3 / Can a taxpayer deduct interest paid on a loan to purchase or carry a life insurance, endowment, or annuity contract?
Interest paid or accrued on indebtedness incurred to purchase or continue in effect a single premium life insurance, endowment, or annuity contract purchased after March 1, 1954, is not deductible.1 For this purpose, a single premium contract is defined as one on which substantially all the premiums are paid within four years from the date of purchase, or on which an amount is deposited with the insurer for payment of a substantial number of future premiums.2 One court has held that payment in the first four years of 73 percent of total annual premiums for a limited-pay policy did not constitute payment of “substantially all” of the premiums.3 Another court has ruled that payment of eight annual premiums in the first four years on a whole life policy was neither “substantially all” nor a “substantial number” of the premiums.4
When a single premium annuity is used as collateral to either obtain or continue a mortgage, the IRS has found that IRC Section 264(a)(2) disallows the allocable amount of mortgage interest to the extent that the mortgage is collateralized by the annuity. However, this result does not hold when a taxpayer’s use of available cash to purchase an annuity results in a larger home mortgage or when a taxpayer does not surrender an annuity even though cash obtained from the surrender would make it possible to reduce the amount of the mortgage.5 A general counsel memorandum has concluded that borrowing against the cash value of a single premium life insurance policy is equivalent to using the policy as collateral.6
In restating the rule concerning single premium contracts, the conference committee report accompanying the Tax Reform Act of 1986 (TRA ’86) states that “no inference is intended that universal life insurance policies are always treated as single premium contracts.”7 It is still unclear whether the four exceptions applicable to contracts other than single premium contracts can be used in the case of universal life contracts.
Other than Single Premium Contract