Monthly LRA Update: August 2021

TAX DEVELOPMENTS

IRS Issues Private Letter Ruling Affirming that a Transfer of Insurance Policies from a Parent to a Subsidiary Retains Tax Exempt Status

On July 2, the IRS publicly released PLR-118450-18 (PLR 202126003) regarding a contemplated transfer of life insurance contracts within a consolidated group of corporations. The PLR involved the Parent and three subsidiaries:

• Sub1 is a wholly owned subsidiary of Parent;
• Sub2 is a wholly owned subsidiary of Sub1; and
• Sub3 is a wholly owned subsidiary of Sub2.

Parent holds life insurance policies on certain employees and former employees (the “Policies”).

Proposed Transactions

In the following set of proposed transactions, the Parent plans to effectively transfer the Policies to Sub3:

1. In a transaction represented to qualify under Section 351(b), Parent will contribute the Policies to Sub1 in exchange for cash (in an amount less than the aggregate built-in gain in the Policies) and a constructive issuance of stock of Sub1 (the “First Contribution”).
2. In a transaction represented to qualify under Section 351(a), Sub1 will contribute the Policies to Sub2 in exchange solely for a constructive issuance of stock of Sub2 (the “Second Contribution”).
3. In a transaction represented to qualify under Section 351(a), Sub2 will contribute the Policies to Sub3 in exchange solely for a constructive issuance of stock of Sub3 (the “Third Contribution”).

The PLR did not clarify the amount of cash consideration (or how it was determined) in transaction (i). The Parent Group represented that it intends to hold the Policies until maturity.

Law and Analysis

The PLR set forth the following relevant attributes of the tax law:

• Section 101(a)(1) excludes from gross income amounts paid under a life insurance contract “by reason of the death of the insured.”
• Section 101(a)(2) limits the exclusion under Section 101(a)(1) to the value of the consideration plus other amounts paid (e.g., premiums) if a life insurance contract has been transferred for valuable consideration.
• Section 101(a)(2)(A) provides that this limitation does not apply if the life insurance contract has a transferred basis, in whole or in part (the “Carryover Basis Exception”).
• Section 362(a) provides that property acquired by a corporation in connection with a transaction to which Section 351 applies has a transferred basis, in whole or in part.
• Section 101(a)(3) provides that the limitation does apply, even if the life-insurance contract has a transferred basis, in whole or in part, in the case of a transfer for valuable consideration that is a reportable policy sale.
• Under Treas. Reg. § 1.101-1(c)(2)(ii), a transfer between members of a consolidated group is not a reportable policy sale.
• Section 1.1502-13(c)(6) provides that under § 1.1502-13(c)(1)(i), S’s intercompany item might be redetermined to be excluded from gross income or treated as a noncapital, nondeductible amount. However, S’s intercompany income or gain is redetermined to be excluded from gross income only to the extent §§ 1.1502-13(c)(6)(ii)(A), (B), (C), or (D) applies.
• Section 1.1502-13(c)(6)(ii)(D) provides that, under certain circumstances, the Commissioner may determine that treating S’s intercompany item as excluded from gross income is consistent with the purposes of § 1.1502-13 and other applicable provisions of the Internal Revenue Code (the “Code”), regulations, and published guidance.

Rulings

Subject to the representations made and conditioned on the execution of a closing agreement, the IRS ruled as follows:

1. For purposes of determining the amount of the Policy proceeds excludable from gross income under Section 101(a)(1), the First Contribution is a transfer that qualifies for the Carryover Basis Exception.
2. Any gain arising from the First Contribution under Section 351(b) (the “Boot Gain”) is redetermined to be excluded from gross income under Treas. Reg. § 1.1502-13(c)(6)(ii)(D).
3. No member of the Parent Group will increase the basis of any asset (including basis in the stock of any member of the Parent Group) as a result of the Boot Gain (for example, under Section 358(a)(1)(B)(ii), Section 362(a), or Treas. Reg. § 1.1502-32).

Reaction

This ruling is consistent with our prior understanding that it is generally possible (though complex) to transfer life insurance policies from a Parent down the chain to subsidiary entities. This PLR is the first we have seen to clarify the use of the exception to the Reportable Policy Sale rules in Treas. Reg. § 1.101-1(c)(2)(ii).

REGULATORY DEVELOPMENTS

Banking Regulators Release Proposed Interagency Guidance for Third-Party Relationships Risk Management

On July 13, the FDIC, FRB, and OCC released Proposed Interagency Guidance on Third-Party Relationships. The proposed guidance would replace each agency’s existing guidance on this topic and, according to the preamble, is largely based on the OCC’s current guidance (OCC 2013-29).

Under this guidance, a third-party relationship is broadly defined as “any business arrangement between a banking organization and another entity, by contract or otherwise.” The document notes that neither a written contract nor a monetary exchange is necessary to establish a business arrangement.

In addition to BOLI vendors who are clearly third-party relationships, BOLI insurance carriers are likely to be deemed third-party relationships under this guidance.

The guidance recommends employing a third-party management life cycle with distinct steps for Planning, Due Diligence, Contract Negotiation, Ongoing Monitoring, and Termination.

The guidance will be open to public comment until September 17, 2021.