COLI LOAN INTEREST NONDEDUCTIBLE

On March 4, The BNA Daily Tax Report reported on the pre-publication release of a technical advice memorandum that declares most interest on loans taken out to pay corporate owned life insurance (COLI) is nondeductible.

IRC section 264 requires insurance to be funded by nonborrowed funds during four of the first seven years of the policy. Funds to pay the remaining three years' premiums may be borrowed, and typically the source of the borrowed funds is the built-up cash value of the policy itself.

For years there has been controversy about whether loans taken out to pay COLI premiums collateralized by the cash value of the COLI itself resulted in deductible interest. In 1996, Congress finally settled the issue by making such interest nondeductible, while also providing for a phaseout of the deduction. This provision appeared to bless the deductibility of COLI interest during the phaseout period.

BNA reports that this may not be so. A technical advice memorandum requested by the Washington, D.C. firm of Sutherland, Asbil, & Brennan, LLP came to the conclusion that interest on loans to pay COLI premiums will only be deductible if the loan proceeds originated from funds outside the policy.*

Source: BNA Daily Tax Report, March 4, 1998, p. G-6.