EMPLOYEE TERM LIFE COVERAGE PURCHASED FROM SUBSIDIARY IS NOT SELF- INSURANCE.

Rev. Rul. 92-93

ISSUES

1. If a parent corporation carries insurance on its employees' lives under a group-term life insurance contract purchased from the parent's wholly owned insurance subsidiary, may the employees exclude from gross income under section 79 of the Internal Revenue Code an amount equal to the cost of $50,000 of the life insurance coverage?

2. Are payments to be made by a parent corporation to its wholly owned insurance subsidiary for group-term life insurance coverage for the parent's employees deductible under section 162 of the Code?

FACTS

X, a domestic manufacturing corporation whose stock is widely held, obtains for each of its employees $100,000 of life insurance coverage under a nonparticipating group-term life insurance contract. The employees do not reimburse X or pay any of the cost of the coverage. X is not a direct or indirect beneficiary under the contract, and the proceeds of the contract are payable to the employees' beneficiaries.

The contract is issued to X by S1, a wholly owned insurance subsidiary of X. S1 is engaged in the trade or business of issuing life insurance and annuity contracts to the general public. S1 is regulated as an insurance company by the states where it transacts business. The contract issued to X qualifies as a life insurance contract under applicable state law. The contractual terms, including the premium rates, are customary in the industry. There is no guarantee of a renewal of the contract by S1. No permanent benefits (for example, a cash surrender value) are provided under the contract.

LAW AND ANALYSIS

Issue 1

Section 61(a) of the Code provides that gross income includes compensation for services, which includes fringe benefits.

Section 1.61-1(a) of the Income Tax Regulations states that gross income means all income realized from whatever source derived, unless excluded by law. Gross income includes income realized in any form, whether in money, property, or services.

Section 1.61-2(d)(1) of the regulations states that if services are paid for in property, the fair market value of the property taken in payment must be included in income as compensation.

Section 1.61-2(d)(2)(ii) of the regulations states that life insurance premiums paid by an employer on the life of an employee where the proceeds of the insurance are payable to the beneficiary of the employee generally are part of the gross income of the employee. Special rules under section 79 of the Code, however, govern the includibility in an employee's gross income of group-term life insurance carried directly or indirectly by his or her employer on the employee's life. See also section 83(e)(5) (section 83 inapplicable to group-term life insurance to which section 79 applies).

Section 79(a) of the Code provides that there shall be included in the gross income of an employee for the taxable year an amount equal to the cost of group-term life insurance on the employee's life for part or all of such year under a policy (or policies) carried directly or indirectly by an employer to the extent that such cost exceeds the sum of (1) the cost of $50,000 of such insurance, and (2) the amount (if any) paid by the employee toward the purchase of such insurance.

Insurance requires the shifting of an economic risk of loss from the insured to the insurer. Helvering v. Le Gierse, 312 U.S. 531 (1941), 1941-1 C.B. 430. Risk shifting entails the transfer of a potential loss from the insured to the insurer. Rev. Rul. 77-316, 1977-2 C.B. 53, AS AMPLIFIED AND CLARIFIED BY Rev. Rul. 88-72, 1988-2 C.B. 31, AS CLARIFIED BY Rev. Rul. 89-61, 1989-1 C.B. 75, concludes that risk shifting does not exist under arrangements whereby a parent corporation purports to shift a risk of the parent to its wholly owned insurance subsidiary. The ruling explains:

     [T]he insuring parent corporation and its domestic subsidiaries,

Although X purchased the group-term life insurance contract covering its employees from its wholly owned insurance subsidiary, S1, this fact does not cause the arrangement to be "self-insurance" because the economic risk of loss being insured shifted to S1 is not a risk of X.

The group-term life insurance that X provides to its employees is compensation for the performance of services. In partial consideration for the employees' services, X paid the premium on a contract that provides each employee with $100,000 of term life insurance coverage. This insurance on the employees' lives is an economic benefit to the employees since it relieves them of the expense of providing life insurance for themselves. Unless excluded under the Code, the value of insurance provided X's employees in connection with the performance of services is includible in the employees' gross income. Section 1.61-2(d)(2)(ii) of the regulations. Therefore, in accordance with section 79 and the regulations thereunder, each employee of X may exclude from gross income an amount equal to the cost of $50,000 of the group-term life insurance carried by X on the employee's life. The cost of insurance coverage in excess of $50,000 must be included in the employee's gross income.

Issue 2

Section 162(a) of the Code provides that there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered.

Section 1.162-1(a) of the regulations states that among the items included in business expenses are labor expenses.

Section 264(a)(1) of the Code provides that no deduction is allowed for premiums paid on any life insurance policy covering the life of any officer or employee, or of any person financially interested in any trade or business carried on by the taxpayer, when the taxpayer is directly or indirectly a beneficiary under such policy.

The amounts paid by X to S1 for group-term life insurance are part of the compensation for the employees' services. If an employer augments an employee's salary by paying the premiums on the employee's life insurance, the premiums are deductible business expenses provided the aggregate amount of compensation does not exceed reasonable compensation for the employee's services and provided the employer is not directly or indirectly a beneficiary under the policy. See Rev. Rul. 56-400, 1956-2 C.B. 116. The holding of Rev. Rul. 77-316 does not preclude an employer from deducting the cost of insurance coverage provided employees as additional compensation for their services in this case because the arrangement in this case does not involve self-insurance. Cf. section 1.809- 5(a)(12) of the regulations (allowing a life insurance company a deduction for amounts representing premiums that the company charges itself with respect to liability for employee insurance and annuity benefits). Accordingly, if the aggregate amount of compensation for an employee's services does not exceed reasonable compensation for the employee's services, X may deduct the premiums paid to S1 for the group-term life insurance on that employee. But see Gulf Oil Corp. v. Commissioner, 89 T.C. 1010 (1987), aff'd, 914 F.2d 396 (3rd Cir. 1990) (no deduction allowed to parent corporation for amounts paid for waiver of premium coverage for disabled employees under a group life insurance plan). The Internal Revenue Service will not follow the decision in Gulf Oil to the extent that it denies a deduction for amounts a parent corporation pays to shift risks of unrelated employees and their beneficiaries to the parent's wholly owned insurance subsidiary.

HOLDINGS

1. If a parent corporation carries insurance on its employees' lives under a group-term life insurance contract purchased from the parent's wholly owned insurance subsidiary, the employees may exclude from gross income under section 79 of the Code an amount equal to the cost of $50,000 of the life insurance coverage.

2. X may deduct the premiums paid to S1 for group-term life insurance on X's employees provided the aggregate amount of compensation with respect to each employee is reasonable. APPLICATION

APPLICATION

The holdings of this revenue ruling also apply to accident and health insurance. Thus, unless excluded under the Code, the value of the accident and health insurance (including waiver of premium coverage upon disability) provided by an employer to its employees in connection with the performance of services is compensation includible in the employees' gross income under section 61 of the Code. The employer may deduct the premiums paid to its wholly owned insurance subsidiary for accident and health insurance on an employee provided the aggregate amount of compensation to the employee does not exceed reasonable compensation.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 77-316 and Rev. Rul. 88-72 are distinguished.

DRAFTING INFORMATION

The principal author of this revenue ruling is William T. Sullivan of the Office of the Assistant Chief Counsel (Financial Institutions and Products). For further information regarding this ruling contact Mr. Sullivan on (202) 622-3970 (not a toll-free call).