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51 IRET Congressional Advisory 1 (1995)

handle is hein.taxfoundation/iretcgadv0049 and id is 1 raw text is: October 30, 1995 No. 51 KEEP INTEREST DEDUCTIBLE ON LOANS BACKED BY CORPORATE OWNED LIFE INSURANCE The tax bill developed by the House Ways and Means Committee has a provision that would deny the normal interest-expense deduction for interest costs businesses incur when they borrow against their corporateeCLI owned life insurance policies expediency, a (COLI policies). This tax principles. disallowance would apply to Conference all interest payments made reconciliation after 1995 on loans secured by COLI proposa COLI policies, including interest payments on already outstanding loans. The Senate Finance Committee's version of the bill would also terminate the interest deduction on these borrowings, with the exceptions that the interest deduction would continue on loans existing prior to June 20, 1986, and would be phased out over [ e te five years on loans existing income, the d, prior to 1996. deduction As an example, suppose a taxation: the g business borrows against a both the lend COLI policy and subsequently on the samie makes a $1,000 interest payment on the loan it has obtained. Under current law, the company can deduct this interest payment from its taxable pr-op~ viola The 7ommll bill s~ 1. lende n its Inial w-rodi iw 1'veO1 'r ani income. Under the House and Senate plans, it could not. (If the loan existed prior to 1996 and the interest was paid in the period 1996-2000, the Senate Finance Committee's version would allow a partial deduction.) At a 35 percent corporate tax rate, the denial of the deduction would raise the company's tax bill and, thus, increase its cost of doing business by $350. Although the U.S. Treasury Department has long viewed denial of the interest-deduction on COLI-backed loans as a possible revenue raiser, preventing a business from claiming an interest expense violates fundamental tax principles. First, it taxes businesses on income they do not have. Income is revenues less expenses, and interest costs are business expenses. Second, because the lender must include the interest in its own taxable income, the denial of the interest deduction produces double ataxation: the government is tsal isornk taxing both the lender and the f sborrower on the same income. House-Senate (Lenders on COLI policies are ittee on the generally insurance companies, Fiould drop the and although their tax treatment is extremely complex, they do pay tax.) Somehow, government officials who are so concerned whenever they feel the government is not collecting all it should have no compunction about taxing two different taxpayers on the same income. - must include Those who object to the own taxable interest deduction seem to own taxable think that paying interest is of eitet costless. In fact, interest tces double payments reduce the resources ment is taxing of the payers, which is why the borrowver people don't borrow unless the use of the borrowed funds produces revenues greater than the cost of servicing the debt. In the real world, of course, households and business borrow for purposes like buying homes, Institute for Research on the Economics of Taxation IRET is a non-profit, tax exempt 501 c){3) economi c pol icy research and educational organization devoted to informing the public about policies that will promote economic growth and efficient operation of the free market economy. 1730 K Street, NWV., Suite 910, Washington, D.C. 20006 Voice 202-463-1400 * Fax 202-463-6199 0 Internet www. iret.org

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