The recent development and growth of a secondary market for life insurance policies (known as Stranger-Owned Life Insurance, Investor-Owned Life Insurance, Trust-Owned Life Insurance or Charity-Owned Life Insurance) has presented a number of tax issues recently addressed by the Tax Section of the New York State Bar Association. In its report, the Tax Section asks the IRS:
- To clarify that Section 1234A of the Code (dealing with gains or losses from certain terminations) does not apply to death benefits under a policy;
- To clarify that the amount of gain realized on the sale of a policy would be ordinary income to the extent of a policy’s cash surrender value and capital gains to the extent of any gain in excess of the cash surrender value;
- To confirm that a purchaser acquires a basis in the policy equal to the sum of the purchase price paid for the policy and the aggregate premiums paid on the policy (without reduction for amounts allocated to the “cost of insurance’”); and
- To clarify the application of Section 264(f) of the Code to the policy.
On the state level, the NAIC and NCOIL Model Acts have adopted different approaches to address the secondary life insurance market. The NAIC Model Act establishes a fiveyear moratorium on the settlement of policies not purchased with the policyholder’s own money. The NCOIL Model Act, on the other hand, applies to all forms of life policies sold in the secondary market, classifying any practice involving such policies as a “fraudulent life settlement act.” Since 2007, 14 states have enacted legislation dealing with the sale of life policies in the secondary market. State activity is expected to continue in 2009.