Internal Revenue Service
Revenue Ruling

TaxLinks.com   sm

 Rev. Rul. 76-78

1976-1 C.B. 25

Section 61
Section 103

IRS Headnote

Exempt interest; proceeds of insurance on state or municipal bonds. The proceeds of insurance, purchased by individual investors or municipal bond funds, representing maturing interest on defaulted obligations of a state or political subdivision are excludable from the gross income of the insured investors or funds under section 103(a)(1) of the Code; Rev. Rul. 72-134 amplified.

Full Text

Rev. Rul. 76-78

An independent insurance company offers insurance protection to individual investors and municipal bond funds by guaranteeing the payment of principal of and interest on bonds issued by a state or political subdivision thereof the interest on which is excludable from gross income under section 103(a)(1) of the Internal Revenue Code of 1954. The insurance protection is available to investors holding a certain minimum face amount of bonds in their investment portfolios.

The insurance policies provide that the insurance company will make payment to the insured of that portion of the principal of and interest on each of the obligations due but unpaid by reason of nonpayment by the issuer of such obligations. Upon payment by the insurance company of principal or interest that is in default, the insurance company is subrogated to all of the rights to payment thereon that the insured bondholder possessed and the insurance company is vested with all of the bondholder's options, votes, rights and powers pursuant to the instruments that governed the issuance of the bonds. Payment by the insurance company to the bondholder does not relieve the issuer of such bonds of its obligation to pay such obligations in accordance with their terms.

Rev. Rul. 72-134, 1972-1 C.B. 29, as amplified by Rev. Rul. 72-575, 1972-2 C.B. 74, holds that the insurance protection obtained by a political subdivision of a state or by an underwriter against default of principal or interest payments on bonds issued by the political subdivision does not affect the exclusion from gross income of interest on the bonds, and the defaulted interest paid by the insurance company is excludable from the gross income of the underwriter and other bondholders under section 103(a)(1) of the Code.

Held, proceeds of insurance purchased by individual investors or municipal bond funds, representing maturing interest on defaulted obligations of a state or political subdivision thereof, are excludable from the gross income of such individual investors or municipal bond funds pursuant to section 103(a)(1) of the Code.

Rev. Rul. 72-134 is further amplified.