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DEAD PEASANTS: IRS QUICKLY RESTORES ITS LEAD

April 29, 2003

The IRS winning streak on "dead peasants" life insurance was broken earlier this month. The IRS quickly came back down the court for an emphatic slam dunk on the issue yesterday, winning an appeal in American Electric Power Co.

"Dead peasant" insurance - known in polite circles as corporate-owned life insurance, or "COLI" - is the practice of purchasing life insurance on a large group of rank-and-file employees. The plan tries to take advantage of the tax-free buildup of earnings in the policy by borrowing against the policy and deducting the interest. While the buildup and the interest expense nearly wash economically, the policy owner comes out ahead if the expense is deductible while the income is tax-free.

The 6th Circuit upheld a decision that such an arrangement by American Electric Power was a "sham" entered into only to produce tax benefits.

The decision casts into doubt the taxpayer victory in Dow Chemical earlier this month; the Dow decision is being appealed to the same court that sided with the IRS in American Electric Power. Dow still has some hope, though, as a concurrence in the American Electric Power opinion noted that there was a difference in the way the Dow plan was done.

WHERE INSURANCE REMAINS USEFUL

The dead peasant plans (which clearly do not work anymore, even if they once did, because of tax law changes) should not be confused with conventional life insurance arrangements in corporations. Life insurance remains a valuable tool in protecting against the loss of key personnel and in financing buy-sell agreements and non-qualified retirement arrangements.

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