AALU Seeks Safe Harbor for Valuation of Life Insurance Contracts

AALU Seeks Safe Harbor for Valuation of Life Insurance Contracts

News story posted in Intangible Personal Property on 11 February 2009| 2 comments
audience: National Publication | last updated: 18 May 2011
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Summary

Writing for the Association for Advanced Life Underwriting, Michael Corry has recommended that a safe harbor for the valuation, substantiation and reporting requirements for life insurance policies donated to charity be recognized in proposed regulations. Currently proposed rules, Corry argues, are "unduly burdensome."

Full Text:

January 27, 2009

Internal Revenue Service
ATTN: Susan J. Kassell, Senior Counsel
Branch 1: Income Tax & Accounting
1111 Constitution Avenue, NW.
Washington, DC 20224

RE: REG-140029-07 Guidance Regarding Appraisal and Reporting Requirements for Noncash Charitable Contributions/Substantiation and Reporting Requirements for Cash and Noncash Charitable Contribution Deductions

To Whom It May Concern:

The following comment is submitted on behalf of the Association for Advanced Life Underwriting (AALU) with regard to Notice 2006-96, 2006-46 I.R.B. 902, issued on October 19, 2006 and REG-140029-07 (Notice of Proposed Rulemaking), issued on August 6, 2008, (collectively the "proposed regulations"), which address reporting and substantiation requirements for cash and noncash charitable contribution deductions.

AALU is a nationwide organization of life insurance agents, many of whom are engaged in complex areas of life insurance such as business continuation planning, estate planning, retirement planning, deferred compensation and employee benefit planning. AALU represents approximately 2,000 life and health insurance agents and financial advisors nationwide.

AALU submits that the "qualified appraiser" and "qualified appraisal" requirements of the proposed regulations are unduly burdensome with respect to charitable contributions of life insurance policies for which certain commonly accepted methods of valuation have been recognized by the Treasury and Internal Revenue Service in published guidance.

For the reasons outlined herein, AALU recommends that the proposed regulations recognize a "safe harbor" for valuations of life insurance polices for which the taxpayer is willing to limit his or her charitable contribution deduction to (i) the cost of the particular contract (or comparable contract) purchased from the issuing company, in the case of a newly issued contract,1 or (ii) the greater of (a) the sum of the interpolated terminal reserve and any unearned premiums plus a pro rata portion of a reasonable estimate of dividends expected to be paid for that policy year based on company experience, and (b) the product of the "PERC amount"2 [or, where applicable, the "variable PERC amount"] and the "applicable Average Surrender Factor" described in section 3.04 of Rev. Proc. 2005-25,3 in the case of a policy that has been in force for some time.

I. Section 170(f)(11)(E)

Under section 170(f)(11)(C), for contributions of property for which a charitable contribution deduction of more than $5,000 is claimed, taxpayers are required to obtain a "qualified appraisal" of the property from a "qualified appraiser." Under section 170(f)(11)(D), for contributions of property for which a charitable contribution deduction of more than $500,000 is claimed, taxpayers must attach a qualified appraisal of the property to the tax return on which the deduction is claimed.

For appraisals prepared with respect to returns filed after August 17, 2006, Section 170(f)(11)(E), as added by American Jobs Creation Act of 2004, Public Law 108-357 (118 Stat. 1418) (Jobs Act), and amended by section 1219 of the Pension Protection Act of 2006, Public Law 109-280 (120 Stat. 780) (PPA), provides statutory definitions of the terms "qualified appraisal" and "qualified appraiser."4

Section 170(f)(11)(E)(i) provides that the term qualified appraisal means an appraisal that is (1) treated as a qualified appraisal under regulations or other guidance prescribed by the Secretary, and (2) conducted by a qualified appraiser in accordance with generally accepted appraisal standards and any regulations or other guidance prescribed by the Secretary.

Section 170(f)(11)(E)(ii) provides that the term qualified appraiser means an individual who (1) has earned an appraisal designation from a recognized professional appraiser organization or has otherwise met minimum education and experience requirements set forth in regulations prescribed by the Secretary, (2) regularly performs appraisals for which the individual receives compensation, and (3) meets such other requirements as may be prescribed by the Secretary in regulations or other guidance. Section 170(f)(11)(E)(iii) further provides that an individual will not be treated as a qualified appraiser unless that individual (1) demonstrates verifiable education and experience in valuing the type of property subject to the appraisal, and (2) has not been prohibited from practicing before the IRS by the Secretary under section 330(c) of Title 31 of the United States Code at any time during the 3-year period ending on the date of the appraisal.

