rp-07-19.pdf

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Part III - Administrative, Procedural, and Miscellaneous

26 CFR § 301.7121: Closing Agreements.
(Also Part I, section 7702A)

Rev. Proc. 2007-19

SECTION 1. PURPOSE

This revenue procedure modifies the procedure by which an issuer of a life
insurance contract may remedy an inadvertent non-egregious failure to comply with the
modified endowment contract rules under § 7702A of the Internal Revenue Code. Rev.
Proc. 2001-42, 2001-2 C.B. 212, is modified and amplified.
SECTION 2. BACKGROUND
.01 Definition of a modified endowment contract

(1) Section 7702A(a) provides that a life insurance contract is a modified
endowment contract (“MEC”) if the contract--
(a) is entered into on or after June 21, 1988, and fails to meet the "7-pay test" of
§ 7702A(b), or
(b) is received in exchange for a contract described in paragraph (a) of this section
2.01(1).
(2) A contract fails to meet the 7-pay test if the accumulated amount paid under
the contract at any time during the first 7 contract years exceeds the sum of the net level

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premiums which would have to be paid on or before such time if the contract were to
provide for paid-up "future benefits" (as defined in §§ 7702A(c)(3) and 7702(f)(4)) after
the payment of 7 level annual premiums.
.02 Tax treatment of amounts received under a MEC. Section 72(e)(10) provides
that a MEC is subject to the rules of § 72(e)(2)(B), which tax non-annuity distributions on
an income-out-first basis, and the rules of § 72(e)(4)(A) (as modified by §§
72(e)(10)(A)(ii) and 72(e)(10)(B)), which generally deem loans and assignments or
pledges of any portion of the value of a MEC to be non-annuity distributions. Moreover,
under § 72(v), the portion of any annuity or non-annuity distribution received under a
MEC that is includible in gross income is subject to a 10% additional tax unless the
distribution is made on or after the date on which the taxpayer attains age 59 1/2, is
attributable to the taxpayer's becoming disabled (within the meaning of § 72(m)(7)), or is
part of a series of substantially equal periodic payments (not less frequently than
annually) made for the life (or life expectancy) of the taxpayer or the joint lives (or joint
life expectancies) of such taxpayer and the taxpayer's beneficiary.
.03 Rev. Proc. 2001-42.
The Internal Revenue Service ("Service") is aware of
situations in which, as a result of inadvertent non-egregious failures to comply with the
MEC rules, life insurance premiums are collected which exceed the 7-pay limit provided
by § 7702A(b). This can produce significant unforeseen tax consequences for the
contract holders. To allow issuers to remedy such situations, Rev. Proc. 2001-42 sets
forth the circumstances under which the Service will enter into closing agreements which
provide that contracts identified in the closing agreements will not be treated as MECs.
Under Rev. Proc. 2001-42, an issuer must provide information about the contracts that

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are subject to the closing agreement, including a template for each contract setting forth
the cumulative amounts paid under the contract, the contract's cumulative 7-pay
premium, the overage, if any, for each contract year, the earnings rate applicable for each
contract year, and the overage earnings for each contract year. In addition, the issuer
must agree to pay under the closing agreement an amount based on the contract's
overage, overage earnings, and tax and interest thereon.
.04 Need for changes to Rev. Proc. 2001-42.
During the 5 years it has
administered Rev. Proc. 2001-42, the Service has become aware of a number of changes
that would make it easier for issuers to use that procedure to seek relief. The Service has
determined that the General Account Total Return would be more accessible to taxpayers
if based on Moody's Seasoned Corporate Aaa and Baa Bond Yields, rather than on the
indices provided in Rev. Proc. 2001-42; similarly, the Bond Fund Total Return would be
more accessible if the Merrill Lynch Corporate Bond Master Bond Index, Total Return,
were instead identified as the Merrill Lynch U.S. Corporate Master Index (C0A0); the
Service has the capacity to process electronic exhibits in connection with requests for
closing agreements involving life insurance contracts (see, e.g.
, Notice 2005-35, 2005-1
C.B. 1087); and, the Service has changed the address to which payments under Rev.
Proc. 2001-42 must be sent.
SECTION 3. CHANGES TO EXISTING PROCEDURE
.01 General Account Total Return. Rev. Proc. 2001-42, section 3.07(2), is
modified to provide that the General Account Total Return is the arithmetic average
(weighted on a 50-50 basis) of the following two rates: (1) Moody's Seasoned Corporate
Aaa Bond Yield, frequency annual; and (2) Moody's Seasoned Corporate Baa Bond

