A Matter of High Interest : How a Quiet Change to an Actuarial Assumption Turbocharges the Life Insurance Tax Shelter

Draft: America’s lengthy income tax code and financial regulations are notoriously full of special treatment for the politically favored. Academics and policymakers argue the relative merits of different approaches to tax and regulatory policy – given the complexity of economic life, should the law attempt to be highly tailored and specific? Or does the exacting approach risk getting lost in the weeds? This Article will showcase the limits of a highly technical approach to policy with the first analysis of an almost completely unnoticed sea change in life insurance tax law, one that engorges a tax shelter at a moment of great attention to laws that enable the wealthiest members of society to face lower effective tax rates than their secretaries.Life insurance has received extremely favorable federal tax treatment since the inception of the federal income tax. In the 1980s, in response to an increasing wave of policies smuggling traditional investment products into products calling themselves life insurance, Congress formalized a mathematical definition of life insurance policies directly into the Internal Revenue Code (§ 7702). § 7702, a fully realized actuarial simulation, placed quantifiable limits on the degree to which policyholders could treat a life insurance policy like an investment (such as a mutual fund) rather than as insurance protection.For decades, the provision was left alone; however, buried in the 2020 COVID-19 omnibus relief bill, Congress included – with essentially no public debate– a change to a key actuarial assumption of the § 7702 test. The result, though heavily obscured by layers of mathematics, was that § 7702 was made substantially more permissive, giving policyholders much greater leeway to use life insurance policies as conduits for tax-exempt wealth accumulation, rather than mere protection of beneficiaries in the event of the worst. After over thirty years of near-total absence of analysis of Congress’ life insurance definition in the legal literature, this paper resurrects the history, purpose, and structural limitations of § 7702 and the hyper-technical approach to tax policy it embodies. It further provides the first exhaustive analysis of the new world of life insurance after the stealth § 7702 amendment, one in which swathes of the industry are preparing to – as the Democratic Party eyes loophole crackdowns on the wealthy – leverage their extraordinary tax advantage into a new role at the center of high-end tax avoidance