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Life Health > Life Insurance

AALU Analyzes Proposed 412(i) Guidance

By Steven Brostoff

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NU Online News Service, Feb. 26, 2004, 12:03 p.m. EST, Washington – Life insurance must be valued correctly and appropriately.[@@]

Bob Plybon, president of the Association for Advanced Life Underwriting, Falls Church, Va., says his group fears that recently proposed Internal Revenue Service guidance on Section 412(i) plans and the valuation of life insurance could interfere with proper valuation.

AALU is concerned that the formula in the proposed IRS guidance would artificially inflate the value of life insurance used in qualified plans above its fair market value. Artificially pegging the value of life insurance above its fair market value can disrupt proper planning, impose significant practical problems and set bad precedent, Plybon says.

But Plybon says AALU is continuing to analyze the proposed guidance.

“AALU will devote considerable attention to this issue over the course of the next 2 months and provide input to the government to try and find workable solutions,” Plybon says.

According to an analysis by AALU, the proposed guidance establishes a new fair market value principle for valuation of life insurance used in qualified plans.

The guidance presents a formulaic statement ? total premiums paid plus earnings less reasonable charges — that takes the form of a safe harbor, AALU says. AALU adds that the guidance says the policy cash value, without reduction for surrender charges, “may be treated” as fair market value if it satisfies the minimum formulaic amount.

That means the cash value could be the fair market value even if it were lower than the minimum formulaic amount, but that the cash value can always be treated as the fair market value if the cash value is equal to or greater than the minimum formulaic amount, AALU says.

AALU notes that the proposed guidance does not propose new gift tax regulations. Instead, it says, the IRS appears to be trying to reach the same result through a “clarification” of existing gift tax regulations.

Under those regulations, it is commonly understood that interpolated terminal reserve can be used as the measure of fair market value for gift tax purposes, AALU says. IRS now seems to be saying, AALU says, that such an understanding may be incorrect, especially in situations in which the cash surrender value does not meet the formulaic standard.

The effective date of this portion of the guidance is not clear, AALU says. AALU says an argument can be made that the gift tax provisions should apply only to future arrangements, not to arrangements that are already in place.

AALU suggests that some parties could propose formulas other than the IRS safe harbor formula for establishing fair market value.

However, AALU says, the IRS probably wants to show that it will accept fair market value calculations based on alternative formulas only in rare and unusual circumstances.

Any taxpayer who uses a fair market value figure that is lower than the figure the IRS formula would produce probably should be prepared for a fight with the IRS, AALU says.

Another issue, AALU says, is the definition of “reasonable charges.” An insurer can use reasonable charges to reduce the value of the policy if the insurer actually imposes the charges and expects the policyholder to pay them, AALU says.

But AALU says the “reasonable charges” definition is unclear about matters such as agent commissions. The IRS probably should treat an agent commission as a reasonable charge, but it says nothing about agent commissions in the guidance, AALU says.

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