“New IRS Revenue Rulings: Amount and Character of Income on Life Insurance Contracts”

On May 1, 2009, the IRS issued a pair of Revenue Rulings that significantly clarify the state of U.S. federal tax law applicable to transactions involving life insurance policies, including life settlements.  Life settlements are a rapidly growing asset category in which investors purchase life insurance policies on the secondary market with the intention of profiting by either reselling them later for a gain or holding them until maturity.  One of the impediments to the development of this asset class has been the uncertainty of the U.S. federal income taxation in this area because most of the cases and rulings predate the development of an active secondary market for life insurance policies.

This Stroock Special Bulletin highlights some of the ways in which the IRS Revenue Rulings are an improvement over the prior state of law, and discusses some important issues that remain and additional questions the Revenue Rulings raise.  The holdings of the Revenue Ruling relating to reductions of basis in the hands of the insured for the cost of insurance protection will not be applied to sales occurring before August 26, 2009.