IRS Shows How the TCJA Life Policy Sale Tax Rules Might Really Work

Taxable income = $30,000 – ($20,000 + $9,000) = $1,000

Life settlement brokers and life settlement companies said Revenue Ruling 2009-13 was hard on consumers, partly because it increased consumers’ tax bills, but partly because many consumers had no practical way to figure out what part of the premiums paid went toward the cost of insurance.

TCJA Section 13521

TCJA Section 13521 has eliminated the need for consumers who sell life insurance policies to include the cost of insurance in the taxable income calculations.

Now, when consumers sell policies, they can simply calculate the taxable income by subtracting the total amount of premiums paid from the policy sale price.

TCJA Section 13521 reversed the 2009 IRS rulings by changing Section 1016(a) of the Internal Revenue Code (IRC).

TCJA Section 13521 refers to life insurance policies, but it does not use the term “life settlement,” or any synonym for life settlement. That means it could end up applying to policy sales that are not life settlements.

Similarly, the authors of Revenue Ruling 2020-05 have written about policy sales without using phrases such as “life settlement” or “life settlement provider.” The ruling could apply to other types of deals in which one party acquires the right to collect a life insurance policy’s death benefits from another party.

The New Revenue Ruling

IRS officials have re-used some of the policy sale scenarios used in the 2009 revenue rulings.

Here’s how they calculated the taxable income for the consumer who sold the permanent life policy, under the new, TCJA rules:

Taxable income = Policy sale price – Total premiums paid = $80,000 – $64,000 = $16,000

In this new scenario, the seller’s taxable income from the policy sale is about 38% lower than in the 2009 version.

Here how officials calculated the taxable income for the consumer who sold the term life policy:

Taxable income = Policy sale price – Total premiums paid = $20,000 – $45,000 = a $25,000 loss

Officials noted that the consumer can recognize the $25,000 loss on the sale, but that the consumer cannot actually deduct the loss from taxable income, unless the consumer is in the business of buying and selling life insurance policies.

For an ordinary consumer, in this scenario, taxable income from the policy sale would go to $0, from $19,750 in the 2009 revenue ruling scenario.

For a business that buys and sells life insurance policies, the formula for calculating taxable income from policy sales will stay the same, because a business could already leave cost-of-insurance amounts out of the calculations under the 2009 rules, IRS officials say.

If a business paid $20,000 for a consumer’s policy, paid $9,000 in premiums to keep the policy in force, and then sold the policy to another company for $30,000, its taxable income from the policy sale would still be $1,000, officials say.

Nuts and Bolts

The IRS lists Megan McGuire, of the IRS Office of the Associate Chief Counsel, as the principal author of the new revenue ruling.

The ruling applies to transactions entered into on or after Aug. 26, 2009.

IRS officials are warning consumers who have sold life insurance policies in the past against trying to collect federal income tax refunds based on the new revenue ruling.

Taxpayers still face time limits on when they can ask for income tax refunds, IRS officials write in the new ruling.

Congress sometimes eases the time limits on when taxpayers can ask for refunds. For life insurance policy sellers, Congress did not do that, IRS officials say.

— Read Life Settlement Players Struggle With Tax Form Void, on ThinkAdvisor.

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