The Internal Revenue Services’ recent ruling on life settlement taxation was in some respects disappointing to the industry but not a surprise, participants agreed during a recent web conference on the rulings.
The gist of Revenue Ruling 2009-13 is that investors in life settlements can include the cost of buying the insurance in the tax basis but that a seller of a policy can’t deduct the cost of insurance and premiums for tax purposes.
The IRS also held in Revenue Ruling 2009-14 that investors would be taxed on the proceeds of death benefits they receive as ordinary income rather than capital gains. If the buyer resells the policy, however, any profit is capital gain.
Furthermore, Ruling 2009-14 makes clear that international investors who buy policies will be subject to U.S. withholding taxes of 30% on any death benefit proceeds, unless the fund is based in a country that has a tax treaty with the United States.
The IRS rulings actually are not new positions but mirror stances the IRS had taken in a 2004 private letter ruling and confirmed in 2005, speakers noted at the May 14 conference, held by Life Settlement Solutions Inc., San Diego, Calif.
Luc Moritz, tax partner, O’Melveny & Myers L.L.P, Los Angeles, said the rulings seem to create a dichotomy between the profits earned from surrendering a policy and those earned from selling it. Generally, the difference for the seller between the price he or she can get from a settlement versus any gain from a surrender of the policy needs to be large for a sales transaction to be worthwhile on an after-tax basis, he said.
Kirk Van Brunt, a tax partner with Locke, Lord, Bissell & Liddell L.L.P., Washington, said that Rev. Rul. 2009-13 favors insurance carriers by making sale of a policy less favorable from a tax viewpoint than surrendering a policy for its cash value.
“I think insurers were pushing for this,” Van Brunt said.
Life Settlement Solutions’ chief executive Larry Simon, who moderated the web session, commented that the advent of life settlements presented a clear benefit to consumers in that they had an opportunity to receive two or more times their policies’ surrender value.
“This ruling strongly favors insurance companies,” he said. “It pays little attention to the rights of consumers.”