The IRS has issued Notice 2018-41 which delays the requirement to file reports on certain sales of life insurance policies mandated by TCJA until the IRS issues final regulations on the provision.

An information return will need to be filed by each person who acquires a life insurance policy in a reportable policy sale under IRC §6050Y for sales completed after December 31, 2017.  A “reportable policy sale” is defined at IRC §101(a)(3)(B) as:

…[T]he 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.

The details on the report will be determined by the IRS, including the time and manner of filing.  The report will contain:

·       The name, address, and TIN of the person acquiring the contract,

·       The name, address, and TIN of each recipient of payment in the reportable policy sale,

·       The date of such sale,

·       The name of the issuer of the life insurance contract sold and the policy number of such contract, and

·       The amount of each payment. [IRC §6040Y(a)(1)]

A statement must also be provided to each person or entity named in the report (that is, the acquirer and the issuer of the contract) that contains the following information:

·       The name, address, and phone number of the information contact of the person required to make such return, and

·       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 amount of each payment. [IRC §6040Y(a)(2)]

The issuer of the life insurance contract will also have a reporting obligation at this point.  The issuer’s required to send a report to the IRS showing:

·       The name, address, and TIN of the seller who transfers any interest in such contract in such sale,

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

·       The policy number of such contract. [IRC §6040Y(b)(1)]

The issuer will also have to give that information to the seller(s) in a report that will include:

·       The name, address, and phone number of the information contact of the person required to make such return, and

·       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. [IRC §6040Y(b)(2)]

When death benefits are paid on a contract that has previously been subject to a reportable policy sale, the death benefits must also be reported by the party paying the death benefit to the IRS.  That report will contain:

·       The name, address, and TIN of the party making such payment (normally the insurance company),

·       The name, address, and TIN of each recipient of such payment,

·       The date of each such payment,

·       The gross amount of each such payment, and

·       The payor’s estimate of the investment in the contract (as defined in section 72(e)(6)) with respect to the buyer. [IRC §6040Y(c)(1)]

At the same time a report will be issued to the party being paid that will contain:

·       The name, address, and phone number of the information contact of the party required to make such return, and

·       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.

TCJA also provides a modification to the transfer for value rules, adding IRC §101(a)(3).  Per the IRS description in Notice 2018-41:

Section 13522 of the Act added § 101(a)(3), which provides that the exception to the § 101(a)(2) limitation provided in the second sentence of § 101(a)(2) does not apply in the case of a reportable policy sale. Accordingly, in the case of a reportable policy sale, the amount of death benefits excluded from gross income under § 101(a)(1) shall not exceed an amount equal to the sum of the actual value of the consideration the buyer paid for the contract and the premiums or other amounts subsequently paid by the buyer. As a result, some portion of the death benefit ultimately payable under such a contract may be includable in income under § 101(a)(2) (for example, if the life insurance contract is transferred for valuable consideration and the death benefit exceeds the sum of the actual value of the consideration and the premiums or other amounts subsequently paid by the transferee of the contract). The modification to the rules for transfers for valuable consideration is effective for transfers occurring after December 31, 2017.

That removes the following exception to the transfer for value rules that would otherwise apply when the transfer involves a “reportable sale” of the policy, which states the limit on excludable death benefits with a transfer for value does 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.

Notice 2018-41 has been issued by the IRS to deal with this provision.  The notice provides that no reporting will be required under this provision until the IRS has issued the final regulations for the provision. The notice also discusses the IRS’s view today of what will be in such regulations when they are issued in proposed form.

