Annuity Contract Fees Are Not Treated as Amounts Received

Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact: * * *, ID No. * * *
Telephone Number: * * *

Index Number: 72.00-00
Release Date: 3/5/2021

Date: December 9, 2020

Refer Reply To: CC:FIP:04 - PLR-113451-20

LEGEND:

Taxpayer = * * *
Parent = * * *

Dear * * *

This letter responds to Taxpayer's request for a letter ruling that the payment of certain investment advisory fees from an annuity contract will not be treated as an amount received by the owner of that annuity contract for purposes of section 72(e) of the Internal Revenue Code (the “Code”).

FACTS

Taxpayer is a life insurance company within the meaning of section 816(a). Taxpayer is wholly owned by Parent and joins in the filing of a consolidated federal income tax return with Parent. Taxpayer offers a non-qualified deferred annuity contract (referred to herein as the “Adviser Contract”). Each Adviser Contract will be issued to and owned by an individual or issued to and owned by a “trust or other entity as an agent for a natural person” within the meaning of section 72(u)(1) (the “Owner”).

Each Adviser Contract is an annuity contract under the law of the jurisdiction where issued. Each Adviser Contract qualifies for treatment as an annuity contract for federal income tax purposes, including by complying with the requirements of section 72(s). Each Adviser Contract is comprised of an accumulation phase and a payout phase. During the accumulation phase, the cash value of the Adviser Contract is credited with earnings or interest based on investment options the Owner selects from a menu provided by Taxpayer (the “Options”).

The Adviser Contract is a variable annuity contract within the meaning of section 817(d) and will be registered as a security with the Security Exchange Commission. The Options correspond to segregated asset accounts that hold diversified portfolios of assets. The Adviser Contract's cash value fluctuates up or down with the actual investment performance and market value of the separate account assets corresponding to the selected Options. Owners can select payments during the payout phase for the single life of a designated annuitant or for the joint life of designated annuitants, with a 10-year guaranteed term certain. Each Adviser Contract allows for amounts to be allocated among the Options at the time the Adviser Contract is purchased and for amounts to be re-allocated among the Options thereafter if the Owner's tolerance for investment risk changes over time.

The Adviser Contract is designed for Owners who will receive ongoing investment advice from an investment adviser (the “Adviser”) on how to allocate an Adviser Contract's cash value (within the meaning of section 72(e)(3)(A)(i)) among the available Options. The Adviser is expected to take into account factors such as (1) the Owner's personal risk tolerance and investment timeline, (2) the interest rate and market environment, (3) the menu of Options available under the Adviser Contract, and (4) the various other benefits and features available under the Adviser Contract. The Adviser will be licensed to provide investment advice in accordance with all applicable laws and regulations. The Adviser and the firm he or she is associated with (if any) may or may not be affiliated with Taxpayer.

In consideration for its advice, the Owner will authorize investment advisory fees (the “Fees”) to be paid periodically to the Adviser from the Adviser Contract's cash value in a separately-negotiated agreement (the “Authorization”). The Fees will be determined based on an arms-length transaction between the Owner and the Adviser. The Fees will not exceed an amount equal to an annual rate of 1.5% of the Adviser Contract's cash value (within the meaning of section 72(e)(3)(A)(i)), determined as a percentage of the cash value as of the last day of the period in which the advisory services were provided. The Fees will compensate the Adviser only for investment advice that the Adviser provides to the Owner with respect to the Adviser Contract, and not for any other services. The Fees will not result in any reduction in fees related to any other asset or for any other service.

Taxpayer will pay the Fees directly to the Adviser. During any period for which the Authorization is in effect, the Adviser Contract will be solely liable for paying the Fees and the Fees will not be paid directly by the Owner. Similarly, the Owner will not have the right to direct payment of the Fees for any other purpose or to any other person. The Adviser will not receive a commission for the sale of the Adviser Contract from Taxpayer, but the Adviser's firm may receive a marketing or wholesaling allowance from Taxpayer to promote Taxpayer's products or to act as intermediary between the Owner and Taxpayer. In all cases, any wholesaling or marketing allowance Taxpayer may pay will fall within requirements provided by state and federal regulatory agencies providing oversight to the annuity industry.

