Creditor Insurance

<p>If the insured stockholder pays the premiums, the stockholder is denied a deduction on the ground that the premium payments are not an ordinary and necessary expense of carrying on the stockholder&rsquo;s business.<a href="#_ftn1" name="_ftnref1">¹</a> If the corporation pays the premiums, they are nondeductible under IRC Section 264(a)(1) because the corporation is indirectly a beneficiary under the policy.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>. <em>Morison v. Comm.</em>, TC Memo 196043.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. See Rev. Rul. 68-5, 1968-1 CB 99.</p></p><br />

<div class="Section1"><br /> <br /> Yes.<br /> <br /> This is true regardless of policy ownership or beneficiary designation. To the extent that the creditor has a right to collect the debt from the proceeds, the proceeds are considered to be receivable for the benefit of the estate ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="81">81</a>).<a href="#_ftn1" name="_ftnref1">¹</a> It is immaterial whether the debt is actually paid from estate assets or that the beneficiary has a right to recover from the estate the amount of proceeds paid to the creditor.<a href="#_ftn2" name="_ftnref2">²</a> The amount of the debt outstanding at the date of the insured&rsquo;s death, with interest accrued to that date, is deductible in determining the taxable estate even though the debt is paid from the proceeds.<a href="#_ftn3" name="_ftnref3">³</a> (For a policy loan, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="187">187</a>.)<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 2042(1); Treas. Reg. &sect; 20.2042-1(b); <em>Fidelity Trust Co. (Matthews) v. Comm.</em>, 3 TC 525 (1944); <em>Est. of Hofferbert v. Comm.</em>, 46 BTA 1101 (1942); <em>Morton v. Comm.</em>, 23 BTA 236 (1931); <em>cf. Prichard v. U.S.</em>, 397 F.2d 60 (5th Cir. 1968) and <em>Bintliff v. U.S.</em>, 462 F.2d 403 (5th Cir. 1972).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. <em>Est. of Gwinn v. Comm</em>., 25 TC 31 (1955).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. Treas. Reg. &sect;&sect; 20.2042-1(b)(1), 20.2053-4.<br /> <br /> </div></div><br />

<p>Yes.<br /> <br /> The entire amount of the death proceeds is exempt, including the interest element in installment settlements. Likewise, any gain realized on lifetime proceeds from matured endowments or surrender of policies is exempt from income tax. Dividends also are exempt from income tax.<a href="#_ftn1" name="_ftnref1">¹</a> The interest on accumulated dividends is not taxable.<a href="#_ftn2" name="_ftnref2">²</a> Accumulated dividends applied to the purchase of additional National Service Life Insurance and the additional paid-up insurance acquired are not subject to federal income tax.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>. 38 U.S.C. &sect; 5301(a); Rev. Rul. 71-306, 1971 CB 76.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. Rev. Rul. 91-14, 1991-1 CB 18.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. Rev. Rul. 72-604, 1972 CB 35.</p></p><br />

<div class="Section1">Based on the reasoning of the cases cited in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="132">132</a>, it appears unlikely that the creditor can secure a nonbusiness expense deduction. Moreover, when proceeds are receivable as tax-exempt life insurance proceeds, it would appear that IRC Section 265(a)(1) prohibits that deduction of premiums ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8794">8794</a>).If the debtor is directly or indirectly a beneficiary under the policy, IRC Section 264(a)(1) prohibits the deduction ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="262">262</a>). The IRS has allowed a business expense deduction for premiums paid by a taxpayer in the business of selling property for one-year term insurance purchased on the lives of installment purchasers where no separate charge was made for the insurance and where the death proceeds (payable to the seller) were in the amount of the unpaid balance of the purchase price. Proceeds receivable by the seller were treated as collections on the purchase price, not as life insurance proceeds excludable under IRC Section 101(a).<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Rev. Rul. 7054, 1970-1 CB 31.<br /> <br /> </div></div><br />

<p>The deduction has been denied on the ground that the premium payments are a capital investment rather than expenses incurred &ldquo;for the production or collection of income, or for the management, conservation and maintenance of property held for the production of income.&rdquo;<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>. <em>U.S. v. Mellinger</em>, 228 F.2d 688 (5th Cir. 1956); <em>Home News Publishing Co. v. Comm.</em>, TC Memo 1969-167; see also <em>Blumenthal v. Comm.</em>, TC Memo 196369, <em>aff&rsquo;d</em>, 14 AFTR 2d 5094 (4th Cir. 1964).</p></p><br />