The IRS had previously outlined the tax treatment of parties that sell or surrender life insurance policies in Revenue Procedure 2009-13.  As IRS describes the treatment outlined in that ruling:

A life insurance policyholder who sells a life insurance contract may have taxable gain on the sale. Rev. Rul. 2009-13, 2009-21 I.R.B. 1029, holds that gain on the sale of a life insurance contract is included in gross income under § 61(a)(3). The gain is capital gain, except to the extent of the amount that would be recognized as ordinary income if the contract were surrendered, which is ordinary income under the substitute for ordinary income doctrine. See Rev. Rul. 2009-13; see also Rev. Rul. 2009-14, 2009-21 I.R.B. 1031. The amount that would be recognized as ordinary income under § 72(e)(5) if the contract were surrendered is the “inside buildup” — the excess of the amount that would be received upon surrender over the investment in the contract as defined in § 72(e)(6).2 Section 72(e)(6) defines the “investment in the contract” as of any date as the aggregate amount of premiums or other consideration paid for the contract before that date, less the aggregate amount received under the contract before that date to the extent that such amount was excludable from gross income.

In the notice the IRS observes that the market for life insurance contract sales and purchases are generally governed by the states.

Over 40 states regulate life settlement transactions. State law may require that life settlement brokers be licensed and that the contract of sale (the life settlement contract) only be entered into by the policyholder and a licensed life settlement provider. A life settlement provider may purchase a life insurance contract on its own behalf. Alternatively, the life settlement provider may purchase a life insurance contract on behalf of the ultimate beneficial owner (for example, a financing entity that provides the funds to purchase the life insurance contract). The ultimate beneficial owner of the life insurance contract may continue to pay the premiums on the life insurance contract and receive death benefits under the contract on the death of the insured, or may, in a separate transaction, sell the life insurance contract to another investor in life insurance contracts.

The notice also describes the treatment of the category of sales known as viatical settlements provided for in IRC §101(g).

A viatical settlement, a subset of life settlement transactions, may involve the sale of a life insurance contract, but may not be taxed as a sale. Under a viatical settlement, a policyholder may sell or assign a life insurance contract after the insured has become terminally ill or chronically ill. If any portion of the death benefit under a life insurance contract on the life of an insured who is terminally ill or chronically ill (within the meaning of § 101(g)) is sold (through the sale of the life insurance contract) or assigned in a viatical settlement to a viatical settlement provider, the amount paid for the sale or assignment of that portion is treated as an amount paid under the life insurance contract by reason of the death of the insured, rather than gain from the sale or assignment. See §§ 101(a) and (g). Amounts received under a life insurance contract paid by reason of the death of the insured are excluded from federal income tax. See § 101(a)(1). For this purpose, a viatical settlement provider is a person regularly engaged in the trade or business of purchasing, or taking assignments of, life insurance contracts insuring the lives of terminally ill or chronically ill individuals (provided certain requirements are met). See Rev. Rul. 2002-82, 2002-51 I.R.B. 978.

The notice provides the following information about the scope of “reportable sales” the IRS plans to include in the regulations:

The proposed regulations will…clarify which parties are subject to the reporting requirements and other definitional issues. For example, Treasury and the IRS intend to define the term “reportable policy sale” in the proposed regulations to include a viatical settlement. In addition, Treasury and the IRS intend to clarify the extent to which § 6050Y applies to sales or acquisitions effected by transferors and transferees outside the U.S. and to sellers and issuers that are foreign persons for purposes of reporting under section 6050Y(b) or (c).

The notice goes on to discuss issues related to who the IRS plans to include as an “acquirer” of a policy that will have a reporting obligation:

For example, the proposed regulations may define “acquirer” in a reportable policy sale to include any person, including the life settlement or viatical settlement provider or financing entity, that takes title or possession for state law purposes or acquires a beneficial interest in the life insurance contract at any time. The statute defines “indirectly,” for purposes of a reportable policy sale, as the acquisition of an interest in a partnership, trust, or other entity that holds an interest in the life insurance contract. The proposed regulations may further refine the definition of “indirectly” for purposes of § 6050Y reporting.

Items under consideration as part of the definition of a reportable payment are as follows:

Treasury and the IRS intend to clarify that a reportable payment may include payments to persons other than the seller, such as brokers and, potentially, life settlement providers acting as intermediaries. Additionally, Treasury and the IRS intend to clarify that the “payment” to the seller reported under § 6050Y(a) is the seller's net proceeds. The net proceeds equal the gross proceeds minus any selling expenses (for example, broker's fees and commissions).

