rr-09-14.pdf

Preserve advance releases and the authoritative Internal Revenue Bulletin rendition; directory timestamps are file-publication metadata, not legal effective dates. HTML bulletins begin June 2003; earlier available issues require full PDF parsing.

This collection currently includes the publisher’s available advance-release directory. Historical bulletin renditions are discovered separately; an advance-release record alone does not certify the collection archive complete.

Part I

Section 101.--Certain Death Benefits.
(Also §§ 263, 865, 1001, 1011, 1012, and 1221)

Rev. Rul. 2009-14

ISSUE
What are the tax consequences to B
, in the situations described below, upon the
receipt of death benefits, or upon the receipt of sale proceeds, with regard to a term life
insurance contract that B purchased for profit?
FACTS
Situation 1

A
is a United States citizen residing in the United States. B is a United States
person as defined in § 7701(a)(30) of the Internal Revenue Code (Code). B determines
taxable income using the cash method of accounting and files its income tax returns on
a calendar year basis.
On June 15, 2008, B purchased from A for $20,000 a “life insurance contract” (as
defined in § 7702) on the life of A
. The contract was originally issued by IC, a domestic
corporation, to A
on January 1, 2001. The contract was a level premium fifteen-year
term life insurance contract without cash surrender value. At the time of purchase, the

2
remaining term of the contract was 7 years, 6 months, and 15 days. The monthly
premium for the contract was $500, due and payable on the first day of each month. As
owner of the contract, B
had the right to change the beneficiary and, pursuant to that
right, named itself beneficiary under the contract immediately after acquiring the
contract.
B had no insurable interest in A's life and, except for the purchase of the contract,
B
had no relationship to A and would suffer no economic loss upon A's death. B
purchased the contract with a view to profit. The contract in B
's hands was not property
described in § 1221(a)(1)-(8). The likelihood that B would allow the contract to lapse by
failing to pay any of the remaining premiums was remote.
On December 31, 2009, A
died, and IC paid $100,000 under the life insurance
contract to B by reason of A's death. Through that date, B had paid monthly premiums
totaling $9,000 to keep the contract in force.
Situation 2

The facts are the same as in Situation 1, except that A did not die and, on
December 31, 2009, B
sold the contract to C (a person unrelated to A or B) for $30,000.
Situation 3

The facts are the same as in Situation 1, except that B
is a foreign corporation
that is not engaged in a trade or business within the United States (including the trade
or business of purchasing, or taking assignments of, life insurance contracts).

3
LAW AND ANALYSIS
SITUATION 1
.
Amount of income recognized by B upon the receipt of death benefits
Section 61(a) provides that, except as otherwise provided in the income tax
provisions of the Code, gross income includes all income from whatever source derived,
including (but not limited to) income from life insurance contracts. See § 61(a)(10). To
the extent that another section of the Code or regulations provides specific treatment of
any item of income, that other provision applies notwithstanding § 61 and the
regulations thereunder. See
§ 1.61-1(b) of the Income Tax Regulations.
Section 72(e) governs the federal income tax treatment of amounts received
under an annuity, endowment, or life insurance contract that are not received as an
annuity. In general, under § 72(e)(2), a non-annuity amount that is received on or after
the annuity starting date is included in gross income. If a non-annuity amount is
received before the annuity starting date, it is included in gross income to the extent
allocable to income on the contract, but not to the extent allocable to investment in the
contract (i.e., it is taxed on an income-first basis).
Section 72(e)(5) provides an exception to the income-first rule in the case of —
(1) certain contracts including, under § 72(e)(5)(C), life insurance contracts other than a
“modified endowment contract” (as defined in § 7702A) and (2) any non-annuity amount
received under a contract on its complete surrender, redemption, or maturity.
If a non-annuity amount is received under a life insurance contract other than a
modified endowment contract before the annuity starting date, or is received under a life

4
insurance contract on the complete surrender, redemption, or maturity of the contract,
§ 72(e)(5)(A) requires that the amount be included in gross income but only to the
extent it exceeds investment in the contract. For this purpose, § 72(e)(6) defines
"investment in the contract" as of any date as the aggregate amount of premiums or
other consideration paid for the contract before that date, less the aggregate amount
received under the contract before that date to the extent that amounts was excludable
from gross income. In the case of a transferee for value, only the actual value of
consideration paid for the contract, plus premiums and other consideration paid after the
transfer, is taken into account. See generally
§ 72(g); § 1.72-10.
Section 101(a)(1) provides, generally, that gross income does not include
amounts received (whether in a single sum or otherwise) under a life insurance
contract, if such amounts are paid by reason of the death of the insured. In the case of
a transfer for valuable consideration, however, § 101(a)(2) provides that the amount
excluded from gross income shall not exceed an amount equal to the sum of the actual
value of the consideration paid and the premiums and other amounts subsequently paid
by the transferee. The "transfer for value" rule of § 101(a)(2) does not apply in the case
of a transfer involving a carryover basis or in the case of a transfer to the insured, a
partner of the insured, a partnership in which the insured is a partner, or to a corporation
in which the insured is a shareholder or officer.
In Situation 1, B
received $100,000 from IC by reason of the death of A, the
insured under the contract. Because B
purchased the contract from A in exchange for a
purchase price of $20,000, B's acquisition of the contract was a "transfer for a valuable

