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

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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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