ACLI Seeks Clarification of Insurance Contract Reporting Regs

May 9, 2019

Ms. Helen Hubbard
Associate Chief Counsel
(Financial Institutions & Products)
Internal Revenue Service
1111 Constitution Ave., NW
Washington, DC 20224

Ms. Kathryn Sneade
Senior Technician Review, Office of Chief Counsel
Internal Revenue Service
1111 Constitution Ave., NW
Washington, DC 20224

Ms. Alexis MacIvor, Chief, Branch 4
Office of the Associate Chief Counsel
(Financial Institutions & Products)
Internal Revenue Service
1111 Constitution Ave., NW
Washington, DC 20224

Ms. Angela Walitt
Attorney Advisor
Department of the Treasury
1500 Pennsylvania Ave., NW
Washington, DC 20220

Re: Proposed regulations (REG-103083-18) regarding information reporting for sales of life insurance contracts

Dear Mses. Hubbard, MacIvor, Sneade, and Walitt:

On behalf of ACLI and its member companies,¹ we are writing to respond to the proposed regulations (“Proposed Regulations”) with guidance on “Information Reporting for Certain Sales of Life Insurance Contract Transactions” as published in the Federal Register on March 25, 2019 (REG-103183-18).² We appreciate your consideration of our previous comments on the topic and thank you for your attention to our comments below on the Proposed Regulations.

A. Proposed Changes to Pre-existing Rules

The Proposed Regulations state “Section 1.101-1 is amended by . . . [r]emoving the second and third sentences in paragraph (a)(1).” The proposed changes would remove “Death benefit payments having the characteristics of life insurance proceeds payable by reason of death under contracts, such as workmen's compensation insurance contracts, endowment contracts, or accident and health insurance contracts, are covered by this provision.”³ It is important that no changes be made with respect to the second sentence, namely regarding current treatment of “[d]eath benefit payments having the characteristics of life insurance proceeds payable by reason of death under contracts, such as workmen's compensation insurance contracts, endowment contracts, or accident and health insurance contracts.” These benefits were written on older policies, some of which are still in effect, and changing the rules would negatively impact policyholders who have long relied on the appropriate exclusion of these death benefits from income. There is a longstanding and extensive body of court decisions and IRS rulings that establish the conditions under which such benefits qualify for treatment as life insurance proceeds.

B. Definitions

i. Definition of Issuer

Treasury Proposed Regulation section 1.6050Y-1(a)(8) generally defines the issuer with respect to a life insurance contract (“Issuer”) as “any person that bears any part of the risk with respect to the life insurance contract on that date and any person responsible on that date for administering the contract, including collecting premiums and paying death benefits.”⁴ This appears to be a reversal of position from the recommendation in Notice 2018-41 that appropriately proposed to exclude “a reinsurer in an indemnity contract covering all or a portion of the risks that the original Issuer (and continuing contract administrator) might otherwise have incurred with respect to a life insurance contract.”⁵

In most instances of indemnity reinsurance transactions, the original insurer continues to administer the contracts, some or all of the underlying risks of which the reinsurer may have assumed. Alternatively, the parties select a third-party contract administrator who assumes such a role, which includes managing ownership changes and other functions relating to contract administration and interfacing with policyholders. If the reversal in proposed treatment of reinsurers for purposes of section 6050Y⁶ reporting is due to any presumption that a reinsurer in an indemnity reinsurance transaction may be or may become privy to any information relating to transfers to domestic or foreign persons, such presumptions are misplaced.

We therefore recommend that the definition of Issuer expressly exclude a reinsurer in an indemnity contract covering all or a portion of the risks that the original Issuer (or its continuing contract administrator) might otherwise have incurred with respect to a life insurance contract.

ii. Definition of Notice of a Transfer to a Foreign Person

We appreciate that the definition of “notice of transfer to a foreign person” in Treas. Prop. Regs. sect. 1.6050Y-1(a)(10) excludes situations where the Issuer knows that no transfer has occurred or that the transferee is a US person. We request the following modification be made to the definition so an Issuer's section 6050Y(b) obligation is not triggered unless (1) there is a “notice of a transfer of a life insurance contract to a foreign person” (mirroring the statutory language set forth in section 6050Y(b)(1)) and (2) information provided to the Issuer includes foreign indicia:

