "unrelated business taxable income" to mean the gross income derived by any [exempt] organization from any unrelated trade or business (as defined in Section 513) regularly carried on by it less the deductions allowed which are directly connected with the carrying on of such trade or business.

Section 513 states the general rule that the term "unrelated trade or business" means, in the case of any organization subject to tax under Section 511, any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization or its charitable, educational, or other purpose or function constituting the basis for its exemption under Section 501.

However, Section 512(b)(1) provides, except in the case of debt-financed income (discussed below), passive income, including but not limited to dividends, interest and annuities, is excluded from UBTI.

If a charity receives income that is not specifically excluded from UBTI (e.g., dividends, interest and annuity payments), that gross income WILL be UBTI if:

(i) it is income from a "trade or business,"

(ii) such trade or business is "regularly carried on" by the organization, and

(iii) the conduct of such trade or business is "not substantially related" (other than through the production of funds) to the charity's performance of its exempt functions.

Section 101(a)(1) provides a general rule that gross income does not include amounts received (whether in a single sum or otherwise) under a life insurance contract, if such amounts are paid by reason of the death of the insured.

Section 101(a)(2) creates an exception from the general rule in the case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance contract or interest therein, in which case the amount excluded from gross income shall not exceed the sum of the value of the consideration and the premiums and other amounts subsequently paid by the transferee.

Section 101(a)(2) provides further that the exception to general rule of exclusion does not apply if<:/p>

(A) the life insurance contract or interest therein has a basis in the hands of the transferee determined based on the basis in the hands of the transferor or

(B) if the transfer is to the insured, to a partner of the insured, to a partnership in which the insured is a partner or to a corporation in which the insured is a shareholder of officer.

In United States v. American Bar Endowment, 477 U.S. 105 (1986), the Supreme Court addressed whether insurance "dividends" paid to an exempt organization by an insurance company constituted UBTI.

The American Bar Endowment (ABE), an organization exempt from tax, raised money by providing to its members group insurance policies underwritten by major insurance companies. ABE would negotiate a reduced group rate with the insurers.

If the insurance company's costs of providing coverage were less than the premiums ABE paid, ABE would receive a refund of the excess. ABE's members agreed that ABE was entitled to keep these refunds for use in its charitable purposes.

With respect to the three-part test for UBTI, ABE conceded that it "regularly carried on" the program and that the program was not "substantially related" to ABE's exempt function. Addressing the only element in issue, the Supreme Court held that ABE's activities were a "trade or business," pointing to ABE's sales of goods and provision of services and the profit in fact earned by ABE.

In Technical Advice Memorandum 9223002 (1992), a charity participated in a casualty insurance promotion program. The organization provided a list of its members to an insurance company and advised its members of the availability of insurance coverage.

Under a rebate program, the insurance company paid the exempt organization a share of the net profits from the program. The IRS ruled that the rebates were UBTI, because they stemmed from a regularly carried on trade or business that was not substantially related to the organization's exempt function.

Even if (1) an activity were a "trade or business" and even if (2) the activity were not "substantially related" to an organization's exempt function, income received from such activity is not UBTI if (3) the activity is not "regularly carried on."

Is this Section 510(m) Commercial Type Insurance?

Section 501(m) denies tax-exempt status to a Section 501(c)(3) organization if a substantial part of its activities "consists of providing commercial type insurance." This provision was enacted to address Congress' concern that exempt organizations engaging in insurance activities had an unfair competitive advantage over taxable insurance companies. Commercial type insurance generally is any insurance of a type provided by commercial insurance companies, and must provide for risk shifting and risk distribution. In the investment technique described herein, the charity does not provide any insurance. Thus, Section 501(m) is not applicable.

Section 512(b)(17) provides that dividends and other items of income generally excluded from UBTI under Section 512(b)(1) can nonetheless be treated as UBTI. Here, the benefit being received is the death benefit proceeds otherwise generally excluded from the definition of gross income under Section 101. However, the charity will be purchasing insurance on the lives of participants. Thus, the Section 512(b)(17) UBTI inclusion does not apply.

