Life Insurance

<p>Life insurance is a contract under which, in exchange for premium payments, an insurance company agrees to pay a death benefit if the person whose life is insured dies while the contract is in force. There are two general categories of life insurance: term coverage and permanent coverage. Term coverage is for a specific period of time, which can last for as little as one year or possibly as long as 30 years. Permanent insurance is intended to cover an insured for the rest of the insured s life. Permanent life insurance can be financed with a single premium, a fixed number of premiums over several years, or premiums paid over the remainder of the insured's life.</p>

<div class="Section1"><br /> <br /> There are four exceptions to this disallowance rule.<a href="#_ftn1" name="_ftnref1">¹</a> However, with respect to interest paid or accrued on policies or contracts covering an individual who is a &ldquo;key person,&rdquo; the deduction may be limited as explained in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="30">30</a>, or denied entirely, even if one of the four exceptions to this disallowance rule is met.<br /> <br /> The four exceptions are:<br /> <blockquote>(1)&nbsp;&nbsp;&nbsp;&nbsp; <em>The seven-year exception.</em> The deduction will not be disallowed under this rule when no part of four of the annual premiums due during the seven-year period, beginning with the date of payment for the first premium on the contract, is paid by means of indebtedness. If there is a substantial increase in the premiums, a new seven-year period for the contract commences on the date the first increased premium is paid. However, a new seven-year period does not begin upon transfer of the policy, whether for value or by gift.<a href="#_ftn2" name="_ftnref2">²</a> A new seven-year period does not commence if modification of a life insurance policy after December&nbsp;31, 1990, becomes necessary because of the insurer&rsquo;s financial insolvency.<a href="#_ftn3" name="_ftnref3">³</a> The addition to a policy of a provision that interest on policy loans is payable in arrears rather than in advance will not cause a new seven-year period to begin.<a href="#_ftn4" name="_ftnref4">⁴</a> A systematic plan of purchase will be presumed when there is borrowing in connection with more than three of the annual premiums due during the seven-year period, but will not be presumed earlier.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> Once a taxpayer has used borrowed funds to pay four of the first seven annual premiums, the taxpayer cannot undo the effect of this action by repaying the policy loan.<a href="#_ftn6" name="_ftnref6">⁶</a> If in any year during the seven-year period, the taxpayer, in connection with any premium, borrows more than an amount necessary to pay one annual premium, the excess will be treated as though he or she borrowed to pay premiums that were paid in prior years with non-borrowed funds (beginning with the first prior year and working backwards).<a href="#_ftn7" name="_ftnref7">⁷</a><br /> <br /> <em>Example.</em> Taxpayer, in Year 1, purchased a $100,000 policy and the annual premium was $2,200. The taxpayer paid the first four premiums without borrowing. In Year 5, the taxpayer borrowed $10,000 with respect to the policy. The borrowing will be attributed first to paying the premium for Year 5 and then attributable to paying the premium for Years 4, 3, 2, and 1 (in part).<br /> <br /> If borrowing in connection with any premium in any year exceeds the premium for that year <em>plus</em> premiums paid in prior years without borrowing, the excess will be attributed to premiums (if any) paid in advance for future years. However, once the seven-year exception has been satisfied, and the seven-year period has expired, there would appear to be no limit under this exception to the amount that might be borrowed (from the policy or otherwise) to pay premiums on the policy. (But if a substantial number of premiums are <em>prepaid</em>, the policy might be considered a single-premium policy &ndash; <em>see</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3">3</a>.)<br /> <br /> Thus, three of the first seven annual premiums may be borrowed, and the interest deduction would not be disallowed by reason of this rule, provided the balance of premiums during the seven-year period is paid with non-borrowed funds. But if the seven-year exception is not met, and the taxpayer cannot rebut the presumption of a systematic plan of borrowing, the interest deduction will be disallowed under this rule for all future years and for all prior years not closed by the statute of limitations. This assumes, of course, that none of the other exceptions to this rule applies.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> (2)&nbsp;&nbsp;&nbsp;&nbsp; <em>$100-a-year exception.</em> Regardless of whether there is a systematic plan of borrowing, the interest deduction will not be disallowed under this rule for any taxable year in which the interest (in connection with such plans) does not exceed $100. But when such interest exceeds $100, the entire amount of interest (not just the amount in excess of $100) is nondeductible under IRC Section&nbsp;264(a)(3).