A U.S. Tax Court judge has ruled against a Texas couple who bought two whole life insurance policies from Massachusetts Mutual Life Insurance Company, borrowed against the value of the policies, and then surrendered the policies without paying back the loans.
Special Trial Judge Lewis Carluzzo agreed with the Internal Revenue Service that the couple's tax bill should be based on total policy distributions, including the value of the loan balances discharged through the policy surrenders, not on how much cash the couple received.
The judge also agreed with the IRS about the year when the distributions should be included in the couple's taxable income.
"Because petitioners requested termination of the policies in January 2018 and received the proceeds in February 2018, the resultant income from the terminations is includible in their 2018 income," the judge wrote in a memorandum discussing the ruling.
For the couple, David and Cindy Fugler, the ruling increases the amount of MassMutual policy distributions included in their 2018 income to about $33,000, from less than $6,000.
Representatives for the Fuglers and the IRS could not immediately be reached for comment.
What it means: Clients who are borrowing against life insurance policies or thinking about surrendering the policies need advice from tax lawyers.
The new ruling could be especially relevant to clients who borrow against the value of cash-value life insurance policies in connection with retirement planning arrangements and other long-term financial planning arrangements, such as college expense funding arrangements.
The policies: The Fuglers bought the whole life insurance policies in 1987. The insureds were the Fuglers' children.
The Fuglers paid $150 in annual premiums for each policy from 1988 through 2006, then borrowed $21,500 from the policies in 2006.
They requested policy terminations in January 2018 and received checks for a total of $5,762 in February 2018. The terminations were effective in 2017.
MassMutual "advised petitioner that surrendering the policies could result in taxable income," Carluzzo wrote.
The MassMutual Form 1099-R notices later showed that the Fuglers had received $32,606 in taxable distributions. The figures included the amount of policy value used to pay off the policy loans.
© Touchpoint Markets, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to TMSalesOperations@arc-network.com. For more information visit Asset & Logo Licensing.