On May 1, 2009, the Internal Revenue Service (“IRS”) issued Revenue Rulings 2009-13 and 2009-14 with respect to the federal income tax treatment of certain life insurance transactions, including life settlements.

Revenue Ruling 2009-13 provides guidance in three situations:

  • Individual insured surrenders whole life policy to insurer for cash value: Revenue Rule 2009-13 provides that the amount received upon surrender must be included in gross income to the extent it exceeds the policyholder’s investment in the policy. For purposes of this scenario, the investment is the amount of premiums paid minus any amount previously received under the policy that was not included in gross income. The surrender is treated as ordinary income rather than capital gain. This part of the ruling is effective immediately.
  • Individual insured sells whole life policy to unrelated third party: The ruling requires that the policyholder recognize the excess of the amount realized on the sale above the adjusted tax basis which is calculated as the amount of the premiums paid minus the portion used to cover the cost of coverage. Proceeds of the sale are treated as ordinary income to the extent that such proceeds would have been treated as ordinary income if the policy had been surrendered. The remaining proceeds are treated as capital gain. This part of the ruling is effective immediately.
  • Individual insured sells term policy to unrelated third party: The ruling requires that the policyholder recognize the excess of the amount realized on the sale above the adjusted tax basis which is the full amount of the premiums paid. All sale proceeds are treated as capital gain because term policies have no cash surrender value. This part of the ruling does not apply to sales which occur before August 26, 2009.

Revenue Ruling 2009-14, like Revenue Ruling 2009-13, also provides guidance in three situations. Revenue Rule 2009-14 addresses situations involving a third party investor who has acquired an individual term policy issued by a U.S. insurer on the life of an unrelated insured who is a U.S. resident:

  • U.S. investor receives death benefits from insurer upon the death of unrelated insured: Revenue Ruling 2009-14 provides that the death benefits are taxed as ordinary income.to the investor. The investor's income is calculated as the amount of the death benefit received minus the consideration paid by the investor for the policy and the premiums paid on such policy.
  • U.S. investor sells policy on an unrelated insured to another unrelated party prior to the insured’s death: The ruling provides that the investor’s income will equal the amount received for the policy minus the tax basis in the policy. The tax basis is calculated as the consideration paid for the policy plus the premiums paid to keep such policy in force. The income recognized is treated as capital gain.
  • Non-U.S. investor receives death benefits from insurer upon the death of unrelated third party insured: The ruling provides that the investor must recognize as income the amount of the death benefit received minus the consideration paid by the investor for the policy and the premiums paid on such policy. In addition, the non-U.S. investor must pay a 30% tax on income derived from U.S. sources unless exempted under a tax treaty.