The IRS released proposed regulations on the rules added for reporting certain transactions related to life insurance policies under IRC §6050Y and changes made to the transfer for value rules found at IRC §101(a)(3) in REG-103083-18.  The provisions were added to the law by the Tax Cuts and Jobs Act (TCJA) in late 2017.

The transfer for value rules are an exception to the general rule that death benefits paid on a life insurance policy are not considered income to the recipient.  Prior to TCJA, the impact of the transfer for value rules that triggered the inclusion of life insurance proceeds in the recipient’s income were found in IRC §101(a)(2) which provides:

(2) Transfer for valuable consideration

In the case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance contract or any interest therein, the amount excluded from gross income by paragraph (1) shall not exceed an amount equal to the sum of the actual value of such consideration and the premiums and other amounts subsequently paid by the transferee. The preceding sentence shall not apply in the case of such a transfer—

(A) if such contract or interest therein has a basis for determining gain or loss in the hands of a transferee determined in whole or in part by reference to such basis of such contract or interest therein in the hands of the transferor, or

(B) if such transfer is to the insured, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer.

The term “other amounts” in the first sentence of this paragraph includes interest paid or accrued by the transferee on indebtedness with respect to such contract or any interest therein if such interest paid or accrued is not allowable as a deduction by reason of section 264(a)(4).

TCJA added a modification to these rules to expand the category of transfer for value tainted transactions by removing from consideration the second sentence of §101(a)(2) (highlighted earlier) in the case of a “reportable policy sale.”  A reportable policy sale is defined in §101(a)(3)(B) as:

(B) Reportable policy sale

For purposes of this paragraph, the term “reportable policy sale” means the acquisition of an interest in a life insurance contract, directly or indirectly, if the acquirer has no substantial family, business, or financial relationship with the insured apart from the acquirer’s interest in such life insurance contract. For purposes of the preceding sentence, the term “indirectly” applies to the acquisition of an interest in a partnership, trust, or other entity that holds an interest in the life insurance contract.

This provision was meant to deal with structures being created, most often using partnerships, to attempt to skirt the transfer for value rules by using IRC §101(a)(2)(B)’s exclusions. 

Some commentators had concerns about what appeared to be the very broad coverage of the “indirect” acquisition provision of §101(a)(3)(B) and the use of the term “other entities” in that clause.  The questions that arose for those involved in mergers and acquisitions was whether this clause could be triggered in an acquisition of a C corporation for any policies owned by that C corporation. 

If taken literally, policies held for legitimate business reasons by the acquired C corporation in a transaction motivated by other business issues would appear to suddenly create taxable income when a death benefit was paid. 

For example, a corporation (A) holds life insurance policies issued to it and for which the corporation has an insurable interest.  If that corporation’s stock is acquired by another corporation (P), then the transaction could be viewed as transforming all of those policies into policies to which the transfer for value rules applied, resulting in any death benefits paid being taxable to the corporation to the extent the payments were in excess of what was paid on the policy.

In an article written by Kristen A. Parillo appearing in Tax Notes Today’s March 25, 2019 edition, the approach taken by the proposed regulations to remove this concern is discussed.[1]  Specifically, Proposed Reg. §1.101-1(e)(3)(ii) provides that for purposes of defining an “other entity” for the reportable policy sale rules “the term other entity does not include a C corporation, unless more than 50 percent of the gross value of the assets of the C corporation consists of life insurance contracts (as determined under paragraph (f)(4) of this section) immediately before the indirect acquisition.”

The proposed regulations also contain guidance on the reporting obligations imposed by new IRC 6050Y.  The IRS released final versions of the 2018 version of Form 1099-LS, Reportable Life Insurance Sale and the 2019 version of Form 1099-SB, Seller’s Investment in Life Insurance Contract.

IRS §6050Y requires reporting in the following situations per IRC §6050Y:

(a) Requirement of reporting of certain payments. --

(1) In general. -- Every person who acquires a life insurance contract or any interest in a life insurance contract in a reportable policy sale during any taxable year shall make a return for such taxable year (at such time and in such manner as the Secretary shall prescribe) setting forth --

(A) the name, address, and TIN of such person,

(B) the name, address, and TIN of each recipient of payment in the reportable policy sale,

(C) the date of such sale,

(D) the name of the issuer of the life insurance contract sold and the policy number of such contract, and

(E) the amount of each payment.

(2) Statement to be furnished to persons with respect to whom information is required. -- Every person required to make a return under this subsection shall furnish to each person whose name is required to be set forth in such return a written statement showing --

(A) the name, address, and phone number of the information contact of the person required to make such return, and

(B) the information required to be shown on such return with respect to such person, except that in the case of an issuer of a life insurance contract, such statement is not required to include the information specified in paragraph (1)(E).

(b) Requirement of reporting of seller's basis in life insurance contracts. --

(1) In general. -- Upon receipt of the statement required under subsection (a)(2) or upon notice of a transfer of a life insurance contract to a foreign person, each issuer of a life insurance contract shall make a return (at such time and in such manner as the Secretary shall prescribe) setting forth --

(A) the name, address, and TIN of the seller who transfers any interest in such contract in such sale,

(B) the investment in the contract (as defined in section 72(e)(6)) with respect to such seller, and

(C) the policy number of such contract.

(2) Statement to be furnished to persons with respect to whom information is required. -- Every person required to make a return under this subsection shall furnish to each person whose name is required to be set forth in such return a written statement showing --

(A) the name, address, and phone number of the information contact of the person required to make such return, and

(B) the information required to be shown on such return with respect to each seller whose name is required to be set forth in such return.

(c) Requirement of reporting with respect to reportable death benefits. --

(1) In general. -- Every person who makes a payment of reportable death benefits during any taxable year shall make a return for such taxable year (at such time and in such manner as the Secretary shall prescribe) setting forth --

(A) the name, address, and TIN of the person making such payment,

(B) the name, address, and TIN of each recipient of such payment,

(C) the date of each such payment,

(D) the gross amount of each such payment, and

(E) such person's estimate of the investment in the contract (as defined in section 72(e)(6)) with respect to the buyer.

(2) Statement to be furnished to persons with respect to whom information is required. -- Every person required to make a return under this subsection shall furnish to each person whose name is required to be set forth in such return a written statement showing --

(A) the name, address, and phone number of the information contact of the person required to make such return, and

(B) the information required to be shown on such return with respect to each recipient of payment whose name is required to be set forth in such return.

[1] Kristen A. Parillo, “Some C Corps Get Carveout in Proposed Insurance Regs,” Tax Notes Today, March 25, 2019, 2019 TNT 57-7, https://www.taxnotes.com/tax-notes-today/insurance/some-c-corps-get-carveout-proposed-insurance-regs/2019/03/25/2991t, (subscription required)