Rev. Rul. 59-184

The Internal Revenue Service has been requested to state its position with respect to whether payments made by a corporation of premiums on insurance contracts on the lives of its stockholders constitute constructive dividends to the insured stockholders, where the proceeds of the policies are to be used to purchase their stock.

A closely held corporation, prior to 1954, was the named beneficiary of two life insurance contracts insuring the respective lives of two of its stockholders who owned a majority interest in the corporation. The corporation paid the annual premiums on these contracts and reported them as unallowable deductions in its corporate income tax returns through the years.

In 1954, an insurance agreement was entered into by and between the two stockholders, the corporation, and other persons who were designated the trustees of an insurance trust created by the agreement. Under the terms of the agreement, the corporation ceased to be the beneficiary of the above two life insurance policies and in its place trustees were named as the beneficiaries of each of such contracts.

Pertinent provisions of the agreement are that: (1) Upon the death of an insured, the proceeds of the contract are to go to the trustees or the survivors of them; (2) the corporation reserves the right of revocation of the beneficiaries; (3) upon the receipt of the proceeds from either of the contracts, and upon written request by the executors or administrators, the trustees are to purchase with the insurance proceeds the corporation's stock held by deceased at the time of his death; (4) in the event that the insurance proceeds are insufficient to purchase the stock, the corporation is to pay the balance thereof, either to the trustees, executors or administrators; (5) the trustees are to deliver such stock to the corporation and the stock is to be retired; (6) in the event the executors or administrators of the estate of the decedent fail to notify the trustees of their election to sell the stock within one year from the date of receipt of the proceeds from the contract, then such proceeds are to be paid over to the corporation by the trustees and the proceeds are to become a part of the corporation's general assets; (7) the purchase price of the corporation's stock held by deceased is to be computed at its book value at the time of death; (8) in the event that the corporation defaults in payment of any premiums on the contracts for five days after the due date of such premiums, the insured may purchase such contract at its then cash surrender value, and in the event of such purchase, the insured has full power with respect to the substitution of beneficiaries; (9) the trustees are to make no payments of premiums but are only to collect the proceeds of the policies; (10) the agreement may be revoked or modified by either the corporation or the officers by written agreement.

Sections 301(a) and (c) of the Internal Revenue Code of 1954 provide, in part, that a distribution of property by a corporation to a shareholder with respect to its stock shall be included in gross income to the extent the amount distributed is considered a dividend under section 316 of the Code. However, section 1.301-1(c) of the Income Tax Regulations states that section 301 of the Code is not applicable to an amount paid by a corporation to a shareholder unless the amount is paid to the shareholder in his capacity as such.

The instant case involves a rather common situation in which two or more stockholders of a closely held corporation arrange for the orderly sale and purchase of the stock of a stockholder who dies. These so-called `buy and sell' agreements are very often funded with insurance policies in view of the fact that in the early years of the corporation's existence proceeds for the consummation of the agreement, in the event of the stockholder's death, would not be available.

There are many methods by which buy and sell agreements can be arranged. Each stockholder could take out insurance on the life of each other stockholder and use the proceeds at death to pay for the stock of the deceased stockholder. In such a case, the corporation itself would not be a party to the agreement. Under such a plan, if the premiums are paid by the corporation, they are considered distributions of dividends to the various stockholders who are the owners and beneficiaries of the policies. See Thomas F. Doran v. Commissioner , 246 Fed.(2d) 934.

However, it is well recognized that a buy and sell arrangement can be prepared with the corporation acting as the prime purchaser of the stock of a deceased stockholder. Such arrangements are quite common and are in effect recognized by the Code in that section 302(b)(3) provide for a capital gain treatment in the event of a complete redemption by the corporation itself of all the stock actually and constructively owned by a stockholder. For purposes of this discussion it is assumed that the obligation to purchase the stock is solely that of the corporation so that the question of the corporation undertaking the obligation of another stockholder is not raised. H. F. Wall v. Commissioner , 164 Fed.(2d) 462.

In the case of Henry E. Prunier et al. v. Commissioner , 248 Fed.(2d) 818, the Commissioner of Internal Revenue contended that where a corporate employee or stockholder, or someone related to him, is the beneficiary, and not the corporation, of a policy of life insurance on such employee or stockholder, payment of the premiums on such policy by the corporation constitutes income to the insured individual. See Paramount-Richards Theatres, Inc., et al. v. Commissioner , 153 Fed.(2d) 602. However, the United States Court of Appeals for the First Circuit, in vacating the decision of the Tax Court of the United States in that case, which had held for the Commissioner, stated that where a corporation was the beneficial owned of the policies on the lives of its officers-shareholders, and such proceeds were to be used to purchase the stock of such shareholders, no income to the shareholders resulted from the payment of the premiums by the corporation. The appellate court concluded that the corporation equitably owned the policies under the law of Massachusetts and was entitled to recover the proceeds of the policies in the event of the death of one of the insured. In its decision, the appellate court said:

Certainly the fact that the corporation may have been contractually bound to apply any proceeds of the policies, had they matured in 1950, to buy out the stock interest of a deceased stockholder, does not mean that the corporation would not have been `enriched' by collecting the face amount of the policies. All that would then have been involved would have been a change in the form of the assets from cash to treasury stock.

The Revenue Service will follow the Prunier decision and will also follow the decisions of the United States Court of Appeals for Tenth Circuit in the case of Robert V. Sanders et al. v. Charles I. Fox , 253 Fed.(2d) 855, involving a similar factual situation, as well as Oreste Casale v. Commissioner , 247 Fed.(2d) 440.

In view of the foregoing court decisions, it is held that whenever a corporation purchases life insurance on the lives of its stockholders, the proceeds of which are to be used in payment for the stock of any stockholder, the premiums on such insurance do not constitute income to any stockholder, even though the stockholder has the right to designate a beneficiary, if such right of the beneficiary to receive the proceeds is conditioned upon the transfer of the corporate stock to the corporation. The payment of premiums by the corporation is merely an independent act by the corporation by which it converts one asset, cash, into another asset, an insurance policy, and such action has no relationship whatsoever to the receipt of income by the stockholders.

Therefore, in the instant case, premiums paid by the corporation on the contracts insuring the lives of its two principal stockholders are not equivalent to dividends to the insured stockholders.

Revenue Ruling 59-79, page 15, this Bulletin, is hereby superseded.

¹ Based on Technical Information Release 115, dated December 8, 1958.