PLR 1152014: IRS addresses a partnership transfer of bank-owned life insurance policies
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This page covers one taxpayer's ruling from 2011, which can't be cited as precedent. Ask about your situation and see what the current Code and IRS guidance say, with citations.
Plain-English summary
The IRS ruled on a proposed transaction in which two banks would transfer certain bank-owned life insurance policies to a partnership in exchange for partnership interests. The transfer would not be treated as a transfer to an investment company if the partnership were incorporated, so IRC § 721(b) would not apply. The IRS also ruled that interest expense allocated to unborrowed policy cash values is not deductible under § 264(f), that the partnership and the bank holding more than 50 percent of its interests are treated as one taxpayer for that rule, and that part of that bank's unrelated interest expense may be disallowed. The bank holding less than 50 percent of the partnership is not aggregated with it for this purpose, so its unrelated interest deductions are not disallowed on account of the partnership's policies. Policies held by the partnership are treated as employer-owned life insurance contracts when they cover employees of the partnership or the controlling bank, but not when they cover employees of the non-controlling bank.
Ruling snapshot
- Question: What are the tax consequences of transferring bank-owned life insurance policies to a partnership, including the treatment of related interest expense and employer-owned life insurance contracts?
- Outcome: Mixed.
- Key authorities: IRC §§ 52, 101, 1035, 264, 267, 351, 6110, 707, 721, 817; Treas. Reg. § 1.52-1
Full text (IRS public release)
Internal Revenue Service Department of the Treasury
Washington, DC 20224
Number: 201152014 Third Party Communication: None
Release Date: 12/30/2011 Date of Communication: Not Applicable
Person To Contact:
Index Number: 264.05-00, 101.01-02 ------------------, ID No. -------------
Telephone Number:
---------------------
------------------------------- Refer Reply To:
-------------------------- CC:FIP:B04
--------------------------------------------- PLR-145159-10
-------------------------------- Date:
----------------------- September 22, 2011
Legend:
Company = ---------------------------------------------------------------------------------------
------------------------
Managing = ---------------------------------------------------------------------------------------
Member -------------------------
Bank A = ---------------------------------------------------------------------------------------
-------------------------
Bank B = ---------------------------------------------------------------------------------------
--------------------------
Date = -----------------
State = -------------
Figure a = ------------------------------------
Figure b = ------------------------------------
Figure c = ------------------------------------
Figure d = -----------------------------------
X = ----
Y = ----
Dear ---------------:
This is in response to the letter submitted by your authorized representative,
requesting rulings on the application of certain sections of the Internal Revenue Code
(the “Code”) to a transaction among the Company, the Managing Member, Bank A, and
Bank B.
PLR-145159-10 2
FACTS
PARTIES
The Company is a limited liability company that was initially formed by the
Managing Member in Date under the laws of State. The Company is governed by a
limited liability company agreement (the “Agreement”) and it is taxable as a partnership
for federal income tax purposes. The Company currently has three member-partners:
Bank A, Bank B, and the Managing Member.
Bank A is a national bank. Bank B is regulated as a financial holding company
by the Federal Reserve Board.
The Managing Member designed and created the transaction that is the subject
of the ruling request. The Managing Member is in the business of providing audit,
reconciliation, placement, and advisory services to banks in connection with bank
owned life insurance (“BOLI”) plans.
TRANSACTION
Background
Bank A and Bank B (collectively, the “Banks”) own life insurance policies on the
lives of current and former employees (“Policies” and each a “Policy”), which were
acquired from various U.S. life insurance companies (“Issuers” and each an “Issuer”) as
an investment to finance various employee benefits, including general welfare and non-
qualified executive compensation plans. Some of the Banks’ Policies are general
account life insurance policies (“General Account BOLI”), which means that the policies
are obligations of the Issuer’ general account and typically this kind of policy provides
for the crediting of interest on policy cash values at the rate or rates periodically
declared by the Issuer. The interest crediting rate cannot be set below a statutory
minimum guaranteed rate.
Some of the Banks’ Policies are separate account life insurance policies
(“Separate Account BOLI”), which means that the policies are variable life insurance
policies, under which assets used to support the policy are held in one or more life
insurance company separate accounts. Under a Separate Account BOLI Policy,
contract cash values and death benefits fluctuate with the performance of the underlying
assets in the separate account(s).
