(f) Pro rata allocation of interest expense to policy cash values
(1) In general
No deduction shall be allowed for that portion of the taxpayer’s interest expense which is allocable to unborrowed policy cash values.
(2) Allocation
For purposes of paragraph (1), the portion of the taxpayer’s interest expense which is allocable to unborrowed policy cash values is an amount which bears the same ratio to such interest expense as—
(A) the taxpayer’s average unborrowed policy cash values of life insurance policies, and annuity and endowment contracts, issued after June 8, 1997, bears to
(B)
(i) in the case of assets of the taxpayer which are life insurance policies or annuity or endowment contracts, the average unborrowed policy cash values of such policies and contracts, and
(ii) in the case of assets of the taxpayer not described in clause (i), the average adjusted bases (within the meaning of section 1016) of such assets.
(3) Unborrowed policy cash value
For purposes of this subsection, the term “unborrowed policy cash value” means, with respect to any life insurance policy or annuity or endowment contract, the excess of—
(A) the cash surrender value of such policy or contract determined without regard to any surrender charge, over
(B) the amount of any loan with respect to such policy or contract.
If the amount described in subparagraph (A) with respect to any policy or contract does not reasonably approximate its actual value, the amount taken into account under subparagraph (A) shall be the greater of the amount of the insurance company liability or the insurance company reserve with respect to such policy or contract (as determined for purposes of the annual statement approved by the National Association of Insurance Commissioners) or shall be such other amount as is determined by the Secretary.
(4) Exception for certain policies and contracts
(A) Policies and contracts covering 20-percent owners, officers, directors, and employees
Paragraph (1) shall not apply to any policy or contract owned by an entity engaged in a trade or business if such policy or contract covers only 1 individual and if such individual is (at the time first covered by the policy or contract)—
(i) a 20-percent owner of such entity, or
(ii) an individual (not described in clause (i)) who is an officer, director, or employee of such trade or business.
A policy or contract covering a 20-percent owner of such entity shall not be treated as failing to meet the requirements of the preceding sentence by reason of covering the joint lives of such owner and such owner’s spouse.
(B) Contracts subject to current income inclusion
Paragraph (1) shall not apply to any annuity contract to which section 72(u) applies.
(C) Coordination with paragraph (2)
Any policy or contract to which paragraph (1) does not apply by reason of this paragraph shall not be taken into account under paragraph (2).
(D) 20-percent owner
For purposes of subparagraph (A), the term “20-percent owner” has the meaning given such term by subsection (e)(4).
(E) Master contracts
If coverage for each insured under a master contract is treated as a separate contract for purposes of sections 817(h), 7702, and 7702A, coverage for each such insured shall be treated as a separate contract for purposes of subparagraph (A). For purposes of the preceding sentence, the term “master contract” shall not include any group life insurance contract (as defined in section 848(e)(2)).
(5) Exception for policies and contracts held by natural persons; treatment of partnerships and S corporations
(A) Policies and contracts held by natural persons
(i) In general
This subsection shall not apply to any policy or contract held by a natural person.
(ii) Exception where business is beneficiary
If a trade or business is directly or indirectly the beneficiary under any policy or contract, such policy or contract shall be treated as held by such trade or business and not by a natural person.
(iii) Special rules
(I) Certain trades or businesses not taken into account
Clause (ii) shall not apply to any trade or business carried on as a sole proprietorship and to any trade or business performing services as an employee.
(II) Limitation on unborrowed cash value
The amount of the unborrowed cash value of any policy or contract which is taken into account by reason of clause (ii) shall not exceed the benefit to which the trade or business is directly or indirectly entitled under the policy or contract.
(iv) Reporting
The Secretary shall require such reporting from policyholders and issuers as is necessary to carry out clause (ii).
(B) Treatment of partnerships and S corporations
In the case of a partnership or S corporation, this subsection shall be applied at the partnership and corporate levels.
(6) Special rules
(A) Coordination with subsection (a) and section 265
If interest on any indebtedness is disallowed under subsection (a) or section 265—
(i) such disallowed interest shall not be taken into account for purposes of applying this subsection, and
(ii) the amount otherwise taken into account under paragraph (2)(B) shall be reduced (but not below zero) by the amount of such indebtedness.
(B) Coordination with section 263A
This subsection shall be applied before the application of section 263A (relating to capitalization of certain expenses where taxpayer produces property).
(7) Interest expense
The term “interest expense” means the aggregate amount allowable to the taxpayer as a deduction for interest (within the meaning of section 265(b)(4)) for the taxable year (determined without regard to this subsection, section 265(b), and section 291).
(8) Aggregation rules
(A) In general
All members of a controlled group (within the meaning of subsection (e)(5)(B)) shall be treated as 1 taxpayer for purposes of this subsection.
(B) Treatment of insurance companies
This subsection shall not apply to an insurance company subject to tax under subchapter L, and subparagraph (A) shall be applied without regard to any member of an affiliated group which is an insurance company.