In determining whether a trade or business is "regularly carried on," consideration is given to the frequency and continuity with which the activities, which produce the income ,are conducted and the manner in which they are pursued.

This requirement must be analyzed in light of the purpose of the unrelated business income tax, which was to eliminate a source of unfair competition by placing the unrelated business activities of certain charities on the same basis as the nonexempt business endeavors with which they compete. Thus, for example, business activities of a charity will be deemed to be regularly carried on if they manifest a frequency and continuity generally comparable to commercial activities of nonexempt organizations.

However, income producing or fund raising activities lasting only a short period of time will not ordinarily be considered as regularly carried on if they recur only occasionally or sporadically. Furthermore, such activities will not be treated as regularly carried on because they are conducted on an annually recurrent basis, such as an annual dance or fund raising event.

Is this Acquisition Indebtedness?

In Mose and Garrison Siskin Memorial Foundation v. U.S., 790 F.2d 480 (6th Cir. 1986) the court held that withdrawals against the accumulated cash value off life insurance policies were "indebtedness" for the purpose of finding "acquisition indebtedness." Implicit in this holding is that the life insurance policies produced either no gross income or the passive type income excludible from UBTI under Section 512(b) but for the fact that they created acquisition indebtedness.

In that case the charity withdrew the accumulated cash value of life insurance policies that the organization owned and reinvested the proceeds in marketable securities and other income paying investments.

However, in the arrangements considered in this white paper, the charity will not receive any proceeds from a life insurance policy until the death of an insured. There will be no draw down of the cash surrender value by the charity.

In Mose and Garrison the charity received the policies from contributors who had donated the life insurance policies to it and named the organization as the beneficiary. The charity held the policies for investment purposes while the contributors continued to pay the annual premiums. The charity argued that the withdrawals were simply advances of amounts that the life insurance company ultimately would pay. If these advances had produced UBTI to the charity, there would have been no need for the IRS to argue that the advances constituted indebtedness.

The allocation and distribution of life insurance proceeds to the charity would not be an allocation of UBTI to the exempt organization either because such proceeds are excluded from the definition of gross income under Section 101 or, if the charity has not incurred acquisition indebtedness to acquire its interest in the policies, because such proceeds are passive-type income excluded from UBTI under Section 512(b)(1). In the absence of debt-financed property, policy dividends and annuity income distributions will be excluded from UBTI for the exempt organization under Section 512(b)(1).

Insurable Interest as Tax Law Issue

In order for a charity to receive benefits free of income tax, a "reasonable" position would be where the benefit is from life insurance, then it should be free from tax under IRC Section 101.

As a general rule, a taxpayer is entitled to a deduction for both income and gift tax purposes for a transfer of a policy of insurance on the taxpayer's life to charity and for the subsequent payment of premiums. The Internal Revenue Service (IRS), however, attempted to deny any deduction for such a transfer. The IRS ruled that no deduction would be permitted for the transfer of a policy or any subsequent payment of premium if the insured acquired the policy with the intent to assign it to the charity, where the state law would not permit the charity to acquire the policy directly. Technically, the IRS contended that the acquisition of the policy by the insured with the intent to assign it caused a violation of the state's "insurable interest" rule. Under the IRS' position, the taxpayer would not only suffer a denial of the income tax deduction, but potentially could be subject to gift tax on the value of the transfers to charity. Transfers to charity are not exempt from gift tax and so avoid taxation only if, as a general rule, they qualify for a special deduction contained in IRC Section 2522.

Insurable Interest as a State Law Problem

All states have a requirement that no one can acquire a policy on the life of another person unless the acquirer has an insurable interest in the life of the insured. Basically, that means that the person acquiring the property is closely related to and/or financially dependent upon the insured. (Leimberg Information Services members can access the various states' laws under the STATE LAW tab at Generally, spouse, children and certain others, such as business partners, will meet this test.

Debt-Financed Income

Section 514(a)(1) provides that in computing UBTI under Section 512, there shall be included with respect to each each debt-financed property as an item of gross income derived from an unrelated trade or business an amount which is the same percentage (but not in excess of 100%) of the total gross income derived during the taxable year from or on account of such property as (A) the "average acquisition indebtedness" for the taxable year with respect to such property is of (B) the average amount of the adjusted basis of such prpoerty during the period it is held by the organization during such taxable year.