Section 170(f)(11)(H) authorizes the Secretary to prescribe regulations as may be necessary or appropriate to carry out the purposes of section 170(f)(11), including regulations that may provide that some or all of the requirements of section 17(f)(11) do not apply in appropriate cases. (Emphasis added.)

II. The Proposed Regulations


    A. Qualified appraisal

In § 1.170A-17(a), the proposed regulations provide that a qualified appraisal means an appraisal document that is prepared by a qualified appraiser in accordance with generally accepted appraisal standards. Generally accepted appraisal standards are defined in the proposed regulations as the substance and principles of the Uniform Standards of Professional Appraisal Practice (USPAP), as developed by the Appraisal Standards Board of the Appraisal Foundation.5

    B. Qualified appraiser

Section 1.170A-17(b) of the proposed regulations incorporates many of the requirements from the current regulations. In general, under the proposed regulations, a "qualified appraiser" must be an individual with verifiable education and experience in valuing the relevant type of property for which the appraisal is performed.

The PPA refers to two types of education and experience: Minimum education and experience in section 170(f)(11)(E)(ii)(I) to establish qualification as an appraiser generally, and verifiable education and experience in valuing the type of property subject to the appraisal in section 170(f)(11)(E)(iii)(I) to establish qualification as an appraiser for a particular appraisal. Under the proposed regulations, satisfaction of the requirement of verifiable education and experience in valuing the type of property subject to the appraisal will also satisfy the minimum education and experience requirement of section 170(f)(11)(E)(ii)(I). The proposed regulations provide that an individual has verifiable education and experience if the individual has successfully completed professional or college-level coursework in valuing the relevant type of property and has two or more years experience in valuing that type of property.

Furthermore, because significant education and experience are required to obtain a designation from a recognized professional appraiser organization, under the proposed regulations appraisers with these designations are deemed to have demonstrated sufficient verifiable education and experience.

As under current regulations, a person is not a qualified appraiser if he or she is "[a] party to the transaction in which the donor acquired the property (for example, the individual who sold, exchanged, or gave the property to the donor, or any individual who acted as an agent for the transferor or for the donor for the sale, exchange, or gift), unless the property is contributed within 2 months of the date of acquisition and its appraised value does not exceed its acquisition price."6 This requirement presumably would exclude from the realm of "qualified appraiser" a life insurance company that sold the policy that is the subject of a charitable contribution to the donor, unless the sale preceded the contribution by less than 2 months.

III. Application to Life Insurance Policies

AALU contends that the application of the foregoing requirements to a charitable gift of life insurance would be unduly burdensome, particularly in light of the fact that the insurance company that sold the policy to the donor, and that would normally issue the Form 712 ("Life Insurance Statement") valuing the policy, would be excluded from the definition of "qualified appraiser" under the proposed regulations.

As a practical matter, it may be difficult to find unrelated individuals with "verifiable education and experience" in valuing life insurance policies who can act in this capacity and are in the business of making such appraisals, although one assumes that relevant education in life insurance could be attained through the Chartered Life Underwriter, Chartered Financial Consultant or other college-based designation. AALU nevertheless believes that the expense involved in locating and compensating such individuals (as contrasted to relying on a statement from the issuing company) is likely to deter charitable gifts of life insurance.

There is, moreover, a body of existing guidance on how to determine the fair market value of a life insurance policy for estate and gift tax purposes (and, in the compensation area, for purposes of applying the rules of Code Sections 79, 83 and 402). A combination of these methods should suffice to provide a valuation safe harbor for most life insurance contracts for purposes of Section 170 of the Code.


    A. Gift Tax Regulations

    Treas. Reg. § 25.2512-6(a) of the gift tax regulations reads as follows:

    "The value of a life insurance contract or of a contract for the payment of an annuity issued by a company regularly engaged in the selling of contracts of that character is established through the sale of the particular contract by the company, or through the sale by the company of comparable contracts. As valuation of an insurance policy through sale of comparable contracts is not readily ascertainable when the gift is of a contract which has been in force for some time and on which further premium payments are to be made, the value may be approximated by adding to the interpolated terminal reserve at the date of the gift the proportionate part of the gross premium last paid before the date of the gift which covers the period extending beyond that date. If, however, because of the unusual nature of the contract such approximation is not reasonably close to the full value, this method may not be used."


Rev. Rul. 59-1957 addressed the determination of the fair market value of a policy in a situation in which an employer sold to an employee a life insurance contract on which premiums were still due. The revenue ruling held that, for purposes of computing the employee's taxable gain in the year of the purchase, the value of the contract should be determined using the approach of § 25.2512-6 of the Gift Tax Regulations. Rev. Rul. 59-195 further notes that "[i]t is the position of the Internal Revenue Service that, in order to avoid the possible inconsistency of two different valuations of the same insurance contract for Federal income tax and for Federal gift tax purposes, the method of valuation prescribed by section 25.2512-6 of the Gift Tax Regulations should be followed for Federal income tax purposes in situations similar to the instant case."

