Revenue Ruling 79-46: Valuing Life Insurance Transfers
Understand the IRS valuation for a life insurance policy transferred from an employer, a method creating taxable income beyond its cash surrender value.
Revenue Ruling 79-46 provides guidance for valuing a life insurance contract when it is transferred from an employer to an employee. This ruling clarifies the method for determining the policy’s fair market value for tax purposes in these transactions. It addresses situations where an employer sells an existing policy on an employee’s life to that employee. The ruling ensures that the value reported for tax purposes reflects the true economic benefit being transferred, rather than a lower, artificial figure.
The Factual Scenario of the Ruling
Revenue Ruling 79-46 was issued in response to a specific employer-employee transaction. In the case presented, a corporation held a life insurance policy on one of its employees and was responsible for paying all the premiums. At a certain point, the corporation sold the policy to the employee.
The price the employee paid for the policy was its stated cash surrender value at the time of the sale. The cash surrender value is the amount the insurance company would pay to the policy owner upon cancellation of the policy. A key detail was that this cash surrender value was lower than the policy’s actual economic worth. This discrepancy prompted the IRS to issue the ruling to prevent the undervaluation of this form of compensation.
The IRS Conclusion and Valuation Method
The IRS concluded that using the cash surrender value did not accurately represent the fair market value of the life insurance policy. The ruling mandates a valuation method based on standards in the Gift Tax Regulations. This regulation stipulates that the value of a policy that has been in force for some time and on which premiums are still being paid is not its cash surrender value, but its “interpolated terminal reserve” on the date of the sale.
To this interpolated terminal reserve figure, one must add the proportionate part of the last premium paid by the employer that covers the period extending beyond the sale date. The term “interpolated terminal reserve” is an approximation of the policy’s reserve value calculated between its anniversary dates. This value must be obtained directly from the insurance company that issued the policy.
Tax Implications for the Employee and Employer
The valuation method has direct tax consequences for both the employee and the employer. For the employee, the difference between the policy’s fair market value, as determined by the interpolated terminal reserve method, and the amount they paid for it is considered taxable income as compensation for services. For instance, if the policy’s interpolated terminal reserve value is $15,000 and the employee purchased it for its cash surrender value of $10,000, the $5,000 difference must be reported as income.
The employer has a corresponding obligation to report this compensation on the employee’s annual Form W-2, Wage and Tax Statement. The employer is responsible for accurately calculating this value based on the information from the insurance carrier and reflecting it in the employee’s payroll records for the year of the transfer.