IRS CORRECTS PROCEDURE FOR TAX-FREE SURRENDER OF TROUBLED INSURER'S POLICY.

Rev. Proc. 92-44 ¹

SECTION 1. PURPOSE

This revenue procedure provides administrative relief for taxpayers who surrender life insurance or annuity contracts issued by financially troubled insurance companies that are subject to conservatorship, receivership, or similar state regulatory proceedings. In general, if the requirements of this revenue procedure are satisfied, a policyholder who receives cash from the surrender of a life insurance or annuity contract issued by such a troubled insurance company and who reinvests the cash in another contract, is eligible for nonrecognition of gain, in whole or in part, under section 1035(a) or 1031(b) of the Code (or Rev. Rul. 90- 24, 1990-1 C.B. 97).

SEC. 2. BACKGROUND

01 Section 1035 of the Code provides that no gain or loss is recognized on the exchange of -- (1) a contract of life insurance for another contract of life insurance or for an endowment or annuity contract; (2) a contract of endowment insurance either for another contract of endowment insurance that provides for regular payments beginning at a date not later than the date payments would have begun under the contract exchanged, or for an annuity contract; or (3) an annuity contract for an annuity contract. See also section 1.1035-1 of the Income Tax Regulations.

The legislative history of section 1035 of the Code states that exchange treatment is appropriate for "individuals who have merely exchanged one insurance policy for another better suited to their needs and who have not actually realized gain." H.R. Rep. No. 1337, 83d Cong., 2d Sess. 81 (1954). Because nonrecognition is limited to "exchanges," section 1035(a) does not apply to "rollovers," in which the cash proceeds from the surrender of one insurance or annuity contract are invested in another.

02 Section 1031(b) of the Code provides in part that if an exchange would be within the provisions of section 1035(a) but for the fact that a taxpayer also receives other property or money in addition to the contract permitted to be received without recognition of gain, the taxpayer must recognize gain, if any, to the extent of the sum of the money and the fair market value of the other property. See also section 1035(c).

03 Section 72(a) of the Code provides in part that gross income includes any amount received as an annuity under an annuity contract. Section 72(e) applies to amounts that are not received as an annuity, and provides, in general, that amounts not received as an annuity are included in gross income to the extent of the income on the contract. A taxpayer's investment in the contract is taken into account in determining income.

04 Section 72(e)(6) defines investment in the contract as of any date as (A) the aggregate amount of premiums or other consideration paid for the policy or contract before such date, minus (B) the aggregate amount received under the policy or contract before such date, to the extent that such amount was excludable from gross income.

05 Revenue Ruling 90-24, 1990-1 C.B. 97, provides that the transfer of a holder's interest in one qualified annuity contract, as defined in section 403(b) of the Code, to another qualified annuity contract is not a taxable transfer.

06 Under sections 6047(d) and 3405(d) of the Code, a corporation issuing life insurance or annuity contracts under which payments or distributions may be made is required to file appropriate returns and reports regarding the contracts with the Internal Revenue Service, the participants and beneficiaries of such contracts, and such other persons as may be prescribed in regulations.

SEC. 3. SCOPE AND APPLICATION

01 The Service will deem section 1035(a) (or Rev. Rul. 90-24, 1990-1 C.B. 97) to apply to a transaction in which cash is distributed from a life insurance policy or annuity contract and the proceeds are reinvested in another policy or contract (including a custodial account that satisfies the requirements of section 403(b)(7) of the Code), but only if the following conditions are satisfied:

(1) The affected policy or contract is issued by an insurance company that is subject to a rehabilitation, conservatorship, insolvency or similar state proceeding at the time of the cash distribution.

(2) The taxpayer withdraws 100 percent of the cash distribution to which the taxpayer is entitled in full settlement of the taxpayer's rights under the affected contract, or, if less, the maximum amount permitted to be withdrawn under the terms of the State proceeding.

(3) An exchange of the affected policy or contract for the policy or contract in which the proceeds are reinvested would qualify for tax-free treatment under section 1035(a) of the Code or a transfer of a holder's interest in the affected contract to the contract in which the proceeds are reinvested would not be taxable under Rev. Rul. 90-24, 1990-1 C.B. 97.

(4) Not later than 60 days after the receipt of the cash distribution (or, if later, September 13, 1992), the taxpayer must reinvest the cash distribution from the policy or contract in a single policy or contract issued by another insurance company, or in a single custodial account. If the cash distribution is restricted by the state proceeding to an amount less than the taxpayer is entitled to in full settlement of his or her rights under the affected policy or contract, the taxpayer must assign all rights to any future distributions under that policy or contract to the issuer of the new policy or contract for investment in the new policy or contract. The discharge of a policyholder loan upon surrender is also to be treated as a cash distribution.

02 If a transaction would be described in section 3.01 of this revenue procedure but for the fact that some of the cash distributed under the affected policy or contract is not timely reinvested in the new policy or contract, the Service will deem the provisions of section 1031(b) to apply to the transaction.

SEC. 4. PROCEDURE

01 The taxpayer must transmit to the insurer issuing the new policy or contract a statement containing the following information with respect to a transaction described in Section 3 of this revenue procedure:

(1) The gross amount of cash distributed under the affected policy or contract;

(2) The amount of the cash received under the affected policy or contract that has been reinvested in the new policy or contract; and

(3) The taxpayer's investment in the affected policy or contract on the date of the initial distribution of cash.

02 The taxpayer must attach to the taxpayer's timely filed individual income tax return for the year in which the initial distribution of cash occurs --

(1) A statement that bears the legend "ELECTION UNDER REV. PROC. 92-44" and includes the name of the issuer of the new policy or contract and the policy number (or analogous identifying information) regarding the new policy or contract, and

(2) A copy of the statement described in section 4.01 that was sent to the issuer of the new policy or contract.

SEC. 5. TRANSITION RULE

For taxable years prior to 1992, taxpayers may claim the relief granted in this revenue procedure on an amended individual income tax return.

DRAFTING INFORMATION

The principal author of this revenue procedure is Thomas M. Preston of the Office of the Assistant Chief Counsel (Financial Institutions and Products). For further information regarding this revenue procedure, contact Mr. Preston on (202) 566-3478 (not a toll- free call).