(10) Notice of a transfer to a foreign person. The term notice of a transfer to a foreign person means any notice of a transfer of title to, possession of, or legal ownership of a life insurance contract to a foreign person received by a 6050Y(b) issuer, including information provided for nontax purposes that includes foreign indicia; such as a change of address notice for purposes of sending statements or for other purposes, and information relating to loans, premiums, or death benefits with respect to the contract unless the 6050Y(b) issuer knows that no transfer of the life insurance contract has occurred or knows that the transferee is a United States person. For this purpose, a 6050Y(b) issuer may rely on a Form W–9, Request for Taxpayer Identification Number and Certification, or a valid substitute form, that meets the requirements of § 1.1441–1(d)(2) (substituting "6050Y(b) issuer" for "withholding agent"), that indicates the transferee is a United States person. For instance, a change of address notice that changes the address to a foreign address or other updates to the information relating to the payment of premiums that includes foreign banking or other foreign financial institution information is notice of a transfer to a foreign person unless the 6050Y(b) issuer knows that no transfer has occurred or the transferee is a United States person.

Section 6050Y(b) requires Issuers to identify transfers to foreign persons to capture transfers that may escape section 6050Y(a)(2) reporting in the event that a foreign acquirer does not comply with section 6050Y(a)(2). The foreign indicia requirement furthers this purpose by allowing an Issuer to identify a foreign acquirer as foreign based on information they provide to the Issuer. If the “foreign” acquirer is in fact a US person, then they would be required to file a section 6050Y(a)(2) statement, and the IRS would have jurisdiction over them in the event they failed to file the section 6050Y(a)(2) statement.

C. Information Reporting

i. Reportable Policy Sale Statement

We appreciate the issuance of new Form 1099-LS to implement the acquirer's reporting obligation to provide a reportable policy sale statement (“RPSS”) under section 6050Y(a). It is important that guidance directs section 6050Y(a) acquirers to send the RPSS to the Issuer's administrative office that, pursuant to the insurance contract, processes transfers of ownership. Such information is clearly provided for in policy materials and acquirers should have no issues identifying and complying with such a requirement.

ii. Gratuitous Transfer

Section 1.101-1(b)(2)(i) of the Proposed Regulations contains the following language (emphasis added):

Gratuitous transfer of an interest in a life insurance contract. To the extent that a transfer of an interest in a life insurance contract is gratuitous, including a reportable policy sale that is not for valuable consideration, the amount of the proceeds attributable to the interest that is excludable from gross income under section 101(a)(1) is limited to the sum of the amount of the proceeds attributable to the gratuitously transferred interest that would have been excludable by the transferor if the transfer had not occurred and the premiums and other amounts subsequently paid by the transferee.⁷

This definition is problematic for two reasons. First, it creates unnecessary and confusing reporting requirements under section 6050Y for gift transfers; second, it is inconsistent with the statutory language of section 101.

1. Creation of Unnecessary and Confusing Reporting Requirements Under Code Section 6050Y for Gift Transfers

Under section 6050Y, an acquirer and an issuer are required to send information returns when a “reportable policy sale” occurs. The acquirer will have to prepare a Form 1099-LS that includes information about the “seller or other reportable policy sale recipient” and the amount of “reportable policy sale payments.”⁸ The term “reportable policy sale payment” is defined, in part, as the “total amount of cash and the fair market value of any other consideration transferred, or to be transferred.”⁹ Because Treas. Prop. Regs. sect. 1.6050Y-1 through -4 define a reportable policy sale by reference to the definition in Treas. Prop. Regs. sect. 1.101-1(b)(2)(i) (above), an acquirer will have to send a Form 1099-LS for transfers that are mere gifts. This will be confusing to the parties involved, making it appear that the transfer will have taxable consequences to both the gift giver, who will receive a Form 1099-SB, and the gift recipient, who will receive a Form 1099-R (when a death benefit is paid). For example, the Form 1099-LS includes fields titled “Amount paid to payment recipient” and “Date of sale,” both strongly indicating that the transaction contemplates a transfer for valuable consideration, i.e., a sale has occurred rather than a gratuitous transfer.

