The IRS issued a broad package of proposed regulations (REG-103083-18
) that includes guidance clarifying changes made by the Tax Cuts and Jobs Act (TCJA) to the transfer-for-value rules under Section 101(a) as well as the new reporting requirements for reportable policy sales of life insurance contracts under Section 6050Y.
Before and after the TCJA changes, death benefit proceeds under employer-owned life insurance contracts (including corporate-owned life insurance (COLI) and bank-owned life insurance (BOLI) contracts) generally are excluded from federal income tax under Section 101(a)(1). However, if a life insurance contract is sold or otherwise transferred for valuable consideration, the “transfer for value rule” set forth in Section 101(a)(2) generally limits the excludable portion to the sum of (1) the amount of consideration paid by the transferee to acquire the life insurance contact, and (2) any premiums and other amounts subsequently paid by the transferee under the contract.
Section 101(a)(2) provides two exceptions to this transfer for value rule. Specifically, the transfer for value rule does not apply if (1) the transferee’s basis in the contract is determined in whole or in part by reference to the transferor’s basis in the contract (for example, in connection with a tax-free merger or acquisition of the original owner of the policy), or (2) the transfer is to the insured, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer.
Under the changes made by the TCJA, the exceptions under Section 101(a) to the transfer-for-value rule remain, but they no longer apply if the acquisition of the life insurance contract constitutes a “reportable policy sale,” a new term defined in Section 101(a)(3) to include “the acquisition of an interest in a life insurance contract, directly or indirectly, if the acquirer has no substantial family, business, or financial relationship with the insured apart from the acquirer’s interest in such life insurance contract.” New Section 101(a)(3) further provides that “the term ‘indirectly’ applies to the acquisition of an interest in a partnership, trust, or other entity that holds an interest in the life insurance contract.”
Before the proposed regulations were issued, it was not clear the extent to which ordinary course business transactions (for example, corporate mergers and acquisitions) could fall within the definition of a reportable policy sale with respect to policies owned by the target before the transaction. The preamble to the proposed regulations acknowledges the confusion, and the proposed regulations include several provisions intended to clarify when ordinary-course business transactions are excluded from the definition of reportable policy sales.
For example, the proposed regulations provide that a substantial business relationship exists if, among other requirements, the insured was an employee of the acquired business immediately preceding the acquisition. In addition, a substantial business relationship exists if the insured was a director, a highly compensated employee or an individual of the acquired trade or business, and the acquirer, immediately after the acquisition, has ongoing financial obligations to the insured with respect to the insured’s employment by the trade or business (for example, the life insurance contract is maintained by the acquirer to fund a current or future retirement, a pension or survivorship obligations based on the insured’s relationship with the entity or to fund a buy-out of the insured’s interest in the acquired trade or business).
The proposed regulations also provide that persons who acquire shares in a C corporation that holds an interest in a life insurance contract generally will not be considered to have an indirect acquisition of an interest in such contracts. However, if more than 50% of the gross value of the assets of the C corporation consists of life insurance contracts, any person that acquires shares in the C corporation will be considered to have an indirect acquisition of an interest in any life insurance contracts held by the C corporation.
New Section 6050Y imposes information reporting obligations with respect to certain life insurance contract transactions, including reportable policy sales and payments of reportable death benefits.
The changes to the transfer for value rules under Section 101(a)(3) are statutorily effective with respect to transfers of life insurance contracts made after Dec. 31, 2017. However, the portion of the proposed regulations addressing the changes to the transfer-for-value rules are proposed to have a prospective applicability date for transfers of life insurance contracts made after the date final regulations are published in the Federal Register. The proposed regulations do not provide for any reliance in the interim.
The proposed regulations are proposed to be applicable for Section 6050Y purposes retroactively from the effective date of the new information reporting requirements – to reportable policy sales made and reportable death benefits paid after Dec. 31, 2017. However, the proposed regulations provide transition relief that delays until after final regulations are issued the information reporting requirements for any reportable policy sales and payments of reportable death benefits occurring after Dec. 31, 2017, and before the date final regulations are issued.
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