Tax overhaul may fuel life settlement industry

A doubled estate/gift tax exemption makes policies less necessary, while more favorable basis rules decrease gain on their sale.
By Gary A. Forster, J.D., LL.M. and Paige L. Minch, J.D.

The law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, approximately doubled the individual exemption from estate and gift tax, which increased from $5.49 million in 2017 to $11.18 million in 2018 through 2025, indexed for inflation.

Life insurance is often employed to reduce the estate tax's financial impact. The doubling of the estate and gift tax exemption diminishes the need for certain estates to use life insurance to cover the estate tax. Life insurance owners whose assets are now sheltered by the increased exemption may consider selling policies that are no longer necessary. Those who sell will also benefit from more favorable basis rules (for their cost of the policy), also provided by the TCJA, retroactive to 2009 and reversing Rev. Rul. 2009-13. The revenue ruling often made the tax impact of selling a policy more severe than surrendering it, by requiring the reduction of a policy's cost basis by the cost of insurance.

Section 13521(a) of the TCJA allows the seller of a policy to include all premiums paid in cost basis when calculating taxes due on a settlement transaction. It provides a "clarification of tax basis of life insurance contracts" (codified at Sec. 1016(a)(1)(B)) stating that when determining the basis of property, no adjustment is made "for mortality, expense, or other reasonable charges incurred under an annuity or life insurance contract."

Thus, sellers of life insurance are now afforded the same tax treatment as those who surrender their policy. Policy owners are now therefore more likely to sell an unwanted policy to a third party rather than simply surrendering or canceling the coverage. The provision applies to transactions entered into after Aug. 25, 2009.

Determining the cost of insurance under Rev. Rul. 2009-13 was problematic because the life insurance carrier typically could not (or refused to) provide the necessary information. This made it difficult for the seller to calculate cost basis. However, because the TCJA allows for the inclusion of the cost of insurance in cost basis, separately accounting for it is no longer necessary. It is simply included in the amount of all premiums paid by the owner.

In summary, the TCJA will likely fuel increased growth in the life settlement market (which has already shown signs of recovery). Thousands of life insurance policies made unnecessary by the increased estate tax exemption may now be sold, with minimized taxable gain. The TCJA will therefore likely bring previously unmarketable life insurance policies back into the life settlement market.

  • P.L. 115-97, Section 13521(a)

— By Gary A. Forster, J.D., LL.M., managing partner, and Paige L. Minch, J.D., attorney, both at Forster Boughman Lefkowitz & Lowe in Maitland, Fla.

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