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Yield, frequency annual. Both rates are published by Moody's Investors Service, Inc., or
any successor thereto, and are publicly available at www.federalreserve.gov. Under this
methodology, the General Account Total Return for 2005 would be (5.23 + 6.06)/2 =
5.645. Section 3.07(2) is further modified to include the following tables setting forth the
General Account Total Return as so determined for the years 1988 through 2005:
General Account General Account
Year Total Return Year Total Return
____ _____________ _____ _____________

1988 10.2% 1997 7.6%
1989 9.7% 1998 6.9%
1990 9.8% 1999 7.4%
1991 9.2% 2000 8.0%
1992 8.6% 2001 7.5%
1993 7.5% 2002 7.2%
1994 8.3% 2003 6.2%
1995 7.8% 2004 6.1%
1996 7.7% 2005 5.6%
.02 Variable Contracts Earnings Rate Table. Rev. Proc. 2001-42, section 3.07(3),
is modified by substituting the following earnings rate table for that which appears in
section 3.07. This table supplements the existing table by providing earnings rates for the
years 2001 through 2005:
Variable contracts Variable contracts
Year Earnings rate Year Earnings rate
____ _____________ _____ _____________

1988 13.5% 1997 17.8%
1989 17.4% 1998 19.7%
1990 1.4% 1999 12.8%
1991 25.4% 2000 -5.5%
1992 5.9% 2001 -7.1%
1993 13.9% 2002 -14.1%
1994 -1.0% 2003 19.6%
1995 23.0% 2004 6.9%
1996 14.3% 2005 2.1%

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.03 Bond Fund Total Return. Rev. Proc. 2001-42, section 3.07(6), is modified to
provide that the Bond Fund Total Return is (a) the "calendar year percentage return" (as
defined in section 3.07(7) of Rev. Proc. 2001-42) represented by the end-of-year values
of the Merrill Lynch U.S. Corporate Master Index (C0A0), as published by Merrill Lynch
& Company, Inc., or any successor thereto, less (b) 1.0 percentage point. The Merrill
Lynch U.S. Corporate Master Index (C0A0) is publicly available at
www.mlindex.ml.com
. Under this methodology, the Bond Fund Total Return for 2005
would be ((1546.511-1516.602)/1516.602) - .01 = 0.9721 percent.
.04 Address for Payment.
The address set forth in Rev. Proc. 2001-42, section
5.04, for payment of the amount required under a closing agreement concerning
inadvertent MECs is modified to read as follows: Internal Revenue Service, Receipt &
Control Stop 31, 201 W. Rivercenter Blvd., Covington, KY 41011.
.05 Electronic Submissions.
A new section 5.06 is added to Rev. Proc. 2001-42
to read as follows:
".06 Electronic submissions
. The information required under this revenue
procedure may be submitted to the Service electronically, in read-only format, on
a CD-ROM. Adobe Portable Document format is a suitable format. Other
formats may be arranged on a case-by-case basis. The issuer must provide a total
of 3 CD-ROMs, one for each of the three (3) copies of the closing agreement."
.06 Additional changes to Rev. Proc. 2001-42
. The Service is aware that
additional changes to Rev. Proc. 2001-42 may be warranted. Notice 2007-15, page ____,
this Bulletin, requests comments on a variety of issues affecting closing agreements for
life insurance products, including inadvertent MECs. The Service will continue to

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process closing agreements under the provisions of Rev. Proc. 2001-42, as modified by
this revenue procedure, until Rev. Proc. 2001-42 is replaced or further modified by
publication in the Internal Revenue Bulletin.
SECTION 4. PAPERWORK REDUCTION ACT
The collections of information in Rev. Proc. 2001-42 have been previously
reviewed and approve by the Office of Management and Budget in accordance with the
Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545-1752. This
revenue procedure does not make substantive changes to those collections of information.
SECTION 5. EFFECTIVE DATE
This revenue procedure is effective for submissions received after January 26,
2007, the date this revenue procedure was made available to the public.
SECTION 6. EFFECT ON OTHER DOCUMENTS
Rev. Proc. 2001-42 is modified and amplified.
DRAFTING INFORMATION
The principal author of this revenue procedure is Katherine A. Hossofsky of the
Office of the Associate Chief Counsel (Financial Institutions & Products). For further
information regarding this revenue procedure, please contact Ms. Hossofsky at (202)
622-8435 (not a toll free call).