Key provisions of the Pension Protection Act of 2006 received an unfavorable reception during a session of the Association for Advanced Life Underwriting’s annual conference here last month. John Adney, an attorney at Davis & Harman, Washington, D.C., took direct aim at the new Internal Revenue Code section 101(j), which he characterized as excessive in its reach and in need of clarification on several points.
“Some of the [code] provisions are not very useful," said Adney. "There are a lot of quirks and traps for the unwary."
Under IRC Section 101(j), death benefit proceeds of employer-owned life insurance covering an employee are taxable to the employer for distributions exceeding premiums paid unless the employer gives notice to, and secures consent from, the covered employee(s). Section 101(j)(2) provides for several exceptions to the rule.
Proceeds are tax-free, Adney noted, if distributed within the 12 months following the death of a covered key employee. Death benefits are also tax-exempt if the face amount is payable to a trust, the key employee's family member or a designated beneficiary other than the employer.
The exceptions notwithstanding, Adney said he was concerned that 101(j)(1) defines employer-owned life insurance so broadly: The rule applies to any policy covering an insured employee of any entity that is directly or indirectly engaged in trade or business. The code might thus invoke affiliate aggregation rules that could impose notice-and-consent provisions on life insurance-funded buy-sell agreements, related persons transactions and voluntary employee benefits associations.
Of as much concern as what rule 101(j) stipulates is what it doesn't. It's not clear, Adney noted, who, apart from the employer (such as the agent or insurer), must satisfy the notice and consent requirement. Also in need of explanation, he said, is whether the requirement that maximum face amounts on contracts be disclosed applies to post-policy issue increases of these amounts, and whether a new or "refreshed" notice and consent is mandated after a coverage increase or other "material change" in the contract, such as a 1035 exchange.
The lack of clarity, Adney said, has prompted the American Council of Life Insurers to seek guidance from the U.S. Treasury Department. In the interim, he has counseled attendees to secure a private letter ruling from the IRS.
In counterpoint to the 101(j) changes, Adney characterized amendments of tax rules governing qualified long-term care insurance enacted by IRS Section 844 of the Pension Protection Act as "good news" for advisors. One reason: The LTC pieces of hybrid LTC/annuity solutions are considered tax-qualified products, thus entitling users to receive benefits income tax-free and to treat premiums paid as medical expenses that may be listed as itemized deductions on the insured's income tax return.
"The treatment applies whether or not the LTC benefit is paid out of the annuity's cash value," said Adney. "This is a great rule and [will help spur sales of] deferred annuities."