Advanced Underwriting Consultants

Question of the Day – October 25

Ask the Experts!

Here’s the question of the day.

Question: How is a life insurance policy transferred from a business to an employee valued for income tax purposes?

Answer: Revenue Procedure 2005-25 created new rules for how life policies transferred in conjunction with employment are to be valued.  While the IRS did not create the final word on fair market value in 2005-25, it did provide a safe harbor method for calculating a policy’s value.

The safe harbor value of a life policy is the greater of

  • the interpolated terminal reserve plus unearned premium (ITR), or
  • the product of the PERC amount and the average surrender factor.

PERC stands for premium, expenses, and reasonable charges.  Stated simply, the PERC amount is premiums, plus dividends and other cash value earnings, minus actual mortality charges and other reasonable charges.  Any distributions taken from the contract prior to its valuation would also reduce the PERC value.  For most transfers related to employment, the PERC value is unadjusted by the policy’s surrender charges.

What is the PERC value of a life policy?  Generally speaking, it’s an amount approximately equal to the gross cash value for most universal life-style contracts.

As with gift tax transfers, we recommend that the policy owner start with his or her insurance agent to get a calculation for the ITR and PERC values for a life policy being transferred in connection with employment.  After those numbers are obtained, the clients should check with their own tax advisors to decide how to report the transaction for income tax purposes.

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