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Wednesday, September 27, 2006


Charitable organizations need to be aware of a new reporting requirement that came into effect under the Pension Protection Act of 2006. Under the Act, if an organization, gifts to which are eligible for a charitable deduction (for estate, income, or gift purposes), acquires an interest in certain life insurance contracts, such interest must be disclosed to the IRS. See Code Section 6050V. This disclosure requirement is only for a two year period.

It is clear that the IRS is concerned about charitable organizations lending their "insurable interest" in a life insurance policy to third parties. More particularly, there are various programs whereby a charitable organization acquires an ownership interest in a donor. The funds for the policy are generally lent to the charitable organization by a third party. When the donor dies, the charity gets the insurance proceeds, less its repayment of the loan to the third party lender.

If the third party lender had instead taken out the policy, it probably would not be enforceable, due to insurance law requirements that a beneficiary have an "insurable interest" in the insured. Generally, an "insurable interest" is an economic interest in the person whose life is insured, or a family relationship. Many states extend the "insurable interest" to include charities who own a policy on a donor’s life. Thus, the third party lender gains an indirect benefit from the policy due to the charitable nature of the beneficiary.

While the new provision does not prohibit or tax such arrangements, the IRS is gathering information and may seek further legislative reform down the line. In the meanwhile, the reporting itself may serve to dissuade charitable organizations from entering into these types of transactions.

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