SECTIONS 61, 83, 409A, 2042 AND 7872 – LIFE INSURANCE
In Michael P. Schwab v. Commissioner, 715 F.3d 1169 (9th Cir. 2013) affirming Schwab v. Commissioner, 136 T.C. 120 (2011) the court determined that the value of surrender charges must be considered when calculating the fair market value of variable universal life policies distributed from a multi-employer welfare benefit trust. The court described the policies as follows:
The policies were of a type called variable universal life, a relatively new type of contract for this old industry. A key characteristic of universal life-insurance policies is that they disconnect to some degree a life-insurance feature (i.e., payment of money upon death) from an investment feature (i.e., the use of premiums to acquire assets that fund the insurance payment). The insurer selling a universal-life policy typically segregates payments from its customers in separate investment accounts from which it makes deductions to pay for the insurance component of the policy. At death, the customer’s beneficiary gets what’s left in the separate account. Under a variable universal life-insurance contract, the customer typically can choose from a menu of different investments (often set up to closely resemble mutual funds) with varying returns and thus varying payouts upon death, though there is (as was true under the contracts here) a minimum death-benefit guaranty.
The court specifically refused to adopt either the government position that surrender charges never affect value or the taxpayer’s position that such charges should always count but rather should be considered. Section 402 of the Code is the governing provision describing fair market value for such purposes.