November 22, 2017

How Section 264(a) negatively affects selling life insurance in A/R Financing Programs

Copyright 2007

Back in August of 2006, I did a newsletter titled “What’s Wrong With A/R Financing.”  (A/R is short for Account Receivables). In that newsletter, I explained what the A/R Financing plan is, why most advisors selling it do not understand the benefits (which are few), and why most who do understand the “real” pros and cons of the plan so it can be sold with full disclosure (which is rarely done because doing so would kill the sale).

Since the theme of my last three newsletters have been on Home Equity Management including wealth building plans using Equity Harvesting, I thought I would cap off month’s worth of newsletters on leveraging topics by discussing how 264(a) affects the A/R Leveraging Plan.

Without restating the past newsletters, I want to briefly summarize a few.

1) What’s wrong with A/R Financing? A/R Financing is a plan sold mainly to doctors by playing on their fear of losing their A/R in a medical malpractice lawsuit.

The sale’s pitch is simple: Doctor, are you afraid of losing the largest asset of your medical practice (A/R which could be $100k-1 million plus)?  Would you like to protect the A/R AND build wealth in a tax-favorable manner?

Doctors are always interested in protecting assets and building wealth so this topic is a very easy “prospecting” tool for insurance professionals. Additionally, insurance advisors like this topic because the average life insurance premium paid into these plans is $200,000-$400,000 over a five year period.

The basics of the plan are simple as well. A medical practice takes out a big loan and then pledges the A/R of the practice as collateral.  The borrowed funds are poured into a cash-building life insurance policy where the cash will grow and where the doctor will borrow income tax free from the policy in retirement.  The life agent shows the doctor borrowing thousands of dollars in retirement tax-free from the policy which creates a very powerful sales presentation.

I do not have time to go into all the problems with the plan or with the sale techniques used to sell it. If you would like to read the newsletter on “What’s Wrong With A/R Financing,” please click here.

As explained in above, money is loaned to the medical practice and the A/R is used as collateral.  On thing that disturbs me about this sale is that most of the vendors pitching it (and their agent sale’s force) either tell the doctor that the interest is deductible on the loan to the practice or the doctor is told that they “don’t give tax advice” and that the doctor needs to talk to his/her own CPA about the interest deduction (who does not understand the subject matter and usually will tell the client to write off the interest on the loan).

Side note: A/R financing “done right” has the money being loaned directly to the doctor and where the medical practice pledges the A/R as collateral.  With this version of the plan, even the sales people tell the client correctly that the interest is not deductible.  That’s great, but the problem then becomes that the interest rates are usually quite high which make the overall finances of the plan marginal and not very saleable.

2) My newsletter from two weeks ago was titled How IRS Section 264(a) Negatively Affects Equity Harvesting (Missed Fortune 101).  In that newsletter, I explained that, when a client borrows equity out of a personal residence and repositions it into a cash-building life insurance policy with contemplation of borrowing from it, the interest on the loan is NOT deductible.  This revelation seemed to depress and shock many Missed Fortune 101 and Stop Sitting on Your Assets disciples.

As you’ll recall from that past newsletter, 264(a)3 states the following when listing situations when interest on a loan is NOT deductible:

(3) Except as provided in subsection (d), any amount paid or accrued on indebtedness incurred or continued to purchase or carry a life insurance, endowment, or annuity contract (other than a single premium contract or a contract treated as a single premium contract) pursuant to a plan of purchase which contemplates the systematic direct or indirect borrowing of part or all of the increases in the cash value of such contract (either from the insurer or otherwise).

Like Equity Harvesting from a personal residence, the A/R Financing Plan is a leveraging plan where borrowed funds are repositioned into cash value life insurance with contemplation of borrowing tax free from the policy.

264(a)3 governs both Equity Harvesting from a residence and the A/R Financing plan. What does that mean?  It means that thousands of clients who have been sold the A/R Financing plan over the last many years (and it’s been around for nearly 20 years) purchased the plan based on the false assumption (or assertion by the advisor) that the interest can be deducted.  Obviously, not being able to write off the interest dramatically affects the finances of the plan (in a negative way).

While you may have read in my past newsletters that Equity Harvesting from a personal residence can still work out well financially even if you do not write off the interest, that is not always the case with the A/F Financing plan. Why?  Because the loan on the A/R Financing plan is many times a commercial loan which significantly increases the annual interest rate (not to mention that the rate cannot be locked for anywhere near as long as a personal home loan).

There are several other problems I have with the A/R Financing plan which makes it one of my least favorite topics. In an attempt to keep this week’s newsletter brief, I’ll just end the newsletter now and refer you to some of the past newsletters for more information.

What I’d like advisors to take from this newsletter is that, if you currently sell or are thinking of selling the A/R Financing plan, DO NOT tell your clients the interest on the loan is deductible (because it is not under 264(a)3).  I also recommend you complete more due diligence on this topic.  Once you learn how the A/R of the medical practice is not at risk and how the finances right now are very marginal due to high commercial lending rates, I believe you will come to the same conclusion I have which is that the topic is not terribly useful when helping clients protect their assets or grow their wealth.

Roccy DeFrancesco, JD, CWPP™, CAPP™, MMB™

Founder, The Wealth Preservation Institute

Co-Founder, The Asset Protection Society

378 River Run Dr.

St. Joseph, MI 49085

269-216-9978

269-983-6917 (fax)

www.thewpi.org

www.assetprotectionsociety.org

Are you a CWPP™,  CAPP™ or MMB™?  To learn more about the CWPP™, CAPP™, or MMB™ certification courses and how to take your consulting to the “next level” go to www.thewpi.org.

Author of The Doctor’s Wealth Preservation Guide which can be purchased for $49.95 from The WPI at info@thewpi.org.

Circular 230 disclaimer: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

This newsletter make is not meant as a commentary pro or con on the PRS Plan.