As a general rule, life insurance death benefits are not subject to income tax. However, the Tax Cuts and Jobs Act (TCJA) enacted IRC Section 101(a)(3), which limits the exclusion for income received upon the death of an insured in the case of a reportable policy sale. New information reporting under Section 6050Y with respect to reportable policy sales under Section 101(a)(3) also was enacted as part of the TCJA.
The new rules left many companies, including banks, confused about whether transactions that occurred in the ordinary course of business would be treated as reportable policy sales, thereby causing the death benefits from company-owned life insurance contracts to be included in taxable income. Recently published proposed regulations provide relief in some situations by excluding certain transactions from being treated as reportable policy sales. However, determining whether a transaction is eligible for an exclusion can be complex.
IRC Section 101(a)(3)(B) defines a reportable policy sale as an 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 an interest in the contract. As such, the new rule applies if 1) there is a “transfer,” and 2) the acquirer and the insured do not have a required relationship. The following highlights the provisions in the proposed regulations that exclude certain transactions from being treated as reportable policy sales.
Transfer. As described in IRC Section 101(a)(3), a reportable policy sale does not occur unless there is a transfer (directly or indirectly) of an interest in a life insurance contract. An indirect transfer is the acquisition of an interest in a partnership, trust, or other entity that itself holds an interest in the life insurance contract.
Section 1.101-1(e)(2) of the proposed regulations clarifies that issuance of a life insurance contract to a policyholder, other than the issuance of a policy in an exchange pursuant to Section 1035, is not a transfer of an interest in a life insurance policy, though limits under Section 101(j) with respect to employer-owned life insurance still might apply. Therefore, the initial owner of a life insurance contract generally is not considered to have acquired the contract in a reportable policy sale.
Section 1.101-1(c)(2) of the proposed regulations also provides an exception to the definition of reportable policy sale for transfers between members of a consolidated group and entities with the same beneficial owners, if the percentage of ownership in the relevant entities meets certain thresholds.
Certain other indirect acquisitions also are excluded from the definition of reportable policy sales. For instance, Section 1.101-1(g)(3)(ii) of the proposed regulations provides that the buyer of a C corporation that owns life insurance contracts generally is not treated as indirectly acquiring those life insurance contracts in a reportable policy sale. However, this exception does not apply if more than 50 percent of the gross value of the assets of the C corporation consists of life insurance contracts. Also, the exception does not apply if the life insurance contracts were acquired by the C corporation in a reportable policy sale. Other exceptions in the case of indirect acquisitions are provided under Section 1.101-1(c)(iii) of the proposed regulations.
Required relationship. Even if a transfer occurs, a reportable policy sale does not exist if the acquirer has a substantial family, business, or financial interest with the insured. Section 1.101-1(d) of the proposed regulations provides rules for determining whether a family, business, or financial interest is substantial. For instance, a sale of a policy to a trust solely for the benefit of family members is not subject to the new rules. The proposed regulations define family members as including all descendants of the insured’s great-grandparent, as well as spouses of those descendants. Also, a substantial business relationship between the insured and the acquirer exists if the insured is a key person (under Section 264) of, or materially participates (under Section 469) in, an active trade or business as an owner, employee, or contractor and at least 80 percent of that trade or business is owned (directly or indirectly) by the acquirer or the beneficial owners of the acquirer.
The proposed regulations generally apply to reportable policy sales occurring after Dec. 31, 2017, and to reportable death benefits paid after that date.
While the proposed regulations narrow the scope of transactions subject to the new rules, the rules are complex and require careful consideration before taxpayers determine that a transaction does not involve a reportable policy sale.
The new rules left many companies, including banks, confused about whether transactions that occurred in the ordinary course of business would be treated as reportable policy sales, thereby causing the death benefits from company-owned life insurance contracts to be included in taxable income. Recently published proposed regulations provide relief in some situations by excluding certain transactions from being treated as reportable policy sales. However, determining whether a transaction is eligible for an exclusion can be complex.
IRC Section 101(a)(3)(B) defines a reportable policy sale as an 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 an interest in the contract. As such, the new rule applies if 1) there is a “transfer,” and 2) the acquirer and the insured do not have a required relationship. The following highlights the provisions in the proposed regulations that exclude certain transactions from being treated as reportable policy sales.
Transfer. As described in IRC Section 101(a)(3), a reportable policy sale does not occur unless there is a transfer (directly or indirectly) of an interest in a life insurance contract. An indirect transfer is the acquisition of an interest in a partnership, trust, or other entity that itself holds an interest in the life insurance contract.
Section 1.101-1(e)(2) of the proposed regulations clarifies that issuance of a life insurance contract to a policyholder, other than the issuance of a policy in an exchange pursuant to Section 1035, is not a transfer of an interest in a life insurance policy, though limits under Section 101(j) with respect to employer-owned life insurance still might apply. Therefore, the initial owner of a life insurance contract generally is not considered to have acquired the contract in a reportable policy sale.
Section 1.101-1(c)(2) of the proposed regulations also provides an exception to the definition of reportable policy sale for transfers between members of a consolidated group and entities with the same beneficial owners, if the percentage of ownership in the relevant entities meets certain thresholds.
Certain other indirect acquisitions also are excluded from the definition of reportable policy sales. For instance, Section 1.101-1(g)(3)(ii) of the proposed regulations provides that the buyer of a C corporation that owns life insurance contracts generally is not treated as indirectly acquiring those life insurance contracts in a reportable policy sale. However, this exception does not apply if more than 50 percent of the gross value of the assets of the C corporation consists of life insurance contracts. Also, the exception does not apply if the life insurance contracts were acquired by the C corporation in a reportable policy sale. Other exceptions in the case of indirect acquisitions are provided under Section 1.101-1(c)(iii) of the proposed regulations.
Required relationship. Even if a transfer occurs, a reportable policy sale does not exist if the acquirer has a substantial family, business, or financial interest with the insured. Section 1.101-1(d) of the proposed regulations provides rules for determining whether a family, business, or financial interest is substantial. For instance, a sale of a policy to a trust solely for the benefit of family members is not subject to the new rules. The proposed regulations define family members as including all descendants of the insured’s great-grandparent, as well as spouses of those descendants. Also, a substantial business relationship between the insured and the acquirer exists if the insured is a key person (under Section 264) of, or materially participates (under Section 469) in, an active trade or business as an owner, employee, or contractor and at least 80 percent of that trade or business is owned (directly or indirectly) by the acquirer or the beneficial owners of the acquirer.
The proposed regulations generally apply to reportable policy sales occurring after Dec. 31, 2017, and to reportable death benefits paid after that date.
While the proposed regulations narrow the scope of transactions subject to the new rules, the rules are complex and require careful consideration before taxpayers determine that a transaction does not involve a reportable policy sale.