PLR-145159-10 3
The Banks claim deductions for interest expense incurred on indebtedness that
is unrelated to the purchase and holding of the Policies (“Unrelated Interest Expense”).
Transfer of BOLI Policies to Company
The Banks will transfer some of their respective General Account BOLI and
Separate Account BOLI to the Company. The transferred Policies will cover both
current and former employees of the Banks. In the future, it is intended that other
banking institutions also transfer Policies to the Company and become members of the
Company. Under the Agreement, the Policies (and any future Policies transferred to the
Company) must meet certain requirements: (1) The date of the transfer to the
Company must be at least five years after the date the Policy was originally issued and
(2) the insured under the Policy must have been provided notice of the coverage and
consented in writing.
The Banks must also make certain representations to the Company. These
include a representation that a Bank will not use the transfer of the Policies to the
Company as the basis for increasing the investment in BOLI policies permitted under
bank regulatory rules governing bank investments in BOLI.
The Banks will transfer the Policies to the Company solely in exchange for
"Membership Interests" therein (which are partnership interests for federal tax
purposes) and the Banks will become "Members" of the Company. Only banks will be
permitted to transfer property to the Company and become Members. It is anticipated
and intended that a number of other banks will participate in the Company and transfer
BOLI policies to it. In that event, the relative membership percentages of Bank A and
Bank B will be reduced as Policies from other banks are contributed to the Company,
such that it is likely that no member of the Company would have a membership
percentage in excess of 50 percent.
In the transfer, the Company will acquire all ownership rights in the Policies and
will be listed as the owner and beneficiary of the Policies on the books and records of
the Issuers.
Immediately after the transfer of the Policies in exchange for Membership
Interests, each Bank will possess a stated percentage interest in the total capital and
profits of the LLC. At that time, Bank A will transfer Policies with an aggregate cash
surrender value (net of any applicable surrender charges) of Figure a and an aggregate
face amount of Figure b. Bank B will transfer Policies with an aggregate cash surrender
value (net of any applicable surrender charges) of Figure c and an aggregate face
amount of Figure d. Based on this, Bank A will receive an approximate interest in the
capital and profits of Company of X percent (which is in excess of 50 percent), and
Bank B will receive an approximate interest of Y percent (which is less than 50 percent)
in the capital and profits of the Company. The identity of the specific Policies that will
PLR-145159-10 4
be transferred to the Company (and their specific face amounts) will be determined
immediately before the transfer based on market conditions and other factors at the
time of the transfer.
Company operations
The Company will be managed by a management committee (the "Management
Committee"), which, in turn, will appoint a managing member (the "Managing Member"),
who will have specialized expertise in the management of BOLI. The Managing
Member and the Management Committee will manage the Policies for the benefit of the
members. As part of this responsibility, the Managing Member and the Management
Committee will assess how contract values should be allocated and reallocated among
available separate account investment options, in the case of Separate Account BOLI.
In addition, the Managing Member and the Management Committee will review
all of the Policies and determine whether any or all should be disposed of or replaced.
If the Managing Member and Management Committee decide to replace Policies with
new life insurance policies, they will select a suitable issuing life insurance company (or
companies) and negotiate the terms of the new Policies with the issuing life insurance
company on behalf of the members. The Banks and the Company anticipate that the
Management Committee will likely act to replace a substantial portion of the Policies
(perhaps even all of the Policies) with new Policies. Any decision about whether to
retain or replace a particular Policy will be made by the Management Committee after
its transfer to the Company.
The Managing Member and Management Committee will also administer the
Company's Policies, tracking rates of return and undertaking necessary recordkeeping
and monitoring of the contracts. Periodic reports will be issued to the Banks.
All profits and losses of the Company will be allocated pro rata among its
member banks. Thus, when an insured under a Policy dies, the death benefit would be
collected by the Company and distributed to the Banks in accordance with their then
current percentage interest in the capital and profits of the Company (their "Membership
Percentage").
Membership interests in the Company will not be redeemable and will not be
transferable without the consent of the Managing Member, which ordinarily will not be
given except in rare and extraordinary circumstances. If a transfer is authorized, the
transferee must be a banking institution.
It is conceivable that the Company could incur interest expense on indebtedness
that is unrelated to the acquisition and holding of Policies ("Company Unrelated Interest
Expense"), although it is not anticipated that the Company will borrow any material
amount of money.
