HIV-POSITIVE INDIVIDUAL IS TAXABLE ON GAIN REALIZED ON SALE OF LIFE INSURANCE CONTRACT.

UIL Number(s) 0061.30-01, 0101.01-00, 1001.02-00, 1012.00-00, 1016.02-00

                                             Date: July 22, 1994

This is in response to your letter dated April 1, 1994, as supplemented on April 22, 1994 and July 14, 1994, asking whether an amount paid to a terminally ill insured by a viatical settlement company upon the assignment of a life insurance contract is excludable from the income of the recipient under section 101(a) of the Internal Revenue Code ("Code") and, if the amounts are not excludable, the amount of gain to be recognized.

Taxpayer is an individual subject to the audit jurisdiction of the District Director of M. Taxpayer was diagnosed as being HIV+ in Date A. Taxpayer represents that he is "an AIDS sufferer with a poor prognosis."

Taxpayer purchased a participating whole life insurance contract with a face amount of $a from Company X on Date B. ¹ Taxpayer is the sole insured under the policy. Taxpayer represents that the aggregate amount of premiums paid for the policy up to the date of sale are $b. The cash value as of Date C was $c. Taxpayer has not surrendered any portion of the contract, received any distributions of cash or other property under the contract, or borrowed, directly or indirectly, from the contract.

On Date D, Taxpayer irrevocably assigned the Company X policy to Company Y, a viatical settlement company, ² in consideration of a payment by Company Y to Taxpayer of $d. This amount is approximately 63 percent of the face amount of the life insurance contract.

Section 61(a) of the Code provides that gross income means "all income from whatever source derived," including gains derived from dealings in property. See section 61(a)(3).

An assignment of a life insurance contract for consideration constitutes a sale of property. Under section 1001(b) of the Code, the amount realized is the amount of money and the fair market value of any property (other than money) received upon the sale. ³ To determine the gain on the sale, the amount realized is reduced by the adjusted basis of the contract. See section 1001(a). See also sections 1011, 1012, and 1016 for provisions relating to the determination of the adjusted basis of property; cf., Century Wood Preserving Co. v. Commissioner, 69 F.2d 967 (3d Cir. 1934); London Shoe Co. v. Commissioner, 80 F.2d 230 (2d Cir. 1935), cert. denied, 298 U.S. 663 (1936) (adjusted basis of life insurance contract for purposes of determining loss). Except as otherwise provided in subtitle A of the Code, the entire amount of the gain realized under section 1001(b) must be recognized. See section 1001(c).

In this case, the amount realized by Taxpayer upon the sale of his life insurance contract is the consideration received from the viatical settlement company. The adjusted basis of Taxpayer's contract is equal to the premiums paid less the sum of (i) the cost of insurance protection provided through the date of sale ⁴ and (ii) any amounts (e.g., dividends) received under the contract that have not been included in gross income. ⁵

Section 101(a)(1) of the Code provides an exclusion from gross income (and exception from gain recognition) for amounts received under a life insurance contract if those amounts are paid by reason of the death of the insured. The amounts received by Taxpayer from the assignment of the Company X policy to Company Y are not amounts received under a life insurance contract by reason of the death of the insured. Therefore, the exclusion under section 101(a) does not apply to any portion of the gain realized by Taxpayer on the sale of the contract.

Accordingly it is held that the amount received by Taxpayer from Company Y, to the extent that the amount exceeds Taxpayer's adjusted basis of his contract, is includable in Taxpayer's gross income. No portion of the amount received is excluded from income under section 101(a)(1) of the Code.

No opinion is expressed under other sections of the Code and income tax regulations which may also be applicable thereto. This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.

A copy of this letter should be attached to the next federal income tax return to be filed by Taxpayer.

                                   Sincerely yours,

² A viatical settlement company is an entity that acquires life insurance contracts from persons who are either terminally ill or who have a dramatically limited life span due to a dread disease. The amount paid to the insured upon assignment is less than the face amount of the policy. The viatical settlement company then collects the full death benefits when the insured dies. See section 101(a)(2) of the Code for provisions applicable to death benefit received following a transfer of a life insurance contract for valuable consideration.

³ If the contract sold had been subject to a loan and the transferor's obligation under the loan was discharged upon sale, the amount of the loan would be an additional amount realized on the transfer. Section 1.1001-2(a) of the Income Tax Regulations.

⁴ On the facts of this case, and in the absence of proof to the contrary, the cost of insurance protection may be approximated using the difference between (i) the aggregate amount of premiums paid and (ii) the cash value of the contract with regard to surrender charges. Century Wood Preserving Co. v. Commissioner, 69 F.2d at 968.

⁵ See section 1016(a)(1) (basis adjustment for items chargeable to capital account). See also section 72(e) of the Code for rules with respect to the taxation of amounts received under a life insurance contract.