SECTION 3. AMENDMENTS MADE

BY THE PPA: DISCUSSION AND APPLICATION

.01 The PPA was enacted on August 17, 2006. Section 844 of the PPA made changes to §§ 72, 1035, and 7702B, and added new reporting requirements for charges or payments for qualified long-term care insurance contracts under combined arrangements.

Section 72

.02 Section 844(a) of the PPA amended § 72(e) by adding a new paragraph, § 72(e)(11). Section 72(e)(11) provides that a charge against the cash value of an annuity contract or the cash surrender value of a life insurance contract made as payment for coverage under a qualified long-term care insurance contract that is part of or a rider on the annuity or life insurance contract is not includible in

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Section 7702B, Information Reporting, and DAC

.07 Section 844(c) of the PPA amended § 7702B(e) of the Code to provide that, in the case of any long-term care insurance coverage (whether or not qualified) provided by a rider on or as part of a life insurance contract or an annuity contract, the portion of the contract providing such coverage is treated as a separate contract. For this purpose, the term “portion” means only the terms and benefits under the life insurance or annuity contract that are in addition to the terms and benefits under the contract without regard to long-term care insurance coverage. Prior to this amendment, § 7702B(e) provided a similar rule, but only for coverage provided as part of a life insurance contract.

.08 Section 844(d) of the PPA added § 6050U of the Code, which requires any person who makes a charge against the cash value of an annuity contract (or the cash surrender value of a life insurance contract) that is excluded from gross income under § 72(e)(11) to file an information return setting forth the aggregate amount of such charges for the year, the amount of the reduction in investment in the contract by reason of such charges, and the name, address, and TIN of the holder of the contract. Statements are required to be furnished to persons with respect to whom information is required.

.09 Section 844(e) of the PPA added § 848(e) of the Code, which treats an annuity or life insurance contract that includes a qualified long-term care insurance contract as a part of or a rider on such a contract as a contract that is subject to a capitalization rate for specified policy acquisition expenses (DAC) equal to 7.7 percent of net premiums.

Effective Date

.10 The amendments made by the PPA are effective generally for contracts issued after December 31, 1996, but only with respect to taxable years beginning after December 31, 2009. The amendments relating to tax-free exchanges apply with respect to exchanges occurring after December 31, 2009. The amendment relating to information reporting applies to charges made after December 31, 2009.

income. The investment in the contract is reduced (but not below zero) by the charge.

.03 The PPA did not otherwise amend the definition of “investment in the contract” in § 72(c)(1) and 72(e)(6). Accordingly, the Treasury Department and the IRS believe that all premiums paid for a combination contract that is an annuity and also provides long-term care insurance are generally included in investment in the contract under § 72 if (i) the premiums are credited to the contract’s cash value (rather than directly to the long-term care insurance contract that is part of or a rider to the contract), and (ii) coverage under the long-term care insurance contract is paid for by charges against the cash value of the contract. Consistently, a waiver of premiums under such a contract, such as on account of disability or because the annuitant has become chronically ill, should be accounted for in the same manner as a waiver of premiums under other contracts for which “investment in the contract” is determined under § 72(c)(1) or 72(e)(6). See, e.g., Estate of Wong Wing Non v. Commissioner, 18 T.C. 205 (1952) (waived premiums not treated as constructively received as disability benefits, and therefore not included as part of premium paid for endowment life insurance policy).

Section 1035

.04 Section 844(b) of the PPA expanded the categories of exchanges that are treated as tax-free under § 1035 to include certain exchanges that involve a qualified long-term care insurance contract. Accordingly, § 1035 now applies to the exchange of a life insurance contract for another life insurance, endowment, annuity, or qualified long-term care insurance contract; an endowment contract for another endowment, annuity, or qualified long-term care insurance contract; an annuity contract for another annuity or qualified long-term care insurance contract; or a qualified long-term care insurance contract for another qualified long-term care insurance contract. The PPA also amended § 1035(b)(2) and (3) to provide that, for purposes of § 1035, a contract does not fail to be treated as a life insurance contract or an annuity contract

solely because a qualified long-term care insurance contract is a part of or a rider on the contract.

.05 Just as the direct transfer of a portion of the cash surrender value of an existing deferred annuity contract for a second annuity contract may be treated as a tax-free exchange under § 1035, the direct transfer of a portion of the cash surrender value of an existing deferred annuity contract for a qualified long-term care insurance contract may be treated as a tax-free exchange, provided the requirements of § 1035 are otherwise met. See, e.g., Rev. Proc. 2011–38, 2011–30 I.R.B. 66 (setting forth conditions under which such a transfer will be treated as a tax-free exchange under § 1035); but see, Rev. Rul. 2007–24, 2007–1 C.B. 1282 (receipt of a check under a nonqualified annuity contract and endorsement of the check to a second company as consideration for a second annuity contract treated as a distribution under § 72(e), rather than as a tax-free exchange under § 1035).

.06 Although § 7702B(b)(1)(D) and (E) limit the extent to which a qualified long-term care insurance contract may have a cash value or premium refund feature, § 7702B(b)(2)(C) permits the refund of premiums in the event of a complete surrender or cancellation of the contract, provided the amount does not exceed the aggregate premiums paid under the contract. Such a refund is includible in gross income to the extent that any deduction or exclusion was allowable with respect to the premiums. Moreover, § 1031(d) provides that if property is acquired in an exchange described in § 1035(a), then the acquired property’s adjusted basis shall be the same as that of the property exchanged, decreased in the amount of any money received by the taxpayer and increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized on such exchange. Accordingly, Treasury and the IRS believe that, under § 1031(d), the adjusted basis of a qualified long-term care insurance contract received in a tax-free exchange under § 1035(a) generally carries over from the life insurance, endowment, annuity, or qualified long-term care insurance contract exchanged.

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ton, DC 20044. Alternatively, taxpayers may submit comments electronically to Notice.Comments@irscounsel.treas.gov . Please include “Notice 2011–68” in the subject line of any electronic communications.

.03 Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (Notice 2011–68), Courier’s Desk, Internal Revenue Service, 1111 Constitution Ave., NW, Washington, DC 20224. All comments will be available for public inspection and copying.