<a href="#_ftn9" name="_ftnref9">⁹</a><br /> <br /> (3)&nbsp;&nbsp;&nbsp;&nbsp; <em>Unforeseen event exception.</em> If indebtedness is incurred because of an unforeseen substantial loss of income or unforeseen substantial increase in the taxpayer&rsquo;s financial obligations, the deduction will not be disallowed under this rule even though the loan is used to pay premiums on the contract. An event is not &ldquo;unforeseen,&rdquo; however, if at the time the contract was purchased it could have been foreseen.<a href="#_ftn10" name="_ftnref10">¹⁰</a><br /> <br /> (4)&nbsp;&nbsp;&nbsp;&nbsp; <em>Trade or business exception.</em> If indebtedness is incurred in connection with the taxpayer&rsquo;s trade or business, the interest deduction will not be denied under IRC Section&nbsp;264(a)(3). Thus, if an insurance policy is pledged as part of the collateral for a loan, the interest deductions will come within this exception if the taxpayer can show that the amounts borrowed actually were used to finance the expansion of inventory or other similar business needs.<a href="#_ftn11" name="_ftnref11">¹¹</a> The IRS has ruled privately that a company that borrowed against key-person life insurance policies to take advantage of the policies&rsquo; lower interest rate and generally to improve its financial position by reducing its overall debt was considered to have incurred the policy loan interest in connection with its trade or business.<a href="#_ftn12" name="_ftnref12">¹²</a> But borrowing to finance business life insurance (such as key person, split dollar, or stock purchase plans) is not considered to be incurred in connection with the borrower&rsquo;s trade or business.<a href="#_ftn13" name="_ftnref13">¹³</a> Systematic borrowing to finance a life insurance policy is not debt incurred in connection with an employer&rsquo;s trade or business even when the net death proceeds and the amounts borrowed in excess of premiums are used to fund employee retirement benefits.<a href="#_ftn14" name="_ftnref14">¹⁴</a></blockquote><br /> The interest deduction will not be disallowed under IRC Section&nbsp;264(a)(3) if any one of these exceptions applies. For example, even though the purchase of business life insurance does not come within the trade or business exception, the interest deduction may be allowed if the borrowing comes within the four-out-of-seven exception, provided no other IRC section operates to disallow or limit the interest deduction ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="30">30</a>).<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect;&nbsp;264(d).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Rev. Rul. 71-309, 1971-2 CB 168.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Rev. Proc. 92-57, 1992-2 CB 410; Let. Rul. 9239026.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Let. Rul. 9737007.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.264-4(c).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Rev. Rul. 72-609, 1972-2 CB 199.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.264-4(c)(ii).<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.264-4(d)(1).<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.264-4(d)(2).<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.264-4(d)(3).<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.264-4(d)(4).<br /> <br /> <a href="#_ftnref12" name="_ftn12">12</a>.&nbsp;&nbsp;&nbsp;&nbsp; Let. Rul. 9138049.<br /> <br /> <a href="#_ftnref13" name="_ftn13">13</a>.&nbsp;&nbsp;&nbsp;&nbsp; <em>American Body &amp; Equipment Co. v. U.S.</em>, 511 F.2d 647 (5th Cir. 1975).<br /> <br /> <a href="#_ftnref14" name="_ftn14">14</a>.&nbsp;&nbsp; Rev. Rul. 81-255, 1981-2 CB 79.<br /> <br /> </div></div><br />

<div class="Section1">Yes. Any increment in the value of prepaid life insurance or annuity premiums or premium deposit funds constitutes taxable income in the year it is applied to the payment of a premium or is made available for withdrawal, whichever occurs first.<a href="#_ftn1" name="_ftnref1">¹</a> The interest treated as taxable income, however, will be included in the cost basis of the contract. Thus, for purposes of IRC Section 72, the cost of the contract would be the amount of premiums paid other than by discount, plus the amount of discounted funds and any increments on such funds that were subject to income taxation. The rule taxing interest increments has no applicability, however, to single premium policies. A later ruling explains in detail how the interest will be taxed.<a href="#_ftn2" name="_ftnref2">²</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     Rev. Rul. 65-199, 1965-2 CB 20.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.     Rev. Rul. 66-120, 1966-1 CB 14.<br /> <br /> </div>

<div class="Section1">These disallowance rules cannot be avoided by having one spouse use funds borrowed by the other. When a husband borrowed money and transferred it to his wife, who used it to buy tax-exempt securities, the interest deduction was denied on the basis that the transfer of the borrowed funds was without economic substance because the purpose of the husband's borrowing was to enable the wife to buy tax-exempt securities.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     Rev. Rul. 79-272, 1979-2 CB 124 (citing <em>Drybrough v. Commissioner</em>, 42 TC 1029 (1964)).<br /> <br /> </div>