References in Text
The date of the enactment of this sentence, referred to in subsec. (e)(2)(B)(ii), probably means the date of enactment of Pub. L. 105–34, which was approved Aug. 5, 1997.
Codification
Another section 1084(b) of Pub. L. 105–34 amended sections 805, 807, 812, and 832 of this title. Another section 1084(c) of Pub. L. 105–34 amended section 265 of this title.
Amendments
1998—Subsec. (a)(3). Pub. L. 105–206, § 6010(o)(1), substituted “subsection (d)” for “subsection (c)”.
Subsec. (a)(4). Pub. L. 105–206, § 6010(o)(2), substituted “subsection (e)” for “subsection (d)”.
Subsec. (f)(3). Pub. L. 105–277 inserted concluding provisions.
Subsec. (f)(4)(E). Pub. L. 105–206, § 6010(o)(3)(A), added subpar. (E).
Subsec. (f)(5)(A)(iv). Pub. L. 105–206, § 6010(o)(4)(A), struck out at end “Any report required under the preceding sentence shall be treated as a statement referred to in section 6724(d)(1).”
Subsec. (f)(8)(A). Pub. L. 105–206, § 6010(o)(5), substituted “subsection (e)(5)(B)” for “subsection (d)(5)(B)”.
1997—Subsec. (a)(1). Pub. L. 105–34, § 1084(a)(1), amended par. (1) generally. Prior to amendment, par. (1) read as follows: “Premiums paid on any life insurance policy covering the life of any officer or employee, or of any person financially interested in any trade or business carried on by the taxpayer, when the taxpayer is directly or indirectly a beneficiary under such policy.”
Subsec. (a)(4). Pub. L. 105–34, § 1602(f)(1), added subpars. (A) and (B) and concluding provisions and struck out former subpars. (A) and (B) and concluding provisions which read as follows:
“(A) is an officer or employee of, or
“(B) is financially interested in,
any trade or business carried on by the taxpayer.”
Pub. L. 105–34, § 1084(b)(1), substituted “individual.” for “individual, who—
“(A) is or was an officer or employee, or
“(B) is or was financially interested in,
any trade or business carried on (currently or formerly) by the taxpayer.”
Subsecs. (b), (c). Pub. L. 105–34, § 1084(a)(2), added subsec. (b) and redesignated former subsec. (b) as (c). Former subsec. (c) redesignated (d).
Subsec. (d). Pub. L. 105–34, § 1084(a)(2), redesignated subsec. (c) as (d). Former subsec. (d) redesignated (e).
Subsec. (d)(2)(B)(ii). Pub. L. 105–34, § 1602(f)(2), amended concluding provisions generally. Prior to amendment, concluding provisions read as follows: “For purposes of subclause (II), the taxpayer shall elect an applicable period for such contract on its return of tax imposed by this chapter for its first taxable year ending on or after October 13, 1995. Such applicable period shall be for any number of months (not greater than 12) specified in the election and may not be changed by the taxpayer without the consent of the Secretary.”
Subsec. (d)(4)(B). Pub. L. 105–34, § 1602(f)(3), substituted “interest in the taxpayer” for “interest in the employer”.
Subsec. (e). Pub. L. 105–34, § 1084(a)(2), redesignated subsec. (d) as (e).
Subsec. (f). Pub. L. 105–34, § 1084(c), added subsec. (f).
1996—Subsec. (a)(4). Pub. L. 104–191, § 501(a)(1), (b)(1), in introductory provisions, substituted “Except as provided in subsection (d), any” for “Any” and inserted “, or any endowment or annuity contracts owned by the taxpayer covering any individual,” after “the life of any individual”.
Pub. L. 104–191, § 501(a)(2), struck out “to the extent that the aggregate amount of such indebtedness with respect to policies covering such individual exceeds $50,000” after “carried on by the taxpayer” in concluding provisions.
Subsec. (d). Pub. L. 104–191, § 501(b)(2), added subsec. (d).
1986—Subsec. (a). Pub. L. 99–514 added par. (4) and last sentence providing that par. (4) shall apply with respect to contracts purchased after June 20, 1986.
1964—Subsec. (a). Pub. L. 88–272 added par. (3) and sentence providing that par. (3) shall apply only to contracts purchased after August 6, 1963.
Subsec. (c). Pub. L. 88–272 added subsec. (c).
Effective Date of 1998 Amendments
Amendment by Pub. L. 105–277 effective as if included in the provision of the Taxpayer Relief Act of 1997, Pub. L. 105–34, to which such amendment relates, see section 4003(l) of Pub. L. 105–277, set out as a note under section 86 of this title.
Amendment by Pub. L. 105–206 effective, except as otherwise provided, as if included in the provisions of the Taxpayer Relief Act of 1997, Pub. L. 105–34, to which such amendment relates, see section 6024 of Pub. L. 105–206, set out as a note under section 1 of this title.
Effective Date of 1997 Amendment
Amendment by section 1084(a), (b)(1), (c) of Pub. L. 105–34 applicable to contracts issued after June 8, 1997, in taxable years ending after such date, with special provisions relating to changes in contracts to be treated as new contracts, see section 1084(d) of Pub. L. 105–34, set out as a note under section 101 of this title.
