IRS PROVIDES RELIEF PROCEDURE FOR ISSUERS OF VARIABLE CONTRACTS.

Rev. Proc. 92-25

SECTION 1. PURPOSE

This revenue procedure provides the procedure by which an issuer of a variable contract may request the relief described in section 1.817-5(a)(2) of the Income Tax Regulations. Pursuant to section 1.817-5(a)(2), the Internal Revenue Service may treat the investments of a segregated asset account on which the contract is based as satisfying the diversification requirements of section 1.817-5(b) of the regulations for periods during which there was an inadvertent failure to satisfy those requirements.

SEC. 2. BACKGROUND

01 Section 817(h) of the Internal Revenue Code provides that a variable contract (other than a pension plan contract) based on a segregated asset account shall not be treated as an annuity, endowment, or life insurance contract if the investments made by the account are not adequately diversified in accordance with regulations prescribed by the Secretary. Section 817(d) defines "variable contract, "and section 818(a) defines "pension plan contract." Section 1.817-5(e) of the regulations defines a "segregated asset account." Assets are within the same segregated asset account if the investment return and market value of each asset must be allocated in an identical manner to any variable contract invested in any of the assets. Section 1.817-5(a)(1) provides that a variable contract is treated as based on a segregated asset account for a calendar quarter period if amounts received under the contract (or earnings thereon) are allocated to the account at any time during the period.

02 Section 1.817-5(b)(1) of the regulations provides that the investments of a segregated asset account are adequately diversified for purposes of section 817(h) of the Code only if --

(1) No more than 55% of the value of the total assets of the account is represented by any one investment;

(2) No more than 70% of the value of the total assets of the account is represented by any two investments;

(3) No more than 80% of the value of the total assets of the account is represented by any three investments; and

(4) No more than 90% of the value of the total assets of the account is represented by any four investments.

For purposes of section 1.817-5, all securities of the same issuer, all interests in the same real property project, and all interests in the same commodity are each treated as a single investment; and in the case of government securities, each government agency or instrumentality is treated as a separate issuer.

03 Section 1.817-5(b)(2) of the regulations provides a safe harbor under which the investments of a segregated asset account are adequately diversified for purposes of section 817(h) of the Code if (1) the account meets the requirements of section 851(b)(4) and the regulations thereunder, and (2) no more than 55% of the value of the total assets of the account is attributable to cash, cash items (including receivables), government securities, and securities of other regulated investment companies.

04 Under section 1.817-5(c)(1) of the regulations, an account that satisfies the requirements of section 1.817-5(b) as of the last day of any calendar quarter period (or within thirty days after that last day) is adequately diversified for that period. Section 1.817- 5(a)(1) provides that, if the investments of a segregated asset account are not adequately diversified for a calendar quarter period, a variable contract based on that account is not treated as an annuity, endowment, or life insurance contract under subchapter L, section 72, or section 7702(a) of the Code for that period and for any subsequent period. Thus, any income on the contract for those periods is treated as ordinary income received or accrued by the holder of the contract during those periods.

05 Section 1.817-5(a)(2) of the regulations provides, however, that the investments of a segregated asset account are treated as satisfying the diversification requirements of section 1.817-5(b) for one or more periods if (1) the issuer or holder of a variable contract based on the account shows that the failure to satisfy the diversification requirements was inadvertent, (2) the investments of the account satisfy the diversification requirements within a reasonable time after discovery of the failure, and (3) the issuer or holder agrees to make such adjustments or pay such amounts as the Commissioner may require. These amounts are based upon the tax that the policyholders would owe if they were treated as receiving income on the contracts for the period or periods of nondiversification. Income on the contracts is computed under section 7702(g)(1)(B) of the Code, without regard to section 7702(g)(1)(C), and is computed using the period or periods of nondiversification instead of the "taxable year" referred to in section 7702(g)(1)(B). Thus, for example, income attributable to each segregated asset account on which a contract is based (including accounts that at all times were adequately diversified) is included in the computation of income on that contract. For this purpose, the term "premiums paid" in section 7702(g)(1)(B) refers only to those premiums paid during the period or periods of nondiversification. SEC. 3. SCOPE

This revenue procedure applies to any issuer of a variable contract seeking relief under section 1.817-5(a)(2) of the regulations.