<div class="Section1"><br /> <br /> If the contract is a life insurance, retirement income, endowment, or other contract providing life insurance protection, the <em>fair market value</em> of the contract at the time of distribution must be included in the distributee&rsquo;s income to the extent that it exceeds the distributee&rsquo;s basis ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3837">3837</a>).<a href="#_ftn1" name="_ftnref1">¹</a> Inclusion of the contract&rsquo;s fair market value in the distributee&rsquo;s income is not required at the time of distribution, however, to the extent that within 60 days after it is distributed (1) all or any portion of the contract is irrevocably converted to an annuity with no life insurance element, or (2) the contract is treated as a rollover contribution under IRC Section 402(c).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> The fair market value standard also applies if the contract is sold by the plan to a participant or beneficiary. If the fair market value of the contract exceeds the value of the consideration, then such excess (i.e., the &ldquo;bargain element&rdquo;) is treated as a distribution to the distributee under the plan for all purposes under the IRC. This treatment of the &ldquo;bargain element&rdquo; as a distribution applies for transfers occurring after August 28, 2005. For transfers occurring before August 29, 2005, the &ldquo;bargain element&rdquo; is includable in the distributee&rsquo;s gross income, but is not treated as a distribution for qualification purposes.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> The fair market value standard is effective for distributions or sales occurring after February&nbsp;12, 2004.<a href="#_ftn4" name="_ftnref4">⁴</a> Fair market value includes the policy cash value and all other rights under the contract (including any supplemental agreements thereto, whether or not guaranteed).<a href="#_ftn5" name="_ftnref5">⁵</a> The IRS has issued safe harbor guidance for determining the fair market value of life insurance contracts.<a href="#_ftn6" name="_ftnref6">⁶</a> Under the safe harbor, fair market value may be the greater of (1) the interpolated terminal reserve and any unearned premiums, plus a pro rata portion of a reasonable estimate of dividends expected to be paid for that policy year, and (2) the product of the &ldquo;PERC amount&rdquo; (PERC stands for premiums, earnings, and reasonable charges) and the applicable &ldquo;Average Surrender Factor.&rdquo; For details on these calculations, <em>see</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="144">144</a>.<br /> <br /> <em>Conversion to annuity contract</em>. If a policy is converted, it then will be subject to the rules for annuity contracts (provided the annuity is nontransferable). The IRS has taken the position that the mere elimination of the element of risk in a retirement income contract when the reserve exceeds the face amount does not convert the insurance contract into an annuity contract. According to the IRS, the insured must act to convert the contract into an annuity contract that has at no time contained an element of life insurance protection.<a href="#_ftn7" name="_ftnref7">⁷</a> If the policy is distributed in a lump sum distribution, the taxable amount is eligible for favorable capital gains and special averaging treatment to the extent that such rules are still applicable.<br /> <br /> <em>Death benefit</em>. When a life insurance contract matures by reason of the insured&rsquo;s death <em>after</em> the policy has been distributed from the plan, the proceeds are wholly tax-exempt to the beneficiary.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.402(a)-1(a)(1)(iii).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.402(a)-1(a)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.402(a)-1(a)(1)(iii).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;&nbsp; Rev. Proc. 2005-25, 2005-17 IRB 962.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.402(a)-1(a)(2)(iii).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp;&nbsp;&nbsp;&nbsp; Rev. Proc. 2005-25, 2005-17 IRB 962.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp;&nbsp;&nbsp;&nbsp; Rev. Rul. 66-322, 1966-2 CB 123.<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp;&nbsp;&nbsp;&nbsp; Rev. Rul. 63-76, 1963-1 CB 23.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> In one revenue ruling, the IRS found systematic borrowing in a plan that contemplated purchase of mutual fund shares and a policy of whole life insurance, together with the insured's use of the shares as security for notes executed each year in the amount of the cumulative premium and accrued interest.