Rev. Rul. 81-126

The purpose of this revenue ruling is to restate, under current law, Rev. Rul. 67-258, 1967-2 C.B. 68.

The issue in Rev. Rul. 67-258 is whether amounts 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, 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. 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.

The employee receiving the distributions contends there is no tax incidence because the receipt of the "loan" value is substantially similar to any conventional loan arrangement.

Section 72(e)(1)(B) of the Code provides, in general, that if any amount is received under an annuity, endowment, or life insurance contract, and if such amount is not received as an annuity, then such amount received before the annuity starting date shall be included 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.

As a result, if the employee's investment in the contract, computed under section 72(c)(1) of the Code, is zero, then all amounts received under that contract are includible in gross income.

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.

Amounts 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 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 gross income, exceeds the employee's consideration paid for the contract.

Accordingly, in this case the amounts received under the contract are fully taxable to the employee because the consideration for the contract paid by the employer was excluded from the employee's gross income.

Any repayment of the "loan" made by the employee to the insurer is includible in the employee's consideration paid for the contract. Thus, upon subsequent distribution of that contract, the employee's investment in the contract will be excludable from gross income in the manner and to the extent provided by section 72(b) or (d) of the Code, whichever is applicable. See Rev. Rul. 70-314, 1970-1 C.B. 20.

The Internal Revenue Service will not follow the decision in Robert W. and Mary F. Minnis v. Commissioner, 71 T.C. 1049 (1979), which held to the contrary.

Revenue Ruling 67-258 is superseded because the position stated therein is restated, under current law, in this revenue ruling.