Rev. Rul. 54-264

Advice is requested whether taxable income results from the surrender at maturity of a single premium 10-year endowment policy in exchange for cash and a participating paid-up life insurance policy payable at death.

On December 15, 1943, the taxpayer purchased a single premium 10-year endowment policy for 4 x dollars. The policy provided for the payment of 5 x dollars to the taxpayer upon maturity of the policy, or payment of the same amount to a designated beneficiary in the event of the taxpayer's death prior to maturity. Also, it provided for two options which the taxpayer may exercise at maturity in lieu of other benefits:

(1) Surrender of the policy for a participating paid-up life insurance policy for 8 x dollars payable at death, or

(2) Surrender of the policy for a participating paid-up life insurance policy for 5 x dollars payable at death, and the immediate withdrawal of cash in the amount of 2 x dollars.

On December 15, 1953, the maturity date of the policy, the taxpayer under option (2) above elected to surrender the policy for a participating paid-up life insurance policy for 5 x dollars payable at death and to receive 2 x dollars in cash.

The Internal Revenue Service has held that if an insured exercises his right under an option to receive a paid-up life insurance policy in lieu of a cash payment, he in effect exchanges one kind of a policy for another and under certain circumstances realizes taxable gain as a result of such exchange. See Sol. Op. 55, C.B. 3, 54 (1920). A policy is considered surrendered for a different type of policy when a supplementary insurance contract is issued or the original policy is amended or endorsed in such a manner that the policyholder is insured under a different type of policy. S.M. 5680, C.B. V-1, 32 (1926), is distinguishable since the policyholder in the case described therein elected to continue the same policy as paid-up life insurance.

In view of the foregoing, it is held that where a single premium endowment policy is surrendered, pursuant to an election made at or prior to the maturity of the policy, in exchange for cash and a paid-up life insurance policy, taxable income is realized under section 22(b)(2)(A) of the Internal Revenue Code. The amount of such taxable income is the excess of (1) the cash plus the value of the policy received over (2) the premiums paid, reduced by any dividends paid or credited to the policyholder. However, if the amount of the premiums paid, reduced by any dividends paid or credited to the policyholder, exceeds the cash plus the value of the policy received, the difference represents a personal expense within the ambit of section 24(a)(1) of the Code and, therefore, is not deductible for Federal income tax purposes. The phrase `value of the policy received' means the same price that any person of the same age, sex, and condition of health as the taxpayer would have to pay for a similar policy with the same company on the date the policy is surrendered. The cash surrender value is not to be used for this purpose. This principle would also apply to any other type of endowment policy or life insurance policy surrendered in exchange for cash and a different type of policy.