- Schwab v. Commissioner, 111 AFTR-2d 2013-667 (April 24, 2013)
- June 5, 2013
- Law Firm: Proskauer Rose LLP - New York Office
The Court of Appeals for the 9th Circuit held that the "amount actually distributed" when taxpayers received ownership of life insurance policies was "the fair market value of what was actually distributed," and that surrender charges associated with a variable universal life insurance policy may be considered as part of the general inquiry into a policy's fair market value.
Two individuals (i.e., a married couple) were both employees and sole shareholders of a corporation. On the advice of their accountant, they purchased variable life insurance through the corporation and the policies were held by a third-party company as part of a nonqualified employee benefit plan. Both policies were subject to surrender charges (i.e., the fee incurred if the policies lapsed or were terminated prior to a contractually specified date). Due to poor performance of the employee benefit plan, the plan administrator terminated the plan and distributed the policies to the respective insured. On the distribution of the policies, there was a taxable event which required inclusion in the couple's gross income of the value of the policies. Believing that they were only required to pay taxes on the net cash surrender values of their policies (which were negative at the time of distribution), the couple did not report any taxable income. The IRS disagreed and issued a deficiency notice indicating that the full stated policy values must be treated as income.
The couple petitioned the Tax Court, arguing that they actually received nothing of value and, thus, should not pay taxes on the distribution. The IRS asserted that the surrender charges may never be considered in determining the value of the policies and that the couple actually received the full stated policy value of their respective policies. The Tax Court came down in the middle finding that the court could consider surrender charges but only as part of a more general inquiry into the policy's fair market value. In this case, the Tax Court considered the surrender charges in determining the value of the policies actually received and found that the only taxable value of the policies at the time of distribution was the unused premium (i.e., the coverage attributable to the single premium that the corporation had paid on each policy some three years earlier).