Budget Proposal Includes Life Settlement Provisions

The transfer-for-value rule "does not apply if the buyer's basis is determined in whole or in part by reference to the seller's basis, nor does the rule apply if the buyer is the insured, a partner of the insured, a partnership in which the insured is a partner, or a corporation in which the insured is a shareholder or officer," Obama administration officials note.

Today, life settlement tax law compliance "is sometimes hampered by a lack of information reporting," Obama administration officials say. "In addition, the current law exceptions to the transfer-for-value rule may give investors the ability to structure a transaction to avoid paying tax on the profit when the insured person dies."

The Obama administration is proposing that a taxpayer notify the Internal Revenue Service about the purchase of any existing life insurance policy with a death benefit of at least $500,000.

"The proposal also would modify the transfer-for-value rule to ensure that exceptions to that rule would not apply to buyers of policies," officials say. "Upon the payment of any policy benefits to the buyer, the insurance company would be required to report the gross benefit payment, the buyer's [taxpayer identification number], and the insurance company's estimate of the buyer's basis to the IRS and to the payee. "

The proposal would affect sales or assignment of interests in life insurance policies and payments of death benefits for taxable years beginning after Dec. 31, 2010.

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Here is the full text of the life settlement issues section of a "temporary recovery measures" document:

Reform Treatment of Insurance Companies and Products

MODIFY RULES THAT APPLY TO SALES OF LIFE INSURANCE CONTRACTS

Current Law

The seller of a life insurance contract generally must report as taxable income the difference between the amount received from the buyer and the adjusted basis in the contract, unless the buyer is a viatical settlement provider and the insured person is terminally or chronically ill.

Under a transfer-for-value rule, the buyer of a previously-issued life insurance contract who subsequently receives a death benefit generally is subject to tax on the difference between the death benefit received and the sum of the amount paid for the contract and premiums subsequently paid by the buyer. This rule does not apply if the buyer's basis is determined in whole or in part by reference to the seller's basis, nor does the rule apply if the buyer is the insured, a partner of the insured, a partnership in which the insured is a partner, or a corporation in which the insured is a shareholder or officer.

Persons engaged in a trade or business that make payments of premiums, compensations, remunerations, other fixed or determinable gains, profits and income, or certain other types of payments in the course of that trade or business to another person generally are required to report such payments of $600 or more to the IRS. However, reporting may not be required in some circumstances involving the purchase of a life insurance contract.

Reasons for Change

Recent years have seen a significant increase in the number and size of life settlement transactions, wherein individuals sell previously-issued life insurance contracts to investors. Compliance is sometimes hampered by a lack of information reporting. In addition, the current law exceptions to the transfer-for-value rule may give investors the ability to structure a transaction to avoid paying tax on the profit when the insured person dies.

Proposal

The proposal would require a person or entity who purchases an interest in an existing life insurance contract with a death benefit equal to or exceeding $500,000 to report the purchase price, the buyer's and seller's taxpayer identification numbers (TINs), and the issuer and policy number to the IRS, to the insurance company that issued the policy, and to the seller.

The proposal also would modify the transfer-for-value rule to ensure that exceptions to that rule would not apply to buyers of policies. Upon the payment of any policy benefits to the buyer, the insurance company would be required to report the gross benefit payment, the buyer's TIN, and the insurance company's estimate of the buyer's basis to the IRS and to the payee.

The proposal would apply to sales or assignment of interests in life insurance policies and payments of death benefits for taxable years beginning after December 31, 2010.