Section 514(a)(2) and (a)(3) together provide that there shall be allowed a deduction with respect to each debt-financed property an amount determined by applying the percentage derived under Section 514(a)(1) to the sum of the deductions which are directly connected with the debt-financed property or the income therefrom.

Under Section 514(b)(1), "debt-financed property" means any property which is held for the production of income with respect to which there is an acquisition indebtedness.

As defined by Section 514(c), "acquisition indebtedness" means, with respect to any debt-financed property, the unpaid amount of:

(A) the indebtedness incurred by the organization in acquiring or improving such property;

(B) the indebtedness incurred before the acquisition or improvement of such property if such indebtedness would not have been incurred but for such acquisition or improvement; and,

(C) the indebtedness incurred after the acquisition or improvement of such property if such indebtedness would not have been incurred but for such acquisition or improvement and the incurrence of such indebtedness was reasonably foreseeable at the time of such acquisition or improvement.

If the charity borrows money to acquire the policies, there could be "acquisition indebtedness" within the meaning of Section 514(c)(1) with respect to the charity and accordingly its benefits could not be considered to be income from "debt-financed property" under Section 514(b)(1). As a result, the distribution of policy dividends and annuity income derived by the charity should not be considered unrelated debt-financed income under Code Section 514.

To the extent any indebtedness is incurred, it should be incurred by an investment partner and not by the charity. The investment partner will deduct its interest expense from loans obtained to fund its capital contribution for the purpose of computing its UBTI.

Finally, the activity of the purchase of the policies itself is not a business that is unrelated to the exempt purpose of the exempt organization. An exception to unrelated trade and business does not include any trade or business in which substantially all the work in carrying on such trade or business is performed for the organization without compensation.

Unrelated Business Taxable Income

Section 512(b)(13)(A) provides the general rule that, if a "controlling organization" receives or accrues (directly or indirectly) a specified payment from another entity which it controls, i.e., the "controlled entity", the controlling organization shall include such payment as an item of gross income derived from an unrelated trade or business to the extent such payment reduces the UBTI of the controlled entity. Under Section 512(b)(13)(D)(II) "control" means, in the case of a partnership, ownership of more than 50 percent of the profits interests or capital interests in such partnership.

The Committee Reports on P.L. 105-206 (IRS Restructuring and Reform Act of 1998) clarifies the purpose of Section 512(b)(13), viz., that rent, royalty, annuity, and interest income that would otherwise be excluded from UBTI is included in UBTI under Section 512(b)(13) if such income is received or accrued from a taxable or tax-exempt subsidiary that is controlled by the parent tax-exempt organization.

The purpose of this provision is to prevent a taxable subsidiary that is controlled by a charity, from making a payment to the controlling exempt organization so as to reduce the taxable subsidiary's income.

In applying Section 512(b)(13) a look-through test should be applied to the arrangement since it is not the issuer of the life insurance policies or annuity contracts and does not itself have any UBTI to be reduced by its distributions of life insurance proceeds or annuity income.

Since the charity will not be in control of the commercial life insurance company or companies issuing the life insurance policies or annuity contracts to the charity, Section 512(b)(13) should not apply to cause the allocations to the exempt organization of life insurance proceeds or annuity income to become UBTI to the exempt organization.

Adverse Impact on Charity's Tax-Exempt Status under Section 501(c)(3).

Section 501(c)(3) provides for the exemption from federal income taxes of organizations organized "exclusively" for religious, charitable, educational or other specified exempt purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual, and which does not engage in proscribed legislative and political activities.

Treas. Reg. § 1.501(c)(3)-1(d)(2) provides that the term "charitable" is used in section 501(c)(3) in its generally accepted legal sense and includes providing relief for the poor and distressed, lessening the burdens of government, and promoting social welfare in a number of specified ways.

Section 501(m)(1) provides that an organization described in Section 501(c)(3) shall be exempt from tax under section 501(a) only if no substantial part of its activities consists of providing "commercial-type insurance."

