Rev. Rul. 67-258

Advice has been requested whether monies received before the annuity starting date from an insurance company representing in whole or in part the "loan" value of an annuity contract are taxable to an employee under the circumstances described below.

An employee entered into an annuity purchase program, referred to in section 403(b) of the Internal Revenue Code of 1954, through a salary reduction agreement in return for which the employer agreed to purchase an annuity contract. Upon request, the employee may receive from the issuer of the contract distributions to the extent of the "loan" value of the contract as provided under its terms. The issuer had no discretion to refuse the loan but was required to make the loan pursuant to the terms of the contract. There is no time limit for repayment, and the amounts need never be repaid. Instead they serve to reduce the total amount which the issuer is ultimately obligated to pay under the contract.

The employee receiving the distributions contends there is no tax incidence since the receipt of the "loan" value is substantially similar to any conventional loan arrangement. Furthermore, the portion of the reserves allocable to the contract on the books of the issuer was not reduced at the time of the transaction but rather is to be adjusted at the time benefits become payable upon surrender, redemption or maturity of the contract by a "netting out" for amounts previously paid to the employee.

Section 72(e)(1)(B) of the Code provides that if an amount is received under an annuity or life insurance contract, and if such amount is not received as an annuity, then such amount shall be includible in gross income, but only to the extent that it (when added to the amounts previously received under the contract which were excludable from gross income) exceeds the aggregate premiums or other consideration paid.

Section 1.72-11(b)(1) of the Income Tax Regulations provides that if a return of premiums or other consideration is received under a contract to which section 72 of the Code applies and such payments are received before the annuity starting date or before the date on which an amount is first received as an annuity, such payments are includible in the gross income of the recipient only to the extent that they, when taken together with all previous payments received under the contract which were excludable from the gross income of the recipient under the applicable income tax law, exceed the aggregate of premiums or other consideration paid or deemed to have been paid by the recipient.

The advances made to the employee in the form of a return of consideration are deemed to be amounts received under the contract and do not serve to create a creditor-debtor relationship. In substance, the transaction is a return of consideration and not a loan. The advance made to the employee never is a debt but merely serves to reduce the sum the insurer ultimately must pay. See Board of Assessors of the Parish of Orleans, The City of New Orleans v. New York Life Insurance Company, 216 U.S. 517 (1910); Cornelius W. Sullivan, 333 F. 2d 100 (1964); and Leo L. Miroff, 353 F. 2d 481 (1965).

Moneys received by the employee pursuant to the terms of the annuity contract, representing in whole or in part a return of the consideration paid for the contract, are includible in his gross income for the taxable year, under section 72 of the Code, to the extent the amount received when taken together with all previous payments received under the contract which were excludable from his gross income, exceeds his consideration paid for the contract.

Accordingly, in this case the amounts received under the contract are fully taxable to the employee since the consideration for the contract paid by the employer was excluded from the employee's gross income. Any redeposit made by the employee with the insurer is includible in the employee's consideration paid for the contract upon subsequent distribution. See Rev. Rul. 66-168, C.B. 1966-1, 25.

Whether a provision in an annuity purchase arrangement described in section 403(b) of the Code, which grants an employee the unrestricted right to withdraw amounts standing to his credit, would render such amounts taxable to the extent provided by section 72 of the Code. See Rev. Rul. 67-388, page 153.r