Amendment by section 1602(f)(1)–(3) of Pub. L. 105–34 effective as if included in the provisions of the Health Insurance Portability and Accountability Act of 1996, Pub. L. 104–191, to which such amendment relates, see section 1602(i) of Pub. L. 105–34, set out as a note under section 26 of this title.
Effective Date of 1996 Amendment
Pub. L. 104–191, title V, § 501(c), Aug. 21, 1996, 110 Stat. 2091, as amended by Pub. L. 105–34, title XVI, § 1602(f)(4), Aug. 5, 1997, 111 Stat. 1095, provided that:
“(1) In general.— The amendments made by this section [amending this section] shall apply to interest paid or accrued after October 13, 1995.
“(2) Transition rule for existing indebtedness.—
“(A) In general.—
“(i) indebtedness incurred before January 1, 1996, or
“(ii) indebtedness incurred before January 1, 1997 with respect to any contract or policy entered into in 1994 or 1995,
the amendments made by this section shall not apply to qualified interest paid or accrued on such indebtedness after October 13, 1995, and before January 1, 1999.
“(B) Qualified interest.—
For purposes of subparagraph (A), the qualified interest with respect to any indebtedness for any month is the amount of interest (otherwise deductible) which would be paid or accrued for such month on such indebtedness if—
“(i) in the case of any interest paid or accrued after December 31, 1995, indebtedness with respect to no more than 20,000 insured individuals were taken into account, and
“(ii)
the lesser of the following rates of interest were used for such month:
“(I) The rate of interest specified under the terms of the indebtedness as in effect on October 13, 1995 (and without regard to modification of such terms after such date).
“(II) The applicable percentage of the rate of interest described as Moody’s Corporate Bond Yield Average-Monthly Average Corporates as published by Moody’s Investors Service, Inc., or any successor thereto, for such month.
For purposes of clause (i), all persons treated as a single employer under subsection (a) or (b) of section 52 of the Internal Revenue Code of 1986 or subsection (m) or (
o) of section 414 of such Code shall be treated as 1 person. Subclause (II) of clause (ii) shall not apply to any month before January 1, 1996.
“(C) Applicable percentage.— For purposes of subparagraph (B), the applicable percentage is as follows:
| For calendar year: |
The percentage is: |
| 1996 |
100 percent |
| 1997 |
90 percent |
| 1998 |
80 percent.” |
Effective Date of 1986 Amendment
Pub. L. 99–514, title X, § 1003(c), Oct. 22, 1986, 100 Stat. 2388, provided that:
“The amendments made by this section [amending this section] shall apply to contracts purchased after June 20, 1986, in taxable years ending after such date.”
Effective Date of 1964 Amendment
Pub. L. 88–272, title II, § 215(c), Feb. 26, 1964, 78 Stat. 56, provided that:
“The amendments made by this section [amending this section] shall apply with respect to amounts paid or accrued in taxable years beginning after December 31, 1963.”
Spread of Income Inclusion on Surrender, Etc. of Contracts
Pub. L. 104–191, title V, § 501(d), Aug. 21, 1996, 110 Stat. 2092, as amended by Pub. L. 105–34, title XVI, § 1602(f)(5), Aug. 5, 1997, 111 Stat. 1095, provided that:
“(1) In general.—
If any amount is received under any life insurance policy or endowment or annuity contract described in paragraph (4) of section 264(a) of the Internal Revenue Code of 1986—
“(A) on the complete surrender, redemption, or maturity of such policy or contract during calendar year 1996, 1997, or 1998, or
“(B) in full discharge during any such calendar year of the obligation under the policy or contract which is in the nature of a refund of the consideration paid for the policy or contract,
then (in lieu of any other inclusion in gross income) such amount shall be includible in gross income ratably over the 4-taxable year period beginning with the taxable year such amount would (but for this paragraph) be includible. The preceding sentence shall only apply to the extent the amount is includible in gross income for the taxable year in which the event described in subparagraph (A) or (B) occurs.
“(2) Special rules for applying section 264.—
A contract shall not be treated as—
“(A) failing to meet the requirement of section 264(c)(1) of the Internal Revenue Code of 1986, or
“(B) a single premium contract under section 264(b)(1) of such Code,
solely by reason of an occurrence described in subparagraph (A) or (B) of paragraph (1) of this subsection or solely by reason of a lapse occurring after October 13, 1995, by reason of no additional premiums being received under the contract.
“(3) Special rule for deferred acquisition costs.—
In the case of the occurrence of any event described in subparagraph (A) or (B) of paragraph (1) of this subsection with respect to any policy or contract—
“(A) section 848 of the Internal Revenue Code of 1986 shall not apply to the unamortized balance (if any) of the specified policy acquisition expenses attributable to such policy or contract immediately before the insurance company’s taxable year in which such event occurs, and
“(B) there shall be allowed as a deduction to such company for such taxable year under chapter 1 of such Code an amount equal to such unamortized balance.”