Value of Life Insurance Contracts When Distributed From a Qualified Retirement Plan, 50967-50972 [05-17046]
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Federal Register / Vol. 70, No. 166 / Monday, August 29, 2005 / Rules and Regulations
between the National Government and
the States, or on the distribution of
power and responsibilities among the
various levels of government. Therefore,
it is determined that this rule does not
have sufficient federalism implications
to warrant application of consultation
provisions of Executive Orders 12372
and 13132. This rule does not impose
any new reporting or recordkeeping
requirements subject to the Paperwork
Reduction Act, 44 U.S.C. Chapter 35.
List of Subjects in 22 CFR Part 126
Accordingly, for the reasons set forth
above, title 22, chapter I, subchapter M,
part 126 is amended as follows:
PART 126—GENERAL POLICIES AND
PROVISIONS
1. The authority citation for part 126
continues to read as follows:
I
Authority: Secs. 2, 38, 40, 42, and 71,
Public Law 90–629, 90 Stat. 744 (22 U.S.C.
2752, 2778, 2780, 2791, and 2797); E.O.
11958, 42 FR 4311; 3 CFR, 1977 Comp., p.
79; 22 U.S.C. 2651a; 22 U.S.C. 287c; E.O.
12918, 59 FR 28205, 3 CFR, 1994 Comp., p.
899; Sec. 1225, Public Law 108–375.
2. Section 126.1 is amended by
revising paragraph (i) to read as follows:
I
§ 126.1 Prohibited exports and sales to
certain countries.
*
*
*
*
(i) Democratic Republic of the Congo.
It is the policy of the United States to
deny licenses, other approvals, exports
or imports of defense articles and
defense services destined for or
originating in the Democratic Republic
of the Congo except for non-lethal
equipment and training (lethal and nonlethal) to the United Nations
Organization Mission in the Democratic
Republic of the Congo (MONUC), the
transitional National Unity Government
of the Democratic Republic of the Congo
and the integrated Congolese national
army and police forces, such units
operating under the command of the
etat-major integre of the Congolese
Armed Forces or National Police, and
such units in the process of being
integrated outside the provinces of
North and South Kivu and the Ituri
district; and non-lethal equipment for
humanitarian or protective use, and
related assistance and training, as
notified in advance to the UN. An arms
embargo exists with respect to any
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BILLING CODE 4710–25–P
DEPARTMENT OF THE TREASURY
Internal Revenue Service
[TD 9223]
I
VerDate Aug<18>2005
Robert G. Joseph,
Under Secretary, Arms Control and
International Security, Department of State.
[FR Doc. 05–17122 Filed 8–26–05; 8:45 am]
26 CFR Part 1
Arms and munitions, Exports.
*
recipient in the Democratic Republic of
the Congo.
RIN 1545–BC20
Value of Life Insurance Contracts
When Distributed From a Qualified
Retirement Plan
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
AGENCY:
SUMMARY: This document contains final
regulations under section 402(a) of the
Internal Revenue Code regarding the
amount includible in a distributee’s
income when life insurance contracts
are distributed by a qualified retirement
plan and regarding the treatment of
property sold by a qualified retirement
plan to a plan participant or beneficiary
for less than fair market value. This
document also contains final regulations
under sections 79 and 83 of the Internal
Revenue Code regarding the amounts
includible in income when an employee
is provided permanent benefits in
combination with group-term life
insurance or when a life insurance
contract is transferred in connection
with the performance of services. These
regulations will affect administrators of,
participants in, and beneficiaries of
qualified retirement plans. These
regulations will also affect employers
who provide permanent benefits in
combination with group-term life
insurance for their employees and
employees who receive those permanent
benefits, as well as service recipients
who transfer life insurance contracts to
service providers in connection with the
performance of services, and service
providers to whom those life insurance
contracts are transferred.
DATES: These regulations are effective
August 29, 2005.
FOR FURTHER INFORMATION CONTACT:
Concerning the section 79 regulations,
Betty Clary at (202) 622–6080;
concerning the section 83 regulations,
Robert Misner at (202) 622–6030;
concerning the section 402 regulations,
Bruce Perlin or Linda Marshall at (202)
622–6090 (not toll-free numbers).
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SUPPLEMENTARY INFORMATION:
Background
A. In General
This document contains amendments
to the Income Tax Regulations (26 CFR
part 1) under section 402(a) of the
Internal Revenue Code (Code) relating to
the amount includible in a distributee’s
income when a life insurance contract,
retirement income contract, endowment
contract, or other contract providing life
insurance protection is distributed by a
retirement plan qualified under section
401(a), and relating to the sale of
property by a qualified retirement plan
to a plan participant or beneficiary for
less than the fair market value of the
property. This document also contains
amendments to the regulations under
sections 79 and 83 relating, respectively,
to permanent benefits that are provided
to employees in combination with
group-term life insurance, and to life
insurance contracts that are transferred
in connection with the performance of
services.
Section 402(a) generally provides that
any amount actually distributed to any
distributee by any employees’ trust
described in section 401(a) which is
exempt from tax under section 501(a) is
taxable to the distributee in the taxable
year of the distributee in which
distributed, in accordance with section
72. Distributions from a qualified
employees’ trust generally are subject to
withholding and reporting requirements
pursuant to section 3405 and
regulations thereunder. Section
1.402(a)–1(a)(1)(iii) provides, in general,
that a distribution of property by a
section 401(a) plan is taken into account
by the distributee at its fair market
value. Prior to its amendment by this
Treasury decision, § 1.402(a)–1(a)(2)
(which was originally published in
1956) provided, in general, that upon
the distribution of a life insurance
contract, the ‘‘entire cash value’’ of the
contract must be included in the
distributee’s income.1 Section 1.402(a)–
1(a) did not define fair market value or
entire cash value, and questions have
arisen regarding the interaction between
these two provisions and regarding
whether the term entire cash value
includes a reduction for surrender
charges.
On April 30, 1975, proposed
regulations under section 402 regarding
the taxation of certain lump sum
1 Section 1.402(a)–1(a)(2) also provides rules
regarding the taxation of the distribution of an
annuity contract. In certain cases, the distribution
of an annuity contract is not includible in the
participant’s gross income until distributions are
made from the annuity contract.
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distributions from qualified plans (the
1975 proposed regulations) were
published in the Federal Register (40
FR 18798) to reflect changes to section
402 made by the Employee Retirement
Income Security Act of 1974 (ERISA)
(Public Law 93–406, 88 Stat. 829).
Under § 1.402(a)–1(a)(2) of the 1975
proposed regulations, the distribution of
an annuity contract must be treated as
a lump sum distribution under section
402(e) for purposes of determining the
separate tax imposed under section
402(e)(1)(A),2 even if the distribution of
the annuity contract itself is not
currently taxable. The 1975 proposed
regulations also expanded the situations
in which the distribution of a retirement
income, endowment, or other life
insurance contract is not currently
taxable to include the situation where,
within 60 days after the distribution of
such contract, the contract is treated as
a rollover contribution under section
402(a)(5), as in effect after December 31,
1973.
Section 79 generally requires that the
cost of group-term life insurance
coverage provided by an employer on
the life of an employee that is in excess
of $50,000 of coverage be included in
the income of the employee. Pursuant to
§ 1.79–1(b), under specified
circumstances, group-term life
insurance may be combined with other
benefits, referred to as permanent
benefits. A permanent benefit is defined
in § 1.79–0 as an economic value
extending beyond one policy year (for
example, a paid-up or cash surrender
value) that is provided under a life
insurance policy. Section 1.79–0 further
provides that certain features are not
permanent benefits, including: (a) a
right to convert (or continue) life
insurance after group life insurance
coverage terminates, (b) any other
feature that provides no economic
benefit (other than current insurance
protection) to the employee, and (c) a
feature under which term life insurance
is provided at a level premium for a
period of five years or less.
Permanent benefits provided to an
employee are subject to taxation under
rules described in § 1.79–1(d). Under
those rules, the cost of the permanent
benefits, reduced by the amount paid for
those benefits by the employee, is
included in the employee’s income.
Section 1.79–1(d) provides that the cost
of the permanent benefits cannot be less
than an amount determined under a
formula set forth in the regulations.
2 The tax imposed under section 402(e)(1)(A), as
in effect at the time of the 1975 proposed
regulations, generally was based on 10–year
averaging of the tax otherwise payable with respect
to a lump-sum distribution.