SEC. 4. PROCEDURE

01 Request for a ruling. An issuer that seeks the treatment afforded by section 1.817-5(a)(2) of the regulations for a segregated asset account must submit a request for a ruling that meets the requirements of Rev. Proc. 92-1, 1992-1 I.R.B. 5 (or a successor revenue procedure). The request must (1) identify the period or periods during which the investments of the account did not satisfy the diversification requirements, (2) show that the failure to diversify was inadvertent, (3) demonstrate that the investments of the account were brought into compliance with the diversification requirements within a reasonable time after discovery of the failure, (4) describe the method used to compute the amount of income that all holders of contracts based on the account would be treated as receiving during the period or periods of nondiversification if the account were not treated as adequately diversified under section 1.817-5(a)(2), and (5) set forth the amounts of income so computed for each of the types of contracts described in section 4.02 of this revenue procedure. The computations described in (4) and (5) are made without regard to contracts that were completely surrendered during the nondiversification period.

02 Closing agreement. In addition, the issuer must submit an unexecuted proposed closing agreement, in substantially the same form as the model closing agreement in section 5 of this revenue procedure, to be executed upon a favorable resolution of the request. For periods in which the highest rate specified in section l of the Code is no greater than 31 percent, the amount shown as owed in the closing agreement for purposes of section 1.817-5(a)(2)(iii) of the regulations is --

(1) For variable annuity contracts, an amount equal to the sum of:

(A) 20% of income on annuity contracts from which payments have not been made as of the end of the period; plus

(B) 15% of income on annuity contracts from which payments have been made as of the end of the period; plus

(C) any interest computed under section 6621(a)(2) of the Code as if the amounts determined under section 4.02(1)(A) and (B) were underpayments by the contract holders for their tax year(s) containing the period(s) of nondiversification.

(2) For variable life insurance or endowment contracts, an amount equal to the sum of

(A) 28% of the income on the contracts; plus

(B) any interest computed under section 6621(a)(2) of the Code as if the amounts determined under section 4.02(2)(A) were underpayments by the contract holders for their tax year(s) containing the period(s) of nondiversification.

SEC. 5. MODEL CLOSING AGREEMENT

Effective as of date executed by Internal Revenue Service

CLOSING AGREEMENT AS TO FINAL DETERMINATION COVERING SPECIFIC MATTERS

THIS CLOSING AGREEMENT ("Agreement"), made pursuant to section 7121 of the Internal Revenue Code (the "Code") by and between [Taxpayer's name, address, and identifying number /1/] ("Taxpayer"), and the Commissioner of Internal Revenue (the "IRS"):

WHEREAS,

A. On _____ Taxpayer submitted to the IRS a request for a ruling that a segregated asset account, the [name of account] ("the Account"), be treated as adequately diversified under section 817(h) of the Code for the period ___, through ___ ("the period of nondiversification");

B. Taxpayer is the issuer of one or more variable contracts, as defined in section 817(d) of the Code (without regard to section 817(h)), that provide for the allocation of amounts received thereunder to the Account;

C. The investments made by the Account were not adequately diversified within the meaning of section 817 of the Code and section 1.817-5(b) of the Income Tax Regulations for the period of nondiversification;

D. The failure of the investments of the Account to satisfy the requirements of section 1.817-5(b) of the regulations for the period of nondiversification was inadvertent;

E. The failure of the investments of the Account to satisfy the requirements of section 1.817-5(b) of the regulations was discovered on _____, and the investments came into compliance with those requirements on _____;

F. The "income on the contract," within the meaning of section 1.817-5(a)(2) of the regulations and section 7702(g)(1)(B) of the Code (without regard to section 7702(g)(1)(C)), for all contracts based on the Account during the period of nondiversification in the aggregate totals $______.

G. The sum of the amounts computed in sections 4.02(1)(A) and (B) and 4.02(2)(A) of Rev. Proc. 92-25, 1992-13 I.R.B. 25 is $______. The sum of the interest amounts computed in sections 4.02(1)(C) and 4.02(2)(B) of Rev. Proc. 92-25 is $ ______.

