Rev. Rul. 68-304

Advice has been requested concerning the Federal income tax treatment of that portion of the premiums attributable to the cost of life insurance protection provided in a retirement income contract purchased under an arrangement described in section 403(b) of the Internal Revenue Code of 1954.

In 1967, an organization exempt from Federal income tax under section 501(c)(3) of the Code purchased a nontransferable, nonforfeitable retirement income contract for an employee. The contract provides that the employee will commence to receive a life annuity of 100 dollars per month if he is alive at age 65. If the employee dies before reaching age 65, a death benefit is provided in an amount equal to the greater of 10,000 dollars or the cash surrender value of the contract.

Insofar as here pertinent, section 403(b) of the Code provides that if an annuity contract is purchased for an employee by an employer described in section 501(c)(3), if the contract is not part of a qualified plan under section 401(a) of the Code, and if the employee's rights under the contract are nonforfeitable except for failure to pay premiums, the amounts contributed by the employer to purchase the annuity contract are excludable from the gross income of the employee for the taxable year contributed to the extent of the `exclusion allowance.'

The exclusion allowance is equal to the excess, if any, of (1) the amount determined by multiplying 20 percent of the employee's `includible compensation' by the number of years of service, over (2) the aggregate of the amounts contributed by the employer for annuity contracts and excludable from the gross income of the employee for any prior taxable year. See section 403(b)(2) of the Code.

Section 403(b)(3) of the Code defines the term `includible compensation' as the amount of compensation that is received from an employer referred to in section 403(b)(1)(A) and is includible in gross income (computed without regard to section 105(d), relating to wage continuation plans, and section 911, relating to earned income from sources without the United States) for the most recent period that may be counted as one year of service. However, the term does not include any amounts contributed by the employer for any annuity contract, whether or not any part of such amounts are includible in the employee's gross income. See section 1.403(b)-1(e) of the Income Tax Regulations.

Section 1.403(b)-1(c)(3) of the regulations provides that an individual contract issued after December 31, 1962, that provides for incidental life insurance protection may be purchased as an annuity contract. Such section further provides that rules relating to the cost of life insurance protection and the proceeds thereunder are determined under section 1.72-16 of the regulations.

Section 1.72-16(b)(2) of the regulations provides that the portion of the premiums applied toward the purchase of life insurance protection under the contract shall be included in the employee's gross income for the taxable year or years in which such amounts are so applied.

Under section 1.72-8(a)(1) of the regulations, the portion of the premiums attributable to the life insurance protection for the employee that were includible in the employee's gross income shall constitute consideration paid or contributed by the employee.

Accordingly, it is held that the current cost of the life insurance protection provided under the annuity contract (determined under the provisions of Revenue Ruling 55-747, C.B. 1955-2, 228, as amplified by Revenue Ruling 66-110, C.B. 1966-1, 12) is includible in the employee's gross income. See also section 72(m)(3)(B) of the Code. Furthermore, such amounts are consideration paid or contributed by the employee for purposes of establishing the contract's basis in the hands of the distributee in accordance with section 72(f) of the Code.

It is further held that the amount specifically includible in the employee's gross income as the cost of life insurance protection is not a part of `includible compensation,' as defined in section 403(b)(3) of the Code, and therefore is not excludable from gross income under the `exclusion allowance.'