SECTION 2. BACKGROUND

A. Sales of Life Insurance Contracts

A life insurance policyholder who sells a life insurance contract may have taxable gain on the sale. ² Rev. Rul. 2009–13, 2009–21 I.R.B. 1029, holds that gain on the sale of a life insurance contract is included in gross income under § 61(a)(3). The gain is capital gain, except to the extent of the amount that would be recognized as ordinary income if the contract were surrendered, which is ordinary income under the substitute for ordinary income doctrine. See Rev. Rul. 2009–13; see also Rev. Rul. 2009–14, 2009–21 I.R.B. 1031. The amount that would be recognized as ordinary income under § 72(e)(5) if the contract were surrendered is the “inside buildup” – the excess of the amount that would be received upon surrender over the investment in the contract as defined in § 72(e)(6). ³ Section 72(e)(6) defines the “investment in the contract” as of any date as the aggregate amount of premiums or other consideration paid for the contract before that date, less the aggregate amount received under the contract before that date to the extent that such amount was excludable from gross income.

Life insurance contracts may be sold in transactions known as life settlement transactions. In a typical life settlement transaction, the policyholder, often the individual insured under the life insurance contract, sells his or her life insurance contract to an unrelated person. The consideration paid generally is a lump-sum cash payment that is less than the death benefit on the policy, but more than the amount that would be received by the policyholder upon surrender of the life insurance contract. In general, life settlement transactions may be arranged by a life settlement broker, who negotiates the

sale of a life insurance contract on behalf of the policyholder in exchange for a fee or commission.

Over 40 states regulate life settlement transactions. State law may require that life settlement brokers be licensed and that the contract of sale (the life settlement contract) only be entered into by the policyholder and a licensed life settlement provider. A life settlement provider may purchase a life insurance contract on its own behalf. Alternatively, the life settlement provider may purchase a life insurance contract on behalf of the ultimate beneficial owner (for example, a financing entity that provides the funds to purchase the life insurance contract). The ultimate beneficial owner of the life insurance contract may continue to pay the premiums on the life insurance contract and receive death benefits under the contract on the death of the insured, or may, in a separate transaction, sell the life insurance contract to another investor in life insurance contracts.

A viatical settlement, a subset of life settlement transactions, may involve the sale of a life insurance contract, but may not be taxed as a sale. Under a viatical settlement, a policyholder may sell or assign a life insurance contract after the insured has become terminally ill or chronically ill. If any portion of the death benefit under a life insurance contract on the life of an insured who is terminally ill or chronically ill (within the meaning of § 101(g)) is sold (through the sale of the life insurance contract) or assigned in a viatical settlement to a viatical settlement provider, the amount paid for the sale or assignment of that portion is treated as an amount paid under the life insurance contract by reason of the death of the insured, rather than gain from the sale or assignment. See §§ 101(a) and (g). Amounts received under a life insurance contract paid by reason of the death of the insured are excluded from federal income tax. See § 101(a)(1). For this purpose, a viatical settlement provider is a person regularly engaged in the trade or business of purchasing, or taking assignments of, life insurance contracts insuring the lives of ter

minally ill or chronically ill individuals (provided certain requirements are met). See Rev. Rul. 2002–82, 2002–51 I.R.B. 978.

B. Information Reporting for Certain Life Insurance Contract Transactions

Section 13520 of the Act added § 6050Y to the Code. In general, § 6050Y imposes information reporting requirements on the acquirer and issuer in the case of the acquisition, or notice of the acquisition, of an existing life insurance contract in a reportable policy sale, and on each person who makes a payment (the “payor”) of reportable death benefits. The reporting requirements set forth in § 6050Y are effective for reportable policy sales that occur after December 31, 2017, and for reportable death benefits paid after December 31, 2017. The term “reportable policy sale” is defined in § 6050Y(d)(2), by cross-reference to § 101(a)(3)(B), which was added by section 13522 of the Act, to mean “the acquisition of an interest in a life insurance contract, directly or indirectly, if the acquirer has no substantial family, business, or financial relationship with the insured apart from the acquirer’s interest in such life insurance contract.” Section 101(a)(3)(B) provides that, for purposes of determining whether an acquisition of an interest in a life insurance contract is a reportable policy sale, “the term ‘indirectly’ applies to the acquisition of an interest in a partnership, trust, or other entity that holds an interest in the life insurance contract.” The term “reportable death benefits” is defined in § 6050Y(d)(4) to mean “amounts paid by reason of the death of the insured under a life insurance contract that has been transferred in a reportable policy sale.”

Section 6050Y(a) imposes reporting requirements on every person who acquires a life insurance contract, or any interest in a life insurance contract, in a reportable policy sale during the taxable year (the “acquirer”). Under § 6050Y(a)(1), the acquirer must file a return with the IRS setting forth (1) the acquirer’s name, address, and taxpayer identification number (TIN); (2) the name, address, and TIN of each recipient of payment

2In this notice, a reference to a sale of a life insurance contract includes a sale of any interest in a life insurance contract.

