In recent months some of the wealthiest older Americans have been buying huge life insurance policies on themselves. Curiously, these people have shopped not for the cheapest rates but for the highest rates they can find. In some cases, they delightedly pay 10 times the lowest rates for that insurance.

Why would anyone willingly pay so much?

Taxes.

Through a technique invented by a lawyer in New York and a chemical engineer in California, each dollar spent on this insurance can typically eliminate $9 in taxes. Spend $10 million on this insurance, avoid $90 million or more in income, gift, generation-skipping and estate taxes.

"I'm not saying this is the best thing since sliced bread, but it's really good for pushing wealth forward tax free," said Jonathan G. Blattmachr, the New York lawyer who heads the estate tax department at Milbank, Tweed, Hadley & McCloy and who explained the plan in a half-dozen interviews.

The technique is legal, blessed by the I.R.S. in 1996. But some leading tax lawyers, as well as some accountants and insurance agents, say it shouldn't be. They say it effectively disguises a gift to one's heirs that should be taxed like any other gift. They also say it is but one example of how a tax exemption on life insurance that was approved by Congress in 1913 to help widows and orphans has been stretched to benefit the very richest Americans.

Several thousand of these jumbo policies have been sold, according to agents who sell them, all under confidentiality agreements with the buyers and their advisors. One member of the Rockefeller family took out a policy, according to people who have seen documents in the deal.

The several billion dollars of this insurance already sold, much of it in the last 18 months, means that tens of billions of taxes will not flow into federal and state government coffers in the coming decade or so.

In recent months, policies with first-year premiums alone of $4.4 million, $10 million, $15 million, $25 million, $32 million and $40 million have been sold by New York Life Insurance, Massachusetts Mutual Life Insurance and other underwriters, according to insurance agents, accountants and tax lawyers who have worked on these deals.

The agents selling the policies find them hard to resist — they can earn millions of dollars for selling just one such policy.

The technique works this way. An older person — typically someone who does not expect to live long and who has at least $10 million and usually much more — wants to avoid estate taxes, which are 50 percent with such fortunes.

Under tax law, money from a life insurance policy goes at death to heirs tax free. The premium paid on that life insurance is considered a gift to those heirs. Any annual premium that exceeds $11,000 is therefore subject to the gift tax of 50 percent. Only the wealthiest Americans pay such large premiums and are subject to this tax.

The new technique sidesteps the gift tax in a two-step process. First, the person who is buying the policy reports on his tax return only a small part of what he really paid in premiums.

Wouldn't the I.R.S. say that is cheating? No. It's perfectly legal. The reason is that insurance companies offer many different rates for the same policy. And the buyer is allowed to declare on his tax return the insurance company's lowest premium for that amount of insurance, even if that person could never qualify for that rate because of his age and health, and even if no one has actually ever been sold a policy at that rate.

A low premium means a low gift tax. But in fact the buyer has really paid the very highest premium offered by that insurer for that amount of insurance. The insurer then invests the difference between the highest premium and the lowest premium. That investment grows tax free, paying for future premiums on the policy. At death, the entire face value of the policy is paid tax free to heirs.

In an example cited by one agent, a customer paid a $550,000 premium for the first year alone, the highest price offered by the insurance company, for a policy that was also offered at $50,000, the lowest price. So $550,000 can be passed on to heirs tax free. Yet the gift tax is only $25,000 — 50 percent of the lowest premium, instead of $275,000, which is 50 percent of the highest premium.

The I.R.S. would not comment officially. But an I.R.S. official who specializes in insurance matters said he had not heard that so many people were exploiting this loophole. He could not say whether the issue would be re-examined.

The deal gets better because of a second step. Even that $25,000 tax can be avoided by shifting the gift-tax obligation to the spouse through a trust. In 1982, Congress made all transfers between spouses tax free, so the gift tax disappears.

If the policy holder continues to pay huge premiums year after year, he can pass along much or all of his fortune tax free if he lives long enough. Michael D. Brown of Spectrum Consulting in Irvine, Calif., said, many clients in their 50's and 60's, working with other agents, are now trying to do just that.

By far the biggest deals have been made by two insurance agents who work together, Mr. Brown, a former chemical engineer, and Louis P. Kreisberg of the Executive Compensation Group in Manhattan.