<p>Yes, provided the cash surrender value of the policy is less than the debt. The creditor may deduct the difference between the cash surrender value and the debt or, if the policy has no cash surrender value, the creditor may deduct the full amount of the worthless debt. The creditor may take the deduction even though the creditor continues to hold the policy and the face of the policy exceeds the debt. Collateral need not be liquidated to establish the worthless portion of the debt.<a href="#_ftn1" name="_ftnref1">¹</a> If a deduction was not previously taken, a deduction for the uncollectible balance may be taken in the year the creditor surrenders the policy.<a href="#_ftn2" name="_ftnref2">²</a> No bad debt deduction will be allowed at any time, however, for advances that were made when prior loans exceeded the face of the policy and the debtor was insolvent.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>. <em>Hatboro Nat&rsquo;l Bank v. Comm.</em>, 24 TC 786 (1955).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. <em>Mattlage v. Comm.</em>, 3 BTA 242 (1925).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. <em>Blumenthal v. Comm.</em>, TC Memo 196369, <em>aff&rsquo;d</em>, 14 AFTR 2d 5094 (4th Cir. 1964).</p></p><br />

<div class="Section1"><br /> As a general rule, if a property interest passing to a surviving spouse is subject to an encumbrance, only the value of the property interest in excess of the amount of the encumbrance qualifies for the marital deduction.<a href="#_ftn1" name="_ftnref1">¹</a> If the debt that is secured by the policy is actually paid from estate assets, or if the spouse-beneficiary has a right of subrogation against the estate and the estate is solvent, the full amount of the proceeds qualifies for the marital deduction despite the collateral assignment.<a href="#_ftn2" name="_ftnref2">²</a> (For a policy loan, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="187">187</a>.)<div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 2056(b)(4)(B).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. <em>Est. of Gwinn v. Comm.</em>, 25 TC 31 (1955), acq. 1956-1 CB 4; <em>Wachovia Bank &amp; Trust Co. v. U.S.</em>, 163 F. Supp. 832 (Ct. Cl. 1958); Treas. Reg. &sect; 20.2056(b)-4(b).<br /> <br /> </div></div><br />

<p>No.<br /> <br /> The answer is the same regardless of whether the debtor takes out a new policy for the benefit of the creditor or assigns an existing policy to the creditor. The deduction will be denied even though the debtor was required to take out the policy to obtain the loan. If the debt is personal, the premiums are nondeductible personal expenses.<a href="#_ftn1" name="_ftnref1">¹</a> If the debt is a business debt, the deduction is denied under IRC Section 264(a)(1), which provides that no deduction is allowed for premiums on any life insurance policy, endowment, or annuity contract if the taxpayer is directly or indirectly a beneficiary under the policy or contract. For this purpose, the insured debtor is at least indirectly a beneficiary under the policy because the proceeds may be used to satisfy the insured&rsquo;s debt.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> IRC Section 264(a)(1) also acts as a bar to a nonbusiness deduction. Thus, the deduction was denied for premiums the taxpayer paid on insurance used as collateral for a bank loan to a company in which the taxpayer was a major stockholder; the premiums were paid to protect the taxpayer&rsquo;s personal securities, which were also part of the collateral for the loan.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> The deduction is disallowed even when the person who pays the premiums is merely a guarantor and therefore only secondarily liable for the debt.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>. IRC &sect; 262.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. <em>Glassner v. Comm</em>, 360 F.2d 33, <em>cert. denied</em>, 385 U.S. 819 (1966); <em>O&rsquo;Donohue v. Comm</em>., 33 TC 698 (1960); <em>Hanson v. Comm</em>., TC Memo 1970-15; Rev. Rul. 68-5, 1968-1 CB 99.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. <em>Carbine v. Comm.</em>, 85 USTC &para; 9854 (11th Cir. 1985).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. <em>D&rsquo;Angelo Assoc., Inc. v. Comm.</em>, 70 TC 121 (1978), acq. in result, 1979-1 CB 1.</p></p><br />