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Prior to its amendment by this Treasury
decision, § 1.79–1(d) provided that one
of the factors used in the formula for
determining the cost of permanent
benefits was ‘‘the net level premium
reserve at the end of that policy year for
all benefits provided to the employee by
the policy or, if greater, the cash value
of the policy at the end of that policy
year.’’
Section 83(a) generally provides that
when property is transferred to any
person in connection with the
performance of services, the service
provider must include in gross income
(as compensation income) the excess of
the fair market value of the property
over the amount (if any) paid for the
property. For this purpose, the fair
market value of the property is
determined without regard to lapse
restrictions and is determined at the
first time that the transferee’s rights in
the property are either transferable or
not subject to a substantial risk of
forfeiture. Prior to its amendment by
this Treasury decision, § 1.83–3(e)
generally provided that in the case of ‘‘a
transfer of a life insurance contract,
retirement income contract, endowment
contract, or other contract providing life
insurance protection, only the cash
surrender value of the contract is
considered to be property.’’
In TD 9092, published in the Federal
Register on September 17, 2003 (68 FR
54336), relating to split-dollar life
insurance arrangements, § 1.83–3(e) was
amended to add the following sentence:
‘‘Notwithstanding the previous
sentence, in the case of a transfer of a
life insurance contract, retirement
income contract, endowment contract,
or other contract providing life
insurance protection, or any undivided
interest therein, that is part of a splitdollar life insurance arrangement (as
defined in § 1.61–22(b)(1) or (2)) that is
entered into, or materially modified
(within the meaning of § 1.61–22(j)(2)),
after September 17, 2003, the policy
cash value and all other rights under
such contract (including any
supplemental agreements thereto and
whether or not guaranteed), other than
current life insurance protection, are
treated as property for purposes of this
section.’’
The prohibited transaction provisions
of ERISA generally prohibit various
transactions between plans covered by
Title I of ERISA and certain parties in
interest (including plan participants)
with respect to such plans. Specifically,
unless an exemption from the
prohibited transaction rules applies,
sections 406(a)(1)(A) and (D) of ERISA
provide that a fiduciary with respect to
a plan shall not cause the plan to engage
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in a transaction, if he knows or should
know that such transaction constitutes a
direct or indirect sale or exchange, or
leasing, of any property between the
plan and a party in interest; or transfer
to, or use by or for the benefit of, a party
in interest of any assets of the plan.
Accordingly, unless a statutory or
administrative exemption is applicable,
the prohibited transaction rules are
applicable to the sale of a life insurance
contract, or annuity contract, by a plan
to a party in interest.
Section 4975 of the Code sets forth
parallel rules that impose excise taxes
on the amount involved with respect to
prohibited transactions involving
certain plans. The prohibited
transaction provisions under section
4975, as well as the exemptions from
the application of such rules, generally
parallel the prohibited transaction
provisions under Title I of ERISA.
Prohibited Transaction Exemption
(PTE) 77–8 (1977–2 C.B. 425),
subsequently amended and redesignated
as Prohibited Transaction Exemption
92–6, was jointly issued in 1977 by the
Department of Labor and the IRS to
provide an exemption from the
restrictions of sections 406(a) and
406(b)(1) and (b)(2) of ERISA and from
the taxes imposed by sections 4975(a)
and (b) of the Code for certain
transactions. Under the exemption set
forth in PTE 77–8 and PTE 92–6, an
employee benefit plan is permitted to
sell individual life insurance contracts
and annuities for the cash surrender
value of the contracts to certain
specified parties, provided conditions
are satisfied. Under PTE 77–8 and PTE
92–6, such specified parties are: (1) A
plan participant insured under such
policies, (2) a relative of such insured
participant who is the beneficiary under
the contract, (3) an employer any of
whose employees are covered by the
plan, or (4) another employee benefit
plan.
The preamble to PTE 77–8 (citing Rev.
Rul. 59–195, 1959–1 C.B. 18) noted that,
for Federal income tax purposes, the
value of an insurance policy is not the
same as, and may exceed, its cash
surrender value, and that a purchase of
an insurance policy at its cash surrender
value may therefore be a purchase of
property for less than its fair market
value. At the time PTE 77–8 was issued,
the regulations under section 402 did
not address the consequences of a sale
of property by a section 401(a) plan to
a plan participant or beneficiary for less
than the fair market value of that
property. In this regard, the preamble to
PTE 77–8 stated that the Federal income
tax consequences of such a bargain
purchase was required to be determined
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in accordance with generally applicable
Federal income tax rules but that any
income realized by a participant or
relative of such participant upon such a
purchase under the conditions of PTE
77–8 would not be deemed a
distribution from the plan to such
participant for purposes of subchapter D
of chapter 1 of subtitle A of the Internal
Revenue Code (i.e., sections 401 to 424
relating to qualified pension, profitsharing, and stock bonus plans).
B. The 2004 Proposed Regulations
In February 2004, the IRS issued
proposed amendments to the
regulations under section 402(a) (69 FR
7384) to clarify that the requirement that
a distribution of property be included in
the distributee’s income at fair market
value is controlling in those situations
where the regulations provided for the
inclusion of the entire cash value of a
retirement income, endowment, or other
life insurance contract. The 2004
proposed regulations provided that the
fair market value of a life insurance
contract is determined taking into
account the value of all rights under the
contract, including any supplemental
agreements thereto and whether or not
guaranteed. The proposed regulations
also provided that, if a qualified
retirement plan transfers property to a
plan participant or beneficiary for
consideration that is less than the fair
market value of the property, the
transfer would be treated as a
distribution by the plan to the
participant or beneficiary to the extent
the fair market value of the distributed
property exceeds the value of the
consideration received. Thus, under the
proposed regulations, such a transfer
would be treated as a distribution for
purposes of applying the plan
qualification requirements of section
401(a).
The 2004 proposed regulations also
contained proposed amendments to
existing regulations under section 83 to
clarify that fair market value is also
controlling with respect to a life
insurance contract, retirement income
contract, endowment contract, or other
contract providing life insurance
protection and thus all of the rights
under the contract (including any
supplemental agreements thereto and
whether or not guaranteed) must be
considered in determining that fair
market value. The proposed regulations
contained proposed amendments to
§ 1.83–3(e), which generally apply the
definition of property for new splitdollar life insurance arrangements to all
situations subject to section 83
involving the transfer of life insurance
contracts. The proposed regulations also
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contained proposed amendments to
§ 1.79–(d) to replace the term ‘‘cash
value’’ in the formula for determining
the cost of permanent benefits with the
term ‘‘fair market value.’’
C. Determination of Fair Market Value
As noted under the heading In
General, § 1.402(a)–1(a)(1)(iii) does not
define the term fair market value. In
Rev. Rul. 59–195, the IRS addressed the
determination of fair market value of a
life insurance contract in situations
similar to those in which an employer
purchases and pays the premiums on an
insurance policy on the life of one of its
employees for several years and on
which further premiums must be paid,
and subsequently sells such policy. The
IRS held that the value of such a policy
for purposes of computing taxable gain
to the employee in the year of purchase
should be determined under the method
of valuation prescribed in § 25.2512–6
of the Gift Tax Regulations. Under this
method, the value of such a policy is not
its cash surrender value but the
interpolated terminal reserve at the date
of sale plus the proportionate part of
any premium paid by the employer
prior to the date of the sale which is
applicable to a period subsequent to the
date of the sale. Section 25.2512–6 also
provides that if ‘‘because of the unusual
nature of the contract such
approximation is not reasonably close to
the full value, this method may not be
used.’’ Thus, this method may not be
used to determine the fair market value
of an insurance policy where the reserve
does not reflect the value of all of the
relevant features of the policy.
Q&A–10 of Notice 89–25 (1989–1 C.B.
662) described a distribution from a
qualified plan of a life insurance policy
with a value substantially higher than
the cash surrender value stated in the
policy. The notice concluded that the
practice of using cash surrender value as
fair market value is not appropriate
where the total policy reserves,
including life insurance reserves (if any)
computed under section 807(d), together
with any reserves for advance
premiums, dividend accumulations,
etc., represent a much more accurate
approximation of the policy’s fair
market value.
