Rev. Rul. 57-191

Advice has been requested whether, under a nontrusteed annuity plan meeting the qualifications of section 401(a) of the Internal Revenue Code of 1954 and exempt under section 501(a) of the Code, premiums paid for individual contracts providing life insurance protection are taxable to the employees according to their nonforfeitable rights therein. Advice has also been requested as to the tax consequences of a distribution of life insurance contracts from a similarly qualified plan.

Section 1.402(a)-1(a)(2) of the Income Tax Regulations, relating to the tax consequences of the distribution of an annuity contract or of a life insurance contract by a trust which meets the requirements of section 401(a) of the Code, states that if such a trust purchases an annuity contract for an employee and distributes it to the employee in a year for which the trust is exempt under section 501(a) of the Code, the contract containing a cash surrender value which may be available to an employee by surrendering the contract, such cash surrender value will not be considered income to the employee unless and until the contract is surrendered. If, however, the contract distributed by such an exempt trust is a retirement income, endowment, or other life insurance contract and is distributed after October 26, 1956, the entire cash value of such contract at the time of distribution must be included in the distributee's income in accordance with the provisions of section 402(a), except to the extent that, within 60 days after the distribution of such contract, all or any portion of such value is irrevocably converted into a contract under which no part of any proceeds payable on death at any time would be excludable under section 101(c) of the Code (relating to life insurance proceeds).

Section 1.403(a)-1(d) of the regulations, relating to the taxability of a beneficiary under a qualified nontrusteed annuity plan, by reason of the purchase of contracts providing life insurance protection, states that if, under a qualified annuity plan, a group contract providing permanent life insurance protection is purchased for the employees, the same rules which are applicable when contracts providing life insurance protection are purchased by a trust described in section 401(a) and exempt under section 501(a) of the Code, shall be applicable in the case of such a contract. For such rules, see section 1.402(a)-1(a)(2), (3), and (4) of the regulations. Section 403(a) of the Code is not applicable to premiums paid after October 26, 1956, for individual contracts providing life insurance protection for employees.

The application of these provisions of the regulations requires that a distinction be made between (1) an annuity contract and (2) (1) an annuity contract and (2) a which provides pure life insurance protection at any time.

The definition of an annuity contract, within the meaning of section 402 and section 403 of the Code, is set forth in Revenue Ruling 55-639, C.B. 1955-2, 230, as a contract which provides primarily for periodic installment payments to the annuitant named therein and under which the death benefits at any time cannot exceed the larger of the reserve or the total premiums paid for the annuity benefits. Thus, in any annuity contract, there is no pure insurance protection at any time. The fact that the contract may provide for return of total premiums paid for the annuity benefits in case of death, and such total premiums may exceed the reserve in the early years, will not be considered as providing insurance protection.

Any other type of contract which involves life contingencies is a life insurance contract. This includes any type of contract which provides pure insurance protection, i.e. , a death benefit which at any time may exceed the larger of the reserve or the aggregate premiums paid to such time, such as a retirement income contract, or an endowment contract, as well as an ordinary life insurance contract. The mere fact that such a contract may contain provisions permitting the application or the conversion of its reserve, or its cash value, or its maturity value, to provide annuity benefits does not make such a contract an annuity contract, unless, and until, such conversion takes place. Thus, while a life insurance contract may be converted into an annuity contract, a contract is never both at the same time. Although such terms as `life insurance-annuity,' `life insurance with annuity,' `annuity with life insurance,' may be used to describe contracts issued by life insurance companies, such contracts will be considered life insurance contracts for the purposes of section 402 and 403 of the Code if they provide pure insurance protection.

Section 1.402(a)-1(a)(2) of the regulations, and corresponding provisions of the regulations under the 1939 Code, grant a deferment of the inclusion in income of the value of an annuity contract distributed by an employees' exempt trust. A similar deferment does not apply in the case of the distribution of an insurance contract, unless, within 60 days after the distribution of such contract, it is irrevocably converted into an annuity. The tax consequences of the distribution of an insurance contract by an exempt employees' trust before October 27, 1956, are set forth in Mimeograph 6461, C.B. 1950-1, 73. The tax treatment of such a distribution made after October 26, 1956, is governed by the second sentence of section 1.402(a)-1(a)(2) of the regulations. This sentence makes Mimeograph 6461, supra , and P.S. 66 /1/, dated November 10, 1950, inapplicable to distributions of an insurance contract after October 26, 1956.

The circumstances under which a distribution is made from a trust of a retirement income, endowment, or other life insurance contract after October 26, 1956, govern whether such distribution will be taxed as ordinary income or as a gain from the sale or exchange on an capital asset. The regulations state that the entire cash value of such contract at the time of distribution must be included in the distributee's income in accordance with the provisions of section 402(a) of the Code. Thus, under some circumstances, the amount includible in the distributee's income in accordance with this provision of the regulations would be entitled to capital gains treatment under section 402(a)(2) of the Code. See section 1.402(a)-1(a)(6) of the regulations.

Under the provisions of section 403(a) of the Code and section 1.403(a)-1 of the regulations, relating to the taxability of a beneficiary under a nontrusted qualified annuity plan, when an annuity contract is purchased by an employer for an employee under a nontrusteed qualified annuity plan, the employee is not required to include in income the amount paid for the contract at the time such amount is paid, but the amounts received or made available under such annuity contract shall be included in income for the taxable year in which received or made available. The first sentence of section 1.403(a)-1(d) of the regulations indicates the similar deferred tax treatment of the portion of the premiums not applicable to current life insurance protection, when the employer pays premiums for a group permanent life insurance contract under a qualified nontrusteed annuity plan for his employees; however, as in the case of a trusteed plan where contracts containing life insurance protection are purchased, the deferment ceases when there is a distribution of a contract or certificate providing life insurance protection.

As indicated in section 1.403(a)-1(d) of the regulations, there is no deferred tax treatment under section 403(a) of the Code when individual contracts providing life insurance protection for employees are purchased by the employer without an intervening trust. The reason for this is that when an employee has a nonforfeitable interest is an individual insurance contract, and thus has ownership rights in the contract, the payment of a premium by the employer is tantamount to an immediate distribution to the employee-owner of the contract. This provision of the regulations has the effect of revoking the last paragraph of PS No. 65,/2/ dated November 10, 1950, with respect to premiums paid after October 26, 1956, for individual contracts providing life insurance protection for employees. Also, this provision has no reference to annuity contracts, since section 403(a) of the Code is specifically applicable to the purchase of annuity contracts under a qualified annuity plan.

Thus, premiums paid by an employer after October 26, 1956, for individual contracts providing life insurance protection for employees are includible in the employee's income to the extent of each employee's nonforfeitable interest therein, where there is no intervening trust.

¹ Not published in the Bulletin.

² Not published in the Bulletin.