PLR-145159-10 5
Purpose of the transaction
The purpose of the transaction is to provide Banks with a more effective,
centralized way to manage Policies and, where appropriate, to negotiate the terms of
new Policies (i.e., via exchange) or renegotiate the terms of existing BOLl holdings.
ADDITIONAL REPRESENTATIONS
The Company makes the following additional representations:
1. The Policies constitute, and have always constituted, "life insurance" for
federal income tax purposes.
2. Separate Account BOLl Policies are "variable contracts" within the meaning of
section 817(d), and the segregated asset accounts on which such Policies
are based have at all times been adequately diversified within the meaning of
section 817(h) and the regulations thereunder.
3. The Policies at issuance, and upon transfer to the Company, meet all
applicable state insurable interest laws.
4. An exchange of a Policy by the Company for a new Policy in a “section 1035
exchange” will comply with any applicable state insurable interest laws.
5. At the time of a transfer to the Company, each Policy is a life insurance policy
described in section 264(f)(4)(A).
6. Bank A’s capital and profits interest in the Company will exceed 50 percent,
until additional banking institutions join the Company.
7. Bank B’s capital and profits interest in the Company will be less than 50
percent.
8. The Company is engaged in a trade or business for federal income tax
purposes.
9. The Company is not characterized as a regulated investment company
(“RIC”) or real estate investment trust (“REIT”) under the Internal Revenue
Code (the “Code”) or under the Investment Company Act of 1940 (the “1940
Act”).
PLR-145159-10 6
REQUESTED RULINGS
Company requests the following rulings:
1. The transfer of the Policies to the Company would not be treated as a transfer
to an investment company, within the meaning of section 351, if the Company
were incorporated.
2. A Member's allocable share of Company Unrelated Interest Expense, to the
extent allocated to unborrowed cash values of Policies held by the Company,
may not be deductible by such Member pursuant to section 264(f)(1).
3. Under the aggregation rule in section 264(f)(8) Bank A and the Company will
be treated as “1 taxpayer, while Bank B and the Company will not be treated
as “1 taxpayer.”
4. Deductions for a portion of Bank A's Unrelated Interest Expense may be
disallowed under section 264(f)(1).
5. Deductions for Bank B’s Unrelated Interest Expense will not be disallowed
under section 264(f)(1) on account of the Company holding Policies with
unborrowed policy cash values.
6. Any Policy held by the Company, under which the Company is the
beneficiary: (a) will not constitute an "employer-owned life insurance contract"
within the meaning of section 101(j)(3)(A) if the Policy covers the life of an
insured who, on the date the Policy is issued, is an employee of Bank B and
not the Company; (b) will constitute an "employer-owned life insurance
contract" within the meaning of section 101(j)(3)(A) if the Policy covers the life
of an insured who, on the date the Policy is issued, is (i) an employee of the
Company, or (ii) an employee of Bank A.
LAW AND ANALYSIS
Ruling Request 1
Section 721(a) provides that no gain or loss shall be recognized to a partnership
or to any of its partners in the case of a contribution of property to the partnership in
exchange for an interest in the partnership.
PLR-145159-10 7
Section 721(b) provides that section 721(a) shall not apply to gain realized on a
transfer of property to a partnership which would be treated as an investment company
(within the meaning of section 351) if the partnership were incorporated.
A transfer of property is a transfer to an investment company if (i) it is a transfer
to a RIC, REIT or a corporation more than 80 percent of the value of whose assets is
held for investment and is stock and securities (the “Transferee Test”), and (ii) the
transfer results, directly or indirectly, in diversification (the “Diversification Test”). The
Transferee Test and Diversification Test are independent and both must be satisfied in
order for a transfer to be considered a transfer to an investment company. In this case,
the Transferee Test will not be satisfied if the only assets (other than minimum cash) of
the Transferee are the Policies.
Therefore, the transfer of the Policies to the Company will not be treated as a
transfer to an investment company (within the meaning of section 351) if the Company
were incorporated and, consequently, section 721(b) does not apply to the transfer of
the Policies to the Company.
Ruling Request 2
Section 264(f)(1) states that “[n]o deduction shall be allowed for that portion of
taxpayer’s interest expense which is allocable to unborrowed policy cash values.”
Section 264(f)(5)(B) states that “[i]n the case of a partnership or S corporation,
[section 264(f)] shall be applied at the partnership and corporate levels.”
