SECTION 3. DEFINITIONS — Internal Revenue Bulletin 2001-36

The following definitions and rules apply solely for purposes of this revenue procedure.

.01 Testing period . The 7-year period described in § 7702A(b) or such addi

.03 Need for a correction mechanism.

(1) The Internal Revenue Service (“Service”) became aware of situations in which, as a result of inadvertent non-egregious failures to comply with the MEC rules, life insurance premiums had been collected which exceed the 7-pay limit provided by § 7702A(b). This could produce significant unforeseen tax consequences for the contract holders. To allow issuers to remedy such situations, Rev. Proc. 99–27, 1999–1 C.B. 1186, set forth the circumstances under which the Service would enter into closing agreements which would provide that contracts identified in the closing agreements would not be treated as MECs. Rev. Proc. 99–27 applied only to requests for relief that were received by the Service on or before May 31, 2001, generally permitted an issuer to make only one request for correction, and excluded certain contracts from the procedure’s correction mechanism.

(2) Some issuers were unable to comply with the May 31, 2001, deadline in Rev. Proc. 99–27 or filed a timely submission for some contracts but desire to file supplemental submissions for additional contracts. Also, issuers desire to correct contracts that were not correctable under Rev. Proc. 99–27. To allow issuers to remedy such situations, the Service under the circumstances described below will enter into closing agreements which will provide that contracts identified in the closing agreements will not be treated as MECs.

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tional period as may be required under § 7702A(c)(3) if a contract undergoes a material change.

.02 Amount paid . The amount paid under a contract in any “contract year” (as defined in § 7702A(e)(2)) equals the premiums paid for the contract during the year, reduced by amounts to which § 72(e) applies (determined without regard to § 72(e)(4)(A)) but not including amounts includible in gross income. For this purpose, premiums paid do not include—

(1) any portion of any premium paid during the contract year that is returned (with interest) to the contract holder within 60 days after the end of the contract year in order to comply with the 7pay test, or

(2) the “cash surrender value” (as defined in § 7702(f)(2)(A)) of another life insurance contract (other than a contract that fails the 7-pay test) exchanged for the contract.

.03 7-pay premium. (1) In general . Except as otherwise provided in section 3.03(2) of this revenue procedure, the 7pay premium for a contract is the net level premium (computed in accordance with the rules in § 7702A(c)) that would have to be paid for the contract if the contract were to provide for paid up future benefits after the payment of 7 level annual premiums.

(2) 7-pay premium for a contract that undergoes a material change. If a contract (other than a contract that fails the 7-pay test) is materially changed, the contract is treated as newly issued on the

date of the material change and the 7-pay premium for the changed contract is an amount equal to the excess, if any, of—

(a) the net level premium (computed in accordance with the rules in § 7702A(c)) that would have to be paid for the changed contract if the contract were to provide for paid up future benefits after the payment of 7 level annual premiums, over

(b) a “proportionate share of the cash surrender value” (as defined in section 3.04 of this revenue procedure) under the contract.

.04 Proportionate share of cash surren- der value. The proportionate share of the cash surrender value of a contract is the amount obtained by multiplying—

(1) the “cash surrender value” (as defined in § 7702(f)(2)(A)) of the contract, by

(2) a fraction, the numerator of which is the net level premium (computed in accordance with the rules in § 7702A(c)) that would have to be paid for the changed or new contract if such contract were to provide for paid up future benefits after the payment of 7 level annual premiums, and the denominator of which is the net single premium (determined using the rules in § 7702) for such contract at that time.

.05 Overage. A contract’s overage is the amount of the excess, if any, of—

(1) the sum of amounts paid under the contract during the testing period for the contract year and all prior contract years, over

(2) the sum of the 7-pay premiums for the contract year and all prior contract years of the testing period.

.06 Overage earnings. The overage earnings for a contract year is the amount obtained by multiplying—

(1) the sum of a contract’s overage for the contract year and its cumulative overage earnings for all prior contract years, by—

(2) the earnings rate set forth in section 3.07 of this revenue procedure.

.07 Earnings rates . (1) Contracts other than variable contracts. Except as otherwise provided in sections 3.07(3) and 3.07(8) of this revenue procedure, the earnings rate applicable to a contract year is the “general account total return” (as defined in section 3.07(2) of this revenue procedure) for the calendar year in which the contract year begins.

(2) General account total return. The general account total return is the calendar year arithmetic average of the monthly interest rates described as Moody’s Corporate Bond Yield Average Monthly Average Corporates as published by Moody’s Investors Service Inc., or any successor thereto.

(3) Variable contracts described in § 817(d). (a) Pre-2001 contract years. The earnings rate applicable to a contract year that begins before January 1, 2001, is the rate set forth in the following table for the calendar year in which the contract year begins.

