144 / How is the value of a life insurance policy determined for income tax purposes?
Transfers of property after June 30, 1969 in connection with the performance of services are governed by IRC Section 83. For transfers before February 13, 2004, Treasury Regulation Section 1.83-3(e) provided that, “In the case of a transfer of a life insurance contract, retirement income contract, endowment contract, or other contract providing life insurance protection, only the cash surrender value of the contract is considered to be property.”
For transfers after February 12, 2004, the Treasury Regulations generally treat the policy’s fair market value (specifically the policy cash value and all other rights under the contract, including any supplemental agreements to the contract, whether or not they are guaranteed, other than current life insurance protection) as property. For transfers of life insurance contracts that are part of split-dollar arrangements that are not subject to the split-dollar regulations ( Q 4022), however, only the cash surrender value of the contract is considered property.1
The IRS has provided a safe harbor on how to determine the fair market value of a life insurance contract.2 The fair market value of a life insurance contract may be the greater of either: (1) the interpolated terminal reserve and any unearned premiums, plus a pro rata portion of a reasonable estimate of dividends expected to be paid for that policy year, or (2) the product of the “PERC amount” (PERC stands for premiums, earnings, and reasonable charges) and the applicable “Average Surrender Factor.”