Attorney Recognized Ordinary Income from Surrender of Life Insurance Policy; Penalty Imposed (Barr, TCM)

The sole owner and beneficiary of a life insurance policy was required to recognize ordinary income upon the surrender of the policy and was liable for the accuracy-related penalty. The individual was taxable on the gross distribution reported by the insurance company on Form 1099-R, not the small net distribution that he received by check, because he constructively received the policy's cash value, without reduction for outstanding policy loans, upon surrender. The character of the gain was ordinary, not capital, because the surrender of the insurance policy did not constitute the sale or exchange of a capital asset.

The individual was liable for the accuracy-related penalty because his failure to report income shown on the Form 1099-R was not on account of reasonable cause and good faith. The individual was an experienced attorney admitted to practice before the Tax Court, and knew or should have known that because he was owner and beneficiary of the policy, any proceeds paid out or gain recognized would be taxable to him.

H.S. Barr, TC Memo. 2009-250, Dec. 57,981(M)

Other References:

Code Sec. 72

CCH Reference - 2009FED ¶6114.52

Code Sec. 1221

CCH Reference - 2009FED ¶30,422.58

Code Sec. 6662

CCH Reference - 2009FED ¶39,651G.155

Tax Research Consultant

CCH Reference - TRC INDIV: 30,100

TRC SALES: 3,054

Practitioner and Treasury Official Discuss Code Sec. 108(i) Issues in Context of Consolidated Corporations

Mark Hoffenberg of KPMG LLP and Donald Bakke of the Treasury Office of Tax Legislative Counsel discussed several issues arising from the interaction of Code Sec. 108(i) and certain corporate transactions. Under Code Sec. 108(i), a corporation can defer cancellation of indebtedness (COI) income realized in 2009 and 2010 until 2014, and then report the income ratably over five years, ending in 2018. However, the income is accelerated and must be reported upon certain events, including bankruptcy, liquidation, sale of assets or cessation of business.

Hoffenberg queried whether a tax-free liquidation of a subsidiary by a consolidated group should accelerate the deferred COI income. In his view, the deferred income is an attribute that should carry over to the acquiring corporation under Code Sec. 381. The acquiring corporation in effect steps into the shoes of the liquidating corporation. He suggested that Code Sec. 381(c)lists bond discount as a carryover item analogous to the deferred COI income and noted that Code Sec. 381(c) does not provide an exclusive list of attributes. Furthermore, the parent corporation is treated as the successor of the subsidiary under the intercompany transaction rules, and the matching rules indicate that the deferred item should not be taken into account right away. However, these arguments would not apply if the debt were extinguished.

Bakke said that acceleration is an issue if there is no relief under Code Sec. 381. He also raised questions about whether the deferral would be an intercompany item.

Hoffenberg pointed out that Code Sec. 108(i) applies to the acquisition of debt at a discount, using an "applicable debt instrument." To match the deferral of income, the provision denies an upfront deduction for original issue discount (OID) that is part of the applicable debt instrument. Practitioners have wondered whether a related party could pay off the old debt, which would generate COI income for the debtor and allow the debtor to deduct the OID up front. Bakke said that the Treasury was considering this issue and may issue clarifying rules for OID in related-party transactions.

Hoffenberg also asked whether interest would be deductible up front if the debtor issues a debt instrument with a large stated interest rate. Bakke had no comment on this issue. Hoffenberg himself noted that the rules for applicable high-yield debt instruments might apply, denying an upfront deduction.

Bakke, Hoffenberg, Bruce Decker of IRS Chief Counsel, and Scott Levine of Jones Day also discussed all-cash "D" reorganizations and temporary regulations issued in 2006 under Temporary Reg. §1.368-2T(l). These regulations sunset on December 18, 2009, and are controversial because they deem the acquiring corporation to issue a nominal share of its own stock to the target corporation so that the distribution requirement of a D reorganization is satisfied. Bakke said that the Treasury is still grappling with the approach it will use in the final regulations, but that the nominal share concept does serve some use.

By Brant Goldwyn, CCH News Staff