Since Notice 89–25 was issued, life
insurance contracts have been marketed
that are structured in a manner which
results in a temporary period during
which neither a contract’s reserves nor
its cash surrender value represent the
fair market value of the contract. For
example, some life insurance contracts
may provide for large surrender charges
and other charges that are not expected
to be paid because they are expected to
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50969
be eliminated or reversed in the future
(under the contract or under another
contract for which the first contract is
exchanged), but this future elimination
or reversal is not always reflected in the
calculation of the contract’s reserve. If
such a contract is distributed prior to
the elimination or reversal of those
charges, both the cash surrender value
and the reserve under the contract could
significantly understate the fair market
value of the contract. Thus, in some
cases, it would not be appropriate to use
either the net surrender value (i.e., the
contract’s cash value after reduction for
any surrender charges) or, because of
the unusual nature of the contract, the
contract’s reserves to determine the fair
market value of the contract.
Accordingly, Q&A–10 of Notice 89–25
should not be interpreted to provide
that a contract’s reserves (including life
insurance reserves (if any) computed
under section 807(d), together with any
reserves for advance premiums,
dividend accumulations, etc.) are
always an accurate representation of the
contract’s fair market value.
The IRS and Treasury recognized that
taxpayers could have difficulty
determining the fair market value of a
life insurance contract for which the
contract’s reserves (including life
insurance reserves (if any) computed
under section 807(d), together with any
reserves for advance premiums,
dividend accumulations, etc.) are not an
accurate representation of the contract’s
fair market value. Accordingly, the IRS
issued Rev. Proc. 2004–16 (2004–10
I.R.B. 559), which provided interim
rules under which the cash value
(without reduction for surrender
charges) of a life insurance contract
distributed from a qualified plan may be
treated as the fair market value of that
contract, provided that certain
requirements are satisfied. This safe
harbor for determining fair market value
was also available for purposes of
sections 79 and 83.
D. Comments and Public Hearing on the
2004 Proposed Regulations and Rev.
Proc. 2004–16
The IRS received comments on the
2004 proposed regulations, and a public
hearing was held on June 9, 2004. While
none of the commentators objected to
the proposed amendments to the
regulations, a number of commentators
raised concerns regarding the safe
harbor formula for fair market value set
forth in Rev. Proc. 2004–16. Several
commentators recommended that final
guidance provide more than one safe
harbor for determining the fair market
value of a policy and asserted that the
safe harbor formulas under Rev. Proc.
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2004–16 produce a value that is too high
and does not reflect market realities.
Suggestions were made that the
interpolated terminal reserve (ITR) and
tax reserve valuation methods under
section 807(d) be used as alternatives to
the interim safe harbor formula.
Some commentators claimed that the
interim safe harbor provided by Rev.
Proc. 2004–16 was not usable for all
types of life insurance policies. In
particular, these commentators asserted
that the formulas did not function well
for traditional whole life policies. In
addition, commentators were concerned
about the possible double-counting of
certain dividends under the formulas,
and the fact that the formulas did not
make an explicit adjustment for
withdrawals or distributions, nor did
they provide for any recognition of the
possibility that a surrender charge
would apply in the future.
E. Rev. Proc. 2005–25—Safe Harbors for
Determining Fair Market Value
After reviewing the comments to the
prior guidance, the IRS and Treasury
concluded that the safe harbor formulas
in Rev. Proc. 2004–16 did not function
well for certain types of traditional
policies, and also should be revised to
reflect a discount for the possibility that
a surrender charge would apply in
certain situations. Accordingly, Rev.
Proc. 2005–25 (2005–17 I.R.B. 962) was
issued to modify and supersede Rev.
Proc. 2004–16 in order to make
adjustments to the safe harbor formulas.
These new safe harbor formulas replace
the formulas in Rev. Proc. 2004–16 for
distributions, sales, and other transfers
made on or after February 13, 2004, and
for permanent benefits provided on or
after February 13, 2004. For all periods,
including periods before May 1, 2005,
taxpayers may rely on the safe harbors
in Rev. Proc. 2005–25. In addition, for
periods on or after February 13, 2004,
and before May 1, 2005, taxpayers may
rely on the safe harbors in Rev. Proc.
2004–16.
Explanation of Provisions
These final regulations retain the
rules set forth in the 2004 proposed
regulations under section 402(a)
providing that the requirement that a
distribution of property be included in
the distributee’s income at fair market
value is controlling in those situations
where the former regulations provided
for the inclusion of the entire cash value
of a retirement income, endowment, or
other life insurance contract. Thus,
these final regulations clarify that, in
those cases where a qualified plan
distributes a life insurance contract,
retirement income contract, endowment
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contract, or other contract providing life
insurance protection, the fair market
value of such a contract (i.e., the value
of all rights under the contract,
including any supplemental agreements
thereto and whether or not guaranteed)
is generally included in the distributee’s
income, and not merely the entire cash
value of the contract. However, these
final regulations retain the rules from
existing final regulations setting forth
the situations under which a
distribution of such a contract is not
currently includible in income.
These final regulations also set forth
a portion of the rules included in the
1975 proposed regulations. Under those
rules, the distribution of an annuity
contract must be treated as a lump sum
distribution for purposes of determining
the amount of tax under the 10-year
averaging rule of section 402(e) (as in
effect prior to the amendment by the
Tax Reform Act of 1986, Public Law 99–
514, 100 Stat. 2085), even if the
distribution of the annuity contract
itself is not currently taxable. The
distribution of a retirement income,
endowment, or other life insurance
contract is not taxable in the situation
where within 60 days after the
distribution of such contract, the
contract is treated as a rollover
contribution under section 402(a)(5), as
in effect after December 31, 1973.
Although the final regulations reject the
use of the term entire cash value as
found in the 1975 proposed regulations,
no inference should be made that other
rules in the 1975 proposed regulations
that have not been included in these
final regulations have also been rejected.
These final regulations retain the
rules provided in the 2004 proposed
regulations that, if a qualified plan
transfers property to a plan participant
or beneficiary for consideration that is
less than the fair market value of the
property, the transfer is treated as a
distribution under the plan to the
participant or beneficiary to the extent
the fair market value of the distributed
property exceeds the value of the
consideration. Thus, in contrast to the
statement to the contrary in the
preamble to PTE 77–8, these regulations
provide that any bargain element in the
sale is treated as a distribution under
section 402(a). In addition, any such
bargain element is treated as a
distribution under the plan for all other
purposes of the Code, including the
qualification requirements of section
401(a). Thus, for example, this bargain
element is treated as a distribution for
purposes of applying the limitations on
in-service distributions from certain
qualified retirement plans and the
limitations of section 415. The rule
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treating the bargain element in a sale as
a distribution from a qualified plan
applies to transfers that occur on or after
August 29, 2005. For transfers before
that date, the bargain element in the sale
must be included in the plan
participant’s income under section 61.
However, such a transfer of a life
insurance contract, retirement income
contract, endowment contract, or other
contract providing life insurance
protection occurring before that date is
deemed not to give rise to a distribution
for purposes of applying the
requirements of subchapter D of chapter
1 of subtitle A of the Code.
These final regulations also retain the
rules set forth in the 2004 proposed
regulations under sections 79 and 83
that clarify that fair market value is also
controlling with respect to life
insurance contracts under those sections
and, thus, that all of the rights under the
contract (including any supplemental
agreements thereto and whether or not
guaranteed) must be considered in
determining that fair market value.
These final regulations amend § 1.79–
1(d) to replace the term cash value in
the formula for determining the cost of
permanent benefits with the term fair
market value. These final regulations
also amend § 1.83–3(e) generally to
apply the definition of property for new
split-dollar life insurance arrangements
to all situations involving the transfer of
a life insurance contract, retirement
income contract, endowment contract,
or other contract providing life
insurance protection. Section 83(a)
requires that the excess of the fair
market value of the property over the
amount paid for the property be
included in income. The purpose of the
changes to the regulations is to clarify
that, unless specifically excepted from
the definition of permanent benefits or
fair market value, the value of all
features of a life insurance policy
providing an economic benefit to a
service provider (including, for
example, the value of a springing cash
value feature) must be included in
determining the employee’s income.
