Springing Value Life Insurance Planning Attacked by IRS

The IRS has issued final regulations that seek to shut down "abusive" transactions involving life insurance policies designed to have a low cash surrender value when transferred from an Code Sec. 412(i) retirement plan or an employer to an employee. The general tax planning that the IRS was attacking generally involved:

a. Funds are transferred by an employer to purchase a life insurance policy on an employee in a retirement plan, with a deduction for the full amount of the contribution.

b. The retirement plan purchases a life insurance policy. The policy is structured to temporarily have a low cash surrender value - much lower than the premiums paid. The policy is distributed to the employee, and the employee is taxed on the low cash surrender value. The cash surrender value of the policy then increases under the terms of the policy.

The net effect - the employer gets a full deduction, but when the insurance policy is distributed to the employee, the income picked up by the employee is less than the deduction allowed the employer.

The new regulations aim to prevent this result by having the employee include income at the full fair market value of the life insurance contract transferred to him from the Code Sec. 412(i) retirement plan or the employer. Preamble to TD 08/26/2005 ; Reg. § 1.79-1 , Prop Reg § 1.83-3 ; Reg. § 1.402(a)-1 , Reg. § 1.402(a)-1(a)(2) .