IRS Posts Eagerly Awaited Life Settlement Tax Reporting Draft

The Internal Revenue Service has proposed a new set of regulations that could change the lives of life settlement market players, create new streams of life settlement market data — and, possibly, touch taxpayers who have nothing to do with life settlements.

The IRS developed the draft to implement a new life settlement transaction reporting requirement included in Sections 13520 and 13522 of the Tax Cuts and Jobs Act of 2017 (TCJA).

(Related: IRS Postpones Life Settlement Tax Reporting Requirement)

The notices could help life settlement market players compute their taxes more easily, and they could the IRS see how well the market players are paying their taxes.

Life settlement brokers and providers have been talking about their urgent need for TCJA tax reporting procedures for more than a year.

IRC Section 6050Y

The TCJA life settlement reporting provisions  added Section 6050Y to the Internal Revenue Code (IRC).

IRC Section 6050Y calls for “every person who acquires a life insurance contract or any interest in a life insurance contract in a reportable policy sale” to create a transaction notice.

The notice must give the name, address and taxpayer identification number of the policy buyer; the names, addresses and taxpayer identification numbers of each recipient of the payments; the date of the sale; the name of the policy issuer; the policy number of each contract involved; and the amount of each payment.

The policy buyer is supposed to send a sale statement to each person listed on the notice.

The Draft Regulations

In the draft regulations, officials would:

• Use an existing Internal Revenue Code definition, IRC Section 7702(a), to define the term “life insurance contract,” or “life insurance policy.”
• Define “reportable policy sale payment” to mean “the total amount of cash and the fair market value of any other consideration transferred,” along any of the seller’s debt assumed by the policy buyer.
• Define the term policy “issuer” to include both the life insurer that wrote the policy and the reinsurer that’s responsible for paying the death benefits.
• Provide a rule for “all gratuitous transfers of interests in life insurance contracts, including reportable policy sales that are not for valuable consideration,” but not a rule for gratuitous transfers involving parties such as a partner of the insured,  because a rule for partner-to-partner transfers “could be subject to abuse.”
• Exempt policy transfers between companies in the same corporate group. 
• Require the issuers to inform the sellers about the sellers’ investments in the contracts, to help the sellers calculate their taxable income.
• Set a Dec. 31, 2017, applicability date, and set a variety of transitional rules.

A Broker Comp Question

IRS officials have included many questions for commenters in the draft regulations.

One is whether the term “policy sale payments” should exclude payments for broker fees and securities intermediary fees.

A Quirk

Congress created IRC Section 6050Y to create a life settlement tax reporting process.

IRS officials say in the preamble to the proposed regulations that they want to set rules to keep the reporting process from applying to other types of situations that lead to purchases of life insurance policies, such as corporate acquisitions that give the buyer control over the seller’s corporate-owned life insurance policies.

The IRS has tried to apply the new regulations solely to life settlement transactions by proposing that the reporting rules should apply only to policy buyers that have no “substantial business relationship” with  the insured.  In the draft regulations, the IRS says a policy buyer has a substantial business relationship with the insured if the insured is a key person or employee in a business the policy buyer owns, or if the buyer ends up with the policy as the result of a corporate acquisition.

But the statute, the proposed regulations and the preamble do not refer to the term “life settlement.”

IRS officials note that their proposed definition of “substantial business relationship” may leave out situations that do create a substantial business relationship between the policy owner and the insured. They ask commenters for ideas about how to flesh out the definition.

But that approach, and the question, raise the possibility that the IRC 6050Y reporting requirements could end up applying to some people or companies that end up acquiring life insurance policies without intentionally trying to participate in the life settlement market.

Commenting Mechanics

The official Federal Register publication date for the new draft will be Monday.

Comments will be due 60 days after the Federal Register publication date.

The IRS contact for the proposed regulations is Kathryn Sneade.

Resources

A link to the proposed regulations is available here.

— Read How the New TCJA Tax Law Affects Life Settlements, on ThinkAdvisor.

— Connect with ThinkAdvisor Life/Health on LinkedIn and Twitter.