Since the Company is a partnership and it holds Policies with unborrowed cash
value, some portion or perhaps all of any Company Unrelated Interest Expense should
be allocable to unborrowed cash values. A deduction for Company Unrelated Interest
Expense allocable to unborrowed cash value would be disallowed under section
264(f)(1). However, the Company, as a partnership, does not itself claim deductions;
instead deductions are claimed at the level of the Members. Therefore, a Member's
share of Company Unrelated Interest Expense, to the extent allocable to unborrowed
cash values of Policies held by the Company, is not deductible by such Member
pursuant to section 264(f)(1).
Ruling Request 3
Section 264(f)(8) states that “[a]ll members of a controlled group (within the
meaning of [section 264(e)(5)(B)] shall be treated as 1 taxpayer for purposes of [section
264(f)].” Section 264(e)(5)(B), in turn, states that "all persons treated as a single
employer under subsection (a) or (b) of section 52 or subsection (m) or (o) of section
414 shall be treated as members of a controlled group.”
PLR-145159-10 8
Section 52(b)(1) states that in the case of partnerships that are under common
control “all employees of trades or business (whether or not incorporated) which are
under common control shall be treated as employed by a single employer.”
Section 1.52-1(c)(1) of the Regulations states that in the case of a "parent-
subsidiary" arrangement a chain of organizations are under common control if they are
connected through ownership of a controlling interest with a common parent
organization. Section 1.52-1(c)(2)(iii), in turn, states that in the case of a partnership, a
partner owns a controlling interest in the partnership if the partner owns more than a 50
percent profit or capital interest in the partnership.
The Company has specifically represented that it satisfies the requirements of
section 52 of the Code and section 1.52-1 of the Regulations because Bank A will have
a Membership Percentage exceeds 50 percent and that Bank B, conversely, will have a
Membership Percentage that is less than 50 percent. Based on this representation,
under section 264(f)(8)(A) Bank A and the Company will be treated as “1 taxpayer” for
purposes of section 264(f), while Bank B and the Company will not be treated as “1
taxpayer” for such purpose.
Ruling Request 4
Bank A represents that it incurs substantial interest expense deductions every
year that are unrelated to the purchase or carrying of the Policies or the acquisition and
holding of its Membership Interest in the Company.
Section 264(f)(1) states that “[n]o deduction shall be allowed for that portion of
taxpayer’s interest expense which is allocable to unborrowed policy cash values.”
Section 264(f)(5)(B) states that “[i]n the case of a partnership or S corporation,
[section 264(f)] shall be applied at the partnership and corporate levels.”
In connection with Ruling Request 3 we held that under the aggregation rule in
section 264(f)(8) Bank A and the Company will be treated as “1 taxpayer,” while Bank B
and the Company will not be treated as “1 taxpayer.”
Based on the Company’s representations and the holding in connection with
Ruling Request 3, a portion of Bank A’s Unrelated Interest Expense may be disallowed
under section 264(f)(1) because of the unborrowed policy cash value of the Policies in
the Company.
Ruling Request 5
Section 264(f)(1) states that “[n]o deduction shall be allowed for that portion of
taxpayer’s interest expense which is allocable to unborrowed policy cash values.”
PLR-145159-10 9
Section 264(f)(5)(B) states that “[i]n the case of a partnership or S corporation,
[section 264(f)] shall be applied at the partnership and corporate levels.”
In connection with Ruling Request 3 we held that under the aggregation rule in
section 264(f)(8) Bank A and the Company will be treated as “1 taxpayer,” while Bank B
and the Company will not be treated as “1 taxpayer.”
Therefore, deductions for Bank B’s Unrelated Interest Expense will not be
disallowed under section 264(f)(1) on account of the Company holding Policies with
unborrowed policy cash values.
Ruling Request 6
Section 101(a) provides that “[e]xcept as otherwise provided in . . . [section
101(j)], gross income does not include amounts received . . . under a life insurance
contract, if such amounts are paid by reason of the death of the insured.”
Section 101(j)(1) prescribes that “[i]n the case of an employer-owned life
insurance contract, the amount excluded from gross income of an applicable
policyholder by reason of [section 101(a)] shall not exceed an amount equal to the sum
of the premiums and other amounts paid by the policyholder for the contract.” However,
section 101(j)(2) lists several exceptions to the rule in section 101(j)(1), as long as the
consent requirements in section 101(j)(4) are met.
