On December 4, 2019, the AALU issued an important WRNewsire AALU Washington Report regarding regulations on Reportable Policy Sales (RPS). The AALU update addresses tax implications for company owned life insurance (COLI) and bank owned life insurance (BOLI) in view of the Treasury Department’s final regulations on RPS. What follows here is an overview of the regulations as provided by AALU. At the end of this overview, you will also find, in entirety, “points 6 through 9” of the previously published Washington Report Newswire analysis.
Many factors can impact qualification for the exceptions under the rule. The team at Fulcrum Partners is available to assist and provide advice on your specific transaction.
- For your reference, we are including this link to the Regulation as recorded in the Federal Register: https://www.govinfo.gov/content/pkg/FR-2019-10-31/pdf/2019-23559.pdf
Implications of the Treasury Department’s Final Regulations on Reportable Policy Sales for 1035 Exchanges Made by Businesses
On October 31, the Treasury Department released its final regulations on Reportable Policy Sales (RPS) final rule. In addition to clarifying the tax implications for company-owned life insurance (“COLI”) and bank-owned life insurance (“BOLI”) transferred in ordinary course transactions, the rule also cemented the Treasury Department’s position on how the requirements will apply with respect to section 1035 exchanges made by businesses.
The rule is twofold:
- First, life insurance companies acquiring an old life insurance policy pursuant to a section 1035 exchange is not treated as a RPS.
- More importantly, the business exchanging a policy, the acquisition of the new policy is treated as an RPS unless the policyholder qualifies for one of the “substantial relationship” (with the insured) exemptions described in points in 6, 7, 8, and 9 of our Washington Report Newswire analysis. (see below) Thus, for section 1035 exchanges on policies written on the life of a former employee, for example, the business may lack a sufficient substantial relationship with the insured in order to avoid an RPS status, limiting the excludable portion of the death benefit to the consideration paid for the policy plus any subsequent premiums paid on the policy.
These clarifications clearly apply to section 1035 exchanges that occur after October 31, 2019. For 1035 exchanges which occurred between the time the TCJA was enacted and October 31, 2019, taxpayers have the discretion to either apply these rules retroactively or simply apply the statutory language contained in the TCJA. If parties decide to retroactively apply the final regulation, it is clear that acquisitions of new polices through section 1035 exchanges are reportable policy sales unless they qualify for a substantial relationship exemption. For taxpayers who choose to not apply the rules retroactively and simply apply the broad statutory language, the result is unclear (but seemingly at least as likely to result in a reportable policy sale).
This product was developed for AALU Members through the work of AALU staff, the Federal Policy Group, and the volunteer members of AALU’s COLI/BOLI Working Group.
Excerpt from the AALU Report: Impact of the Treasury Department’s Final Regulations on Reportable Policy Sales on COLI/BOLI Marketplace
“Points 6 through 9” of the previously published Washington Report Newswire analysis.
…Exceptions based on the Definition of a Substantial Relationship
Other universally applicable carveouts from reportable policy sale status do not depend on the existence of specific transaction types but are related to the determination of whether a substantial “financial” or “business” relationship exists between the acquirer and the insured.
- Substantial Relationship Rules Generally.The RPS Final Rule includes a helpful rule to establish whether an acquiring entity has a substantial relationship with the insured[i]. The rule specifies that an entity will have a substantial relationship with the insured so long as every “beneficial owner” of the entity has a substantial relationship with the insured; however, these relationships do not need to be all the same type of substantial relationship. Therefore, the entity will be deemed to have a substantial relationship so long as each of the “beneficial owners” have a substantial relationship which they can establish by identifying either some type of substantial familial, business, or financial that the particular owner has with the insured. As an example, a partnership with three partners would itself have a “substantial relationship” with the insured where one partner has a substantial familial relationship with the insured, one partner has a substantial business relationship with the insured, and one partner has a substantial financial relationship with the insured.
- Special Rule for Indirect Acquisitions of Life Insurance. In applying the substantial relationship tests, an acquirer in an indirect acquisition is deemed to have a substantial business or financial relationship with the insured so long as the acquired entity has a substantial business or financial relationship with the insured both immediately before and immediately after the acquisition[ii] This is a very helpful rule in the case of Ordinary Course Transactions because it “counts” a substantial relationship that exists with respect to either the acquirer or the acquired entity.