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(b) Post-2000 contract years. Except as otherwise provided in section 3.07(8), the earnings rate applicable to a contract year that begins after December 31, 2000, is equal to the sum of— (i) 10 percent of the general account total return (as defined in section 3.07(2) of this revenue procedure), and (ii) 90 percent of the “separate account total return” (as defined in section 3.07(4) of this revenue procedure) for the calendar year in which the contract year begins.

(4) Separate account total return. Except as otherwise provided in section 3.07(8), the separate account total return equals—

(a) 75 percent of the “equity fund total return” (as defined in section 3.07(5) of this revenue procedure), plus

(b) 25 percent of the “bond fund total return” (as defined in section 3.07(6) of this revenue procedure), less

(a) the “calendar year percentage return” (as defined in section 3.07(7) of this revenue procedure) represented by the end-of-year values of the Standard and Poor’s (S&P) 500 Total Return Index, with daily dividend reinvestment, as published by The McGraw-Hill Companies, Inc., or any successor thereto, less

(b) 1.5 percentage point. (6) Bond Fund Total Return. The bond fund total return equals—

(a) the “calendar year percentage return” (as defined in section 3.07(7) of this revenue procedure) represented by the end-of-year values of the Merrill Lynch Corporate Bond Master Bond Index, Total Return, as published by Merrill Lynch & Company, Inc., or any successor thereto, less

(b) 1.0 percentage point. (7) Calendar year percentage return. The calendar year percentage return for an index described in section 3.07(5) or section 3.07(6) of this revenue procedure is calculated by—

(a) dividing the end-of-year value of the index for the calendar year by the end-of-year value of the index for the immediately preceding calendar year, and

(b) subtracting 1 from the result obtained under paragraph (a) of this section 3.07(7).

(8) If the general account total return or the separate account total return for a calendar year cannot be determined because the calendar year in which the contract year begins has not ended, then the earnings rate for the contract year (or portion thereof) is determined using the general account total return and, if applicable, the average separate account total return, for the 3 calendar years immediately preceding the calendar year in which the contract year begins.

.08 Proportionate share of overage earnings allocable to taxable distribu- tions . The proportionate share of overage earnings allocable to taxable distributions under a contract is the amount obtained by multiplying—

(1) the total amount of the taxable distributions under the contract, by

(2) a fraction, the numerator of which is the contract’s cumulative overage earnings and the denominator of which is the total income on the contract.

.09 Total income on a contract. The total income on a contract as of any date is an amount equal to the excess, if any, of—

(1) the contract’s cash surrender value (as defined in § 7702(f)(2)(A)) on such date, over

(2) the premiums paid under the contract before such date, reduced by amounts to which § 72(e) applies (determined without regard to § 72(e)(4)(A)) but not including amounts includible in the contract holder’s gross income.

.10 Distribution frequency factor . The distribution frequency factor for a contract is—

(1) .8, if—

(a) the interest rate with respect to any portion of a policy loan that could be made under the contract at any time (including policy loans that could be made after a contractually specified date in the future) is guaranteed not to exceed the sum of:

(i) 1 percentage point, plus (ii) the rate at which earnings are credited to the portion of the contract’s cash surrender value (as defined in § 7702(f)(2)(A)) that is allocable to such portion of the policy loan; or

(b) the contract holder has an option to make a partial withdrawal of the contract’s cash surrender value that reduces the “death benefit” (as defined in

§ 7702(f)(3)) under the contract by less than an amount determined by multiplying—

(i) the death benefit under the contract immediately before the withdrawal, by

(ii) the percentage obtained by dividing the withdrawn amount by the contract’s cash surrender value (as defined in § 7702(f)(2)(A)) immediately before the withdrawal; and

(2) .5 for all other contracts. .11 Applicable percentage . (1) In gen- eral. The applicable percentage for a contract is—

(a) 15%, if the death benefit under the contract is less than $50,000,

(b) 28%, if the death benefit under the contract is equal to or exceeds $50,000 but is less than $180,000, and

(2) Determination of amount of death benefit. For purposes of determining the applicable percentage, the death benefit under the contract will be the death benefit (as defined in section 7702(f)(3)) as of any date within 120 days of the date of the request for closing agreement, or the last day the contract is in force.

.12 Reported amount. The reported amount for a contract is the amount that—

(1) the issuer reports on a timely filed information return as includible in the contract holder’s gross income, or

(2) the contract holder includes in gross income on a timely filed income tax return.

.13 Aggregation of contracts . All MECs issued by the same issuer to the same contract holder during any calendar year are treated as one MEC.