Tax experts serving the life settlement industry are paying close attention to a proposed rule from the US Treasury Department that addresses unintended tax consequences resulting from Internal Revenue Service regulations issued in 2019 under IRC Sections 101 (death benefit exclusion) and 6050Y (Form 1099 information reporting).
The proposed rule to clarify how life settlement exchanges are taxed, “Information Reporting and Transfer for Valuable Consideration Rules for Section 1035 Exchanges of Life Insurance and Certain Other Life Insurance Contract Transactions,” was published in early May 2023 and comments from interested parties were closed on July 10, 2023.
According to the IRS summary, the proposed rule would “provide guidance on the application of the transfer for valuable consideration rules and associated information reporting requirements for reportable policy sales of interests in life insurance contracts to exchanges of life insurance contracts qualifying for nonrecognition of gain or loss, as well as to certain acquisitions of interests in life insurance contracts in transactions that qualify as corporate reorganisations.”
Industry experts say this is good news for the life settlement industry, as it clarifies the tax treatment of Section 1035 exchanges and makes it more likely that these exchanges will be tax-free. This could lead to increased activity in the life settlement market, as more people are able to take advantage of the tax benefits of exchanging their life insurance policies.
“These final regulations had inadvertently treated certain Section 1035 exchanges as reportable policy sales thus subjecting them to the transfer-for-value rules that could limit the Section 101 death benefit exclusion,” James Davis, CPA, of EC Barrett, LLC in Atlanta told Life Risk News.
“The proposed regulation under Section 101 would correct the mistake in the existing regulations by eliminating the treatment of some Section 1035 exchanges as reportable policy sales and would clarify that Section 1035 exchanges do not result in a taxable transfer-for-value.”
At the close of the comment period the American Bankers Association was the single association to post a point of view, noting, in part, how the 2019 final regulations helped clarify what constitutes an RPS, or reportable policy sales.
“The proposed regulations include a new exception from the definition of RPS for certain direct acquisitions of interests in life insurance contracts by C corporations that arise as part of ordinary course mergers and acquisitions where life insurance constitutes a de minimis amount of the total assets being acquired,” the ABA wrote.
“With that in mind, however, the De Minimis Exception should be expanded to cover certain taxable transactions between C corporations, including transactions involving one or more holding companies and their subsidiaries.
The proposed changes are still in the early stages, and it is not yet clear when they will be finalised. However, the fact that the IRS is proposing these changes is a positive sign for the life settlement industry. It shows that the IRS is aware of the uncertainty surrounding life settlement exchanges and reorganizations, and is taking steps to address it.
Here are some specific examples of how the proposed changes would affect life settlement exchanges and reorganizations:
Currently, there is some uncertainty about whether the death benefit from a life settlement exchange is taxable.
The proposed changes would clarify that the death benefit from a life settlement exchange is not taxable, as long as the exchange meets certain requirements.
There is some uncertainty about whether reorganizations involving life insurance contracts are subject to the same rules as other types of insurance transactions.
The proposed changes would clarify that reorganizations involving life insurance contracts are not subject to the same rules, and that the death benefit from a life insurance contract is not taxable in the event of a reorganization.
The proposed changes would make life settlement exchanges and reorganizations more attractive to investors and companies. This could lead to increased activity in these markets, as more people are able to take advantage of the tax benefits.
Jeffrey Davis, Contributing Editor, Life Risk News