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 Rev. Rul. 65-57

1965-1 C.B. 56

Sec. 101

IRS Headnote

Where a life insurance contract purchased by a taxpayer could not have been acquired by him except in combination with a nonrefund life annuity contract for which he paid a single premium equal to the face value of the insurance contract, the insurance contract has no element of insurance, even though it has the usual form of an insurance policy and contains all the usual provisions. The proceeds of such a policy paid by reason of death of the insured are not excludable from gross income under section 101(a) of the Internal Revenue Code of 1954. The proceeds are subject to income tax to the extent they exceed the aggregate of the net premiums paid for the contract designated as a life insurance contract.

Full Text

Rev. Rul. 65-57

Advice has been requested whether the proceeds of a life insurance policy taken out under the circumstances described below will be excludable from the gross income of the beneficiary under section 101(a) of the Internal Revenue Code of 1954.

The taxpayer purchased a life insurance policy which he could not have acquired except in combination with a nonrefund life annuity contract for which he paid a single premium equal to the face value of the life insurance contract. The annuity payments to the taxpayer are to cease at his death. The contracts are the usual form of contracts issued by the insurance company and the premium rates on both are at the regular rates charged by the company for nonparticipating ordinary life insurance on standard lives and life annuity contracts of the type issued to the taxpayer. The taxpayer named his daughter as beneficiary of the life insurance policy. After its issuance, he assigned the policy to the beneficiary by gift.

Section 101(a)(1) of the Code states the general rule that the proceeds of life insurance policies, if paid by reason of the death of the insured, are excludable from the gross income of the recipient.

In order to be an insurance contract, for Federal tax purposes, a contract must involve an element of risk. The risk must be an actuarial one under which the premium cost is based upon the likelihood that the insured will live for a certain period and the insurer stands to suffer a loss if the insured does not in fact live for the expected period.

In Helvering v. Edyth Le Gierse, et al. , 312 U.S. 531 (1941), Ct. D. 1491, C.B. 1941-1, 430, a decedent took out simultaneously an insurance policy on her life and a nonrefund annuity contract entitling her to payments for her life. A single premium was paid for each, the aggregate of the two premiums exceeding the face value of the life insurance policy by an amount representing loading and other incidental charges. Issuance of the Insurance policy was expressly contingent upon the simultaneous purchase of the annuity contract. Each contract was in standard form for that type of contract. The Supreme Court of the United States, in holding that the proceeds of the life insurance policy did not qualify as an `amount receivable * * * as insurance' within the meaning of section 302(g) of the Revenue Act of 1926, stated, in part, as follows:

* * * the amounts must be received as the result of a transaction which involved an actual `insurance risk' at the time the transaction was executed. Historically and commonly insurance involves risk-shifting and risk-distributing. * * *

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Considered together the contracts wholly fail to spell out any element of insurance risk. It is true that the `insurance' contract looks like an insurance policy, contains all the usual provisions of one, and could have been assigned or surrendered without the annuity. Certainly the mere presence of the customary provisions does not create risk, and the fact that the policy could have been assigned is immaterial since, no matter who held the policy and the annuity, the two contracts, relating to the life of the one to whom they were originally issued, still counteracted each other. * * * The fact remains that annuity and insurance are opposites; in this combination the one neutralizes the risk customarily inherent in the other. * * *

The concept of insurance laid down in Le Gierse was predicated not upon elements peculiar to the estate tax but upon fundamental principles of what constitutes insurance. The concept is equally applicable to the term `insurance' found in section 101(a) of the Code in reference to the income tax, as the term is employed in that section not in any specialized sense but with its normal meaning. See Mary Tighe v. Commissioner , 33 T.C. 557 (1959), acquiescence, C.B. 1960-2, 7, and Revenue Ruling 55-313, C.B. 1955-1, 219, in both of which the Le Gierse decision was cited in connection with section 22(b)(1) of the Internal Revenue Code of 1939, the counterpart of section 101(a) of the 1954 Code.

In transactions of the type described herein the insurance company has not undertaken to shift the risk of premature death from the insured and to distribute the risk among its other policyholders. On the contrary, by requiring the purchase of a nonrefund annuity contract the company has eliminated this risk.

The holding in Le Gierse was not overruled by the later decision of the Court in Fidelity-Philadelphia Trust Co. et al. v. Smith , 356 U.S. 274 (1958), Ct. D. 1824, C.B. 1958-1, 557, wherein the decedent (as in Le Gierse ) simultaneously took out three life insurance and three annuity contracts which were in such terms that one contract offset any actuarial risk in another. Subsequently, the decedent transferred to the beneficiaries under the life insurance policies all rights and benefits thereunder. It was conceded by both parties that under the authority of Le Gierse the proceeds of these policies did not qualify as insurance for estate tax purposes. It was contended by the United States, however, that, because of the economic interrelation of the contracts, they constituted a single property interest the income from which (in the form of the annuity payments) was retained by the decedent until death, with the principal (the insurance policy proceeds) passing upon death. This analysis of the transaction (if valid) would have authorized the inclusion of the proceeds of the life insurance policies in the taxable estate. The Court rejected this contention, holding that the life insurance policies were property interests separate from the annuities and were not property the income from which was retained by the decedent until death. The opinion makes extended reference to Le Gierse and distinguishes the situation there ruled upon, but does not purport to overrule the holding in that case.

The results reached in the two decisions are not inconsistent. In Le Gierse , the factor stated by the Court to be indispensable to the concept of insurance was an actual insurance risk at the time the transaction was executed . In Fidelity-Philadelphia, the Court recognized that the life insurance and annuity contracts, once issued , were so separable that one could be disposed of independently of the other. This is consistent with the view that the life insurance contracts, even after issue, still lacked the character of insurance because they did not embody assumption of the risk fundamental to true insurance. As was brought out in the Le Gierse opinion, this attribute of risk assumption was still absent even though the insurance policies, after issuance, came into the ownership of persons other than the annuitant. The insurer was still relieved of any risk that the insured would die either before or after the expiration of his life expectancy. As noted, both parties in the Fidelity-Philadelphia case conceded that the life insurance contracts did not qualify as insurance under the estate tax law.

In the instant case the taxpayer is considered to have purchased two contracts, one a life annuity contract and the other a contract which, while designated a life insurance contract, has no element of `insurance' and is, therefore, not a contract of the type contemplated in section 101(a) of the Code.

Accordingly, it is held that the annual payments received under the annuity contract will be subject to the provisions of section 72(b) of the Code. The proceeds of the other contract, even though received by reason of the insured's death, will not be excludable from gross income under section 101(a) of the Code and will be subject to income tax to the extent they exceed the net premiums paid for that contract.