Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 79-41

1979-1 C.B. 124

Section 264

IRS Headnote

Interest paid; single premium annuity contract. A deduction for interest paid on a loan, where the loan proceeds are used to buy stock and the collateral is a single premium annuity contract that was purchased for cash, is disallowed under section 264 of the Code.

Full Text

Rev. Rul. 79-41

ISSUE

Will a deduction be allowed for federal income tax purposes for interest paid or accrued on indebtedness incurred in connection with the purchase of stock under the circumstances described below?

FACTS

In 1976, A, an individual taxpayer, purchased a single premium annuity contract from an insurance company. The contract required that A make one payment of 5,000x dollars. A withdrew 5,000x dollars from a savings account and paid that amount to the insurance company in full satisfaction of A's obligation.

In 1977, in a separate transaction, A purchased 4,000x dollars of stock from a brokerage firm. A borrowed 4,000x dollars from a lending institution, using the annuity contract as collateral, and paid that amount to the brokerage firm in full satisfaction of A's obligation. A paid interest of 320x dollars a year to the lending institution on the 4,000x dollars owed.

LAW AND ANALYSIS

Section 264(a)(2) of the Internal Revenue Code of 1954 provides that no deduction shall be allowed for any amount paid or accrued on indebtedness incurred or continued to purchase or carry a single premium life insurance, endowment, or annuity contract.

Section 1.264-2 of the Income Tax Regulations provides, in part, that amounts paid or accrued on indebtedness incurred or continued, directly or indirectly, to purchase or to continue in effect a single premium annuity contract purchased after March 1, 1954, are not deductible under section 163 of the Code or any other provision of Chapter 1 of the Code.

Direct evidence of a purpose to carry a single premium annuity contract exists where such a contract is used as collateral for indebtedness. One who borrows to buy a single premium annuity contract and one who borrows against such a contract already owned are in virtually the same economic position. Section 264(a)(2) of the Code makes no distinction between them. See Wisconsin Cheeseman, Inc. v. United States, 388 F.2d 420 (7th Cir. 1968) and Rev. Proc. 72-18, 1972-1 C.B. 740, section 3.03, for analogous language, but concerning section 265(2) of the Code.

In the instant case, rather than liquidate the annuity for its cash surrender value, A maintained the annuity investment by borrowing, using the annuity as collateral, and then purchasing the stock.

HOLDING

There is a direct relationship between the annuity contract and the loan indebtedness. Therefore, pursuant to section 264(a)(2) of the Code, no interest deduction is allowed. See section 7.02 of Rev. Proc. 72-18, for the proper method of computing the amount of nondeductible interest.