These final regulations do not affect
the relief granted by the provisions of
Section IV, paragraph 4 of Notice 2002–
8 (2002–1 C.B. 398) to the parties to any
insurance contract that is part of a preJanuary 28, 2002, split-dollar life
insurance arrangement. Also, consistent
with the effective date of the final splitdollar life insurance regulations at
§ 1.61–22(j), these final regulations do
not apply to the transfer of a life
insurance contract which is part of a
split-dollar life insurance arrangement
entered into on or before September 17,
2003, and not materially modified after
E:\FR\FM\29AUR1.SGM
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Federal Register / Vol. 70, No. 166 / Monday, August 29, 2005 / Rules and Regulations
§ 1.79–1 Group-term life insurance—
general rules.
that date. However, taxpayers are
reminded that, in determining the fair
market value of property transferred
under section 83, lapse restrictions
(such as life insurance contract
surrender charges) are ignored.
*
Effective Date
*
*
*
*
(d) * * *
(3) Formula for determining deemed
death benefit. The deemed death benefit
(DDB) at the end of any policy year for
any particular employee is equal to—
These regulations are effective August
29, 2005. The amendments to
§ 1.402(a)–1(a) apply to any distribution
of a retirement income, endowment, or
other life insurance contract occurring
on or after February 13, 2004. The
amendment to § 1.79–1 is applicable to
permanent benefits provided on or after
February 13, 2004. The amendment to
§ 1.83–3(e) is applicable to any transfer
occurring on or after February 13, 2004.
R/Y
Where—
R is the net level premium reserve at the end
of that policy year for all benefits
provided to the employee by the policy
or, if greater, the fair market value of the
policy at the end of that policy year; and
Y is the net single premium for insurance
(the premium for one dollar of paid-up,
whole life insurance) at the employee’s
age at the end of that policy year.
Special Analyses
Drafting Information
The principal authors of these
regulations are Bruce Perlin and Linda
Marshall, Office of Division Counsel/
Associate Chief Counsel (Tax Exempt
and Government Entities). However,
other personnel from the IRS and
Treasury participated in the
development of these regulations.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
Amendments to the Regulations
Accordingly, 26 CFR part 1 is
amended as follows:
I
Paragraph 1. The authority citation
for part 1 continues to read, in part, as
follows:
I
Authority: 26 U.S.C. 7805 * * *
Par. 2. In § 1.79–1, paragraph (d)(3) is
revised to read as follows:
I
Jkt 205001
§ 1.83–3
Meaning and use of certain terms.
*
*
*
*
*
(e) * * * In the case of a transfer of
a life insurance contract, retirement
income contract, endowment contract,
or other contract providing life
insurance protection, or any undivided
interest therein, the policy cash value
and all other rights under such contract
(including any supplemental
agreements thereto and whether or not
guaranteed), other than current life
insurance protection, are treated as
property for purposes of this section.
However, in the case of the transfer of
a life insurance contract, retirement
income contract, endowment contract,
or other contract providing life
insurance protection, which was part of
a split-dollar arrangement (as defined in
§ 1.61–22(b)) entered into (as defined in
§ 1.61–22(j)) on or before September 17,
2003, and which is not materially
modified (as defined in § 1.61–22(j)(2))
after September 17, 2003, only the cash
surrender value of the contract is
considered to be property. * * *
*
*
*
*
*
I Par. 4. Section 1.402(a)–1 is amended
by:
I 1. Revising paragraph (a)(1)(iii).
I 2. Revising paragraph (a)(2).
The revisions read as follows:
§ 1.402(a)–1 Taxability of beneficiary under
a trust which meets the requirements of
section 401(a).
PART 1—INCOME TAXES
15:16 Aug 26, 2005
*
*
*
*
Par. 3. In § 1.83–3, paragraph (e), the
fourth and fifth sentences are revised to
read as follows:
I
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment is not required. It
has also been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply
to these regulations. In addition,
because no collection of information is
imposed on small entities, the
provisions of the Regulatory Flexibility
Act (5 U.S.C. chapter 6) do not apply,
and therefore, a Regulatory Flexibility
Analysis is not required. Pursuant to
section 7805(f) of the Code, the notice
of proposed rulemaking preceding these
regulations was submitted to the Small
Business Administration for comment
on its impact on small business.
VerDate Aug<18>2005
*
(a) * * *
(1) * * *
(iii) Except as provided in paragraph
(b) of this section, a distribution of
property by a trust described in section
401(a) and exempt under section 501(a)
shall be taken into account by the
distributee at its fair market value. In
PO 00000
Frm 00021
Fmt 4700
Sfmt 4700
50971
the case of a distribution of a life
insurance contract, retirement income
contract, endowment contract, or other
contract providing life insurance
protection, or any interest therein, the
policy cash value and all other rights
under such contract (including any
supplemental agreements thereto and
whether or not guaranteed) are included
in determining the fair market value of
the contract. In addition, in the case of
a transfer of property that occurs on or
after August 29, 2005 where a trust
described in section 401(a) and exempt
under section 501(a) transfers property
to a plan participant or beneficiary in
exchange for consideration and where
the fair market value of the property
transferred exceeds the value of the
consideration, then the excess of the fair
market value of the property transferred
by the trust over the value of the
consideration received by the trust is
treated as a distribution to the
distributee under the plan for all
purposes under the Internal Revenue
Code. Where such a transfer occurs
before that date, the excess of the fair
market value of the property transferred
by the trust over the value of the
consideration received by the trust is
includible in the gross income of the
participant or beneficiary under section
61. However, such a transfer of a life
insurance contract, retirement income
contract, endowment contract, or other
contract providing life insurance
protection occurring before that date is
not treated as a distribution for purposes
of applying the requirements of
subchapter D of chapter 1 of subtitle A
of the Internal Revenue Code.
*
*
*
*
*
(2) If a trust described in section
401(a) and exempt under section 501(a)
purchases an annuity contract for an
employee and distributes it to the
employee in a year in which the trust is
exempt, and the contract contains a cash
surrender value which may be available
to an employee by surrendering the
contract, such cash surrender value will
not be considered income to the
employee unless and until the contract
is surrendered. For the rule as to
nontransferability of annuity contracts
issued after 1962, see § 1.401–9(b)(1).
For additional requirements regarding
distributions of annuity contracts, see,
e.g., §§ 1.401(a)–20, Q&A–2,
1.401(a)(31)–1, Q&A–17, and
1.401(a)(9)–6, Q&A–4. However, the
distribution of an annuity contract must
be treated as a lump sum distribution
for purposes of determining the amount
of tax under the 10-year averaging rule
of section 402(e) (as in effect prior to
amendment by the Tax Reform Act of
E:\FR\FM\29AUR1.SGM
29AUR1
50972
Federal Register / Vol. 70, No. 166 / Monday, August 29, 2005 / Rules and Regulations
1986, Public Law 99–514, 100 Stat.
2085). If, however, the contract
distributed by such exempt trust is a life
insurance contract, retirement income
contract, endowment contract, or other
contract providing life insurance
protection, the fair market value of the
contract at the time of distribution must
be included in the distributee’s income
in accordance with the provisions of
section 402(a), except to the extent that,
within 60 days after the distribution of
the contract, all or any portion of such
value is irrevocably converted into a
contract under which no part of any
proceeds payable on death at any time
would be excludable under section
101(a) (relating to life insurance
proceeds), or the contract is treated as
a rollover contribution under section
402(c). If the contract distributed by
such trust is a transferable annuity
contract, or a retirement income,
endowment, or other life insurance
contract and such contract is not treated
as a rollover contribution under section
402(c), then, notwithstanding the
preceding sentence, the fair market
value of the contract is includible in the
distributee’s gross income unless,
within such 60 days, such contract is
made nontransferable.
*
*
*
*
*
Mark E. Matthews,
Deputy Commissioner for Services and
Enforcement.
Approved: August 9, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary for Tax
Policy.
[FR Doc. 05–17046 Filed 8–26–05; 8:45 am]
BILLING CODE 4830–01–P
DEPARTMENT OF HOMELAND
SECURITY
Coast Guard
33 CFR Part 117
[CGD11–05–023]
Drawbridge Operation Regulations;
Petaluma River, Blackpoint, CA
Coast Guard, DHS.
Notice of temporary deviation
from regulations.
AGENCY:
ACTION:
SUMMARY: The Commander, Eleventh
Coast Guard District, has issued a
temporary deviation from the regulation
governing the operation of the
Blackpoint Railroad Drawbridge across
the Petaluma River, mile 0.8, at
Blackpoint, CA. This deviation allows
the bridge to remain in the closed-to-
VerDate Aug<18>2005
15:16 Aug 26, 2005
Jkt 205001
navigation position for necessary bridge
repair.
