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Life Health > Life Insurance

Forum Experts Cover Life Settlement Rulings, EOLI

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ST. PETERSBURG, FLA. — Recent Internal Revenue Service life settlement revenue rulings, the new employer-owned life insurance notice and consent provisions, and increased IRS interest in life insurance took top billing here at the Advanced Sales Forum general session.

LIMRA International, Windsor, Conn., kicked off the 3-day event here Wednesday/

Stephan Leimberg, chief executive officer of Leimberg Information Services Inc., Bryn Mawr, Pa., and Thomas Commito, director of sales concepts at Lincoln Financial Distributors, Hartford, led a session — “What’s Hot…What’s Not” – that explored developments affecting life insurance, annuities, and estate and tax planning.

“When Tom [Commito] and I started doing these lectures more than 15 years ago, we had to scramble to find cases and rulings to talk about,” Leimberg said. “The IRS didn’t know anything about insurance. Now the IRS has gotten very sophisticated. It’s amazing how much the Service knows now that it didn’t know before.”

That knowledge, he added, is reflected in part in two revenue rulings–2009-13 and 2009-14–that featured prominently during the kick-off general session.

Revenue Ruling 2009-13 addresses the tax consequences of the surrender or sale of a policy to a person who lacks an insurable interest in the contract. The panelists talked about how 2009-13 applies to the surrender of a life insurance policy for its cash surrender value; the sale of a cash value policy to a life settlement company; and the sale of a term life policy to a life settlement company.

The ruling has proved “contentious,” the panelists said, because of the lack of guidance as to calculate the cost of insurance when determining the amount of ordinary or capital gain resulting from one of the three transactions. When the transaction involves a sale to a life settlement company, for example, the COI is used to determine a policy’s “adjusted basis,” which in turn is subtracted from the policy’s sale price (or amount realized) to arrive at the gain. In this case, the gain is part ordinary income and part capital gain.

However determined, said Leimberg, the COI’s inclusion in the gain calculation is likely to make both legitimate life settlements and controversial stranger-initiated life insurance policies less attractive for seniors who are well advanced in age.

“The rule makes these kinds of pie-in-the-sky transactions much less appealing,” said Leimberg. “If you have to subtract the cost of insurance for an 80-year-old woman over 2 years, you’re talking about a lot of subtraction from basis. And that means the gain from a policy will be astronomical compared to what people were told when then they originally got involved in stranger-initiated transactions.

“The same conclusion applies with a legitimate life settlement,” he added. “Clearly if you have to subtract COI and you’re in your 80s, the gain is going to be much greater than was anticipated just a couple of years ago.”

A policy’s cost of insurance also factors into Revenue Ruling 2009-14, a ruling that addresses the tax implications involving a policy transferee. But in discussing the rule, the speakers directed much of their attention to a loophole that could be used to circumvent the IRS transfer-for-value rule. When invoked, the rule requires that life insurance death benefits be included in one’s gross income, thus making the death proceeds taxable.

The speakers talked about the 2009-14 tax treatment of a policy’s death benefit in the event that a life settlement company receives the proceeds upon the death of the insured by the settlement company; a life settlement company resells the policy while the insured is still alive; or a sale of the policy is effected by a foreign corporation.

Under the first scenario, said Leimberg, all gain resulting from a transfer for value would be taxed as ordinary income, except for the sum of premiums paid (or basis).

Under second scenario, any gain resulting from the resale of a term policy would be deemed a capital gain, because the policy is a capital asset in the hands of the life settlement company, and because the gain is realized on a sale or exchange. (In the case of a permanent policy, part of the resale, Leimberg noted, may be treated as ordinary income.)

When there is a sale effected by a foreign corporation, the death proceeds are subject to U.S. income tax.

But Commito noted that, with some creative planning, clients could easily circumvent the transfer-for-value rule, and, thus avoid gain-related tax consequences.

“It is relatively easy to structure a transaction where there is no transfer for value,” he said. “Many life settlements programs use limited liability companies, where the LLC falls under a partnership exception [to the transfer for value rule].”

“Under President [Obama's] current tax proposals, no exception to the transfer for value would apply,” he added. “But it doesn’t appear Congress will take up tax legislation this year, given its other priorities.”


Sure to be a top priority for advisors in the years ahead, the speakers said, is compliance with notice and consent provisions concerning the issuing of employer-owned life insurance.

A product of the Pension Protection Act of 2006, Internal Revenue Code Section 101(j) mandates that (exceptions notwithstanding) businesses provide written notice to, and secure the written consent of, employees who are to be insured under an employer-owned life insurance policy. Failure to do so will cause the EOLI policy to lose its tax-preferential treatment.

“It’s astounding how ignorant most insurance professionals remain outside–and even inside–our business about the operation of employer-owned life insurance,” Leimberg said. “We have to make sure that our constituents are not only aware of the requirements of 101(j) but know the code section inside and out.

“Given 101(j)’s broad scope–it covers much more than just rank-and-file employees–my advice is to be paranoid,” he added. “If you have any doubt in your mind as to whether 101(j) applies, assume that you need to give notice and get consent–and do so before the policy is issued.”

In addition to the notice and consent provisions, Leimberg highlighted the reporting and record-keeping requirements of 101(j). Employers must, for example, attach a Form 8925 to the policyholder’s tax return. Though potentially a source of aggravation, he said, the paperwork could also provide a marketing opportunity for advisors to keep partnering attorneys and accountants in the know about the code section’s provisions.

Leimberg added the IRS may forgo imposing tax penalties for failure to comply with 101(j)’s provisions if the employer meets three tests. The employer must make a good faith effort to comply (e.g., there must be a system in place for providing notice and securing consent); the failure must have been inadvertent; and the employer must fix the oversight before the tax return’s due date.

“But if the employee’s death occurs before the notice and consent provisions are met, then all bets are off,” said Leimberg. “And, if the employer fails to comply and hasn’t met the three tests then, assuming the employee is still alive and healthy, the only option is to surrender the policy and start over. I don’t know a better way to solve the problem.”


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