5
consideration" within the meaning of § 101(a)(2). Neither the carryover basis exception
of § 101(a)(2)(A) nor the exception for transfers involving parties related to the insured
under § 101(a)(2)(B) applied. Accordingly, § 101(a)(1) excludes from B
's gross income
the amount received by reason of A's death, but § 101(a)(2) limits the exclusion to the
sum of the actual value of the consideration paid for the transfer ($20,000) and other
amounts paid by B ($9,000), or $29,000. B therefore must include in gross income
$71,000, which is the difference between the total death benefit received ($100,000)
and the amount excluded under § 101 ($29,000).
Character of income recognized by B upon the receipt of death benefits

Neither § 61(a) nor § 72(e) specifies whether taxable amounts of death benefits
received by a transferee for value of a life insurance contract by reason of the death of
the insured are treated as ordinary income or as capital gain. Thus, the character of the
income that B
recognized upon receipt of death benefits under the contract is capital
gain only if it so qualifies under the general rules of subchapter P (§§ 1201-1260).
Section 1222(3) defines long-term capital gain as gain from the sale or exchange
of a capital asset held for more than one year if and to the extent such gain is taken into
account in computing gross income. Section 1221(a) provides that the term "capital
asset" means property held by the taxpayer (whether or not connected with a trade or
business), but does not include items described in § 1221(a)(1)-(8). The life insurance
contract in B
's hands was not property described in § 1221(a)(1)-(8), and was thus a
capital asset in B
's hands.

6
Neither the surrender of a life insurance or annuity contract nor the receipt of a
death benefit from the issuer under the terms of the contract produces a capital gain.
Accordingly, the $71,000 income recognized by B upon the receipt of death benefits
under the contract is ordinary income.
SITUATION 2
.
Amount of income recognized by B upon sale of life insurance contract
Section 1001(a) provides that the gain realized from the sale or other disposition
of property is the excess of the amount realized over the adjusted basis provided in
§ 1011 for determining gain. Thus, to determine the amount of B
's income from the sale
of the life insurance contract to C, it is necessary to determine B's amount realized from
the sale, and B
's adjusted basis in the contract.
Pursuant to § 1001(b), B's amount realized from the sale of the life insurance
contract is the sum of money received from the sale, or $30,000.
Under §§ 1011 and 1012, the adjusted basis for determining gain or loss is
generally the cost of the property as adjusted provided in § 1016, except as otherwise
provided in subchapters O (§§ 1011 through 1092), C (§§ 301 through 386), K (§§ 702
through 777), and P (§§ 1201 through 1298). Section 101(a)(2) has no bearing on the
determination of the basis of a life insurance contract that is sold, because § 101(a)(2)
applies only to amounts received by reason of the death of the insured.
The starting point for determining the basis of a life insurance contract for
purposes of measuring gain on its sale is its cost. Section 1.263(a)-4(c)(1)(iv) requires
taxpayers to capitalize an amount paid to another party to acquire an intangible

7
(including a life insurance contract) from that party in a purchase or similar transaction.
In Situation 2, B
paid $20,000 to A to acquire the life insurance contract from A, which is
included in B’s cost basis.
In Situation 2, B also paid $9,000 in monthly premiums to prevent the contract
from lapsing. No deduction is allowed for these monthly premiums under section 264.
However, § 1.263(a)-4(b)(1)(iv) authorizes the Service and Treasury to publish
guidance in the Internal Revenue Bulletin that identifies a future benefit as an intangible
for which capitalization is required. The premiums paid by a secondary market
purchaser of a term life insurance contract serve to create or enhance a future benefit
for which capitalization is appropriate. Accordingly, this revenue ruling requires a
secondary market purchaser to capitalize premiums paid to prevent a term life
insurance contract (without cash value) from lapsing. The Service will not challenge the
capitalization of such premiums paid or incurred prior to the issuance of this ruling.
In Situation 2, B
paid $20,000 to acquire the life insurance contract and $9,000 in
monthly premiums to prevent the contract from lapsing. Therefore, B’s adjusted basis
for purposes of measuring gain on the sale to C
was $29,000.
In Rev. Rul. 2009-13, page ___ , this Bulletin, Situation 2, a taxpayer paid
premiums totaling $64,000 with regard to a life insurance contract, and $10,000 of "cost
of insurance" charges were subtracted from the contract's cash surrender value. The
taxpayer sold the contract for $80,000. The ruling concludes that the taxpayer's gain on
the sale was equal to $26,000, representing the $80,000 amount realized less $54,000
adjusted basis ($64,000 total premiums paid minus $10,000 cost of insurance charges).

