by Stefan Gottschalk and Joseph Wiener
RSM US LLP is an IMA Member
The Treasury Department and the IRS have published proposed regulations addressing reporting requirements and tax obligations for buyers and sellers of life insurance contracts. Included in the regulations is a favorable rule important to the banking industry—a carve-out permitting a company acquiring a corporation that owns life insurance policies to avoid taxes on payouts under those policies.
In order to reduce tax avoidance of certain types of transactions involving secondary market purchases and transfers of life insurance contracts, the Tax Cuts and Jobs Act (TJCA) enacted in 2017 included provisions related to the acquisition of a life insurance contract or an interest in a life insurance contract. Along with reporting requirements under new section 6050Y of the Tax Code, the provisions added a taxable income rule to section 101 which, on its face, would appear to affect anyone that acquires a corporation that is both the owner and beneficiary of a life insurance policy. The TCJA-enacted rule would appear to require the buyer in such a case to pay tax on the death benefits paid under one of the acquired corporation’s life insurance policies.
This new rule presented a particular problem to the banking industry due to the prevalence of bank-owned life insurance (BOLI). BOLI is a form of life insurance purchased by banks wherein the bank is both the owner and beneficiary of the policy. Under the new TCJA rule, an acquisition of a target bank that has BOLI policies would appear to have the undesirable result that the buyer would be taxed on receipt of death benefits.
Under section 101, the receipt of death benefit payments under a life insurance contract generally is not subject to federal income tax. A “transfer for value” rule provides an exception to the general rule. Under the transfer for value rule, the acquirer of a life insurance policy who receives a death benefit payment under the policy generally must include that payment in income, reduced by the acquirer’s cost of the policy (i.e., acquisition price plus premiums paid).
Prior to the TCJA, the transfer for value rule did not apply to a corporation that acquired a target corporation that owned life insurance policies either (1) in a tax-free acquisition, or (2) in a certain situations where the policy covered the life of a corporate officer or shareholder. The TCJA, however, added section 101(a)(3), which appears to eliminate these favorable exceptions in the case of a transfer of an interest in a life insurance contract where the acquirer has no substantial, business, or financial relationship with the insured. This unfavorable rule extends to acquisitions of interests in entities that hold life insurance policies.
The newly proposed regulations would exclude from the TCJA’s unfavorable rule an acquisition of a C corporation, provided that life insurance contracts do not constitute more than 50 percent of the gross value of the C corporation’s assets. Under this proposed rule, the pre-TCJA exceptions to the transfer for value rule could apply after a corporate acquisition.
It is important to note that this favorable provision of the proposed regulations would be effective for transactions occurring after the date the proposed regulations are finalized. The proposed regulations rules regarding life insurance policy transfer reporting under section 6050Y, on the other hand, generally are applicable to sales and payments made after Dec. 31, 2017. This Alert does not cover the section 6050Y information reporting rules.
Acquirers of banks with BOLI (or of other corporations owning life insurance policies) should both be pleased with the proposed regulations and cautious given their prospective effective date. Corporations considering such acquisitions should consult with their tax advisors regarding the tax treatment of the target corporation’s life insurance policies.
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