DEPARTMENT OF HOMELAND
SECURITY
This deviation is effective from
6:30 a.m. until 8 p.m. on Monday
August 29, 2005.
Coast Guard
Materials referred to in this
document are available for inspection or
copying at Commander (oan), Eleventh
Coast Guard District, Building 50–3,
Coast Guard Island, Alameda, CA
94501–5100 between 8 a.m. and 4 p.m.,
Monday through Friday, except Federal
holidays. The telephone number is (510)
437–3516. Commander (oan), Eleventh
Coast Guard District maintains the
public docket for this temporary
deviation.
[CGD07–04–124]
DATES:
ADDRESSES:
FOR FURTHER INFORMATION CONTACT:
David H. Sulouff, Chief, Bridge Section,
Eleventh Coast Guard District,
telephone (510) 437–3516.
The
Sonoma-Marin Area Rail Transit District
requested to secure the Blackpoint
Drawbridge, mile 0.8, Petaluma River, in
the closed-to-navigation position on 29
August 2005, during daylight hours for
bridge repair. The drawbridge provides
unlimited vertical clearance in the full
open-to-navigation position, and 7 feet
vertical clearance, above Mean High
Water, when closed. The drawbridge is
normally maintained in the fully open
position, except for the crossing of
trains or for maintenance, as required by
33 CFR 117.187.
The proposed work was coordinated
with waterway users. From 6:30 a.m. to
8 p.m. on Monday, August 29, 2005, the
drawspan may be secured in the closedto-navigation position and need not
open for vessels. If safe to do so, a vessel
can pass through the bridge during this
period. The drawspan will be able to
open in an emergency with a one-hour
advance notice. The drawspan shall
resume normal operations after 8 p.m.
on August 29, 2005.
In accordance with 33 CFR 117.35(c),
this work will be performed with all due
speed in order to return the bridge to
normal operation as soon as possible.
This deviation from the operating
regulations is authorized under 33 CFR
117.35.
SUPPLEMENTARY INFORMATION:
Dated: August 16, 2005.
Kevin J. Eldridge,
Rear Admiral, U.S. Coast Guard, Commander,
Eleventh Coast Guard District.
[FR Doc. 05–17094 Filed 8–26–05; 8:45 am]
BILLING CODE 4910–15–P
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Frm 00022
Fmt 4700
Sfmt 4700
33 CFR Part 117
RIN 1625–AA09
Drawbridge Operation Regulation;
Skidaway Bridge (SR 204), Intracoastal
Waterway, Mile 592.9, Savannah,
Chatham County, GA
Coast Guard, DHS.
Final rule.
AGENCY:
ACTION:
SUMMARY: The Coast Guard is changing
the operating regulations of the
Skidaway Bridge (SR 204) across the
Intracoastal Waterway, mile 592.9, in
Savannah, Georgia. This rule allows the
bridge to open on signal, except that
from Monday through Friday, not
including Federal holidays, the bridge
need only open on the hour between
6:31 a.m. and 8:59 a.m. and on the hour
and half hour between 4:31 p.m. and
6:29 p.m.
DATES: This rule is effective September
28, 2005.
ADDRESSES: Comments and material
received from the public, as well as
documents indicated in this preamble as
being available in the docket, are part of
docket (CGD07–04–124) and are
available for inspection or copying at
Commander (obr), Seventh Coast Guard
District, 909 SE 1st Avenue, Suite 432,
Miami, Florida 33131, between 7:30
a.m. and 4 p.m., Monday through
Friday, except Federal holidays. Bridge
Branch (obr), Seventh Coast Guard
District, maintains the public docket for
this rulemaking.
FOR FURTHER INFORMATION CONTACT: Mr.
Gwin Tate, Project Manager, Seventh
Coast Guard District, Bridge Branch,
(305) 415–6747.
SUPPLEMENTARY INFORMATION:
Regulatory History
On December 3, 2004, we published
a notice of proposed rulemaking
(NPRM) entitled Drawbridge Operation
Regulations; Skidaway Bridge (SR 204),
Intracoastal Waterway, Mile 592.9,
Savannah, Chatham County, GA in the
Federal Register (69 FR 70209). We
received 8 letters commenting on the
proposed rule. No public meeting was
requested, and none was held.
Background and Purpose
On January 7, 2004, the General
Manager of the Landings Association, a
residential development with over 8500
residents that comprises approximately
E:\FR\FM\29AUR1.SGM
29AUR1
]]>Agencies
[Federal Register Volume 70, Number 166 (Monday, August 29, 2005)]
[Rules and Regulations]
[Pages 50967-50972]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-17046]
=======================================================================
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9223]
RIN 1545-BC20
Value of Life Insurance Contracts When Distributed From a
Qualified Retirement Plan
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
-----------------------------------------------------------------------
SUMMARY: This document contains final regulations under section 402(a)
of the Internal Revenue Code regarding the amount includible in a
distributee's income when life insurance contracts are distributed by a
qualified retirement plan and regarding the treatment of property sold
by a qualified retirement plan to a plan participant or beneficiary for
less than fair market value. This document also contains final
regulations under sections 79 and 83 of the Internal Revenue Code
regarding the amounts includible in income when an employee is provided
permanent benefits in combination with group-term life insurance or
when a life insurance contract is transferred in connection with the
performance of services. These regulations will affect administrators
of, participants in, and beneficiaries of qualified retirement plans.
These regulations will also affect employers who provide permanent
benefits in combination with group-term life insurance for their
employees and employees who receive those permanent benefits, as well
as service recipients who transfer life insurance contracts to service
providers in connection with the performance of services, and service
providers to whom those life insurance contracts are transferred.
DATES: These regulations are effective August 29, 2005.
FOR FURTHER INFORMATION CONTACT: Concerning the section 79 regulations,
Betty Clary at (202) 622-6080; concerning the section 83 regulations,
Robert Misner at (202) 622-6030; concerning the section 402
regulations, Bruce Perlin or Linda Marshall at (202) 622-6090 (not
toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
A. In General
This document contains amendments to the Income Tax Regulations (26
CFR part 1) under section 402(a) of the Internal Revenue Code (Code)
relating to the amount includible in a distributee's income when a life
insurance contract, retirement income contract, endowment contract, or
other contract providing life insurance protection is distributed by a
retirement plan qualified under section 401(a), and relating to the
sale of property by a qualified retirement plan to a plan participant
or beneficiary for less than the fair market value of the property.
This document also contains amendments to the regulations under
sections 79 and 83 relating, respectively, to permanent benefits that
are provided to employees in combination with group-term life
insurance, and to life insurance contracts that are transferred in
connection with the performance of services.
Section 402(a) generally provides that any amount actually
distributed to any distributee by any employees' trust described in
section 401(a) which is exempt from tax under section 501(a) is taxable
to the distributee in the taxable year of the distributee in which
distributed, in accordance with section 72. Distributions from a
qualified employees' trust generally are subject to withholding and
reporting requirements pursuant to section 3405 and regulations
thereunder. Section 1.402(a)-1(a)(1)(iii) provides, in general, that a
distribution of property by a section 401(a) plan is taken into account
by the distributee at its fair market value. Prior to its amendment by
this Treasury decision, Sec. 1.402(a)-1(a)(2) (which was originally
published in 1956) provided, in general, that upon the distribution of
a life insurance contract, the ``entire cash value'' of the contract
must be included in the distributee's income.\1\ Section 1.402(a)-1(a)
did not define fair market value or entire cash value, and questions
have arisen regarding the interaction between these two provisions and
regarding whether the term entire cash value includes a reduction for
surrender charges.
---------------------------------------------------------------------------
\1\ Section 1.402(a)-1(a)(2) also provides rules regarding the
taxation of the distribution of an annuity contract. In certain
cases, the distribution of an annuity contract is not includible in
the participant's gross income until distributions are made from the
annuity contract.
