Valuing Life Insurance for Income Tax Purposes

In the case of certain income tax situations, the IRS has provided more recent guidance regarding the value of a life insurance policy. In 2005, primarily in reaction to certain perceived valuation abuses occurring with fully insured defined benefit plans (section 412(e)(3) plans, formerly known as section 412(i) plans), the IRS issued Revenue Procedure 2005-25.8 This revenue procedure applies for purposes of determining the value of life insurance distributed from a qualified plan, determining the value of life insurance distributed by an employer to an employee in conjunction with the performance of services, and determining the cost of permanent benefits provided under a group life plan.

The revenue procedure indicates that the general rule for income tax purposes for which the revenue procedure applies is that the value of life insurance is its FMV. Conceptually, this is no different than the guidance provided for estate and gift tax purposes. However, the revenue procedure provides a safe harbor value that does differ from the estate and gift tax rules. The safe harbor value is the greater of ITR or Premiums plus Earnings less Reasonable Charges (PERC). PERC is a newly created formula for determining the value of a policy in the above situations.

It should be noted that there are actually two different PERC formulas. With respect to a distribution of a life insurance policy from a qualified plan, the PERC formula can take into account an average surrender factor of as much as 30 percent. With respect to the distribution of a policy from an employer to an employee or when determining the cost of permanent benefits for a group life plan, an average surrender factor is not permitted as part of the PERC formula.

As a result of the creation of the PERC formula, it may appear that this revenue procedure provides more clarity when it comes to the valuation of a life insurance policy for income tax purposes. However, this is not necessarily the case. With ITR being a component of the safe harbor value, there will still be considerable uncertainly as insurance companies continue to struggle with how to calculate ITR for products other than whole life.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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