Transfer-for-Value Rule
If a life policy is sold or otherwise transferred for valuable consideration, part of the death benefit becomes taxable income to the transferee basis rules, unless an exception applies (partner, partnership, corporation, or basis-then-tax-free portion).
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Practice This Concept
Under the transfer-for-value rule in IRC §101(a)(2), when a life insurance policy is sold or transferred for valuable consideration, the death benefit received by the new owner is:
Taxable to the extent it exceeds the amount paid for the policy plus premiums subsequently paid — Normally death proceeds are tax-free, but the transfer-for-value rule under IRC §101(a)(2) is an exception: if a policy is transferred for valuable consideration, the new owner includes in gross income the death proceeds to the extent they exceed the consideration paid plus any premiums the new owner later paid. The buyer's basis is the purchase price plus later premiums, and the gain is taxed as ordinary income at death. Certain transfers are exempt, such as transfers to the insured or to a partner or partnership of the insured, and those exempt transfers preserve the tax-free death benefit.
National insurance concept
Under the transfer-for-value rule, which transfer of a life insurance policy does NOT trigger the loss of the tax-free death benefit?
A transfer to the insured individual — IRC §101(a)(2) provides exceptions to the transfer-for-value rule. If the policy is transferred to the insured, the rule does not apply and the death benefit remains tax-free to the recipient. Other exempt transfers include transfers to a partner or to a partnership in which the insured is a partner, and transfers to a corporation in which the insured is a shareholder or officer. A sale to an unrelated investor or a stranger generally does trigger the rule, making the proceeds taxable to the buyer beyond their basis.
National insurance concept
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