Academic journal article Journal of Accountancy

Transfers for Value

Academic journal article Journal of Accountancy

Transfers for Value

Article excerpt

Life insurance can be an attractive financial planning tool because the proceeds payable on the death of an insured generally are exempt from taxation. This is not always the case, however.

TRANSFER-FOR-VALUE RULE

If a life insurance policy (or interest in such a policy) is transferred for consideration, the proceeds are exempt from tax only up to the amount of the consideration paid by the transferee and any premiums he or she paid after the transfer.

This rule applies to outright sales of insurance policies but also extends to other transactions: the naming of a beneficiary in exchange for consideration, the creation (through a separate contract) of a right to receive the insurance policy's proceeds, the assignment by two shareholders of existing policies to each other to fund a cross-purchase agreement or the transfer of a policy by a corporation to a shareholder in a liquidation distribution. A transfer for value can occur even if the policy has no cash surrender value and even if no purchase price is paid, provided some sort of consideration is involved.

EXCEPTIONS TO THE RULE

There are several exceptions to the transfer-for-value rule. If any of these transactions occurs, the life insurance proceeds are exempt from income taxation:

* A sale or transfer for value to the insured himself or herself.

* A transfer for value to a partner of the insured, to a partnership of which the insured is a partner or to a corporation of which the insured is an officer or shareholder.

* A transfer for value in which the transferee carries over the transferor's basis in the policy--for example, when a policy is transferred from one corporation to another as part of a tax-free reorganization, when a policy is transferred between spouses or when a policy is acquired as a gift.

Series of transfers. If the same policy is transferred several times, the final transfer determines its status. If the final transfer is a transfer for value, a portion of the policy proceeds is taxable. If the final transfer is to someone exempt in accordance with the exceptions, the entire proceeds are tax-free.

The transfer-for-value rule, therefore, can be both an advantage and a disadvantage. …

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