The Issuer will have to send a Form 1099-SB, which includes the investment in the contract with respect to the “seller” and the amount the “seller” would have received if the policy had been surrendered instead of transferred. Per the Preamble to the Proposed Regulations, the purpose of this reporting requirement is to provide the “IRS with the information needed to determine the seller's taxable income from the sale.”¹⁰ Aside from the fact that there is no “seller” when there is a gift, the filing of a Form 1099-SB by the Issuer will act to confuse the gift giver, as this transfer does not result in the realization of income.

The following real-world example will help to further illustrate our point: Individual A owns a life insurance policy insuring A. A transfers the policy to B, an individual, purely as a gift. There is no policy loan and B does not pay any valuable consideration for the policy. B is not related to A in any way. There is no familial relationship, no financial relationship, and no business relationship. Perhaps A and B have a relationship (friendship or love) but are not married or in a domestic partnership/civil union. Perhaps A has no “natural” family but wants to give the policy to a lifelong friend purely as a gift. When the issuer of A's policy pays a death benefit with respect to this gift, where the “transfer of an interest in a life insurance contract is gratuitous, including a reportable policy sale that is not for valuable consideration,” the issuer would be required to treat that death benefit as a “reportable death benefit” under section 6050Y(c) and report the non-taxable death benefit on a Form 1099-R to the gift recipient. This will confuse the Form 1099-R recipient, who now possesses a Form 1099 reporting a gross distribution amount that indicates a possible taxable distribution where none exists. To further confuse the gift recipient, the Form 1099-R will also indicate the estimate of the investment in the contract, which would indicate to a taxpayer that they have a taxable gain based on the difference between the gross distribution amount and the basis amount reported on the form.

Requiring tax reporting for any transfer that is not for valuable consideration, including gratuitous transfers required to be reported under the definition of a “reportable policy sale” on Forms 1099-LS, 1099-SB, and 1099-R under sections 6050Y(a), (b), and (c), will confuse taxpayers, possibly subjecting taxpayers to erroneous tax liabilities on distributions that are not taxable, and create additional burdens on Issuers and the IRS in addressing these situations.

2. Inconsistency with the Statutory Language

The definition of reportable policy sale in the Proposed Regulations includes transfers that are not for valuable consideration. This is not consistent with section 101, which requires a “transfer for valuable consideration” under section 101(a)(2) before a transaction can also be a reportable policy sale under section 101(a)(3).

The first sentence of section 101(a)(2) provides that the death benefit of a life insurance policy will be subject to income taxation if there is a “transfer for valuable consideration.” The second sentence of section 101(a)(2) provides a list of exceptions to the rule in the first sentence (i.e., the transfer for value rule will not apply if there is a carry-over basis or a transfer to the insured, a partner of the insured, a partnership in which the insured is a partner, or a corporation in which the insured is a shareholder).

Moreover, the title for section 101(a)(3) states, “Exception to valuable consideration rules for commercial transactions.” This title makes it very clear that a reportable policy sale is only relevant if and only if there has been a transfer for valuable consideration under section 101(a)(2) in the first place. Even without the title, sections 101(a)(3)(A) and (B) make this clear:

• Section 101(a)(3)(A) provides that the “the second sentence of paragraph (2) shall not apply in the case of a transfer of a life insurance contract, or any interest therein, which is a reportable policy sale.”

• Section 101(a)(3)(B) provides, “For purposes of this paragraph, the term 'reportable policy sale' means 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 . . .” (emphasis added).

These provisions of sections 101(a)(3)(A) and (B) limit the relevancy of reportable policy sales to only those situations where a taxpayer needs to determine whether one of the section 101(a)(2) exceptions apply. Since those exceptions are never relevant for gratuitous transfers, reportable policy sales are never relevant for gratuitous transfers. We thus request that Treas. Prop. Regs. sect. 1.101-1(b)(2)(i) defining gratuitous transfers be modified to strike the phrase “including a reportable policy sale that is not for valuable consideration” from the first sentence.