REQUESTED RULING

Taxpayer requests a ruling that the Fees Taxpayer deducts from the Adviser Contract's cash value and remits to the Adviser will not be treated as an “amount received” by the Owner of the Adviser Contract for purposes of section 72(e).

LAW AND ANALYSIS

Law

Section 72 distinguishes between an “amount received as an annuity” under an annuity, endowment, or life insurance contract and an “amount not received as an annuity” under those contracts. Section 1.72-1(b) of the Income Tax Regulations (the “Regulations”) provides that “amounts received as an annuity” are amounts which are payable at regular intervals over a period of more than one full year from the date on which they are deemed to begin, provided the total of the amounts so payable or the period for which they are to be paid can be determined as of that date. See section 1.72-2(b)(2) and (3) of the Regulations. Any other amounts to which the provisions of section 72 apply are considered to be “amounts not received as an annuity.” See section 1.72-11 of the Regulations.

Section 1.72-2(b)(2) of the Regulations provides that amounts “are considered 'amounts received as an annuity' only in the event that the following tests are met:

Section 1.72-11(a)(1) of the Regulations describes “amounts not received as an annuity” as “amounts received under a contract to which section 72 applies [i.e. an annuity contract] if either:

Section 72(e) applies to any “amount not received as an annuity” under an annuity, endowment, or life insurance contract. Section 72(e)(2)(A) provides that if any amount which is not received as an annuity is received on or after the annuity starting date, it is included in gross income. Section 72(e)(2)(B) provides that if any amount which is not received as an annuity is received before the annuity starting date, it is included in gross income to the extent allocable to income on the contract and is not included in gross income to the extent allocable to the investment in the contract.

Analysis

In this case, the Fees are integral to the operation of the Adviser Contract. During any period for which the Authorization is in effect, the Owner will receive ongoing investment advice from the Adviser with respect to the Adviser Contract so that the Owner may properly utilize the Adviser Contract. The Adviser is expected to help the Owner select Options related to the Adviser Contract. Taxpayer has represented that the Fees will not serve as consideration for anything other than investment advice provided by the Adviser in relation to the Adviser Contract. Furthermore, Taxpayer has represented that the Fees will not exceed an annual rate of 1.5% of the Adviser Contract's cash value based on the period to which the Fees relate. Based on Taxpayer's representations, the Fees will only be used to pay for ongoing investment advisory services relating to the Adviser Contract. Because the Adviser Contract is designed to work with an Adviser, the Adviser Contract is solely liable for the Fees. The Fees do not constitute compensation to the Adviser for services related to any assets of the Owner other than the Adviser Contract or any services other than investment advice services with respect to the Adviser Contract. Therefore, the Fees are an expense of the Adviser Contract, not a distribution to the Owner.

RULING

The Fees Taxpayer deducts from the Adviser Contract's cash value and remits to the Adviser will not be treated as an “amount received” by the Owner of the Adviser Contract for purposes of section 72(e).

CAVEATS

The ruling contained in this letter is based upon information and representations submitted by Taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

The ruling contained in this letter does not apply to any amount paid by Taxpayer that compensates the Adviser for services related to assets other than the Adviser Contract or for any services provided other than ongoing investment advice services with respect to the Adviser Contract. Any such amount would be an “amount received” by the Owner of the Adviser Contract for purposes of section 72(e).

Except as specifically set forth above, no opinion is expressed or implied concerning the federal tax consequences of the proposed transaction under any other provision of the Code or Regulations.

This letter ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

Taxpayer must attach a copy of this letter ruling to any tax return to which it is relevant.

In accordance with the power of attorney on file with this office, a copy of this letter is being sent to your authorized representative.

Sincerely,

Rebecca L. Baxter
Senior Technician Reviewer, Branch 4
(Financial Institutions & Products)

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