Section 501(m)(2) provides that if an organization described in Section 501(c)(3) provides insurance as an insubstantial part of its activities, the activity of providing commercial-type insurance shall be treated as an unrelated trade or business (as defined in Section 513), or in lieu of the tax imposed by Section 511, the organization shall be treated as an insurance company for purposes of applying Subchapter L with respect to such activity.

Section 501(m)(4) states that the issuance of annuity contracts shall be treated as providing insurance. However, the exempt organization in the arrangement at issue in this white paper will not issue annuity contracts or life insurance policies.

No part of the exempt organization's activities with respect to the charity's exempt status under 501(a) and 501(c)(3) should be adversely affected by its participation in this opportunity.


As we have seen in the past, many times altering or skewing an otherwise viable arrangement can create problems. Advisors and the Service are reviewing several important potential problems.

  • Insurable interest
  • Private benefit
  • Charitable split-dollar

Insurable interest. As indicated earlier, the ability to maintain the benefits arranged requires that the charity have an insurable interest in the insured. The specific state requirements must be adhered to. Whether the insured's domicile laws are applicable, the law in the state where the charity is located and the law in the state where the "transaction" occurred must be considered and reviewed by appropriate counsel.

Private benefit. The issue of whether the transaction violates the private benefit rules may be confusing. The rules of private benefit require that a charity promote a public, rather than private purpose. This is another way of stating that the charity meet the "operational test" for exemption. IRC Section 501(c)(3) provides, in part, for recognition of exemption for organizations "organized and operated exclusively" for charitable, religious, educational, and other purposes stated in the statute.

The operational test of the regulations elaborates the "operated exclusively" requirement of the statute. The test is aimed at ensuring that an organization's programs are devoted to furthering the "exempt purposes" that are specified in IRC Section 501(c)(3). The regulations indicate the charity will not be regarded as "operated exclusively" for one or more exempt purposes if more than an "insubstantial part" of its activity is not in furtherance of an exempt purpose.

Finally, another part of the regulations, which lists the permissible exempt purposes, provided that by definition, a charity will not be operated exclusively as well as not organized exclusively for a permissible exempt purpose - "unless it serves a public rather than a private interest."

Thus, if a charity's activity is shown to benefit a private interest, it will be deemed to further a non-exempt purpose, and thereby will fail the operational test. The consequence of failing to meet the operational test is disqualification of the organization from exemption under IRC Section 501(c)(3).

One recent Tax Court case, Westward Ho v. Commissioner, illustrates the concept of private benefit. While the facts may be extreme, they prove the point.

Three restaurateurs wanted to move homeless individuals out of Burlington, Vermont by way of a one-way ticket by plane to anywhere. The IRS refused to recognize this entity as a charitable organization. The organization filed suit in Tax Court and the court held against exemption for the organization on private benefit grounds. Clearly, there are many situations in which a charity will provide a degree of benefit to specific groups of individuals in the course of conducting a charitable program.

To provide further clarity, the IRS in GCM 39862 (November 22, 1991) stated:

"Any private benefit arising from a particular activity must be "incidental" in both a qualitative and quantitative sense to the overall public benefit achieved by the activity if the organization is to remain exempt. To be qualitatively incidental, a private benefit must occur as a necessary concomitant of the activity that benefits the public at large; in other words, the benefit to the public cannot be achieved without necessarily benefiting private individuals. Such benefits might be characterized as indirect or unintentional. To be quantitatively incidental, a benefit must be insubstantial when viewed in relation to the public benefit conferred by the activity."

I am advised by members of the American College of Trust and Estate Counsel (ACTEC) that the IRS is reviewing the use of life insurance with premium financing to determine if it raises private benefit issues. In a phone conversation with an IRS representative, the Service did not confirm it is considering the validity of such programs.

Charitable Split Dollar Issues. With the issues that were raised in both the newspaper on Charitable Split Dollar and CHOLI (Charitable-owned life insurance) (Wall Street Journal, February 6, 2003), the Planned Giving Community is continually reviewing these types of planning tools.