<a href="#_ftn1" name="_ftnref1">¹</a> When there is a systematic plan of borrowing, the borrowing will be treated as a plan for borrowing the increases in cash value of the policy, regardless of whether the borrowing is direct or indirect (that is, regardless of whether the borrowing is from the insurer, a bank, or some other person). Moreover, such a plan need not involve a pledge of the contract, but may contemplate unsecured borrowing or the use of other property.<a href="#_ftn2" name="_ftnref2">²</a> When there is a systematic plan, and none of the exceptions applies, a deduction will be disallowed for interest on the entire amount borrowed, not just for interest on the borrowing equal to the increases in the cash value.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> Historically, the general disallowance rule applies only with respect to life insurance contracts purchased after August 6, 1963. However, IRS regulations state that this date relates to the date of purchase by the taxpayer, whether the purchase is from the insurer or from a previous policyowner. When a policy issued in 1959 was to be exchanged, the purchase date of the new policy was considered the date upon which the exchange was made, with the taxpayer losing the benefit of a policy issued prior to August 6, 1963.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     Rev. Rul. 74-500, 1974-2 CB 91.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.     Treas. Reg. § 1.264-4(c)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.     Treas. Reg. § 1.264-4(b).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.     GCM 39728 (4-29-88). However, <em>see also</em> PLR 200804010 (acquisition as part of merger not a purchase for purposes of IRC Section 264(a)(3)).<br /> <br /> </div>

<div class="Section1">A single premium life insurance policy generally is treated in the same manner as a multiple-premium life insurance policy for income tax purposes. For all life insurance policies that meet the definition of life insurance ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="65">65</a>), cash surrender value increases generally are not taxed until received ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8">8</a>) and death proceeds generally are received income tax-free ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="63">63</a>).<div></div><div class="Section1">The tax treatment of policy loans depends on whether the policy is treated as a modified endowment contract (MEC). Most single premium policies are considered MECs; policies entered into on or after June 21, 1988 that do not meet the seven pay test of IRC Section 7702A(b) are classified as MECs. Loans from MECs are taxable as income at the time received to the extent that the cash value of the contract immediately before the payment exceeds the investment in the contract.<a href="#_ftn1" name="_ftnref1">¹</a> These distributions also may be subject to a penalty tax of 10 percent ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="13">13</a>).<a href="#_ftn2" name="_ftnref2">²</a></div><div class="Section1"><br /> <br /> Life insurance policies, including single premium policies, issued prior to June 21, 1988, generally are grandfathered and are not subject to the seven pay test. Loans from these policies will not be treated as taxable income. Loans from policies that are not grandfathered but that meet the requirements of the seven pay test also are not treated as taxable income. Any outstanding loan becomes taxable income at the time of policy surrender or lapse, however, to the extent that the loan exceeds the owner&rsquo;s basis in the contract ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="10">10</a>). If policy death proceeds are tax-free, the amount of the loan is not taxed but is treated as part of the tax-free death proceeds ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="65">65</a>). Note that a grandfathered policy may lose its grandfathered status if it undergoes a material change in its terms or benefits or is exchanged for another life insurance policy under IRC Section 1035 ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="13">13</a>).<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect;&nbsp;72(e).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect;&nbsp;72(v).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Transfers of property after June 30, 1969 in connection with the performance of services are governed by IRC Section 83. For transfers before February 13, 2004, Treasury Regulation Section 1.83-3(e) provided that, &ldquo;In the case of a transfer of a life insurance contract, retirement income contract, endowment contract, or other contract providing life insurance protection, only the cash surrender value of the contract is considered to be property.&rdquo;<br /> <br /> For transfers after February 12, 2004, the Treasury Regulations generally treat the policy&rsquo;s fair market value (specifically the policy cash value and all other rights under the contract, including any supplemental agreements to the contract, whether or not they are guaranteed, other than current life insurance protection) as property. For transfers of life insurance contracts that are part of split-dollar arrangements that are <em>not</em> subject to the split-dollar regulations ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4022">4022</a>), however, only the cash surrender value of the contract is considered property.