Insurance Product Tax Seminar September Kirk Van Brunt Richard Safranek Josephine Firehock. Moderator Michael LeBoeuf

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1 Insurance Product Tax Seminar September E: Tax Issues in Life Settlements & STOLI Kirk Van Brunt Richard Safranek Josephine Firehock Moderator Michael LeBoeuf

2 Tax Issues in Life Settlements September 9, 2008 Faculty Kirk Van Brunt, Locke Lord Bissell & Liddell Richard Safranek, Deloitte Tax LLP Josephine Firehock, Office of Associate Chief Counsel (Financial Institutions & Products) Michael LeBoeuf, SMART Business Advisory and Consulting LLC

3 Overview Introduction of Faculty Brief Background Life Settlements Domestic Tax Issues International Tax Issues Comments Questions Background on Life Settlements What is a Life Settlement? Who are the parties in a Life Settlement transaction? Provider Broker Underwriter Investors What types of policies are preferred in Life Settlements? How are Life Settlements blocks of business managed? General administration Investment funds

4 Kirk Van Brunt LOCKE LORD BISSELL & LIDDELL th Street, NW Suite 400 South Washington, DC (202) Domestic Tax Issues Insurance Product Tax Seminar Conference Society of Actuaries September 9, 2008 State regulation of life settlements Insurable interest requirements Life settlements vs. STOLI STOLI law trends

5 Tax Overview Domestic Issues 1. Sale of policy by the original policyholder 2. Acquisition of policy by investor 3. Disposition of policy by investor (other than death) Surrender of a policy Resale of a policy 4. Death of the insured Death benefits Realization of Gain or loss Measurement of gain/loss: Policyholder s adjusted basis London Shoe et al. Comparison with section 72 withdrawal

6 Recognition of Gain Recognition of Loss Character of gain/loss Cash surrender value growth Life settlement premium Investor s Cost Basis Initial consideration capitalized items subsequent premiums paid Other items Deductibility of premiums paid section 264(a)(1) Interest disallowance sections 264(a)(2) (a)(4) & (f)

7 Application Section 72(e) Measurement of gain premiums paid COIs? Character of gain Substitution doctrine Recognition and character of losses Section 72 vs. section 1001 Calculating adjusted basis COIs: The London Shoe et al. line of cases Other periodic charges 1016 adjustments Depreciation? Recognition and character of gain Recognition and character of loss

8 Transfer for value rule the actual value of such consideration and the premiums and other amounts subsequently paid What is it? Relevance of deductibility? Disallowed interest Character of gain Arguments for capital gain treatment? Section 1234A

9 International Tax Issues In Life Settlements Richard Safranek, Deloitte Tax LLP September 9, 2008 What tax regime applies Business or Investment? If business income and business is conducted in US, tax is imposed on US source net income calculated subject to the same general limitations (e.g., sections 264 and 101) applicable to domestic taxpayers. Foreign source income generally would not be taxable. Section 864(c)(4). If business income but business is not conducted in the US, then there would be a 30% withholding tax (under Reg. sec (b)) if the income has a US source but no withholding taxes if the income has a foreign source. Query whether cited regulation affects substantive definition of fixed or determinable annual or periodic income under sections 871(a) and 881.

10 Investment Income If investment income, it would not matter where the management activity is conducted no business unless the owner is a trader. See 864(b)(2) regarding trading in securities or commodities. Would be 30% withholding tax if FDAP (i.e., regulation is upheld) and income is considered US source. Treaty Issues If business income, same as no-treaty result above if owner has a US permanent establishment. If no US permanent establishment, business income may not be taxed by the US directly or via withholding. See FSA If investment income, same as no-treaty result above unless owner qualifies for reduced withholding tax rates (e.g. other income article).

11 Source Two income types: gain from sale of policy prior to the death of an insured; benefit payments upon the death of an insured or at maturity of the policy. Revenue Rulings and Section 865. IRS Revenue Rulings Rev. Rul , CB 322 Death benefits fully exempt Gain on surrender or maturity of policy subject to withholding. Rev. Rul , CB 109 Death benefits exempt, subject to 101(a)(2) limitations Gain on death or surrender or maturity of policy subject to withholding.

12 Section 865 Under 1986 Tax Reform Act, gain from the sale of personal property is sourced by reference to residence of owner. Section 865(a). Sales through US office. Section 865(e). Sales through non-us office. Section 865 Gain on sale of policy prior to death. Benefit payments on death or maturity of a policy as gain from the sale, exchange or any other disposition of personal property

13 Calculation of Withholding Tax Base Section 101(a)(2) Capitalization issues Premiums, interest, commissions, fees Coordination of sections 871(a) and 881 with section 101(a)(2) exclusion US - Owned Foreign Entities Subpart F Foreign personal holding company income ( FPHCI ) Income equivalent to interest (FSA ) Gain from the sale of property that does not give rise to any income. Section 956

14 Passive Foreign Investment Company Rules Passive foreign investment company ( PFIC ) CFC override in section 1297(e). For Non-CFC, section 1297(b) defines passive income by reference to section 954(c) FPHCI rules. Circular 230 Disclosure: Any tax advice included in this written communication was not intended or written to be used as tax advice, and it cannot be used by the taxpayer for the purpose of avoiding any penalties that may be imposed by any governmental taxing authority or agency.