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IRS Safe Harbor Proposal Needs Revising, Say Industry Groups

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IRS Safe Harbor Proposal Needs Revising, Say Industry Groups



A safe harbor for the valuation of life insurance contracts proposed by the Internal Revenue Service has numerous shortcomings and should be revised, industry representatives say.

While generally agreeing it is appropriate for the IRS to establish a safe harbor establishing the fair market value of life insurance policies for tax purposes, both agent and company representatives say modifications in the proposed IRS formula are needed.

The comments were made during an IRS hearing on proposed regulations that were issued on Feb. 13, 2004, in conjunction with Section 412(i) plans and which require life insurance contracts be valued at fair market value.

One part of the proposed regulations establishes a new safe harbor for fair market value. The safe harbor value is the sum of all the premiums paid on the policy plus all earnings minus reasonable mortality charges and other reasonable charges actually charged and expected to be paid.

Under the proposal, the cash surrender value of the policy can be treated as the fair market value so long as it is at least as large as the safe harbor value.

But Lawrence Raymond, secretary of the Association for Advanced Life Underwriting, says life insurance agents have both general and specific concerns with the IRS approach. He testified on behalf of both AALU and the National Association of Insurance and Financial Advisors.

In general, he says, agents are concerned about the establishment of uniform valuation standards for most purposes under the Internal Revenue Code.

Raymond notes that in issuing its proposal the IRS was concerned about perceived problems involving the distribution of life insurance contracts from retirement plans. But as proposed, he says, the safe harbor appears to apply to several life insurance valuation scenarios, including distributions or sales from retirement plans, compensatory transfers, and estate and gift tax transactions.

Because of the diverse nature of these scenarios and the underlying contracts, we urge the IRS to exercise care in establishing uniform valuation standards that are targeted at a problem of limited scope, Raymond says.

More specifically, he says the safe harbor formula should be simplified by eliminating the cash value standard.

He says AALU believes the PERC amountwhich stands for premiums, earnings and reasonable chargesshould be the safe harbor standard, regardless of cash value.

Elimination of the cash value standard, Raymond says, would simplify the determination of fair market value. The cash value would not have to be determined, and all contracts could use the safe harbor, whether or not the cash value exceeds the PERC amount, he says.

Moreover, he says, the IRS proposal does not define how cash value should be determined. By eliminating the cash value standard, he says, the safe harbor would not depend on non-defined factors that potentially could be manipulated.

In addition to recommending the PERC amount as the safe harbor, Raymond says the IRS should include as part of the PERC calculation, a reduction for surrender charges. Potential surrender charges are relevant, he says, because insurance contracts are regularly surrendered for many unplanned and unanticipated reasons.

In many cases, Raymond says, the only option for liquidating an insurance contract is to surrender it, because there is no realistic marketplace.

The failure to include surrender charges in the safe harbor is an inherent weakness in the IRS proposal, he says.

Mark Canter, senior counsel with the American Council of Life Insurers, also criticizes the safe harbor, arguing that, in effect, it provides no safe harbor at all for bundled traditional life insurance products. These policies, Canter says, comprise the majority of all non-variable permanent life insurance in force, as well as new sales of non-variable policies.

He notes that the safe harbor formula appears to reflect universal life contracts, which are different from traditional ordinary life contracts.

For traditional policies, Canter says, there are no periodic calculations based upon a formula contained in the contract and there are no explicitly stated mortality or expense charges.

Thus, he says, while the cash value for UL contracts will closely approximate the safe harbor formula for traditional life products, the formula will always produce a larger value.

This is because, Canter says, the safe harbor provides no mechanism for reducing the sum of premiums paid by the mortality charges and other expenses, since they are not specifically stated in the contract.

“Thus, the safe harbor will never be available for these contracts,” Canter says. He urges the IRS to adopt an alternative safe harbor for ordinary life.

Reproduced from National Underwriter Edition, June 11, 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.


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