NOW THEREFORE, IT IS HEREBY FURTHER DETERMINED AND AGREED BETWEEN TAXPAYER AND THE IRS AS FOLLOWS:

1. In consideration for the agreement of the IRS as set forth in Section 3 below, Taxpayer agrees as follows:

(A) To pay to the IRS the sum of __________ dollars and _____ cents ($ _____) at the time and in the manner described in Section 2 below; and

(B) Not to treat the sum set forth in section 1 (A) above as deductible in any taxable year; and

(C) For purposes of information reporting --

(i) Not to increase the holders' investment in any contract investing in the Account by any portion of the sum set forth in Section 1(A) above; and

(ii) Not to increase the holders' investment in any contract investing in the Account by any portion of the sum that Taxpayer represents to be the "income on the contract" attributable to the period of nondiversification.

2. Payment of the sum described in Section 1(A) above shall be made within thirty (30) days of the date of execution of this agreement by the IRS. This payment must be made by check payable to the IRS delivered, together with a fully executed copy of this Agreement, to The Internal Revenue Service Center, 11601 Roosevelt Boulevard, Philadelphia, Pennsylvania 19154, ATTN: Chief, Receipt and Control Branch, DP319. In the event that this payment is not made within this time limit, this agreement shall be considered null and void and shall have no effect.

3. In consideration for the agreement of Taxpayer set forth in Section 1 above, and upon payment by the Taxpayer of the amount specified above, the IRS and the Taxpayer agree, under section 1.817- 5(a)(2) of the regulations, to treat the investments of the Account as adequately diversified for purposes of section 817(h) of the Code during the period of nondiversification.

4. This Agreement shall be effective upon execution by the IRS and shall thereafter be binding upon the successors and assigns of the IRS and Taxpayer.

5. This Agreement is, and shall be construed as being, for the benefit of Taxpayer. Holders of contracts based on the Account shall be third party beneficiaries of this Agreement. This Agreement shall not be construed as creating any liability of Taxpayer to the holders of the contracts based on the Account. Furthermore, no portion of the sum, described in Section 1(A) above will be treated as income to the holders of contracts based on the Account.

6. Neither the IRS nor Taxpayer shall endeavor by litigation or other means to attack the validity of this Agreement.

7. This Agreement may not be cited or relied upon as precedent in the disposition of any other matter.

NOW THIS CLOSING AGREEMENT FURTHER WITNESSETH, that Taxpayer and the IRS mutually agree that neither party shall challenge the validity or binding effect of this Agreement, and that the matters so determined shall be final and conclusive, except as follows:

1. The matter to which this Agreement relates may be reopened in the event of fraud, malfeasance, or misrepresentation of material facts set forth herein.

2. This Agreement is subject to sections of the Code that expressly provide that effect be given to their provisions not with- standing any other law or rule of law except section 7122 of the Code.

3. This Agreement is subject to any legislation enacted subsequent to the date of execution hereof if the legislation provides that it is effective with respect to closing agreements.

IN WITNESS WHEREOF, the parties have subscribed their names to these presents in triplicate.

                                             [Taxpayer's name]

Inquiries concerning this revenue procedure should refer to its number and be addressed to the Office of the Assistant Chief Counsel (Financial Institutions and Products), Branch 4 (CC:FI&P:4) P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044.

SEC. 7. EFFECTIVE DATE

This revenue procedure is effective March 30, 1992, the date of its publication in the Internal Revenue Bulletin.

SEC. 8. EFFECT ON OTHER REVENUE PROCEDURES

Rev. Proc. 92-1 is amplified; Rev. Rul. 91-17 is amplified.

DRAFTING INFORMATION

The principal author of this revenue procedure is Laurie D. Lewis of the Office of the Assistant Chief Counsel (Financial Institutions and Products). For further information regarding this revenue procedure contact Laurie D. Lewis on (202) 566-3603 (not a toll-free call).

¹ If the Taxpayer is a member of a consolidated group and files its income tax returns with its parent, the Taxpayer should also include the name, address and EIN of the parent.