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Transfer-for-Value Rule

Transfer-for-Value Rule
Personal FinanceInsuranceLife Insurance

What Is the Transfer-for-Value Rule?

The transfer-for-value rule specifies that if a life insurance policy (or any interest in that policy) is transferred for something of value (e.g., money, property, and so on), a portion of the death benefit is subject to taxation as ordinary income. This portion is equivalent to the death benefit minus the item(s) of value, as well as any premiums paid by the transferee at the hour of the transfer.

Say John Doe needs to sell his life insurance policy with a $250,000 death benefit for $5,000. He's so far paid $10,000 in premiums. The amount subject to income tax would be $235,000 ($250,000 - $10,000 - $5,000).

Understanding the Transfer-for-Value Rule

The transfer-for-value rule incorporates the outright sale of a life insurance policy, as well as viaticals and different transfers or assignment of the policy. The life insurance policy doesn't itself lose its tax-exempt status when the policy is transferred to the insured, a partner of the insured, or to a company where the insured is an officer or stockholder.

One of the key benefits of any sort of life insurance is the tax-free death benefit it presents to beneficiaries. Be that as it may, a few examiners have started to transfer life insurance policies between parties to harvest tax-free bonuses. In response, Congress declared that any life insurance policy that is transferred for any sort of material consideration might turn out to be to some extent or completely taxable when the death benefit is paid.

The transfer-for-value rule remains as one of a handful of the special cases for the overall exemption from taxation concurred to all life insurance death benefit proceeds. The Tax Cuts and Jobs Act (TCJA) of 2017 explained the basis for taxation of insurance policies by including another term "reportable policy sale."

The term alludes to the acquisition of an interest in a life insurance contract straightforwardly or in a roundabout way, in the event that the acquirer has no substantial family, business, or financial relationship with the insured separated from the acquirer's interest in such a life insurance contract. This characterizes the tax liabilities remembered for certain business circumstances, like mergers and acquisitions.

Special Considerations

Be that as it may, the rule has several special cases, especially as they apply to business-claimed life insurance. A portion of these exemptions for taxing life insurance policy transfers are listed below.

Life insurance transfers are tax free when the transfer is to the accompanying:

  • Anybody whose basis is determined by reference to the original transferor's basis
  • The insured (or insured's spouse or ex-spouse, if episode to a divorce under Sec. 1041)
  • A partner of the insured
  • A partnership wherein the insured is a partner
  • A corporation wherein the insured is a shareholder or officer

Inspecting the Transfer-for-Value Rule

The transfer-for-value rule is adroitly genuinely straightforward, however it must be analyzed carefully to lay out when it applies, as different insurers might remember different language for their policies. Regardless of the common comprehension that coverage applies to a form of monetary payments, in some cases no formal transfer of any sort need happen or unmistakable consideration be given to disregard this rule.

Consideration can, in this case, be simply a reciprocal agreement or the like that is tied to the transfer of the policy.

For instance, in the event that two shareholders in a closely held business take out life insurance policies on themselves and name each other as beneficiaries to form a [buy-sell agreement](/trade agreement), then, at that point, the beneficiary of the death benefit proceeds from the policy of the partner who bites the dust first will face a substantial tax bill under the transfer-for-value rule. The rule applies here in light of the fact that the two partners apparently agreed to name each other as beneficiaries, consequently introducing the receipt of consideration into the equation.

Features

  • It is consistently important to inspect fine print as it applies to this rule before making a life insurance policy transfer or sale.
  • There are several exemptions for the rule, including on the off chance that the policy was purchased by a firm for continuity of business purposes.
  • The transfer-for-value rule guarantees that transfers of life insurance policies are taxable.

FAQ

What are special cases for the transfer-for-value rule?

Life insurance transfers are tax free when the transfer is to the accompanying: the insured or a partner; to a partnership wherein the insured is a partner; to a corporation wherein the insured is a shareholder or officer or to anybody whose basis is determined by reference to the original transferor's basis

For what reason was the transfer-for-value rule executed?

Examiners host transferred life insurance policies between gatherings to exploit the tax-free death benefit it presents, consequently harvesting tax-free bonuses. Congress in the 2017 Tax Reform Act declared that any life insurance policy that is transferred for any sort of material consideration might turn out to be to some degree or completely taxable when the death benefit is paid.