A new federal tax ruling could change the way some life insurers account for “qualified additional benefits” and force some to make $50,000 in extra tax payments.[@@]

The Internal Revenue Service has published a ruling, Revenue Ruling 2005-6, that deals with the implications of Internal Revenue Code section 7702(c)(3)(B)(i), which deals with treatment mortality charge revenue, and section 7702(c)(3)(B)(ii), which deals with treatment of expense charge revenue, on taxation of revenue from qualified additional benefits, such as extra insurance riders sold along with life insurance policies.

Insurers should use the expense charge rule when calculating taxes for revenue from from qualified additional benefits, Melissa Luxner, an IRS financial institutions specialist, writes in the revenue ruling 2005-6.

Insurers that have accounted for QAB revenue incorrectly but withheld the correct amount of taxes can update their compliance systems without contacting the IRS.

Insurers that have accounted for QAB revenue incorrectly in ways that have cut policyholders’ tax bills may have to make payments ranging from $1,500 for companies with fewer than 20 or fewer affected contracts to $50,000 for companies with more than 10,000 affected contracts.

The insurer payments will be “in lieu of an amount based on the tax and interest that would have been owed by the policyholders if they were treated as receiving the income on the contract,” Luxner writes in the revenue ruling.

In her ruling, Luxner cites the case of an insurer that adds appeal to an individual life insurance policy by adding a term life rider that covers one of the insured’s family members.

Many parts of Section 7702 say nothing about treatment of QAB charges, but, one section, Section 7702(b)(2)(B), says QAB charges are subject to the expense charge rule for purposes of determining whether a contract satisfies the cash value accumulation test, Luxner writes.

There is no indication that Congress intended for QAB revenue to be accounted for under one rule for purposes of the cash value accumulation test and under another rule for purposes of applying the requirements of Section 7702(c), Luxner writes.

Section 7702(c) lets contract revenue qualify as mortality charge revenue if the sum of the premiums paid under the contract is less than a specified “guideline premium limitation.”

Section 7702(c) requires insurers to use standard mortality table data, their own experience with charges other than mortality charges, and an interest rate of 6% when calculating guideline premium limitations.

The revenue ruling is on the Web at http://www.irs.gov/pub/irs-drop/rr-05-06.pdf