The technique was devised in 1995 by Mr. Blattmachr and Mr. Brown. Mr. Blattmachr has since expanded his idea and other estate tax lawyers have copied his methods.

"In 1995 I was told that this was the stupidest idea ever by a guy who is now collecting millions in commissions from selling" such insurance, Mr. Blattmachr said.

Among his peers Mr. Blattmachr is renowned for his creativity in finding ways to pass down fortunes without paying taxes and without breaking the law.

He is a busy man. Recently he set off to counsel clients in eight cities over three days — a trip made possible by a client who provided him with a private jet. Afterward he spent the weekend fishing with his brother, Douglas, whose company, Alaska Trust, helps wealthy Americans set up perpetual trusts, some of them using Mr. Blattmachr's insurance plan.

One buyer of an insurance plan like Mr. Blattmachr's paid $32 million in the first year for a policy that will pay $127 million tax free to the grandchildren, according to a lawyer who worked on the deal and spoke on condition of not being identified. No gift taxes were paid.

Sales of such insurance soared after the Internal Revenue Service announced 18 months ago that it was considering restrictions on similar techniques, which are known as split-dollar plans.

In Alaska, premiums for such insurance totaled just $1.1 million in 1999, but ballooned to more than $80 million last year, state records show.

This month, when the I.R.S. issued its proposed restrictions, it did nothing to stop Mr. Blattmachr's plan.

Indeed, the proposed I.R.S. rules can be read as strengthening the validity of his plan, Mr. Blattmachr and some other estate tax lawyers say.

Mr. Brown said that in some cases, when the policy holder dies quickly, both the government and the heirs come out winners, at the expense of the insurance company.

"This is a good deal because both the government and the heirs get 90 percent of what they could have gotten," he said.

He added: "We think it is good policy to allow this because it discourages games like renouncing your citizenship or investing offshore."

But many estate tax lawyers and insurance experts think that because Mr. Blattmachr's plan is similar to the plans the I.R.S. moved to stop on July 3, it should be ended as well.

While the I.R.S. in 1996 approved the outlines of the Blattmachr plan, these opponents argue that the plan as sold by agents like Mr. Brown and Mr. Kreisberg stretches that ruling so far that it no longer provides protection in an I.R.S. audit.

Some of them say it is the huge fees involved that are blinding their competitors to aspects of the Blattmachr plan that make it vulnerable to being banned as an abusive tax shelter.

Commissions for the insurance agents run between 70 percent and 200 percent of the first-year premium when it is $1 million or so, while on the jumbo policies commissions are typically 9 percent to 11 percent, or up to $4.4 million on a policy with a $40 million first-year premium, Mr. Kreisberg said.

He acknowledged that many peers in the estate tax world say that he earned $100 million in gross commissions last year, but said, "I wish it were half that." Mr. Kreisberg did not dispute a statement by someone with knowledge of payment records that his small firm's commissions this year have already reached $20 million.

Lawyers who opine on the validity of the deals can also earn big fees. Mr. Blattmachr gets $100,000 for his basic opinion letter and is reported to have charged as much as $250,000.

Sanford J. Schlesinger of the law firm Kaye Scholer said he passed up a chance to collect a six-figure fee for advising on one of these deals because he thinks the deals should not pass muster with the I.R.S. "My mother taught me that if something seems too good to be true, it isn't true," he said.

Other leading estate tax lawyers, as well as some accountants and insurance agents, say Mr. Blattmachr's insurance technique should fail because it is wholly outside the intent of Congress in giving tax breaks for life insurance, the I.R.S. ruling on the plan notwithstanding.

"If the I.R.S. understood this they would say that it relies on a disguised gift — and if you have to pay gift taxes, then Jonathan's insurance deal does not work," said an estate partner at a tax firm in New York, who like others, said they could not be identified because they have signed confidentiality agreements that are part of all such insurance deals.

Another legal expert said paying 10 times too much for insurance in a plan like this reminds him of a matriarch selling the family business to her granddaughter for $10 million when it was actually worth 10 times that amount. "The I.R.S. wouldn't let a family get away with selling the business for a dime on the dollar," this lawyer said, "and they should not allow it to work in reverse through insurance."

Copyright 2002 The New York Times Company

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