In proposed regulations released March 25, 2019, the IRS and Treasury provide guidance under Section 6050Y on new information reporting obligations resulting from life settlement transactions, including reportable life insurance policy sales, transfers of life insurance contracts to foreign persons, and payments of reportable death benefits. The proposed regulations also include guidance under Section 101 on the amount of death benefits excluded from gross income following a reportable policy sale.

Background

The Tax Cuts and Jobs Act, enacted December 22, 2017, added IRC Section 6050Y, and modified Section 101. In Notice 2018-41, the IRS identified which parties would be subject to the new provisions, and issued draft forms on August 9, 2018, to facilitate the new reporting requirement, including Forms 1099-LS, Reportable Life Insurance Sale, and 1099-SB, Seller's Investment in Life Insurance Contract. At that time, Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance, etc., was also modified to collect the payment date of reportable death benefits.

The proposed regulations would apply to reportable life insurance policy sales made and reportable death benefits paid after December 31, 2017. Transition relief applies until the regulations are finalized. While many previous industry comments were taken into account in the proposed regulations, additional comments are requested and a public hearing on these proposed regulations is scheduled for June 5, 2019.

EY observes: Those required to report must look back to identify reportable life insurance policy sales and reportable death benefits paid from January 1, 2018 forward. While transition relief applies until after the regulations are finalized, those that must report are not relieved of their reporting responsibilities for the period before the issuance of the final regulations.

EY observes: All organizations that must report on these transactions should prepare for the new rules and consider how best to implement them in practice. Creating processes and systems to capture, collect and report all the now required information will be a substantial effort.

Key highlights

The proposed regulations introduce many new concepts. Highlights in the proposed regulations include the following:

Affected parties. Issuers and acquirers have reporting obligations to the IRS and to other parties to the transactions. The proposed regulations identify these parties as:

1. Issuers - broadly defined to include life insurance companies, reinsurers, administrators
2. Acquirers - include US and non-US investors who acquire interests in life insurance contracts either directly or indirectly through investments trusts, partnerships or other investments
3. Sellers - whether original insureds or subsequent sellers
4. Life settlement companies, other brokers and intermediaries

Definition of issuer includes reinsurers and others. The proposed regulations broadly define the "issuer" of a life insurance contract, which is important in determining who is responsible for reporting. Prop. Treas. Reg. Section 1.6050Y-1(a)(8) defines "issuer" as "any person that bears any part of the risk with respect to the life insurance contract," including the person collecting premiums and paying death benefits. An "issuer" includes the original issuer of the insurance contract, reinsurers and designees for reporting purposes. While there may be multiple issuers, Prop. Treas. Reg. Section 1.6050Y-3(b) provides that, for purposes of reporting a reportable policy sale to the IRS or transfer to foreign persons, an issuer is deemed to have met its obligations if just one of the applicable issuers or designees makes a timely report.

EY observes: The inclusion of reinsurance companies as issuers is broader than had been provided in Notice 2018-41, which stated that reporting obligations would not apply to reinsurers.

EY observes: While all issuers are obligated to report, one report from one issuer satisfies the obligations of all issuers in the transaction. It is expected that agreements covering life insurance business, including reinsurance and intermediary and broker agreements, will specify which party will report.

Transfers to foreign persons. Under Prop. Treas. Reg. Section 1.6050Y-1(a)(10), notice of transfer to a foreign person means "any notice of a transfer," including a change-of-address notice "for purposes of sending statements or for other purposes," unless the issuer knows that no transfer has occurred or knows the transferee is a US person because a Form W-9 is on file for the transferee.

EY observes: Notices of this sort are common and may not currently be able to be tracked easily by issuers. While the examples given in the proposed regulations identify a notice that changes an address to a foreign address or foreign financial institution, the proposed regulation does not limit itself to changes from US addresses to foreign addresses, but implies that any address change must be reviewed for a potential notice of transfer.

Life insurance owned by C corporations. The proposed regulations would apply the new Section 6050Y and Section 101 rules to policies that are directly or indirectly transferred. Prop. Treas. Reg. Section 1.101-1(e)(3)(i) provides that an indirect transfer includes an acquisition of a policy through the purchase of an interest in a "partnership, trust, or other entity" that holds a direct or indirect interest in a life insurance contract. The proposed regulations provide that the term "other entity" does not include a C corporation unless more that 50% of the gross value of the C Corporation's assets are life insurance contracts.

EY observes: The 50% threshold is a welcome provision in the regulations. Corporations often buy life insurance on their key executives, shareholders and employees. There has been some concern that the purchase of a corporation could be treated as the indirect purchase of life insurance contracts owned by that corporation, thereby requiring notice and reporting. One remaining question is whether the 50% threshold will be tested on an entity-by-entity basis or a group-wide basis. Corporate groups often place ownership of the group's policies directly in a single member of the group. If testing is done on an entity basis, it is more likely that an entity will fail the 50% test than if the test is performed at a group level. It is also unclear how these rules will apply to corporate acquisitions that are structured as asset transfers.

Acquirer reporting to brokers and intermediaries. A broker or other intermediary that retains a portion of the payment is a recipient of a reportable policy sale payment. An acquirer must report net payments made to each recipient. The Treasury and IRS request comments on whether to allow reporting to continue in the "normal course" or to require new life settlement reporting.

Comments requested. While Treasury and the IRS have already taken into account many comments from industry, they have specifically requested additional input on the following:

1. Electronic furnishing of statements. Whether Section 6050Y reporting should provide rules that differ from those set forth in Treas. Reg. Section 31.6051-1(j).
2. Ancillary payments. Types and timing of payments of ancillary costs and expenses paid in reportable policy sales, the recipients of those payments, and existing reporting associated with such payments.
3. Should brokers, administrators and others have reporting responsibility? Whether only issuers should be considered payors of reportable death benefits under Section 6050Y or whether payors should be more broadly defined to include any holder of an interest in a life insurance contract that receives reportable death benefits and is contractually obligated to pay them to the beneficial owner of the interest.
4. Any other situation that would remove the reporting requirement. Whether there are other situations not mentioned in Prop. Treas. Reg. Section 1.101-1(d)(2) or (3) where a substantial business relationship or substantial financial relationship is considered to exist between the acquirer and the insured.
5. Regulations for Section 1035 exchanges. Whether the regulations should include additional provisions regarding treatment of Section 1035 exchanges.
6. Foreign partnerships and foreign trusts. Whether the exceptions to reporting by issuers and payors covering sellers and reportable death benefit payment recipients documented as foreign beneficial owners are appropriate when a foreign partnership or foreign trust is the seller or reportable death benefit recipient, and whether the proposed reporting requirements are duplicative or could be combined with other reporting requirements.

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