---------------------------------------------------------------------------
On April 30, 1975, proposed regulations under section 402 regarding
the taxation of certain lump sum
[[Page 50968]]
distributions from qualified plans (the 1975 proposed regulations) were
published in the Federal Register (40 FR 18798) to reflect changes to
section 402 made by the Employee Retirement Income Security Act of 1974
(ERISA) (Public Law 93-406, 88 Stat. 829). Under Sec. 1.402(a)-1(a)(2)
of the 1975 proposed regulations, the distribution of an annuity
contract must be treated as a lump sum distribution under section
402(e) for purposes of determining the separate tax imposed under
section 402(e)(1)(A),\2\ even if the distribution of the annuity
contract itself is not currently taxable. The 1975 proposed regulations
also expanded the situations in which the distribution of a retirement
income, endowment, or other life insurance contract is not currently
taxable to include the situation where, within 60 days after the
distribution of such contract, the contract is treated as a rollover
contribution under section 402(a)(5), as in effect after December 31,
1973.
---------------------------------------------------------------------------
\2\ The tax imposed under section 402(e)(1)(A), as in effect at
the time of the 1975 proposed regulations, generally was based on
10-year averaging of the tax otherwise payable with respect to a
lump-sum distribution.
---------------------------------------------------------------------------
Section 79 generally requires that the cost of group-term life
insurance coverage provided by an employer on the life of an employee
that is in excess of $50,000 of coverage be included in the income of
the employee. Pursuant to Sec. 1.79-1(b), under specified
circumstances, group-term life insurance may be combined with other
benefits, referred to as permanent benefits. A permanent benefit is
defined in Sec. 1.79-0 as an economic value extending beyond one
policy year (for example, a paid-up or cash surrender value) that is
provided under a life insurance policy. Section 1.79-0 further provides
that certain features are not permanent benefits, including: (a) a
right to convert (or continue) life insurance after group life
insurance coverage terminates, (b) any other feature that provides no
economic benefit (other than current insurance protection) to the
employee, and (c) a feature under which term life insurance is provided
at a level premium for a period of five years or less.
Permanent benefits provided to an employee are subject to taxation
under rules described in Sec. 1.79-1(d). Under those rules, the cost
of the permanent benefits, reduced by the amount paid for those
benefits by the employee, is included in the employee's income. Section
1.79-1(d) provides that the cost of the permanent benefits cannot be
less than an amount determined under a formula set forth in the
regulations. Prior to its amendment by this Treasury decision, Sec.
1.79-1(d) provided that one of the factors used in the formula for
determining the cost of permanent benefits was ``the net level premium
reserve at the end of that policy year for all benefits provided to the
employee by the policy or, if greater, the cash value of the policy at
the end of that policy year.''
Section 83(a) generally provides that when property is transferred
to any person in connection with the performance of services, the
service provider must include in gross income (as compensation income)
the excess of the fair market value of the property over the amount (if
any) paid for the property. For this purpose, the fair market value of
the property is determined without regard to lapse restrictions and is
determined at the first time that the transferee's rights in the
property are either transferable or not subject to a substantial risk
of forfeiture. Prior to its amendment by this Treasury decision, Sec.
1.83-3(e) generally provided that in the case of ``a transfer of a life
insurance contract, retirement income contract, endowment contract, or
other contract providing life insurance protection, only the cash
surrender value of the contract is considered to be property.''
In TD 9092, published in the Federal Register on September 17, 2003
(68 FR 54336), relating to split-dollar life insurance arrangements,
Sec. 1.83-3(e) was amended to add the following sentence:
``Notwithstanding the previous sentence, in the case of a transfer of a
life insurance contract, retirement income contract, endowment
contract, or other contract providing life insurance protection, or any
undivided interest therein, that is part of a split-dollar life
insurance arrangement (as defined in Sec. 1.61-22(b)(1) or (2)) that
is entered into, or materially modified (within the meaning of Sec.
1.61-22(j)(2)), after September 17, 2003, the policy cash value and all
other rights under such contract (including any supplemental agreements
thereto and whether or not guaranteed), other than current life
insurance protection, are treated as property for purposes of this
section.''
The prohibited transaction provisions of ERISA generally prohibit
various transactions between plans covered by Title I of ERISA and
certain parties in interest (including plan participants) with respect
to such plans. Specifically, unless an exemption from the prohibited
transaction rules applies, sections 406(a)(1)(A) and (D) of ERISA
provide that a fiduciary with respect to a plan shall not cause the
plan to engage in a transaction, if he knows or should know that such
transaction constitutes a direct or indirect sale or exchange, or
leasing, of any property between the plan and a party in interest; or
transfer to, or use by or for the benefit of, a party in interest of
any assets of the plan. Accordingly, unless a statutory or
administrative exemption is applicable, the prohibited transaction
rules are applicable to the sale of a life insurance contract, or
annuity contract, by a plan to a party in interest.
Section 4975 of the Code sets forth parallel rules that impose
excise taxes on the amount involved with respect to prohibited
transactions involving certain plans. The prohibited transaction
provisions under section 4975, as well as the exemptions from the
application of such rules, generally parallel the prohibited
transaction provisions under Title I of ERISA.
Prohibited Transaction Exemption (PTE) 77-8 (1977-2 C.B. 425),
subsequently amended and redesignated as Prohibited Transaction
Exemption 92-6, was jointly issued in 1977 by the Department of Labor
and the IRS to provide an exemption from the restrictions of sections
406(a) and 406(b)(1) and (b)(2) of ERISA and from the taxes imposed by
sections 4975(a) and (b) of the Code for certain transactions. Under
the exemption set forth in PTE 77-8 and PTE 92-6, an employee benefit
plan is permitted to sell individual life insurance contracts and
annuities for the cash surrender value of the contracts to certain
specified parties, provided conditions are satisfied. Under PTE 77-8
and PTE 92-6, such specified parties are: (1) A plan participant
insured under such policies, (2) a relative of such insured participant
who is the beneficiary under the contract, (3) an employer any of whose
employees are covered by the plan, or (4) another employee benefit
plan.
The preamble to PTE 77-8 (citing Rev. Rul. 59-195, 1959-1 C.B. 18)
noted that, for Federal income tax purposes, the value of an insurance
policy is not the same as, and may exceed, its cash surrender value,
and that a purchase of an insurance policy at its cash surrender value
may therefore be a purchase of property for less than its fair market
value. At the time PTE 77-8 was issued, the regulations under section
402 did not address the consequences of a sale of property by a section
401(a) plan to a plan participant or beneficiary for less than the fair
market value of that property. In this regard, the preamble to PTE 77-8
stated that the Federal income tax consequences of such a bargain
purchase was required to be determined
[[Page 50969]]
in accordance with generally applicable Federal income tax rules but
that any income realized by a participant or relative of such
participant upon such a purchase under the conditions of PTE 77-8 would
not be deemed a distribution from the plan to such participant for
purposes of subchapter D of chapter 1 of subtitle A of the Internal
Revenue Code (i.e., sections 401 to 424 relating to qualified pension,
profit-sharing, and stock bonus plans).
B. The 2004 Proposed Regulations
In February 2004, the IRS issued proposed amendments to the
regulations under section 402(a) (69 FR 7384) to clarify that the
requirement that a distribution of property be included in the
distributee's income at fair market value is controlling in those
situations where the regulations provided for the inclusion of the
entire cash value of a retirement income, endowment, or other life
insurance contract. The 2004 proposed regulations provided that the
fair market value of a life insurance contract is determined taking
into account the value of all rights under the contract, including any
supplemental agreements thereto and whether or not guaranteed. The
proposed regulations also provided that, if a qualified retirement plan
transfers property to a plan participant or beneficiary for
consideration that is less than the fair market value of the property,
the transfer would be treated as a distribution by the plan to the
participant or beneficiary to the extent the fair market value of the
distributed property exceeds the value of the consideration received.
Thus, under the proposed regulations, such a transfer would be treated
as a distribution for purposes of applying the plan qualification
requirements of section 401(a).
The 2004 proposed regulations also contained proposed amendments to
existing regulations under section 83 to clarify that fair market value
is also controlling with respect to a life insurance contract,
retirement income contract, endowment contract, or other contract
providing life insurance protection and thus all of the rights under
the contract (including any supplemental agreements thereto and whether
or not guaranteed) must be considered in determining that fair market
value. The proposed regulations contained proposed amendments to Sec.
1.83-3(e), which generally apply the definition of property for new
split-dollar life insurance arrangements to all situations subject to
section 83 involving the transfer of life insurance contracts. The
proposed regulations also contained proposed amendments to Sec. 1.79-
(d) to replace the term ``cash value'' in the formula for determining
the cost of permanent benefits with the term ``fair market value.''
