43 / How is the purchaser of a life insurance or endowment contract taxed?

Editor’s Note: The 2017 tax reform legislation reversed the IRS position in Revenue Ruling 2009-13, and instead now provides that in determining basis, no adjustment is made for mortality, expense or other reasonable charges incurred under the contract (the “cost of insurance”) in the case of a policy sale. See Q 36 to Q 39.

If a purchaser receives lifetime proceeds under a life insurance or endowment contract, the purchaser is generally taxed in the same way as an original owner would be taxed, but with the following differences. The purchaser’s cost basis is the consideration the purchaser paid for the contract, plus any premiums the purchaser paid after the purchase, less any excludable dividends and unrepaid excludable loans received by the purchaser after the purchase.¹ It also should be noted that the purchase of a life insurance policy will, under some circumstances, result in loss of the income tax exemption for the death proceeds, under IRC Section 101(a)(2), the so-called “transfer-for-value” rule (see Q 279 through Q 290).

Revenue Ruling 2009-14

In 2009, the IRS released guidance regarding the different tax consequences for an investor (B) upon the receipt of either (1) death benefits or (2) sale proceeds with regard to a term life insurance policy that the investor purchased for profit.²