143 / Does the income taxation of a life insurance policy that insures more than one life differ from the taxation of a policy that insures a single life?

Multiple-life policies may insure two or more lives. Typically, a “first-to-die” or “joint life” policy pays a death benefit at the death of the first insured person to die while a “second-to-die” or “survivorship” policy does not pay a death benefit until the death of the survivor. Estate planning and business continuation planning are two of the more common uses for these types of policies. Generally, multiple-life policies are subject to the same definition of life insurance applicable to policies insuring a single life. One exception is that for purposes of calculating the net single premium under IRC Section 7702, multiple-life policies may not take advantage of the three safe harbor tests set forth in proposed regulations for meeting the reasonable mortality charge requirement ( Q 65).¹

For multiple-life policies that meet the definition of life insurance, cash surrender value increases generally are not taxed until received ( Q 8) and death proceeds generally are received income tax-free ( Q 63). Multiple-life policies are subject to the seven pay test of IRC Section 7702A(b) ( Q 13) in the same manner as single life policies. Distributions from life insurance policies entered into before June 21, 1988, or from policies entered into on or after this date that meet the seven pay test, are included in gross income only to the extent they exceed the investment in the contract ( Q 10). Policies entered into on or after June 21, 1988 that do not meet the seven pay test become classified as modified endowment contracts. Distributions, including loans, from modified endowment contracts are subject to taxation rules that generally are less favorable than the rules governing the taxation of distributions from life insurance policies that are not modified endowment contracts ( Q 13).

In a private letter ruling, the IRS concluded that exchanges involving policies insuring a single life for a policy insuring two lives did not qualify for nonrecognition treatment under IRC Section 1035. The IRS reached this outcome in five similar fact patterns ( Q 44).²