Implications of the Treasury Department’s Final Regulations on Reportable Policy Sales for 1035 Exchanges Made by Businesses

On October 31, the Treasury Department released its final regulations on Reportable Policy Sales (RPS). In addition to clarifying the tax implications for company-owned life insurance (“COLI”) and bank-owned life insurance (“BOLI”) transferred in ordinary course transactions, the rule also cemented the Treasury Department’s position on how the requirements will apply with respect to section 1035 exchanges made by businesses.

• First, life insurance companies acquiring an old life insurance policy pursuant to a section 1035 exchange is not treated as a RPS.
• More importantly, for the business exchanging a policy, the acquisition of the new policy is treated as an RPS unless the policyholder qualifies for one of the “substantial relationship” (with the insured) exemptions:
  • Substantial Relationship Rule
  • Special Rule for Indirect Acquisitions of Life Insurance
  • Substantial Business Relationship Exists
  • Substantial Financial Relationship
• Thus, for section 1035 exchanges on policies written on the life of a former employee, for example, the business may lack a sufficient substantial relationship with the insured in order to avoid an RPS status, limiting the excludable portion of the death benefit to the consideration paid for the policy plus any subsequent premiums paid on the policy. 

We hope you find this information useful. Feel free to contact us if we may be of further assistance.

Through a powerful combination of independence and experience, Mullin Barens Sanford Financial and Insurance Services (MBS Financial) is a leading consulting firm that assists companies with 409A and other executive benefit needs.