Recently, an unidentified writer has urged Treasury and the IRS to issue a warning about potential abuses of charity-owned life insurance which promises an income tax deduction but provides little benefit to the Charity (Tax Notes Today, March 11, 2004 - 2004 TNT 48-29). If the donor is not receiving a deduction for the "donation" of their life, this position lacks the connection to the transaction.

Once again care and caution must be taken in using these tools. If some program is mass-marketed, the goal may not be primarily to help the charity meet its exempt purposes but rather to generate commissions or fees to the promoters.

AALU Notice

On Friday, April 2, 2004, the AALU announced they were taking a position of opposing allowing unrelated third parties to invest in life insurance. The announcement described certain arrangements with charities and life insurance. The issue of insurable interest, transfer for value, and wagering are of concern and were referenced in the announcement.

These actions will bring further focus and hopefully clarity to the process.


As with many tools when properly used, tremendous benefits may flow to all involved. The same tool in the wrong hands can be destructive.

This tool can be used successfully and the IRS, upon review, may conclude it is an appropriate device when properly used.

An Estate and Trust attorney who is a member of the ACTEC fashioned a matrix that is of tremendous value for charities interested in this planning technique (Table 1). Perhaps this arrangement should have a disclaimer,

"Do not try this procedure at home without adult (proper) supervision."


Table 1


(Current Law) Probability (0 to 10)

Worst Case

Risk Management

1. Lose 501(c)(3)

Only if activity is a primary activity of charity

Structure so charity issue never deemed to life insurance or annuity (Exc: CGA)


(a) Debt financed income esp. after insured's life expectancy.

(b) Step transaction prearrangement (marketing)

- Helvering v. Le Gierse and RR 65- 57, no shifting of risk.

- No life insurance "Income and death benefit as possible UBTI

- But two separate insurance co. and separate owners of life insurance v. annuity (Trust v. LLC).

Reduces cash flow, question whether remains economically viable

- Get Private Letter Ruling (PLR).

- Consider premium reduction after life expectancy.

3. Insurable Interest

Without it, may get only premiums paid instead of death benefit

Never owns policy

4. Economics - Cash Flow depends on assumptions

- Works best where better rating for LI than annuity (arbitrage)

- LI crediting rate must be higher than financing interest

- Arbitrage must allow for first year premium and interest on loan, and expenses, + "profit" for Investment Partner

Charity gets nothing (or, charity must contribute more later).

Interim distributions mentioned, but unlikely

LI and annuity guarantees

Fixed rate interest on note (not likely)

Define Investment Partner's "profit"

5. Late IRS action, i.e., "over the hill" legislation


Related to 4. Need Exit Strategy. What if all policies and annuities terminated in future.

6. Life Insurance Company Failure (maximum ex. Age 78 = 25 years)

Charity gets nothing

Use quality companies.


Leimberg and Gibbons, "TOLI, COLI, BOLI, and Insurable Interests" - An Interview With Michel Nelson, Estate Planning Magazine, Vol. 28, No. 1, July 2001, Pg. 333. See Tools and Techniques of Charitable Planning (800 543 0874).


Steve Leimberg's Estate Planning Newsletter # 671 at

Copyright 2004 Leimberg Information Services, Inc. Reprinted by Planned Giving Design Center, LLC with Permission. Reproduction in Any Form or Forwarding to Any Person Prohibited - Without Express Permission.

  1. IRC § 170(f)(3)(A), Donor Reversion; Freeman, Douglas, JD, LLM, "Charitable Reverse Split-Dollar: Booby Trap or Bonanza," Journal of Gift Planning, April 1998; Green, Carolyn, "One Charitable Deduction Could Land You In A Tax Trap," Fortune Magazine, February 15, 1999; NCPG Board of Directors Position Paper on Charitable Reverse Split Dollar, National Committee of Planned Giving (February 1998); IRS Notice 99-36.back

  2. Philanthropy Todayback

  3. IRC § 511-513back

  4. IRC § 514.back

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Debt-financed income?

Our charity has been approached several times by insurance agents to borrow funds to pay the premiums of new life insurance policies (used as an investment). Would that constitute debt-financed income, IRC Sec. 514? Or could it be classified under acquisition indebtedness?

Re: Debt-financed income?

I am interested in the answer to this question.

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