Taxation & Estate Planning

Basis in a Life Insurance Policy

By Charles Rubin

Life insurance contracts may be sold for many reasons, including among family members as circumstances change, between trusts when it is desired to move a policy out of an irrevocable trust to one that has more desirable terms (although oftentimes that is nontaxable if it is a sale between grantor trusts), or changes in business relationships and coverages.

Previously, the IRS had adopted the position that an owner?s basis in a life insurance policy was the total premiums paid, less the portion of premiums paid attributable to mortality, expense or other insurance coverage (except when the policy was not owned for purposes of insurance protection). This was based on its reading of Code §1016. Thus, persons selling an existing policy could not use a higher basis equal to gross premiums paid in calculating their gain or loss.

Many practitioners disagreed with this interpretation of the law. Happily, the 2017 tax act modified Code §1016(a) to specifically provide that the above basis reduction for mortality, expense, or other reason charges under the insurance contract does not occur. Further, the change was made retroactive to 2009.

There were still some Revenue Rulings in force that were contrary to the new law. So in Rev. Rul. 2020-05, the IRS revised Rev. Rul. 2009-13 and Rev. Rul. 2009-14 so that the examples included in them no longer have a basis reduction.

The old rulings were mooted by the new law, so this ruling is more in the nature of Treasury Dept. housekeeping. Nonetheless, it is a good reminder of the beneficial change enacted in 2017, and may educate some that missed picking up in the revision that occurred in 2017.

Rev. Rul. 2020-05

Full post as published by Rubin on Tax on February 23, 2020 (boomark / email).