Section 101(j)(3)(A) defines the term "employer-owned life insurance contract"
as:
a life insurance contract which (i) is owned by a person engaged in a trade
or business and under which such person (or a related person described
in [section 101(j)(3)(B)(ii)]) is directly or indirectly a beneficiary under the
contract, and (ii) covers the life of an insured who is an employee with
respect to the trade or business of the applicable policyholder on the date
the contract is issued.
The term "applicable policyholder," in turn, is defined by section 101(j)(3)(B)(i) as,
"with respect to any employer-owned life insurance contract, the person described in
[section 101(j)(A)(i)] which owns the contract." Section 101(j)(3)(B)(ii) expands the
definition of “applicable policyholder" by including "related persons," who are defined as
"any person which (I) bears a relationship to the person described in [section
101(j)(3)(B)(i)] which is specified in section 267(b) or 707(b)(1), or (II) is engaged in
trades or businesses with such person which are under common control (within the
meaning of subsection (a) or (b) of section 52).”
PLR-145159-10 10
Once the Policies are transferred to the Company, and the Company becomes
the owner of the Policies, the Company will be the "applicable policyholder" with respect
to those Policies and any new Policies the Company may acquire. Thus, given the
representation that the Company is engaged in a trade or business and the fact that the
Company is the beneficiary under the Policies, a Policy held by the Company that
covers an insured who is an "employee" of the Company (as defined in section
101(j)(5)(A)) at the time the Policy is issued will constitute an "employer-owned life
insurance policy."
The Company has represented that it satisfies the requirements of section 52 of
the Code and section 1.52-1 of the Regulations because Bank A will have a
Membership Percentage that exceeds 50 percent. Based on these representations,
Bank A and the Company will be aggregated under section 101(j)(3)(B)(ii)(II) and
treated as a single "applicable policyholder." This means that any Policy held by the
Company that covers an insured who is an "employee" of Bank A (as defined in section
101(j)(5)(A)) at the time the Policy is issued will constitute an “employer-owned life
insurance policy."
Conversely, since Bank B will not have a Membership Percentage in excess of
50 percent, Bank B and the Company will not be aggregated under section
101(j)(3)(B)(ii)(II) and treated as a single "applicable policyholder." Therefore, any
Policy held by the Company that covers an insured who is an "employee" of Bank B (as
defined in section 101(j)(5)(A)) at the time the Policy is issued will not constitute an
"employer-owned life insurance policy."
HOLDINGS
-
The transfer of the Policies to the Company will not be treated as a transfer to an
investment company (within the meaning of section 351) if the Company were
incorporated. -
A Member's allocable share of Company Unrelated Interest Expense, to the
extent allocated to unborrowed cash values of Policies held by the Company,
may not be deductible by such Member pursuant to section 264(f)(1). -
Under section 264(f)(8) Bank A and the Company will be treated as “1 taxpayer,”
while Bank B and the Company will not be treated as “1 taxpayer.” -
Deductions for a portion of Bank A’s Unrelated Interest Expense may be
disallowed under section 264(f)(1). -
Deductions for Bank B’s Unrelated Interest Expense will not be disallowed under
section 264(f)(1) on account of the Company holding Policies with unborrowed
policy cash values.
PLR-145159-10 11-
Any Policy held by the Company of which the Company is the beneficiary will
constitute an "employer-owned life insurance contract" if the Policy covers the life
of an insured who, on the date the Policy is issued, is (i) an employee of the
Company, or (ii) an employee of Bank A, but will not constitute an "employer-
owned life insurance contract" if the Policy covers the life of an insured who, on
the date the Policy is issued, is an employee of Bank B.Except as expressly provided herein, no opinion is expressed concerning the tax
consequences of any aspect of any transaction or item discussed or referenced in this
letter. The rulings contained in this letter are based upon information and
representations submitted by the Company and accompanied by a penalty of perjury
statement executed by an appropriate party. While this office has not verified any of the
material submitted in support of the request for rulings, it is subject to verification on
examination. This ruling is directed only to the taxpayer who requested it. Section
6110(k)(3) provides that it may not be used or cited as precedent.In accordance with the Power of Attorney on file with this office, a copy of this
letter is being sent to your authorized representative.Sincerely, /S/ SHERYL B. FLUM Branch Chief, Branch 4 Office of the Associate Chief Counsel (Financial Institutions & Products)
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