The Treasury Department and the IRS recently issued final regulations on reporting requirements and tax obligations for buyers and sellers of life insurance contracts. Included in the regulations is a favorable rule critical for the banking industry—a carve-out permitting a company that acquired a corporation that owns life insurance policies in certain transaction forms to avoid taxes on the payouts of those policies. This article covers only the rule pertaining to acquisitions and does not discuss the insurance policy sale reporting requirements. In addition, consider reading our additional content on the topic titled "Taxpayer-friendly proposed regulation on insurance policy transfers".
The Tax Cuts and Jobs Act (TJCA), enacted in 2017, includes provisions related to the acquisition of a life insurance contract or an interest in a life insurance contract. Along with reporting requirements, the provisions added an income tax obligation which, on its face, would have adversely affected any acquirer of a corporation having corporate-owned life insurance. The acquirer generally would be required to pay tax on the excess of the death benefit payments received by the acquirer over the amount the acquirer paid with respect to the insurance policy.
This new rule presented a particular problem to the banking industry due to the prevalence of bank-owned life insurance (BOLI). There was concern that, under the new TCJA rule, an acquisition of a target bank having BOLI policies would have the undesirable result that the acquirer would be taxed on receipt of death benefits.
Under section 101, the receipt of death benefit payments under a life insurance contract generally is not subject to federal income tax. An exception is the “transfer for value” rule, which requires the acquirer of a life insurance policy who receives a death benefit payment under the policy to include that payment in income, reduced by the acquirer’s cost of the policy (i.e., acquisition price plus premiums paid).
Prior to the TCJA, the transfer for value rule did not apply to a corporation that acquired a target corporation that owned life insurance policies either (1) in a tax-free acquisition, or (2) in certain situations where the policy covered the life of a corporate officer or shareholder. The TCJA, however, added section 101(a)(3), which eliminated these favorable exceptions in situations that appeared to broadly extend to acquisitions of interests in entities that hold life insurance policies.
The new final regulations exclude from the TCJA’s unfavorable rule acquisition of a C corporation (i.e., a corporation that has not elected to be treated as an S corporation), provided that life insurance contracts do not constitute more than 50 percent of the gross value of the C corporation’s assets. (Reg. section 1.101-1(e)(3)(ii).) This exception applies upon the acquisition of any interest in a C corporation. It thus applies to an interest acquired via a tax-free reorganization structured as a stock acquisition. It does not, however, apply to an acquisition made via a tax-free reorganization structured as an asset acquisition.
These regulations generally are effective for insurance policy transfers or acquisitions occurring on or after Oct. 31, 2019. Acquirers of banks with BOLI should generally be pleased with the finalized regulations.
Some bank acquisition transactions are structured as a tax-free stock acquisition of a bank holding company via merger, followed by a second tax-free merger involving the target bank. These regulations do not expressly address the results of the second merger. Those considering such acquisitions or other acquisitions of corporations holding corporate-owned life insurance should consult with their tax advisors regarding the tax treatment of the target corporation’s life insurance policies.