iii. Timing of Returns

We appreciate that the Proposed Regulations confirm our request by allowing Issuers to meet the obligations under section 6050Y(b) on or before February 15.¹¹ We also appreciate the thirty-day period granted under Treas. Prop. Regs. sect. 1.6050Y-3(d)(2) if the section 6050Y(b) Issuer does not receive notice of a transfer to a foreign person until after January 31 of the calendar year following the year in which the transfer occurred. We request that a similar thirty-day period be provided under this section if the section 6050Y(b) Issuer does not receive a reportable policy sale statement until after January 31 of the calendar year following the year in which the reportable policy sale occurred.

iv. Form 1099-R and Instructions

We anticipate that Form 1099-R and instructions for Form 1099-R will be modified to reflect that death benefits reported pursuant to section 6050Y(c) shall be so reported. Treas. Prop. Regs. sect. 1.6050Y-4(a)(4) requires the Form 1099-R return filed by the Issuer to include the “gross amount of payments made to the reportable death benefits payment recipient during the taxable year.”¹² We request the following modification be made to clarify that “gross amount of payments” are death benefit payments, because the broader term of “payments made” could be confused to include items such as interest paid on a delayed claim which is reportable on Form 1099-INT, or even partial surrenders paid to the policyowner in the same year as the insured's death:

In addition, it is not uncommon that, as a result of a reportable policy sale, a foreign person is ultimately the recipient of reportable death benefits. We request that the Proposed Regulations clarify that the reportable death benefits paid to a foreign person should be reported on Form 1042-S, not Form 1099-R. We recommend that the IRS include an explanation of how to report such benefits in the instructions to Form 1042-S, including guidance pertaining to what amount should be reported in Box 1 on the form. In addition, we request guidance clarifying whether withholding should be based on the full amount of the payment or the difference between the death benefit amount and the estimate of the cost basis.

v. Corrected Forms 1099-R

Treasury Proposed Regulation section 1.6050Y-4(d) requires that the Issuer provide a corrected Form 1099-R after receiving notice of rescission. However, if the Issuer has already paid the death benefit pursuant to the change in ownership, it may not be contractually required, or may not attempt, to reclaim such benefit after a rescission. Issuers generally do not file corrected Forms 1099-R in similar instances because the payment was in fact made to the initial recipient. We recommend that Treas. Prop. Regs. sect. 1.6050Y-4(d) be modified to provide that the Issuer is only required to correct the Form 1099-R if the reportable death benefit payment was returned to the Issuer.

vi. Issuer Reporting When Taxable Amount is Unknown

There are several instances where Issuers cannot be charged with the obligation to determine the taxable amount for the information form recipient. One such category involves Issuer reporting — whether under section 6050Y(b) or (c) — wherein a reportable policy sale was followed by a transfer that was not a reportable policy sale, such as Examples 5 and 6 in Treas. Prop. Regs. sect. 1.101-1(g). In all such cases we request updated form instructions clarify that Issuers may indicate “taxable amount not determined” by checking the “taxable amount not determined” box on the Form 1099-R instead of putting the taxable amount in box 2a, as appropriate. In the event of multiple transfers of a policy, we also request guidance regarding how to calculate the estimated cost basis.

D. Effective Dates, Transition Dates, and Penalty Relief

i. Proposed Regulations under Section 101

We appreciate the clarification contained in the Proposed Regulations as to what constitutes a “reportable policy sale,” in particular those contained in Treas. Prop. Regs. sect. 1.101-1, which are very important to businesses that own life insurance. Since the enactment of section 101(a)(3), such businesses have been looking for greater clarity on this topic — and the Proposed Regulations go a long way towards providing such clarity. It is fairly consequential, therefore, that the proposed applicability date articulated in Treas. Prop. Regs. sect. 1.101-6(b) be clarified so businesses that own life insurance and that have undertaken mergers, acquisitions, joint-ventures, and other strategic transactions after the enactment of P.L. 115-97 and before the date the Proposed Regulations are made final may rely on the Proposed Regulations as to what is considered a “reportable policy sale” for any purpose other than with respect to information reporting.

Since the enactment of P.L. 115-97 (the Tax Cuts and Jobs Act or “TCJA”), businesses that own life insurance have understood that ordinary course business transactions (e.g., mergers, acquisitions, etc.) involving businesses that own life insurance contracts were not intended by Congress to fall within the meaning of a “reportable policy sale.” Given the potentially broad manner in which section 101(a)(3) could conceivably be interpreted, the rules describing a reportable policy sale that are proposed in the Proposed Regulations are very helpful in confirming Congress' narrow intent.

