We, the authors, represent family offices, frequently speak at large family office conferences and have held numerous ad hoc meetings with a wide range of family office representatives. The one thing we get asked about most often is the tax risk profile of private placement life insurance (PPLI). While our evidence is anecdotal, the ever-increasing number of questions and pitches suggests to us that the tax risk for PPLI is on a steep upward trajectory. This article summarizes our thoughts and how we answer those questions.
In general, PPLI is a form of permanent variable universal life insurance that builds cash value based on the performance of investment accounts it holds. Typically, PPLI policies allow customizable investment options, including investments in hedge funds, real estate or derivatives. Because the tax code treats PPLI as life insurance—assuming it meets all requirements—it can offer substantial tax benefits, including tax-free investment growth and a tax-free death benefit, though these benefits may also give rise to tax risks.
PPLI presents two different types of tax risk: audit and legislative. Audit risk refers to the probability of an IRS audit and the potential that such an audit could result in additional taxes or, in more serious cases, penalties. The likelihood of an audit is decreasing due to reduced IRS resources, not because of the strength—or lack thereof—of reporting positions. The exam coverage rate for tax year 2019—the most recent year outside the statute of limitations period— of individual taxpayers reporting total positive income (TPI) of $10 million or more was 11%. That number may increase for 2020 to 2024 as the IRS reallocated resources to cover those returns and enjoyed the benefit of increased funding. However, recent budget and staffing cuts will likely leave the IRS less equipped to audit those returns in the future than it was in 2019—potentially significantly less.
An IRS audit of a family office does not automatically imply that a PPLI policy will also be subject to audit. PPLI is not subject to specific reporting requirements, making it difficult to detect unless the taxpayer is already under audit and the IRS examiner specifically inquires about it. With that said, some aspects of PPLI, especially the offshore variety, can require the f iling of certain forms. Participants should be extra cautious in ensuring that all required forms are filed as the failure to do so could lead to penalties and an open-ended statute of limitations for the IRS to assess additional tax.
Declining resources have compelled the IRS to focus more on previously identified audit issues and less on exploring new arguments to raise—though the latter can still occur. For PPLI, we anticipate most IRS audits—which are relatively uncommon— will focus on the investor control doctrine, given its longstanding presence and the IRS’ occasional use of it in court cases.
The investor control doctrine prohibits the policy owner from directing that premiums be invested in specific investments. While the owner can dictate broad strategies, communications with the investment manager regarding specific strategies can spell trouble. This fact-intensive test warrants careful consideration as errors can result in full taxation on the inside buildup.
The best examination is, of course, the one that never occurs. The next best outcome is an examination that proceeds smoothly and concludes quickly because the taxpayer is well prepared and properly represented. A lack of important funding may well impact the volume of examinations the IRS can conduct, but those selected for an examination will understand that a modernized IRS is more than capable of conducting in-depth traditional tax examinations in a target-rich environment. Start preparing today by collecting all relevant information to support your return positions—and then prepare some more.
That brings us to legislative risk, which currently seems low. While the Biden administration proposed some legislative restrictions on PPLI, the Trump administration has not. Similarly, in 2024, the Senate Finance Committee—then under Democratic control—proposed legislation that would significantly restrict PPLI. However, we have seen no indication that the Republican-led Congress plans to advance that proposal. Our view is that meaningful legislative risk is unlikely unless and until the political balance shifts back to the Democrats. If that occurs, the risk could be acute, given that legislation has already been drafted and some groundwork laid.
Notably, if enacted, the legislation proposed by the Senate Finance Committee would have a quasiretroactive effect. Specifically, it would require policy owners to include in current income all preceding years’ earnings from within the policy. The draft legislation includes an exit provision stating that prohibited contracts will not be treated as such if they are canceled within 180 days of enactment.
Tax legislation often takes years to become law after its initial proposal. Although we cannot predict whether any of the legislation proposed in 2024 will become law, failure to previously pass does not eliminate the possibility of future traction. High-value PPLI owners should carefully evaluate how the proposed legislation might impact their policies and, assuming the outlook is unfavorable, develop an exit strategy should legislative risk increase.
Tom Cullinan is a shareholder in the Tax Controversy & Litigation practice at law firm Chamberlain Hrdlicka. He previously served as counselor to the IRS commissioner and as acting IRS chief of staff. He can be reached at tom.cullinan@chamberlainlaw.com.
John Hackney, a shareholder at Chamberlain Hrdlicka, represents clients in federal and state tax controversy matters and tax litigation, including tax-related examinations and administrative appeals. He can be reached at john.hackney@chamberlainlaw.com.
Chuck Rettig is a shareholder at Chamberlain Hrdlicka and a former commissioner of the IRS. He represents clients in tax matters and federal and state tax controversies and investigations. He can be reached at charles. rettig@chamberlainlaw.com.
This article originally posted in the Family Office Magazine Summer 2025 Issue in July 2025.