3For some contracts, such as term life insurance contracts, the amount that would be received upon surrender of the contract is zero and the policyholder therefore has no ordinary income on the sale of the contract.

Bulletin No. 2018–20 585 May 14, 2018

in the reportable policy sale; (3) the date of the sale; (4) the name of the issuer of the life insurance contract sold and the policy number of such contract; and (5) the amount of each payment. Under § 6050Y(a)(2), the acquirer must furnish written statements to each payment recipient and the issuer named in the return required by § 6050Y(a)(1). The statement furnished by the acquirer to any payment recipient must include items (1) through (5), above. The statement furnished by the acquirer to the issuer must include items (1) through (4), above; however, the statement is not required to include item (5) (the amount of each payment). The statements furnished by the acquirer to each payment recipient and the issuer must also include the name, address, and phone number of the acquirer’s information contact. The term “payment” is defined by § 6050Y(d)(1) with respect to any reportable policy sale as “the amount of cash and the fair market value of any consideration transferred in the sale.” The term “issuer” is defined by § 6050Y(d)(3) as “any life insurance company that bears the risk with respect to a life insurance contract on the date any return or statement is required to be made under this section.”

Section 6050Y(b) imposes reporting requirements on an issuer of a life insurance contract upon the receipt of a written statement furnished by an acquirer under § 6050Y(a)(2), or upon any notice of the transfer of a life insurance contract to a foreign person. Under § 6050Y(b)(1), the issuer must file a return with the IRS setting forth (1) the name, address, and TIN of the seller who transfers any interest in such contract in such sale; (2) the seller’s investment in the contract within the meaning of § 72(e)(6); and (3) the policy number of the contract. Under § 6050Y(b)(2), the issuer must furnish the seller with a written statement that includes items (1) through (3), above, as well as the name, address, and phone number of the issuer’s information contact.

Section 6050Y(c) imposes reporting requirements on every person who makes a payment of reportable death benefits during any taxable year. Under § 6050Y(c)(1), the payor must file a return with the IRS setting forth (1) the payor’s name, address, and

TIN; (2) the name, address, and TIN of each recipient of such payment; (3) the date of each such payment; (4) the gross amount of each such payment; and (5) the payor’s estimate of the buyer’s investment in the contract within the meaning of § 72(e)(6). Under § 6050Y(c)(2), the payor must furnish to each recipient of such payment a written statement that includes items (1) through (5), above, as well as the name, address, and phone number of the payor’s information contact.

C. Proceeds of Life Insurance Contracts Payable by Reason of Death

Generally, amounts received under a life insurance contract that are paid by reason of death of the insured are excluded from federal income tax. See § 101(a)(1). However, if a life insurance contract is sold or otherwise transferred for valuable consideration (such as in a life settlement transaction or viatical settlement), the excludable portion of the amount paid by reason of the death of the insured is limited. See § 101(a)(2). In general, under the § 101(a)(2) limitation, the excludable amount following a transfer for valuable consideration may not exceed the sum of (1) the actual value of the consideration paid by the transferee to acquire the life insurance contract and (2) the premiums and other amounts subsequently paid by the transferee. The second sentence of § 101(a)(2) provides that the § 101(a)(2) limitation does not apply if (1) the transferee’s basis in the contract is determined in whole or in part by reference to the transferor’s basis in the contract or (2) the transfer is to the insured, to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is a shareholder or officer. See § 101(a)(2).

Rev. Rul. 2009–14 holds that a portion of the death benefit received by a buyer of a life insurance contract on the death of the insured is included in income under § 101(a)(2). The portion included in income is the excess of the death benefit over the premiums or other consideration the buyer paid for the contract. Rev. Rul. 2009–14 holds that the receipt of a death benefit from the issuer under the terms of the contract does not produce a capital gain and, therefore, the income recog

nized by the buyer upon the receipt of death benefits under the contract is ordinary income.

D. A Modification to the Transfer for Valuable Consideration Rules

Section 13522 of the Act added § 101(a)(3), which provides that the exception to the § 101(a)(2) limitation provided in the second sentence of § 101(a) (2) does not apply in the case of a reportable policy sale. Accordingly, in the case of a reportable policy sale, the amount of death benefits excluded from gross income under § 101(a)(1) shall not exceed an amount equal to the sum of the actual value of the consideration the buyer paid for the contract and the premiums or other amounts subsequently paid by the buyer. As a result, some portion of the death benefit ultimately payable under such a contract may be includable in income under § 101(a)(2) (for example, if the life insurance contract is transferred for valuable consideration and the death benefit exceeds the sum of the actual value of the consideration and the premiums or other amounts subsequently paid by the transferee of the contract). The modification to the rules for transfers for valuable consideration is effective for transfers occurring after December 31, 2017.