- A Substantial Business Relationship Exists:
- Where the insured isa “key person[iii]” of the acquired business or “materially participates[iv]” in the acquired business, andthe acquirer/acquiree directly/indirectly owns at least 80 percent of the acquired business[v]. OR
- Where (i) the acquirer acquires an active business, (ii) the insured (a) isan employee of the acquired business immediately before the acquisition or(b) was a director, highly-compensated employee, or highly-compensated individual of the acquired business and immediately after the acquisition the acquirer has ongoing financial obligations to the insured with respect to the insured’s employment, and(iii) the acquirer carries on the acquired business or uses a significant portion of the acquired business’s assets in an active business (not including investing in life insurance contracts[vi]).
- A Substantial Financial Relationship Exists:
- Where (i) the acquirer (or its beneficial owners) has a common investment with the insured and (ii) it is reasonably foreseeable that in the event of the insured’s death his or her interest will be bought out by the co-investors[vii]. OR
- Where the acquirer is (i) either a section 170(c) organization (e., certain tax-exempt charitable organizations), an organization described in section 2055(a) (i.e., certain charitable and/or tax exempt organizations), or an organization described in section 2522(a) (i.e., certain charitable and/or tax exempt organizations) and (ii) the particular organization had previously received a substantial amount of financial support or significant volunteer support from the insured[viii]. OR
- Where the acquirer/acquiree has the life insurance contract on the insured to provide funds to purchase assets of or satisfy liabilities of the insured or the insureds estate, heirs, legatees, or successors in interest or to satisfy other liabilities arising upon or by reason of the death of the insured[ix]. This latter exception detailed in 9(c) was significantly narrowed in the RPS Final Rule. Under the RPS Final Rule, a substantial financial relationship may only arise when at least some portion of the particular liabilities are connected to the insured or their successors in interest. This cuts off the possibility that the funds derived from the life insurance contract could be used solelyto satisfy liabilities unrelated to the insured, such as funding retiree health benefits, but doesn’t describe what quantum of connection must exist. This may prove problematic for certain entities looking to establish the existence of a substantial financial relationship. Further, it is not clear how the IRS will ultimately interpret this exception. Given the lack of clarity on this point (and the possibility that the IRS will take a very narrow view of the exception) practitioners relying on this exception should be particularly cautious.
Another important facet of the rules describing when a substantial business or financial relationship exists is that the rules apply to both indirect and direct transfers of life insurance contracts[x].
#tax #BOLI #COLI #AALU #FulcrumPartners
[i] Treas. Reg. sec. 1.101-1(d)(4)(iii)
[ii] Treas. Reg. sec. 1.101-1(d)(4)(i)
[iii] As defined in section 264
[iv] As defined in section 469
[v] Treas. Reg. sec. 1.101-1(d)(2)(i)
[vi] Treas. Reg. sec. 1.101-1(d)(2)(ii)
[vii] Treas. Reg. sec. 1.101-1(d)(3)(i)
[viii] Treas. Reg. sec. 1.101-1(d)(3)(iii)
[ix] Treas. Reg. sec. 1.101-1(d)(3)(ii)
[x] As noted in greater detail above, direct transfers of life insurance will still have to meet either the Carryover Basis Exception or the Transfer-to-Insured Exception in order to be excepted from the TFV rules (thereby making the death benefits paid with respect to such insurance eligible for full income exclusion under section 101(a)).
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. Any tax advice contained herein is of a general nature. You should seek specific advice from your tax professional before pursuing any idea contemplated herein.
Securities offered through Lion Street Financial, LLC (LSF) and Valmark Securities, Inc. (VSI), each a member of FINRA and SIPC. Investment advisory services offered through CapAcuity, LLC; Lion Street Advisors, LLC (LSF) and Valmark Advisers, Inc. (VAI), each an SEC registered investment advisor. Please refer to your investment advisory agreement and the Form ADV disclosures provided to you for more information. VAI/VSI, LSF and BDO Alliance USA are non-affiliated entities and separate entities from Fulcrum Partners and CapAcuity, LLC.