The Internal Revenue Service has come out with two batches of advice discussing how buyers and sellers of in-force life policies should treat the transactions.
http://www.irs.gov/pub/irs-drop/rr-09-13.pdf discusses the tax implications for insureds who sell policies.
IRS Revenue Ruling 2009-14 discusses the tax implications for companies or others that buy policies and receive the benefits when the insureds die.
In the first ruling, officials one situation involving an policyholder insured who surrenders a policy from a U.S. insurer with a cash surrender value of $78,000 in policy year 8; a second situation involving a policyholder insured who sells the same policy in policy year 8; and a third situation involving a policyholder insured who sells a policy with no cash value in policy year 8.
If the insured surrenders the policy and the cash surrender value is greater than the amount of premiums the insured has paid, then the difference between the cash surrender value and the total premiums paid for coverage will be taxed as ordinary income, officials write.
If the insured sells the same policy, then the insured must calculate the "adjusted basis" by totaling the amount of premiums paid, then subtracting the cost of the insurance protection from the premium total. If, for example, the insured has paid $64,000 for coverage with a $10,000 cost of insurance, and then sells the policy for $80,000, the adjusted basis is equal to $64,000 minus $10,000, or $54,000.
The insured must pay taxes on an amount equal to the sale price minus the adjusted basis. In the example given, the amount would be $26,000 -- $80,000 minus $54,000.
The difference between the policy's cash surrender value and the total amount premiums paid -- in this case, $78,000 minus $64,000, or $14,000 -- will be taxed as ordinary income, and the rest of the sale price will be taxed as a long-term capital gain, officials write.
In the third case, involved a term life contract, the insured would end up having to pay taxes on most of life settlement transaction proceeds, and the proceeds would be treated as long-term capital gains, officials write.
In IRS Revenue Ruling 14, officials describe one situation involving a company that pays $20,000 for an in-force life contract written by a U.S. insurer. The policy will pay $100,000 in death benefits. The company pays $9,000 in premiums to keep the policy in force, and then the insured dies.
In the second situation, the insured stays alive, and the first purchaser of the policy sells it to a second party unrelated to it or the insured.
In the third situation, the buyer of the policy is a foreign corporation.
In the first situation, officials write, the taxed amount is equal to the death benefit, minus the total value of premiums the company pays to keep the policy in force, minus the amount paid to the insured. In the example given, the taxable amount would be $71,000 -- $100,000, minus $9,000, minus $20,000.
The amount taxed would be treated as ordinary income, officials write.
The sum of the premiums paid and the amount paid to the insured -- $29,000 in this case -- would be the life settlement company's adjusted basis.
In the second situation, if the life settlement company that bought the policy had an adjusted basis of $29,000 and then sold the policy to another company for $30,000, it would have to recognize $1,000 in revenue -- the difference between the adjusted basis and the resale price -- and the revenue would be taxed as a long-term capital gain, officials write.
In the third situation, involving a foreign life settlement company buyer, the buyer still would have to recognize $71,000 in taxable income, just as in the first situation, officials write.
The buyer would have to treat the income as being ordinary income from sources within the United States, and the taxation of the income would follow the rules set out in Section 881(a)(1) of the Internal Revenue Code, officials write.
Article provided courtesy of Life Insurance Settlement Association (LISA). Opinions and conclusions stated in the article do not necessarily reflect the opinion and conclusion of Advanced Settlements. Advanced Settlements does not guarantee the accuracy of statements in the article. Advanced Settlements does not provide tax or legal advice.
|
