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Tax Authority For This Technique

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The authority for this technique dates back to a pair of Private Letter Rulings: 8108110 and 8426090. Although PLR rulings apply only to the taxpayer who requests them, they do indicate the general thinking of the IRS.

Private Letter Ruling 8108110 discussed a fact pattern where the specific purpose was to fund a buy-sell agreement. With this fact pattern in mind, three questions were asked of the IRS:

1. Whether an insurance policy on the life of a plan participant B, could be purchased by the plan trustee and allocated to the account of plan participant A;

2. Whether the payment of insurance premiums would be treated as a current distribution of plan assets to A, resulting in taxable income to A and/or disqualification of the plan; and

3. Whether the proposed arrangement would disqualify the plan for any other reason.

The IRS provided a favorable ruling. With respect to the first question they deferred to the Department of Labor, noting that the department has sole authority for determining fiduciary standards for plan investments under Title I of ERISA.

With respect to the second question, the IRS noted that under IRC 72 (m)(3)(A) and (B), amounts paid for the purchase of life insurance in a qualified plan are includable in the income of the participant for the tax year in which they are applied, directly or indirectly, to the participant. The amount taxable is the P.S. 58 cost.

The ruling goes on to say that where there is a death of an insured, an amount equal to the cash surrender value of the contract, immediately prior to the death, shall be taxable as a distribution from the trust.

Amounts in excess of the cash surrender value would not be includable in gross income under IRC 101. The ruling went on to discuss the fact that these dollars being paid indirectly to a named beneficiary, through the profit sharing trustee, would not change the tax consequences.

Most importantly, the ruling confirmed that insurance purchased on the life of B, in As plan account, would be taxed annually (PS 58 costs), under IRC 72 (m)(3)(c). The IRS declined to rule on question three, noting that plan qualification varies from situation to situation.

In PLR 8426090, three years later, the IRS reached a similar conclusion. It is this pair of rulings that provides the road map for this approach.

Only profit-sharing plans permit the purchase of life insurance on lives other than the participants themselves. The IRS does not permit this technique to be used under pension plans.

–Thomas B. Higgins

Reproduced from National Underwriter Life & Health/Financial Services Edition, October 15, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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