C. Determination of Fair Market Value
As noted under the heading In General, Sec. 1.402(a)-1(a)(1)(iii)
does not define the term fair market value. In Rev. Rul. 59-195, the
IRS addressed the determination of fair market value of a life
insurance contract in situations similar to those in which an employer
purchases and pays the premiums on an insurance policy on the life of
one of its employees for several years and on which further premiums
must be paid, and subsequently sells such policy. The IRS held that the
value of such a policy for purposes of computing taxable gain to the
employee in the year of purchase should be determined under the method
of valuation prescribed in Sec. 25.2512-6 of the Gift Tax Regulations.
Under this method, the value of such a policy is not its cash surrender
value but the interpolated terminal reserve at the date of sale plus
the proportionate part of any premium paid by the employer prior to the
date of the sale which is applicable to a period subsequent to the date
of the sale. Section 25.2512-6 also provides that if ``because of the
unusual nature of the contract such approximation is not reasonably
close to the full value, this method may not be used.'' Thus, this
method may not be used to determine the fair market value of an
insurance policy where the reserve does not reflect the value of all of
the relevant features of the policy.
Q&A-10 of Notice 89-25 (1989-1 C.B. 662) described a distribution
from a qualified plan of a life insurance policy with a value
substantially higher than the cash surrender value stated in the
policy. The notice concluded that the practice of using cash surrender
value as fair market value is not appropriate where the total policy
reserves, including life insurance reserves (if any) computed under
section 807(d), together with any reserves for advance premiums,
dividend accumulations, etc., represent a much more accurate
approximation of the policy's fair market value.
Since Notice 89-25 was issued, life insurance contracts have been
marketed that are structured in a manner which results in a temporary
period during which neither a contract's reserves nor its cash
surrender value represent the fair market value of the contract. For
example, some life insurance contracts may provide for large surrender
charges and other charges that are not expected to be paid because they
are expected to be eliminated or reversed in the future (under the
contract or under another contract for which the first contract is
exchanged), but this future elimination or reversal is not always
reflected in the calculation of the contract's reserve. If such a
contract is distributed prior to the elimination or reversal of those
charges, both the cash surrender value and the reserve under the
contract could significantly understate the fair market value of the
contract. Thus, in some cases, it would not be appropriate to use
either the net surrender value (i.e., the contract's cash value after
reduction for any surrender charges) or, because of the unusual nature
of the contract, the contract's reserves to determine the fair market
value of the contract. Accordingly, Q&A-10 of Notice 89-25 should not
be interpreted to provide that a contract's reserves (including life
insurance reserves (if any) computed under section 807(d), together
with any reserves for advance premiums, dividend accumulations, etc.)
are always an accurate representation of the contract's fair market
value.
The IRS and Treasury recognized that taxpayers could have
difficulty determining the fair market value of a life insurance
contract for which the contract's reserves (including life insurance
reserves (if any) computed under section 807(d), together with any
reserves for advance premiums, dividend accumulations, etc.) are not an
accurate representation of the contract's fair market value.
Accordingly, the IRS issued Rev. Proc. 2004-16 (2004-10 I.R.B. 559),
which provided interim rules under which the cash value (without
reduction for surrender charges) of a life insurance contract
distributed from a qualified plan may be treated as the fair market
value of that contract, provided that certain requirements are
satisfied. This safe harbor for determining fair market value was also
available for purposes of sections 79 and 83.
D. Comments and Public Hearing on the 2004 Proposed Regulations and
Rev. Proc. 2004-16
The IRS received comments on the 2004 proposed regulations, and a
public hearing was held on June 9, 2004. While none of the commentators
objected to the proposed amendments to the regulations, a number of
commentators raised concerns regarding the safe harbor formula for fair
market value set forth in Rev. Proc. 2004-16. Several commentators
recommended that final guidance provide more than one safe harbor for
determining the fair market value of a policy and asserted that the
safe harbor formulas under Rev. Proc.
[[Page 50970]]
2004-16 produce a value that is too high and does not reflect market
realities. Suggestions were made that the interpolated terminal reserve
(ITR) and tax reserve valuation methods under section 807(d) be used as
alternatives to the interim safe harbor formula.
Some commentators claimed that the interim safe harbor provided by
Rev. Proc. 2004-16 was not usable for all types of life insurance
policies. In particular, these commentators asserted that the formulas
did not function well for traditional whole life policies. In addition,
commentators were concerned about the possible double-counting of
certain dividends under the formulas, and the fact that the formulas
did not make an explicit adjustment for withdrawals or distributions,
nor did they provide for any recognition of the possibility that a
surrender charge would apply in the future.
E. Rev. Proc. 2005-25--Safe Harbors for Determining Fair Market Value
After reviewing the comments to the prior guidance, the IRS and
Treasury concluded that the safe harbor formulas in Rev. Proc. 2004-16
did not function well for certain types of traditional policies, and
also should be revised to reflect a discount for the possibility that a
surrender charge would apply in certain situations. Accordingly, Rev.
Proc. 2005-25 (2005-17 I.R.B. 962) was issued to modify and supersede
Rev. Proc. 2004-16 in order to make adjustments to the safe harbor
formulas. These new safe harbor formulas replace the formulas in Rev.
Proc. 2004-16 for distributions, sales, and other transfers made on or
after February 13, 2004, and for permanent benefits provided on or
after February 13, 2004. For all periods, including periods before May
1, 2005, taxpayers may rely on the safe harbors in Rev. Proc. 2005-25.
In addition, for periods on or after February 13, 2004, and before May
1, 2005, taxpayers may rely on the safe harbors in Rev. Proc. 2004-16.
Explanation of Provisions
These final regulations retain the rules set forth in the 2004
proposed regulations under section 402(a) providing that the
requirement that a distribution of property be included in the
distributee's income at fair market value is controlling in those
situations where the former regulations provided for the inclusion of
the entire cash value of a retirement income, endowment, or other life
insurance contract. Thus, these final regulations clarify that, in
those cases where a qualified plan distributes a life insurance
contract, retirement income contract, endowment contract, or other
contract providing life insurance protection, the fair market value of
such a contract (i.e., the value of all rights under the contract,
including any supplemental agreements thereto and whether or not
guaranteed) is generally included in the distributee's income, and not
merely the entire cash value of the contract. However, these final
regulations retain the rules from existing final regulations setting
forth the situations under which a distribution of such a contract is
not currently includible in income.
These final regulations also set forth a portion of the rules
included in the 1975 proposed regulations. Under those rules, the
distribution of an annuity contract must be treated as a lump sum
distribution for purposes of determining the amount of tax under the
10-year averaging rule of section 402(e) (as in effect prior to the
amendment by the Tax Reform Act of 1986, Public Law 99-514, 100 Stat.
2085), even if the distribution of the annuity contract itself is not
currently taxable. The distribution of a retirement income, endowment,
or other life insurance contract is not taxable in the situation where
within 60 days after the distribution of such contract, the contract is
treated as a rollover contribution under section 402(a)(5), as in
effect after December 31, 1973. Although the final regulations reject
the use of the term entire cash value as found in the 1975 proposed
regulations, no inference should be made that other rules in the 1975
proposed regulations that have not been included in these final
regulations have also been rejected.
These final regulations retain the rules provided in the 2004
proposed regulations that, if a qualified plan transfers property to a
plan participant or beneficiary for consideration that is less than the
fair market value of the property, the transfer is treated as a
distribution under the plan to the participant or beneficiary to the
extent the fair market value of the distributed property exceeds the
value of the consideration. Thus, in contrast to the statement to the
contrary in the preamble to PTE 77-8, these regulations provide that
any bargain element in the sale is treated as a distribution under
section 402(a). In addition, any such bargain element is treated as a
distribution under the plan for all other purposes of the Code,
including the qualification requirements of section 401(a). Thus, for
example, this bargain element is treated as a distribution for purposes
of applying the limitations on in-service distributions from certain
qualified retirement plans and the limitations of section 415. The rule
treating the bargain element in a sale as a distribution from a
qualified plan applies to transfers that occur on or after August 29,
2005. For transfers before that date, the bargain element in the sale
must be included in the plan participant's income under section 61.