AALU recognizes that a gift of a policy to an individual or trust and a charitable contribution of a policy are not strictly analogous.8 However, the general intention of the Rev. Rul. to avoid "possible inconsistency of two different valuations of the same insurance contract for Federal income tax and for Federal gift tax purposes" remains applicable. The valuation of an insurance contract should not turn on whether it is gifted to an individual vs. a charity.

Further, using the "interpolated terminal reserve" value of the policy for purposes of the federal income tax charitable deduction has the additional benefit of reflecting (in many cases) the actual price at which the issuing insurance company would offer to redeem the policy upon its surrender.


    B. Rev. Proc. 2005-25 and T.D. 9223.

In Rev. Proc. 2005-25 and T.D. 9223,9 the Treasury promulgated a valuation safe harbor under Section 402(a) of the Code for life insurance contracts distributed or sold by a qualified retirement plan to a plan participant or beneficiary. These authorities also apply under Section 79 and 83 of the Code to situations in which an employee is provided permanent benefits in combination with group-term life insurance or when a life insurance contract is transferred in connection with the performance of services.

The preamble to the final regulations incorporating the approach of Rev. Proc. 2005-25 references with approval both Rev. Rul. 59-195 and Treas. Reg. § 25.2512-6, but notes that ". . . this method may not be used to determine the fair market value of an insurance policy where the reserve does not reflect the value of all of the relevant features of the policy."

The Rev. Proc. and Treasury Decision thus go beyond the approach of the gift tax regulations in providing two safe harbor formulas that, if used to determine the value of an insurance contract, retirement income contract, endowment contract, or other contract providing life insurance protection that is distributed or otherwise transferred from a qualified plan, will meet the definition of "fair market value" for purposes of these Code sections.

For nonvariable contracts, the fair market value of an insurance contract, retirement income contract, endowment contract, or other contract providing life insurance protection may be measured, with required adjustments,10 as the greater of: A) the sum of the interpolated terminal reserve and any unearned premiums plus a pro rata portion of a reasonable estimate of dividends expected to be paid for that policy year based on company experience, and B) the product of the "PERC amount"11 and the "applicable Average Surrender Factor" described in section 3.04 of the revenue procedure.

For variable contracts, the fair market value may be measured, with required adjustments, as the greater of: A) the sum of the interpolated terminal reserve and any unearned premiums plus a pro rata portion of a reasonable estimate of dividends expected to be paid for that policy year based on company experience, and B) the product of the "variable PERC amount" and the applicable Average Surrender Factor described in section 3.04 of the revenue procedure.

AALU suggests that the value of a life insurance contract for purposes of Code Section 170 could, in most cases, be determined, at the option of the taxpayer, under a similar approach that combines the gift tax valuation methodology with the valuation safe harbors of Rev. Proc. 2005-25 and T.D. 9223, and that the taxpayer should be allowed to rely on the statement of the issuing insurance company to determine that value. Assuming that the taxpayer is willing to forgo any additional deduction that might accrue through obtaining a qualified appraisal, within the meaning of the proposed regulations, the taxpayer should be able, upon making an election, to determine, based on a statement from the issuing company, the fair market value of a life insurance policy for purposes of Section 170 in the following manner: (i) the cost of the particular contract (or comparable contract) purchased from the issuing company, in the case of a newly issued contract, or (ii) the greater of (a) the sum of the interpolated terminal reserve and any unearned premiums plus a pro rata portion of a reasonable estimate of dividends expected to be paid for that policy year based on company experience, and (b) the product of the "PERC amount" [or, where applicable, the "variable PERC amount"] and the "applicable Average Surrender Factor" described in section 3.04 of Rev. Proc. 2005-25, in the case of a policy that has been in force for some time.


    Conclusion

The Secretary of the Treasury has the power, under Code Section 170(f)(11)(H), to provide that some or all of the requirements relating to Code Section 170(f)(11) do not apply in appropriate cases. AALU believes that the Secretary should exercise this authority to provide an elective "safe harbor" in the final regulations for the valuation of life insurance policies contributed to charity where the taxpayer is willing to accept the limits on his or her deduction as outlined above.

You consideration of these comments is appreciated.

                Very truly yours,

                Michael P. Corry,
                President
                AALU
                Washington, DC
FOOTNOTES

1 See Treas. Reg. § 25.2512-6(a). Section references are to the Internal Revenue Code of 1986 and applicable Treasury Regulations, unless otherwise noted.