<p>The IRS takes the position that the creditor cannot claim a deduction unless the creditor shows that the creditor&rsquo;s right to reimbursement for the premium payment was worthless in the year of payment. Thus, if the creditor has a right to proceed against the debtor for reimbursement, the debtor must be insolvent or the claim must be otherwise uncollectible. If the creditor has a right, express or implied, to reimbursement from the policy, the cash surrender value must be insufficient to cover the balance of the unpaid debt and the premium payment. If the creditor has both rights, both must be worthless.<a href="#_ftn1" name="_ftnref1">¹</a> Premiums that are not deductible are treated as additional advances that increase the debt.<br /> <br /> Courts, however, have allowed the deduction without regard to the taxpayer&rsquo;s ability to recover the premium out of the cash surrender value of the policies.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> The IRS would disallow a deduction for the premium payment if the creditor has taken a bad debt deduction for the debt and the cash surrender value of the policy is sufficient to provide reimbursement for the premium payment. In <em>Charleston Nat&rsquo;l Bank</em>, however, the court held that the premium payment was deductible even though the creditor had taken a bad debt deduction for the debt and the cash surrender value exceeded the current premium and premium payments not deducted in prior years.<br /> <br /> The deduction is allowable not as a bad debt but as an ordinary and necessary business expense, incident to the protection of the collateral.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> If premiums that have been deducted are later recovered from the proceeds, the recovery must be reported as taxable income. If the premiums have not been deducted, however, the recovery will be tax-free.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> <hr align="left" size="1" width="33%"><a href="#_ftnref1" name="_ftn1">1</a><p>. Rev. Rul. 75-46, 1975-1 CB 55.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. <em>Comm. v. Charleston Nat&rsquo;l Bank</em>, 20 TC 253 (1953) <em>aff&rsquo;d,</em> 213 F.2d 45 (4th Cir. 1954); <em>First Nat&rsquo;l Bank &amp; Trust Co. v. Jones</em>, 143 F.2d 652 (10th Cir. 1944).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. <em>First Nat&rsquo;l Bank &amp; Trust Co. v. Jones, supra; Blumenthal v. Comm</em>., TC Memo 196369, <em>aff&rsquo;d</em>, 14 AFTR 2d 5094 (4th Cir. 1964). See also Rev. Rul. 75-46, 1975-1 CB 55.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. <em>St. Louis Refrigerating &amp; Cold Storage Co. v. U.S.</em>, 162 F.2d 394 (8th Cir. 1947).</p></p><br />

<div class="Section1">Basically, no.<div></div><div class="Section1">Multiple-life policies may insure two or more lives. Typically, a &ldquo;first-to-die&rdquo; or &ldquo;joint life&rdquo; policy pays a death benefit at the death of the first insured person to die while a &ldquo;second-to-die&rdquo; or &ldquo;survivorship&rdquo; 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 <a href="javascript:void(0)" class="accordion-cross-reference" id="65">65</a>).<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> For multiple-life policies that meet the definition of life insurance, cash surrender value increases generally are not taxed until received ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8">8</a>) and death proceeds generally are received income tax-free ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="63">63</a>). Multiple-life policies are subject to the seven pay test of IRC Section 7702A(b) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="13">13</a>) 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 <a href="javascript:void(0)" class="accordion-cross-reference" id="10">10</a>). 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 <a href="javascript:void(0)" class="accordion-cross-reference" id="13">13</a>).<br /> <br /> 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 <a href="javascript:void(0)" class="accordion-cross-reference" id="44">44</a>).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> In another private ruling, however, the IRS approved IRC Section 1035 treatment of the exchange of a joint and last survivor life insurance policy, following the death of one of the insured persons, for a universal variable life insurance policy that insured the survivor ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="44">44</a>).<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> There has been no formal guidance from the IRS as to which rates should be used to measure economic benefit when a multiple-life policy is used in an arrangement that requires the insured or insureds to include the economic benefit of the coverage in income. The most frequently used rates have been those derived from U.S. Life Table 38, which also is used to derive the P.S. 58 rates. P.S. 58 rates generally may not be used in arrangements entered into after January 27, 2002; however, in those situations, Table 2001 may be used. According to the IRS, taxpayers should make appropriate adjustments to the Table 2001 rates if the life insurance protection covers more than one life.<a href="#_ftn4" name="_ftnref4">⁴</a> When the policy death benefit is payable at the second death, it generally is believed that following the first death, the Table 2001 rates (or P.S. 58 rates, if appropriate) for single lives should be used to measure the survivor&rsquo;s economic benefit. See volume 2, Appendix G for P.S. 58 and Table 2001 rates.<br /> <br /> For estate taxation of policies insuring more than one life, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="199">199</a>. For gift taxation of these policies, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="211">211</a>.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Prop. Treas. Reg. &sect; 1.7702-1(c).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. Let. Rul. 9542037.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. Let. Rul. 9248013; see also Let. Rul. 9330040.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. Notice 2002-8, 2002-1 CB 398.<br /> <br /> </div></div><br />