However, such a transfer of a life insurance contract, retirement
income contract, endowment contract, or other contract providing life
insurance protection occurring before that date is deemed not to give
rise to a distribution for purposes of applying the requirements of
subchapter D of chapter 1 of subtitle A of the Code.
These final regulations also retain the rules set forth in the 2004
proposed regulations under sections 79 and 83 that clarify that fair
market value is also controlling with respect to life insurance
contracts under those sections and, thus, that all of the rights under
the contract (including any supplemental agreements thereto and whether
or not guaranteed) must be considered in determining that fair market
value. These final regulations amend Sec. 1.79-1(d) to replace the
term cash value in the formula for determining the cost of permanent
benefits with the term fair market value. These final regulations also
amend Sec. 1.83-3(e) generally to apply the definition of property for
new split-dollar life insurance arrangements to all situations
involving the transfer of a life insurance contract, retirement income
contract, endowment contract, or other contract providing life
insurance protection. Section 83(a) requires that the excess of the
fair market value of the property over the amount paid for the property
be included in income. The purpose of the changes to the regulations is
to clarify that, unless specifically excepted from the definition of
permanent benefits or fair market value, the value of all features of a
life insurance policy providing an economic benefit to a service
provider (including, for example, the value of a springing cash value
feature) must be included in determining the employee's income.
These final regulations do not affect the relief granted by the
provisions of Section IV, paragraph 4 of Notice 2002-8 (2002-1 C.B.
398) to the parties to any insurance contract that is part of a pre-
January 28, 2002, split-dollar life insurance arrangement. Also,
consistent with the effective date of the final split-dollar life
insurance regulations at Sec. 1.61-22(j), these final regulations do
not apply to the transfer of a life insurance contract which is part of
a split-dollar life insurance arrangement entered into on or before
September 17, 2003, and not materially modified after
[[Page 50971]]
that date. However, taxpayers are reminded that, in determining the
fair market value of property transferred under section 83, lapse
restrictions (such as life insurance contract surrender charges) are
ignored.
Effective Date
These regulations are effective August 29, 2005. The amendments to
Sec. 1.402(a)-1(a) apply to any distribution of a retirement income,
endowment, or other life insurance contract occurring on or after
February 13, 2004. The amendment to Sec. 1.79-1 is applicable to
permanent benefits provided on or after February 13, 2004. The
amendment to Sec. 1.83-3(e) is applicable to any transfer occurring on
or after February 13, 2004.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It has also been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations. In addition,
because no collection of information is imposed on small entities, the
provisions of the Regulatory Flexibility Act (5 U.S.C. chapter 6) do
not apply, and therefore, a Regulatory Flexibility Analysis is not
required. Pursuant to section 7805(f) of the Code, the notice of
proposed rulemaking preceding these regulations was submitted to the
Small Business Administration for comment on its impact on small
business.
Drafting Information
The principal authors of these regulations are Bruce Perlin and
Linda Marshall, Office of Division Counsel/Associate Chief Counsel (Tax
Exempt and Government Entities). However, other personnel from the IRS
and Treasury participated in the development of these regulations.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Amendments to the Regulations
0
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read, in
part, as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 2. In Sec. 1.79-1, paragraph (d)(3) is revised to read as
follows:
Sec. 1.79-1 Group-term life insurance--general rules.
* * * * *
(d) * * *
(3) Formula for determining deemed death benefit. The deemed death
benefit (DDB) at the end of any policy year for any particular employee
is equal to--
R/Y
Where--
R is the net level premium reserve at the end of that policy year
for all benefits provided to the employee by the policy or, if
greater, the fair market value of the policy at the end of that
policy year; and
Y is the net single premium for insurance (the premium for one
dollar of paid-up, whole life insurance) at the employee's age at
the end of that policy year.
* * * * *
0
Par. 3. In Sec. 1.83-3, paragraph (e), the fourth and fifth sentences
are revised to read as follows:
Sec. 1.83-3 Meaning and use of certain terms.
* * * * *
(e) * * * In the case of a transfer of a life insurance contract,
retirement income contract, endowment contract, or other contract
providing life insurance protection, or any undivided interest therein,
the policy cash value and all other rights under such contract
(including any supplemental agreements thereto and whether or not
guaranteed), other than current life insurance protection, are treated
as property for purposes of this section. However, in the case of the
transfer of a life insurance contract, retirement income contract,
endowment contract, or other contract providing life insurance
protection, which was part of a split-dollar arrangement (as defined in
Sec. 1.61-22(b)) entered into (as defined in Sec. 1.61-22(j)) on or
before September 17, 2003, and which is not materially modified (as
defined in Sec. 1.61-22(j)(2)) after September 17, 2003, only the cash
surrender value of the contract is considered to be property. * * *
* * * * *
0
Par. 4. Section 1.402(a)-1 is amended by:
0
1. Revising paragraph (a)(1)(iii).
0
2. Revising paragraph (a)(2).
The revisions read as follows:
Sec. 1.402(a)-1 Taxability of beneficiary under a trust which meets
the requirements of section 401(a).
(a) * * *
(1) * * *
(iii) Except as provided in paragraph (b) of this section, a
distribution of property by a trust described in section 401(a) and
exempt under section 501(a) shall be taken into account by the
distributee at its fair market value. In the case of a distribution of
a life insurance contract, retirement income contract, endowment
contract, or other contract providing life insurance protection, or any
interest therein, the policy cash value and all other rights under such
contract (including any supplemental agreements thereto and whether or
not guaranteed) are included in determining the fair market value of
the contract. In addition, in the case of a transfer of property that
occurs on or after August 29, 2005 where a trust described in section
401(a) and exempt under section 501(a) transfers property to a plan
participant or beneficiary in exchange for consideration and where the
fair market value of the property transferred exceeds the value of the
consideration, then the excess of the fair market value of the property
transferred by the trust over the value of the consideration received
by the trust is treated as a distribution to the distributee under the
plan for all purposes under the Internal Revenue Code. Where such a
transfer occurs before that date, the excess of the fair market value
of the property transferred by the trust over the value of the
consideration received by the trust is includible in the gross income
of the participant or beneficiary under section 61. However, such a
transfer of a life insurance contract, retirement income contract,
endowment contract, or other contract providing life insurance
protection occurring before that date is not treated as a distribution
for purposes of applying the requirements of subchapter D of chapter 1
of subtitle A of the Internal Revenue Code.
* * * * *
(2) If a trust described in section 401(a) and exempt under section
501(a) purchases an annuity contract for an employee and distributes it
to the employee in a year in which the trust is exempt, and the
contract contains a cash surrender value which may be available to an
employee by surrendering the contract, such cash surrender value will
not be considered income to the employee unless and until the contract
is surrendered. For the rule as to nontransferability of annuity
contracts issued after 1962, see Sec. 1.401-9(b)(1). For additional
requirements regarding distributions of annuity contracts, see, e.g.,
Sec. Sec. 1.401(a)-20, Q&A-2, 1.401(a)(31)-1, Q&A-17, and 1.401(a)(9)-
6, Q&A-4. However, the distribution of an annuity contract must be
treated as a lump sum distribution for purposes of determining the
amount of tax under the 10-year averaging rule of section 402(e) (as in
effect prior to amendment by the Tax Reform Act of
[[Page 50972]]
1986, Public Law 99-514, 100 Stat. 2085). If, however, the contract
distributed by such exempt trust is a life insurance contract,
retirement income contract, endowment contract, or other contract
providing life insurance protection, the fair market value of the
contract at the time of distribution must be included in the
distributee's income in accordance with the provisions of section
402(a), except to the extent that, within 60 days after the
distribution of the contract, all or any portion of such value is
irrevocably converted into a contract under which no part of any
proceeds payable on death at any time would be excludable under section
101(a) (relating to life insurance proceeds), or the contract is
treated as a rollover contribution under section 402(c). If the
contract distributed by such trust is a transferable annuity contract,
or a retirement income, endowment, or other life insurance contract and
such contract is not treated as a rollover contribution under section
402(c), then, notwithstanding the preceding sentence, the fair market
value of the contract is includible in the distributee's gross income
unless, within such 60 days, such contract is made nontransferable.
* * * * *
Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
Approved: August 9, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary for Tax Policy.
[FR Doc. 05-17046 Filed 8-26-05; 8:45 am]
BILLING CODE 4830-01-P