2 "PERC" stands for premiums, earnings and reasonable charges.

3 2005-17 I.R.B. 962, modifying and superseding Rev. Proc. 2004-16, 2004-10 I.R.B. 559. See also, T.D. 9223, 70 Fed. Reg. No. 166, pp. 50967-50972 (August 29, 2005).

4 The PPA also increased taxpayer penalties for appraisals that cause a tax understatement.

5 See Title XI of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, Public Law 101-73, 103 Stat. 183 (12 U.S.C. 3331-3351).

6 Prop. Reg. § 1.170A-17(b)(5)(iii).

7 1959-1 C.B. 18.

8 One difference in the income tax area arises from the nature of the gain from the sale of a life insurance as ordinary income, as opposed to capital gain. Usually, the fair market value of an asset that qualifies as a capital asset held by the donor taxpayer for at least one year may be deducted by the taxpayer to the extent of its full fair market value. When a life insurance policy is sold, however, the gain is, in most cases, ordinary income. In that case, the amount of the charitable contribution deduction generally is limited to the policy's basis, unless the policy's fair market value is lower. This difference should not, however, affect the valuation of the policy.

9 2005-17 I.R.B. 962, modifying and superseding Rev. Proc. 2004-16, 2004-10 I.R.B. 559. See also, T.D. 9223, 70 Fed. Reg. No. 166, pp. 50967-50972 (August 29, 2005).

10 The formulas set forth above, for example, "must be interpreted in a reasonable manner, consistent with the purpose of identifying the fair market value of a contract."

11 "PERC" stands for premiums, earnings and reasonable charges.


END OF FOOTNOTES

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APPRAISALS

As a follow up to Brian

Letter to Mr. Corry

This is a note I sent to Mr. Corry that I thought might be helpful to others as well as there are some particular points left out of his letter. And, I know, I know, I am an insurance appraiser beware of my conflicts going in! Dear Mr. Corry, I hope you are well and thank you for all you do in your role at AALU - it is much appreciated! On the subject on charitable appraisals of life insurance, I had a few comments I thought might be helpful. I perform these qualified appraisals and have for three years (see http://www.charitablesolutionsllc.com/appraisal.html). I complete about 80-90/year, and am fairly confident I do more than anyone else nationally. This represents about 5% of my income so I would not be so agitated if it went away - plus it is very boring work! Having said that, here are some key points that I believe your letter omitted: 1. My fee for this work is $350 for the policy and $200 for each additional policy and is identical to my national competitor Alan Breus (a friend from long ago). This is equal to or less than other non-cash appraisals and I have never had a charity say it was "burdensome" and have never heard any negative comments from the donor who is the payor. 2. In terms of "difficulty finding appraisers," Google is wonderful and typing in "qualified appraisals of charitable life insurance" pulls Alan and myself up #1 and 2. So it really isn't that difficult. 3. Most importantly, you would be amazed how inaccurate relying on the Form 712 would be. In about 20% of my appraisals, it is wrong. Not in terms of the numbers, but in terms of the valuation date. The 712s are ordered by the charity typically post-gift, and they tend to be sloppy about the completed gift transfer date being either the execution date of the Absolute Assignment or the Date Received by the life insurance company. Also, they sometimes make the mistake of acknowledging the gift from the parent charity rather than the Foundation or other different entity. 4. Also, as part of the appraisal, I request a stress-tested in-force ledger to notify the charity if there are likely to be any issues with the policy. As you may know, many of these policies have been in-force for many years and are running off very diffferent mortality, interest and expense assumptions. This is part of the appraisal of course but more practically of value to the charity from an on-going management standpoint. 5. The charity/donor would likely not be able to accurately account for outstanding loans properly using the 712 alone. Any gift with an outstanding loan is not entitled to an income tax deduction nor are any deductions received for future premium payments. Plus, it raises unrelated business taxable income issues for the charity. 6. The donor would not benefit from a greater valuation to the extent the policy could be "settled" in the secondary market. The deduction in that case would be lesser of adjusted cost basis or FMV of the ordinary income component PLUS any amount that would be long term capital gain. Not only would the donor lose the potential additional deduction, it is likely the charity would cash the policy in at what it deemed to be fair value and thus forfeiting the additional amount. The appraisal process notifies both parties, on Form 8283, as to what the fair market value of the policy was on the date of gift. I hope these points are helpful in filling out this process a bit more. And most importantly, the benefit to the charity, the donor and the CPA is hopefully worth the fee paid for both the intended compliance result, but also for the practical management advice for the donated policies post-gift. Best regards, Bryan Clontz, CFP

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