The IRS also announces that they plan to limit the definition of the “issuer” for reporting purposes.

Treasury and the IRS intend to limit the information reporting obligations imposed under § 6050Y(b) to the life insurance company that is responsible for administering the contract, including paying death benefits under the life insurance contract. Under the proposed regulations, the reporting obligations would not apply, for instance, to a reinsurer in an indemnity contract covering all or a portion of the risks that the original issuer (and continuing contract administrator) might otherwise have incurred with respect to a life insurance contract. This proposed definition of “issuer” will reduce the burden on reporting life insurance companies and prevent duplicative reporting.

The IRS announced that the agency does plan to require one additional piece of information from the issuer regarding the contract that was sold:

Treasury and the IRS intend to propose regulations requiring the issuer to report the amount that would have been received by the policyholder upon surrender of the contract because this information is needed to determine the amount of the seller's gain that is ordinary income. See Rev. Rul. 2009-13; see also Rev. Rul. 2009-14.

The IRS also announces that they plan to allow issuers to file statements in some cases even if they have not received the formal notice from the acquirer:

Issuers of life insurance contracts acquired by a domestic person in a reportable policy sale are subject to the reporting obligations of § 6050Y(b) only if the issuer receives the statement required by § 6050Y(a)(2) to be furnished by the acquirer in a reportable policy sale to the issuer. Treasury and the IRS intend to propose regulations providing that issuers who have not received a written statement from an acquirer under § 6050Y(a)(2), but who have received notice of a transfer of a life insurance contract to a domestic person, may optionally file a return with the IRS under § 6050Y(b)(1) and furnish written statements to sellers under § 6050Y(b)(2), unless the issuer knows the transfer is not a reportable policy sale.

One key issue not addresses in the IRC is when this report will need to be provided.  The IRS gives its initial view on the timing in the notice:

The recipients of the written statements required to be furnished under § 6050Y may use the information therein to determine their taxable income. To facilitate recipients’ proper tax reporting, Treasury and the IRS intend to require that an acquirer furnish the written statements required under § 6050Y(a)(2) to an issuer by the later of (1) 20 days after the reportable policy sale, or (2) 5 days after the end of the applicable state law rescission period, if any, but in no event later than January 15 of the year following the calendar year in which the reportable policy sale occurs. Treasury and the IRS intend to require that all other written statements required under §§ 6050Y(a)(2), (b)(2), and (c)(2) be furnished to the recipients identified in the statute and regulations no later than January 31 of the year following the calendar year in which the reportable policy sale or reportable death benefit payment occurs. The earlier deadline for acquirers to furnish issuers with the written statements required under § 6050Y(a)(2) is needed because reporting under § 6050Y(b) is contingent on the issuer receiving either notice of a reportable policy sale via a written statement furnished under § 6050Y(a)(2) or notice of the transfer of a life insurance contract to a foreign person.

Treasury and the IRS intend to propose regulations requiring the returns required by 6050Y(a)(1), (b)(1), and (c)(1) to be filed with the IRS no later than February 28 of the year following the calendar year in which the reportable policy sale or reportable death benefit payment occurs, for paper returns, and no later than March 31 of the year following the calendar year in which the reportable policy sale or reportable death benefit payment occurs, for electronically filed returns.

Treasury and the IRS intend to propose regulations regarding reporting obligations upon the rescission of a reportable policy sale or transfer to a foreign person. Upon receiving notice of the rescission, any person who has filed a return required by § 6050Y with respect to the reportable policy sale or transfer would have 15 days to file a corrected return. Upon receiving notice of the rescission, any person who has furnished a written statement under § 6050Y with respect to the reportable policy sale or transfer would have 15 days to furnish the recipient of that statement with a corrected statement reporting the rescission.

The notice concludes by asking for comments on several specific issues as the IRS begins the process of drafting regulations to implement this new information reporting requirement.