Use and abuse of COLI policies

Under a company-owned life insurance program, the company takes out life insurance policies on its employees, naming itself as the beneficiary. As an added twist under so-called leveraged COLI policies, the company borrows against the policies, with the interest it charges itself being tax-deductible.

In 1986, concerned about a loss of tax revenue, the U.S. Congress limited to $50,000 the maximum amount of a loan for which interest could be tax-deductible. In response, some employers greatly expanded the number of employees they covered under the plans in order to maintain the same level of tax breaks.

In recent years, though, the IRS challenged many of these broad-based COLI programs as tax shams. Additionally, in 1996, Congress tightened the screws, phasing out over a five-year period the interest deductions on loans for policies covering all but a company's key employees.