33 / Are there any exceptions to the general rule of nondeductibility of policy loan interest for unborrowed policy cash values?
There is an exception to the general rule of nondeductibility of policy loan interest expense that is allocable to unborrowed policy cash values. The exception applies to any policy or contract owned by an entity engaged in a trade or business if the policy or contract covers only one individual who, at the time first covered by the policy or contract, is: (1) a 20 percent owner of the entity, or (2) an individual who is not a 20 percent owner but who is an officer, director, or employee of the trade or business. (A 20 percent owner is defined in IRC Section 264(e)(4)). A policy or contract covering a 20 percent owner will not fail to come within this exception simply because it covers both the owner and the owner’s spouse. Apparently, however, the policy will not qualify for this exception if spouses of officers, directors, or employees who are not also 20 percent owners are covered. For purposes of this rule, if coverage for each insured under a master contract (that is not a group life insurance contract) is treated as a separate contract for certain purposes, the coverage for each insured is treated as a separate contract.1
The exception is effective generally for contracts issued after June 8, 1997, in taxable years ending after this date. For purposes of this effective date, any material increase in the death benefit or other material change in the contract will be treated as a new contract. However, in the case of a master contract, the addition of covered lives is treated as a new contract only with respect to the additional covered lives.2
1. IRC § 264(f)(4)(E).
2. TRA ’97 § 1084(d), as amended by IRSRRA ’98 § 6010(o)(3)(B). See IRC § 264(f)(4)(E) for the definition of “master contract.”