The IRS issued final regulations (T.D. 9879
) on 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. The final regulations adopt proposed regulations issued earlier this year with some modifications and provide special transition rules and relief.
Death benefit proceeds under employer-owned life insurance contracts, including corporate-owned life insurance (COLI) and bank-owned life insurance (BOLI) contracts, are generally 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 the amount of consideration paid by the transferee to acquire the life insurance contact and 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. The transfer for value rule does not apply if (i) 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 (ii) 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 Tax Cuts and Jobs Act (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 and final regulations were issued, it was not clear the extent to which ordinary-course business transactions, such as 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 final regulations acknowledges the confusion and the final regulations include several provisions intended to clarify when ordinary-course business transactions are excluded from the definition of reportable policy sales.
The final rules 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, highly compensated employee or 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 current or future retirement, 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 final 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.
In the preamble to the final regulations, the IRS acknowledges that the exclusions from the definition of reportable policy sales can result in different treatment with respect to stock acquisitions and asset acquisitions. It noted that one commenter correctly concluded that the exceptions apply in the case of acquisition transactions in which the corporate existence of the target survives the acquisition (such as a taxable stock sale with no Section 338 election, a reverse subsidiary merger structured to qualify as a tax-free reorganization under Section 368(a)(2)(E), or a tax-free reorganization under Section 368(a)(1)(B)), but may not apply in the case of acquisition transactions in which the target corporation is merged with and into the acquiring corporation and the target’s separate corporate existence is terminated as of the merger date (such as a tax-free reorganization under Sections 368(a)(1)(A), (C), or (D) or Section 368(a)(2)(D).
New Section 6050Y imposes information reporting obligations on the buyer in the case of the purchase of an existing life insurance contract in a reportable policy sale and imposes reporting requirements on the payor (underlying insurance company) in the case of the payment of reportable death benefits. A reportable death benefit means an amount paid by reason of the death of the insured under a life insurance contract that has been transferred in a reportable policy sale.
Under the reporting requirement, the buyer reports information about the purchase to the IRS, to the insurance company that issued the contract, and to the seller. Upon receipt of this report, the insurance company is required to report to the IRS certain identifying information of the seller, the tax basis of the contract, and the policy number of the contract. In addition, when a reportable death benefit is paid under a life insurance contract, the payor insurance company is required to report information about the payment to the IRS and to the payee.
The changes made by TCJA are statutorily effective for reportable policy sales occurring and reportable death benefits paid after Dec. 31, 2017.
For purposes of determining whether a transfer of an interest in a life insurance contract is a reportable policy sale or a payment of death benefits is a payment of reportable death benefits subject to the new reporting requirements, the definitions in the final regulations apply to reportable policy sales made after Dec. 31, 2018, and to reportable death benefits paid after that date. For purposes of determining the amount of the proceeds of life insurance contracts payable by reason of death that are excluded from gross income under Section 101, the final regulations apply to amounts paid by reason of the death of the insured under a life insurance contract transferred after Oct. 31, 2019. However, the final regulations provide that a taxpayer may apply the final regulations with respect to all amounts paid by reason of the death of the insured under a life insurance contract transferred after Dec. 31, 2017, and on or before Oct. 31, 2019.
To give buyers and insurance companies ample time to develop and implement reporting systems, the portion of the final regulations addressing the new reporting requirements applies to reportable policy sales made and reportable death benefits paid after Dec. 31, 2018. Thus, no reporting is required under Section 6050Y for reportable policy sales made and reportable death benefits paid after Dec. 31, 2017, and before Jan. 1, 2019. The final regulations also provide certain transition relief with respect to reportable policy sales made and reportable death benefits paid after Dec. 31, 2018, and on or before Oct. 31, 2019.
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