Recent IRS Guidance on Life Insurance Payments in the Form of Viaticals

Author(s): Rufus Rhoad­es and Alex­ey Man­a­suev Date: Jan­u­ary 2011

The Back­ground

A “viat­i­cal” is a con­trac­tu­al arrange­ment in which an investor buys a life insur­ance pol­i­cy from an insured (or, per­haps, anoth­er) for a nego­ti­at­ed pur­chase price. The investor gen­er­al­ly con­tin­ues to pay the pre­mi­ums on the pol­i­cy and is paid the pro­ceeds from the insur­ance com­pa­ny upon the death of the insured. The investor may be either domes­tic or for­eign.

The Prob­lem

When the insured dies and the insur­ance com­pa­ny pays the pol­i­cy amount, the investor is faced with a ques­tion of what the tax result of his invest­ment pay­off is. Cer­tain­ly, he has a return of cap­i­tal (his cap­i­tal being the amount paid to the insured and the sub­se­quent­ly paid pre­mi­ums) but, hope­ful­ly, he also has a prof­it from his invest­ment. Part of that prof­it might be inter­est, depend­ing on the cir­cum­stances, and the rest is gain on the invest­ment. Look­ing only at the gain, the ques­tion is whether the gain is ordi­nary or cap­i­tal. When the investor is a for­eign per­son (gen­er­al­ly, a non­res­i­dent alien) he is look­ing at an addi­tion­al ques­tion of how much of the amount received, if any, is sub­ject to with­hold­ing. That answer might vary, depend­ing on whether the for­eign investor is a res­i­dent of a treaty coun­try.

Twin Rul­ings

In May 2009, the Ser­vice issued twin rev­enue rulings1 (twin in a sense that they both were issued on the same date and addressed a U.S. tax treat­ment of cer­tain trans­ac­tions involv­ing viat­i­cals). Let’s take a look at each rul­ing, in turn.…

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