8
The ruling notes that on these facts, the reduction for cost of insurance charges is
necessary to account for the insurance protection the taxpayer received before the sale.
Similarly, in Century Wood Preserving Co. v. Commissioner
, 69 F.2d 967 (3rd Cir.
1934), the court concluded that a taxpayer who sold a life insurance contract could not
include in basis amounts that were used to provide annual insurance protection. See
also London Shoe Co. v. Commissioner, 80 F.2d 230 (2d Cir. 1935); Keystone
Consolidated Publishing Co. v. Commissioner, 26 B.T.A. 1210 (1932).
B
is not required to reduce its basis in the life insurance contract by any cost of
insurance charges that may have been imposed. In Rev. Rul. 2009-13, Century Wood
Preserving, London Shoe, and Keystone Consolidated, adjusted basis was reduced by
cost of insurance charges because those charges represented the cost of insurance
protection that was enjoyed by the policyholder as the beneficiary of the policy. In
contrast, in Situation 2 B
is wholly unrelated to A and did not purchase the life insurance
contract for protection against any economic loss upon A's death. B acquired and held
the contract solely with a view to profit, and paid additional premiums to prevent the
lapse of B
's purely financial investment, the contract. Situation 2 is thus distinguishable
from Rev. Rul. 2009-13 and the authorities cited therein.
As the amount realized on B's sale of the life insurance contract to C was
$30,000, and the adjusted basis was $29,000, B
must recognize $1,000 on the sale to
C in Situation 2.

9
Character of income recognized by B upon sale of life insurance contract
Because the term life insurance contract was not property described in
§ 1221(a)(1)-(8) and was held for more than one year, the $1,000 of gain recognized by
B under § 1001 upon the sale of the contract to C is long-term capital gain. Rev. Rul.
2009-13. Additionally, the contract was a term contract without any cash value. Hence,
the substitute for ordinary income doctrine under United States v. Midland Ross
, 381
U.S. 54 (1965), and its progeny does not apply.
SITUATION 3

Amount and characterization of income recognized by B upon the receipt of death
benefits
As in Situation 1, B
must recognize $71,000 of income upon the receipt of death
benefits. This income is “fixed or determinable annual or periodical” income within the
meaning of § 881(a)(1). See
§ 1.1441-2(b); Rev. Rul. 64-51, 1964-1 C.B. 322; Rev.
Rul. 2004-75, 2004-1 C.B. 516. Consequently, B is subject to tax under § 881(a) with
respect to this income, if the income is from sources within the United States.
Source of income recognized by B upon the receipt of death benefits

Section 861(a)(1) provides that interest received from a domestic corporation is
generally from sources within the United States.
Section 861(a)(7) provides that premiums received from the issuance of any life
insurance contract are generally income from sources within the United States when the
premiums are derived in connection with a life insurance contract issued in respect of
the lives of residents of the United States.

10
Section 865 provides that the source of income from the sale of personal
property is generally determined by reference to the residence of the taxpayer.
When the source of an item of income is not specified by statute or by regulation,
courts have determined the source of the item by comparison and analogy to classes of
income specified within the statute. See
Bank of America v. United States, 680 F.2d
142, 147 (Ct. Cl. 1982); Howkins v. Commissioner, 49 T.C. 689 (1968); Clayton v.
United States, 33 Fed. Cl. 628 (1995), aff'd without published opinion, 91 F.3d 170 (Fed.
Cir. 1996), cert. denied, 519 U.S. 1040 (1996). See also
Rev. Rul. 79-388, 1979-2 C.B.
270.
The Code does not specify the source of income resulting from the payment of
death benefits pursuant to a term life insurance contract. See also
Rev. Rul. 2004-75.
Consequently, the source of such income is determined by comparison and analogy to
classes of income that are specified within the statute.
In the current situation, A
is a United States citizen residing in the United States,
and IC is a domestic corporation. B’s income is from sources within the United States.
HOLDINGS
1. In Situation 1, B
must recognize $71,000 of ordinary income on the receipt of
death benefits with respect to the life insurance contract.
2. In Situation 2, B
must recognize $1,000 of long-term capital gain on the sale of
the life insurance contract.

11
3. In Situation 3, B must recognize $71,000 of ordinary income from sources
within the United States, and tax is imposed under § 881(a)(1) with respect to this
amount.
DRAFTING INFORMATION
The principal authors of this revenue ruling are Josephine H. Firehock of the
Office of Associate Chief Counsel (International) and Stephen D. Hooe of the Office of
Associate Chief Counsel (Financial Institutions and Products). For further information
regarding this ruling, contact Stephen D. Hooe at (202) 622-3970 (not a toll-free call).
For questions relating to section 263(a), contact the Office of Associate Chief Counsel
(Income Tax & Accounting) at (202) 622-4800. For questions relating to section 861 or
881, contact Josephine H. Firehock at (202) 622-4233.