AALU Has Some Concerns About Proposed Guidance On 412(i) Plans

Washington

Proposed Internal Revenue Service guidance on Section 412(i) plans may artificially inflate the value of life insurance above its fair market value, says the Association for Advanced Life Underwriting.

Bob Plybon, president of the Falls Church, Va.-based group, says AALU is continuing to analyze the recent guidance on 412(i) plans and the valuation of life insurance.

But he adds that artificially pegging the value of life insurance above its fair market value can disrupt proper planning, impose significant practical problems and set bad precedent.

AALU, he adds, is following a process to make sure it combines the input of producers, experts, carriers and the industry broadly.

“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 in valuing life insurance for purposes of qualified plans.

The proposed guidance, AALU says, is presented in terms of a formulaic statementtotal premiums paid plus earnings less reasonable chargesthat takes the form of a safe harbor. Literally, AALU says, the guidance says that cash value, without reduction for surrender charges, “may be treated” as fair market value if it satisfies the minimum formulaic amount.

This suggests, AALU says, that cash value could be the fair market value even if it does not satisfy the formulaic amount but that it can always be treated as fair market value if it is at least equal to that calculation.

AALU notes that the proposed guidance does not actually propose new gift tax regulations. Instead, 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 where the cash surrender value does not meet the formulaic standard.

The effective date of this portion of the guidance is not clear, AALU notes, but an argument certainly can be made that this part of the guidance should not be retroactive.

It is apparent, AALU says, that other methods might be put forward as establishing fair market value even though they do not meet the formulaic standard.

However, AALU continues, it is likely that IRS wants to establish this standard with the intent that it is going to be a rare and unusual circumstance in which noncompliance with the standard would succeed.

Thus, AALU says, while the door may be open to the possibility, any taxpayer seeking to use fair market value when it does not come up to the formulaic standard probably should be prepared for a fight with the IRS.

Another issue, AALU says, is the portion of the formula dealing with “reasonable charges.” These can be used to reduce the value of the policy if they actually are charged and expected to be paid, according to AALU.

But this open-ended statement leaves several questions, AALU says. For example, AALU explains, one of the major potential charges not clearly dealt with in this context is commissions paid to agents.

As an initial reaction, AALU says, it would certainly seem that commissions should be considered a “reasonable charge,” but it is notable that there is nothing explicit on this point in the guidance.


Reproduced from National Underwriter Life & Health/Financial Services Edition, March 5, 2004. Copyright 2004 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.