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> The IRS has provided a safe harbor on how to determine the fair market value of a life insurance contract.<a href="#_ftn2" name="_ftnref2">²</a> The fair market value of a life insurance contract may be the greater of either: (1) the interpolated terminal reserve and any unearned premiums, plus a pro rata portion of a reasonable estimate of dividends expected to be paid for that policy year, or (2) the product of the &ldquo;PERC amount&rdquo; (PERC stands for premiums, earnings, and reasonable charges) and the applicable &ldquo;Average Surrender Factor.&rdquo;<br /> <br /> The PERC amount for a life insurance contract that is not a variable contract is the aggregate of:<br /> <blockquote>(1)&nbsp;&nbsp;&nbsp;&nbsp; the premiums paid on the policy without a reduction for dividends that offset the premiums, plus<br /> <br /> (2)&nbsp;&nbsp;&nbsp;&nbsp; dividends that are applied to purchase paid-up insurance, plus<br /> <br /> (3)&nbsp;&nbsp;&nbsp;&nbsp; any other amounts credited or otherwise made available to the policyholder, including interest and similar income items, but not including dividends used to offset premiums and dividends used to purchase paid up insurance, minus<br /> <br /> (4)&nbsp;&nbsp;&nbsp;&nbsp; reasonable mortality charges and other reasonable charges, but only if those charges are actually charged and those charges are not expected to be refunded, rebated, or otherwise reversed, minus<br /> <br /> (5)&nbsp;&nbsp;&nbsp;&nbsp; any distributions (including dividends and dividends held on account), withdrawals, or partial surrenders taken prior to the valuation date.</blockquote><br /> The PERC amount for a variable life contract is the aggregate of:<br /> <blockquote>(1)&nbsp;&nbsp;&nbsp;&nbsp; the premiums paid on the policy without a reduction for dividends that offset the premiums, plus<br /> <br /> (2)&nbsp;&nbsp;&nbsp;&nbsp; dividends that are applied to increase the value of the contract, including dividends used to purchase paid-up insurance, plus or minus<br /> <br /> (3)&nbsp;&nbsp;&nbsp;&nbsp; all adjustments that reflect the investment return and the market value of the contract&rsquo;s segregated asset accounts, minus<br /> <br /> (4)&nbsp;&nbsp;&nbsp;&nbsp; reasonable mortality charges and other reasonable charges, but only if those charges are actually charged on or before the valuation date and those charges are not expected to be refunded, rebated, or otherwise reversed, minus<br /> <br /> (5)&nbsp;&nbsp;&nbsp;&nbsp; any distributions (including dividends and dividends held on account), withdrawals, or partial surrenders taken prior to the valuation date.</blockquote><br /> The Average Surrender Factor is 1.0 when valuing life insurance contracts for purposes of the rules regarding group term life (Section 79), property transferred in connection with the performance of services (Section 83), and certain transfers involving deferred compensation arrangements (Section 402(b)). This is because under these rules no adjustment for potential surrender charges is allowed.<br /> <br /> The IRS pointed out that the formulas in its safe harbor rules must be interpreted in a reasonable manner, consistent with the purpose of determining the contract&rsquo;s fair market value. Specifically, the rules are not allowed to be interpreted in such a way as to understate a contract&rsquo;s fair market value.<br /> <br /> For transfers of property before July 1, 1969, the IRS ruled that the value of an unmatured policy is determined for income tax purposes in the same manner as for gift tax purposes (<em>see</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="119">119</a>).<a href="#_ftn3" name="_ftnref3">³</a> In one case, the court accepted the value stipulated by the parties in an arm&rsquo;s length agreement.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.83-3(e).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Rev. Proc. 2005-25, 2005-17 IRB 962.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; Rev. Rul. 59-195, 1959-1 CB 18.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;&nbsp; <em>Gravois Planing Mill v. Commissioner</em>, 9 AFTR 2d 733 (8th Cir. 1962).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Yes.<br /> <br /> A payee, however, generally may elect not to have anything withheld. Only the amount that it is reasonable to believe is includable in income is subject to withholding. Amounts are to be withheld from periodic payments at the same rate as wages. Payments are periodic, even if they are variable, if they are payable over a period of more than a year. If payments are not periodic, 10 percent of the includable amount is withheld. Payments to a beneficiary of a deceased payee are subject to withholding under the same rules.<a href="#_ftn1" name="_ftnref1">¹</a> An election out of withholding will be ineffective, generally, if a payee does not furnish his or her taxpayer identification number (TIN, usually the payee's Social Security number) to the payor, or furnishes an incorrect TIN to the payor and the payor is so notified by the IRS.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 3405; Temp. Treas. Reg. § 35.3405-1T (A-9, A-10, A-12, A-17, F-19 through 24).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.     IRC § 3405(e)(12).<br /> <br /> </div>

