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Regulation and Compliance > Federal Regulation > IRS

IRS Releases Annuity-LTC Exchange Guidance

By Allison Bell

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The Internal Revenue Service (IRS) has come out with a document, IRS Notice 2011-68, that discusses the tax rules that apply to annuity-long term care (LTC) benefits hybrids and exchanges of annuity cash surrender value for qualified LTC insurance.

Tax experts at the American Council of Life Insurers (ACLI), Washington, asked the IRS to put those issues on its 2011-2012 guidance priority list just two months ago, to help taxpayers make better use of their new freedom to exchange LTC insurance policies for other LTC insurance policies — and life and annuity contracts for LTC insurance policies — without necessarily paying any extra income taxes.

Section 1035 of the Internal Revenue Code (IRC) has been letting taxpayers trade in life and annuity products for other life and annuity products tax-free for many years. A provision in the Pension Protection Act of 2006 added IRC Section 844, which lets taxpayers get or dispose of LTC policies through tax-free Section 1035 exchanges

Although taxpayers have had the freedom to make the exchanges, they have not been sure how to report the exchanges, or how the exchanges might affect their income tases, the ACLI tax experts told the IRS in a comment on the IRS guidance development priority list.

The ACLI tax experts asked the IRS to confirm that premiums paid for annuity-LTC combination product are included in the investment in the contract.

In IRS Notice 2011-68, IRS officials say they believe all premiums paid for an annuity-LTC combination contract that is an annuity and also provides long-term care insurance are generally included in investment in the contract, as long as the combination premiums are credited to the contract’s cash value, rather than directly to the LTC insurance contract, and coverage under the LTC insurance contract is paid for by charges against the cash value of the contract, officials say.

IRS officials also have confirmed that a taxpayer can use a Section 1035 exchange to trade in a portion of the cash surrender value of an existing deferred annuity for a qualified LTC contract, and the officials have discussed the basis of a qualified LTC contract.

In a Section 1035(a) exchange, “the acquired property’s adjusted basis shall be the same as that of the property exchanged, decreased in the amount of any money received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized on such exchange,” officials say. “Accordingly, Treasury and the IRS believe that … the adjusted basis of a qualified long-term care insurance contract received in a tax-free exchange under Section 1035(a) generally carries over from the life insurance, endowment, annuity, or qualified long-term care insurance contract exchanged.”

The officials note that PPA added Section 6050U to the Internal Revenue Code. IRC Section 6050U requires a person who makes a charge against the cash value of an annuity contract, or the cash surrender value of a life insurance contract, that is excluded from gross income to file an information return reporting the total amount of the charges for the year, the amount of the reduction in investment in the contract resulting from the charges, and the name, address, and taxpayer identification number of the holder of the contract.

The IRS also has included a section of questions for the public it may use to develop additional guidance for life and annuity contracts with LTC insurance features.

The IRS asks questions such as, “What issues arise when the owner of an annuity contract with a long-term care insurance feature decides to annuitize the contract?” and, “For the purpose of determining whether the long-term care features of an annuity contract qualify as an insurance contract and thus as a qualified long-term care insurance contract, what is the appropriate characterization of long-term care payments that cause a reduction in a contract’s cash value?”

Comments on the notice are due Nov. 9.

Other LTC insurance coverage from National Underwriter Life & Health:

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