Notwithstanding, there is some uncertainty as to whether the proposed rules apply to transactions entered into after the enactment of the TCJA but before the date the proposed rules are made final. To address this concern, we request that Treasury and the IRS clarify the proposed effective date of the rules issued with respect to section 101(a)(3) to apply to all transfers of life insurance contracts, or interests therein, made after December 31, 2017. If Treasury and the IRS decline to adopt this suggestion, we request in the alternative that the IRS and Treasury modify the proposed effective date to allow taxpayers to rely upon the rules in Treas. Prop. Regs. sect. 1.101-1 for transactions undertaken after December 31, 2017 and before the date that Treasury adopts final rules in this regard. In both cases, we request that the IRS and/or Treasury provide notice to taxpayers before the issuance of final rules indicating that either the effective date will be extended in the manner identified above or that taxpayers will be allowed to rely upon the Proposed Regulations pending the issuance of final rules.

ii. Transition Relief for Filing

Section 1.6050Y–1(b) of the Proposed Regulations would allow 60 days for Form 1099-LS filing and 90 days for Forms 1099-SB and 1099-R filing, commencing from the date that final regulations are issued. This proposed treatment would effectively provide Issuers with only 30 days to complete Forms 1099-SB and 1099-R reporting. Issuers require significantly more time than 30 days to add new forms (such as Form 1099-SB) to their systems. In addition, Issuers must identify the policies that are subject to reporting once the Forms 1099-LS are received as well as enhance systems to track these policies over their life and transmit data between various systems in order to accurately report under sections 6050Y(b) and (c). Moreover, returns in excess of 250 must be filed electronically. We thus request at least 60 days to file Forms 1099-SB and 1099-R after the 60-day extension period provided to acquirers of interest in life insurance policies, i.e., 120 days after the date that final regulations are issued. We also request waivers from electronic filing for 2018 and 2019 Issuer reporting under section 6050Y(b) and (c).

iii. Penalty Relief under Section 6724

We urge you to consider providing permanent penalty relief for Issuers unable to meet the filing due date for reasons beyond the control of the Issuer. We believe such relief is available under section 6724(a), which allows for waivers for reasonable cause for reporting failures. We believe this can be accomplished through guidance that designates late receipt of a Form 1099-LS as establishing reasonable cause for purposes of section 6724. To identify reports eligible for such relief, a check box could be added to Form 1099-SB for “late receipt of Form 1099-LS,” thereby avoiding the inefficiencies and costs associated with waiver and abatement procedures.

iv. Information Contact

We request that the IRS provide clarification with respect to the Form 1099-SB requirement to provide a “phone number of the information contact of the person filing the return.” The form instructions state, “This contact information must provide direct access to the person that can answer questions about the statement.” Insurers' dedicated call centers contain a number of individuals that may address such questions; therefore, we ask that the instructions be clarified such that, to meet this requirement, the Issuer may provide the contact number of the call center.

E. Section 1035 Exchanges

In the Preamble to the Proposed Regulations, the IRS requests comments on “Whether the proposed regulations should include additional provisions regarding the treatment of section 1035 exchanges of life insurance contracts.” In order for an exchange of policies to qualify as a section 1035 exchange, the owner of the new contract must be the same person who owned the old contract at the time of the exchange. However, an insurer can issue a new policy only when that new policy will meet state insurance laws requiring an insurable interest in the life of the proposed insured. Generally, an insurable interest is based on a close familial relationship with the insured or a lawful and substantial financial interest in the continued life of the insured. Given the definition in section 101(a)(3)(B) of what constitutes a reportable policy sale, the acquirer is unlikely to meet the requirements for an insurable interest in the insured and, consequently, would not be able to purchase a new policy in exchange for the policy obtained through the reportable policy sale. Therefore, we do not recommend that additional provisions be added to the Proposed Regulations for this circumstance.

We thank you for considering our recommendations. Please do not hesitate to contact us should you wish to discuss any of the issues addressed in this letter.

Sincerely,

Regina Rose

Mandana Parsazad

American Council of Life Insurers
Washington, DC