107 / What is the tax treatment of other transfers of an existing life insurance policy in connection with a divorce settlement to which the nonrecognition rules do not apply?

If an existing policy was transferred before July 19, 1984, or after July 18, 1984 pursuant to an instrument in effect prior to such date (and no election is made to have the IRC Section 1041 nonrecognition rules apply), then the following rules apply.

If the fair market value of the policy at the time of transfer exceeds the transferor’s cost basis for the policy (net premiums paid), the transferor may have some taxable gain. (For fair market value, see Q 144.) In Commissioner v. Davis,¹ the U.S. Supreme Court held that a transfer of property by a husband in exchange for his wife’s relinquishment of her marital rights is a taxable exchange, and the value of the marital rights exchanged is equal to the fair market value of the property at time of transfer. The Davis rule apparently would apply to such a transfer involving a life insurance policy.

The value of the policy transferred would not be taxable to the transferee and would not be deductible by the transferor.² The same results would follow if a spouse purchased a single premium policy for the spouse’s former spouse pursuant to the divorce settlement.³ Pre-2019, these values were not taxable to the recipient and deductible by the payor because they represented single sum payments rather than periodic payments of alimony. For tax years beginning after 2018, alimony is no longer deductible by the payor.

Transfer of an existing policy can result in adverse tax consequences to the former spouse. If the policy is assigned to the former spouse, the proceeds are received as life insurance proceeds and not as alimony income. However, it would seem that the former spouse is a purchaser for value and, consequently, the proceeds would be subject to the transfer for value rule ( Q 77, Q 79).⁴ Hence, the profit (the excess of the proceeds over the value of the contract on the date of transfer plus all premiums and certain other amounts paid thereafter) would be taxable to the former spouse as ordinary income.⁵