<div class="Section1"><br /> <br /> Basically, no.<br /> <br /> Multiple-life policies may insure two or more lives. Typically, a &ldquo;first-to-die&rdquo; or &ldquo;joint life&rdquo; policy pays a death benefit at the death of the first insured person to die while a &ldquo;second-to-die&rdquo; or &ldquo;survivorship&rdquo; policy does not pay a death benefit until the death of the survivor. Estate planning and business continuation planning are two of the more common uses for these types of policies.<br /> <br /> Generally, multiple-life policies are subject to the same definition of life insurance applicable to policies insuring a single life. One exception is that for purposes of calculating the net single premium under IRC Section 7702, multiple-life policies may not take advantage of the three safe harbor tests set forth in proposed regulations for meeting the reasonable mortality charge requirement ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="65">65</a>).<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> For multiple-life policies that meet the definition of life insurance, cash surrender value increases generally are not taxed until received ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8">8</a>) and death proceeds generally are received income tax-free ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="63">63</a>). Multiple-life policies are subject to the seven pay test of IRC Section 7702A(b) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="13">13</a>) in the same manner as single life policies. Distributions from life insurance policies entered into before June 21, 1988, or from policies entered into on or after this date that meet the seven pay test, are included in gross income only to the extent they exceed the investment in the contract ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="10">10</a>). Policies entered into on or after June 21, 1988 that do not meet the seven pay test become classified as modified endowment contracts. Distributions, including loans, from modified endowment contracts are subject to taxation rules that generally are less favorable than the rules governing the taxation of distributions from life insurance policies that are not modified endowment contracts ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="13">13</a>).<br /> <br /> In a private letter ruling, the IRS concluded that exchanges involving policies insuring a single life for a policy insuring two lives did not qualify for nonrecognition treatment under IRC Section 1035. The IRS reached this outcome in five similar fact patterns ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="44">44</a>).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> In another private ruling, however, the IRS approved IRC Section 1035 treatment of the exchange of a joint and last survivor life insurance policy, following the death of one of the insured persons, for a universal variable life insurance policy that insured the survivor ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="44">44</a>).<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> There has been no formal guidance from the IRS as to which rates should be used to measure economic benefit when a multiple-life policy is used in an arrangement that requires the insured or insureds to include the economic benefit of the coverage in income. The most frequently used rates have been those derived from U.S. Life Table 38, which also is used to derive the P.S. 58 rates. P.S. 58 rates generally may not be used in arrangements entered into after January 27, 2002; however, in those situations, Table 2001 may be used. According to the IRS, taxpayers should make appropriate adjustments to the Table 2001 rates if the life insurance protection covers more than one life.<a href="#_ftn4" name="_ftnref4">⁴</a> When the policy death benefit is payable at the second death, it generally is believed that following the first death, the Table 2001 rates (or P.S. 58 rates, if appropriate) for single lives should be used to measure the survivor&rsquo;s economic benefit.<br /> <br /> For estate taxation of policies insuring more than one life, <em>see</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="199">199</a>. For gift taxation of these policies, <em>see</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="211">211</a>.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; Prop. Treas. Reg. &sect;&nbsp;1.7702-1(c).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Let. Rul. 9542037.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; Let. Rul. 9248013; <em>see also</em> Let. Rul. 9330040.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp;&nbsp;&nbsp; Notice 2002-8, 2002-1 CB 398.<br /> <br /> </div></div><br />