Monthly LRA Update

REGULATORY DEVELOPMENTS

House Financial Services Hearing – Regulators to Pause Major Rulemakings until 2025 On November 20 the House Financial Services Committee held a hearing entitled “Oversight of Prudential Regulators.” Witnesses included Michael Barr (FRB Vice Chairman), Martin Gruenberg (FDIC Chairman) and Michael Hsu (OCC Acting Comptroller).

Of note, during the session, the banking regulators expressed that major rulemakings, including Basel III Endgame, would not proceed until after the change in presidential administrations.

TAX DEVELOPMENTS

JCT Description of the Revenue Provisions Contained in the President’s Fiscal Year 2025 Budget Proposal On November 22 the Joint Committee on Taxation (JCT) released its description and analysis of the revenue provisions that are included in President Biden’s fiscal year 2025 budget proposal as submitted to the Congress on March 11, 2024 (as covered our March LRA Update).

Two topics in the JCT description bear highlighting:

1. Proposal to Expand the Pro Rata Interest Expense Disallowance for Business-Owned Life Insurance; and

2. Proposal to Limit the Tax Benefits for Private Placement Life Insurance (PPLI).

While it is clear that the Trump administration will have vastly different tax policy objectives, some of the modest revenue raisers could possibly get pulled into consideration as part of broader legislative negotiations.

Expansion of 264(f) Interest Expense Disallowance

This proposal has been included in a number of previous budget proposals. In this JCT report, the authors provided a slightly more balanced assessment of the proposal. A primary purported rationale for the proposal is that businesses which own life insurance on employees can borrow from third parties (unconnected to the life insurance) and achieve a “tax arbitrage” by deducting interest on the debt while retaining tax-deferred and/or tax-free earnings from the life insurance.

The JCT report includes the following perspectives (each excerpted verbatim) in opposition to the measure:

● Small businesses might argue that they need access to cash, in particular the cash value of life insurance on employees, officers, and directors, so retaining the tax subsidy provided by the exception for those individuals is appropriate for small businesses, regardless of the application of the proposal to others.

● Opponents of the proposal argue that the funds borrowed under the life insurance contracts are used for tax-advantaged pre-funding of expenses such as retiree health benefits and supplemental pension benefits.

● A related argument is that investments in such insurance contracts are accepted as tier 1 capital for banks, an important incentive for banks to hold the contracts, and that

limiting their tax advantages negatively impacts these financial institutions. Arguably, limiting this source of tier 1 capital may be a particularly inappropriate side effect of the proposal at times of economic downturn, illiquidity, unavailability of credit, or instability among banks.

● Some might view the proposal as somewhat ineffective because it would not impose any dollar limitation on the amount of insurance an employer would be permitted to purchase with respect to a 20-percent owner, nor on the amount of interest expense allocable to unborrowed policy cash values with respect to such insurance that would remain deductible under the proposal. It could be argued that the proposal would not effectively deter undesirable tax arbitrage in many cases, without any such limitations.

The report largely counters each of the above perspectives as well; however, it is encouraging that the report acknowledges countervailing perspectives.

In total, the JCT scored this proposal at ~$8.3 billion over ten years. The Biden budget scored it at ~$7 billion.

Limit Tax Benefits for PPLI

This was a new proposal in Biden’s fiscal year 2025 budget proposal. As a quick recap, this proposal would look to modify the tax treatment for variable contracts that are exempt from SEC registration in an attempt to target utilization by high-net-worth individuals. The adjusted tax treatment would include applying a tax on death benefits (to the extent such benefits exceed basis) and applying a 10% excise tax to any taxable distributions, including death benefits.

The JCT report on this provision appears to be slightly inconsistent in explaining and defending the rationale. First, it states that the proposal “ends tax deferral for this type of contract … by imposing current income tax on all distributions from such a contract on an income-first basis…” Note that an income tax is already imposed on pre-death distributions of inside build-up from life insurance, and MECs are already subjected to the income-first recognition treatment. As such, the current taxation of distributions is not highly

controversial. However, the existing MEC and non-MEC distinctions are based on meaningful structural differences and adjusting non-MEC treatment solely on the basis of whether a contract is issued on a private placement basis strikes us as illogical.

The report later observes that the proposal “does not change the tax treatment of amounts that are not distributed (or are not loaned or pledged) with respect to the contract.” Hence, the proposal does not look to end tax deferral. However, the imposition of a 10% excise tax would likely overwhelm the value of tax deferral in most instances.

Similar to the discussion on interest expense disallowance, the JCT report acknowledges that this proposal has some opposition (each excerpted verbatim):

● Opponents of a change in the law may point out that deferral of income tax on inside buildup of life insurance and annuity contracts has been the same for decades starting in the previous millennium.

● Some might question the idea of identifying a specific type of contract that may arguably be abusive and changing its tax treatment. Potential drawbacks of the approach may be that the proposal is either overbroad and taxes non-abusive contracts inappropriately, or is underinclusive and does not address contracts or arrangements that could cost-effectively be adapted to achieve the results of using private placement life insurance and annuity contracts today.

● Another potential criticism of the proposal’s approach is that it might deter individuals from buying life insurance or annuity contracts generally, whether due to unfamiliarity with the scope of the proposal, or due to trepidation about future changes to the treatment of such contracts or the market for such contracts.

● Issuers, reinsurers, investment advisors, and others may be concerned about the market as well and may feel that the proposal unfairly limits the profitability of their business activity.

In total, the JCT scored this proposal at ~$9.8 billion over ten years. The Biden budget scored it at ~$7 billion.

Increase the Corporate Tax Rate to 28%

The Biden budget proposal called for increasing the corporate tax rate to 28%. The administration estimated this would increase revenues by ~$1.35 trillion. The JCT didn’t score it as high, but still estimated ~$0.88 trillion in increased revenue.

IRS Releases Contribution Limits for 2025

On November 1 the IRS released its annual update regarding amounts individuals can contribute to 401(k) plans and other cost-of-living adjustments for various purposes (IRS Notice 2024-80).

Notable updates include: