ABA Section of Taxation 2014 Midyear Meeting

1. ABA Section of Taxation 2014 Midyear Meeting Information Reporting on Life Insurance Products Bryan Keene, Davis & Harman LLP, Washington DC Sheryl Flum, IRS Office of Chief Counsel, Insurance Branch, Washington DC Iris Goldman, PricewaterhouseCoopers LLP, New York NY

2. Overview Background Determining who gets the 1099-R Determining what gets reported on the 1099-R Life insurance policy lapses Escheats & unclaimed property issues New reporting requirements Addressing reporting mistakes ABA Section of Taxation Midyear Meeting 2014

3. Background • Distributions of income of $10 or more are reportable on Form 1099-R (Sec. 6047(d)) • Generally no reporting if distribution is tax-free • Exception for external exchanges • Distributions of income are subject to withholding (Sec. 3405) • Policyholders may elect out • Rules differ for annuity payments vs. withdrawals • IRS penalties for non-compliance ABA Section of Taxation Midyear Meeting 2014

4. Background (cont.) • Form 1099-R • Used to report distributions • General Form 1099 instructions • Specific Form 1099-R & Form 5498 instructions • Form 5498 • Used to report certain information about IRAs • Other forms may apply • Form 1099-INT (premium deposit accounts, etc.) ABA Section of Taxation Midyear Meeting 2014

5. Who gets the 1099-R • Generally the person who receives the distribution • Corporations? • But what if someone else owes the tax? • Trust-owned annuities • The trust? The grantor? The trust beneficiaries? • Different owner & payee • Assignment of income doctrine? • Annuity payments vs. withdrawals? ABA Section of Taxation Midyear Meeting 2014

6. Who gets the 1099-R (cont.) • Nominee / middleman (per general 1099 instructions) • “Generally, if you receive a Form 1099 for amounts that actually belong to another person, you are considered a nominee recipient. You must file a Form 1099 with the IRS (the same type of Form 1099 you received) for each of the other owners showing the amounts allocable to each. You must also furnish a Form 1099 to each of the other owners…. The nominee, not the original payer, is responsible for filing the subsequent Forms 1099 to show the amount allocable to each owner.” ABA Section of Taxation Midyear Meeting 2014

7. What gets reported • Generally, the gross distribution and taxable amount • No reporting if it is “reasonable to believe that none of the payment is includible in the income of the recipient” (1099-R instructions & Code sec. 3405(e)(1)(B)(ii)) • No “taxable amount” for IRAs (owner’s responsibility) • Penalty tax applicability • Determine whether an exception applies ABA Section of Taxation Midyear Meeting 2014

8. What gets reported (cont.) • “Taxable amount not determined” (1099-R instructions): • Use “only if you are unable to reasonably obtain the data needed to compute the taxable amount” • “[M]akeevery effort to compute the taxable amount.” • What do “reasonably” and “every effort” mean? ABA Section of Taxation Midyear Meeting 2014

9. What gets reported (cont.) • Deemed distributions taxable under sec. 72(e) • Gift of annuity; COI charges (qualified plans); plan loans • Not sales between parties (legislative proposals on those) • Aggregation rule of Code sec. 72(e)(12) • Unrecovered basis on surrender / death • External 1035 exchanges & importance of basis records • “[I]t is anticipated that the issuer of the contract to be exchanged will provide the information necessary to compute the amount to be withheld to the policyholder and to the issuer of the new contract.” Treas. Reg. sec. 35.3405-1T, Q&A-E-8 ABA Section of Taxation Midyear Meeting 2014

10. Life insurance policy lapses • Lapse with outstanding policy loan = deemed distribution • Deemed to receive cash distribution from the policy, which is then used to repay the loan • “Phantom income” & very unhappy policyholders • Especially if using automatic premium loan feature • Policyholders keep fighting this in court & typically lose: • See, e.g., Brown v. Commissioner, 693 F.3d 765 (7th Cir. 2012), aff’g T.C. Memo. 2011-83 (April 12, 2011) • Rarely, however, they win: ABA Section of Taxation Midyear Meeting 2014

11. Life insurance policy lapses (cont.) • Moore v. Commissioner, T.C. Summary Opinion 2012-83 • Policyholder shifted burden of proof to IRS by pointing to uncertainty in record that policy had actually remained in force through tax year in question (even though insurer treated it as in force) • Court held that policy had, in fact, lapsed many years before and therefore no tax event in current year • Should this make companies think twice about reporting these situations as taxable, at least if records are not complete? • No; TC summary opinions not precedential; well-settled that tax arises in these situations ABA Section of Taxation Midyear Meeting 2014

12. Escheats • Transfers under state unclaimed property laws • Initial focus on IRAs • Similar issues for annuity and life insurance contracts • When are amounts treated as unclaimed vs. when are amounts payable under the terms of the contract? • Annuity contracts • Prior to the annuity starting date • After annuity payments have commenced • Payments to the beneficiary ABA Section of Taxation Midyear Meeting 2014

13. Escheats (cont.) • Do withholding and reporting requirements apply to amounts transferred to a state? • In what capacity will the state hold the funds? • Do the amounts transferred constitute “designated distributions”? • Do constructive receipt principles apply to the amount transferred? ABA Section of Taxation Midyear Meeting 2014

14. New reporting requirements • Form 1099-R: • Distribution Code D (net investment income tax) • Distribution Code K (distributions of IRA assets not having a readily available FMV) • Form 5498: • Codes A through H to report FMV of certain investments held in an IRA ABA Section of Taxation Midyear Meeting 2014

15. Addressing mistakes • Form 1099-R instructions: • “If you filed a Form 1099-R with the IRS and later discover that there is an error on it, you must correct it as soon as possible.” (Emphasis added.) • How far back does this apply? • For example, what if the error occurred 10 years ago? • Policyholder’s statute of limitations is probably closed • What would the IRS do with a new or amended 1099-R that old? ABA Section of Taxation Midyear Meeting 2014

16. Addressing mistakes (cont.) • Is there a statute of limitations on penalty exposure? • Code sec. 6671(a): penalties for failure file correct information returns are assessed in the same manner as taxes • Code sec. 6501(a): IRS generally must assess taxes within a three-year period beginning with the date a “return” is filed • Is an information return a “return” for this purpose? • IRS has suggested no (CCA 200142021 (Sept. 5, 2001)) • Even if an information return is a “return,” the statute of limitations is not available if the payor never filed the return ABA Section of Taxation Midyear Meeting 2014

17. Addressing mistakes (cont.) • What happens if you don’t correct? • No additional penalty, but … • May show lack of prior compliance, which is an element of “intentional disregard” for future errors • May raise questions about basis • Policyholder should have paid tax but likely did not because the amount was never reported to him or her • Does this mean the taxpayer effectively took the position that the distribution was not taxable? • If so, should basis be reduced? (Probably not) ABA Section of Taxation Midyear Meeting 2014

18. Addressing mistakes (cont.) • How can companies correct? • File new or corrected 1099-R for prior year (if still open under statute of limitations) • Pay policyholder’s expenses to file their own amended returns? • If so, report that amount too • Voluntarily approach IRS for a closing agreement? • Generally through LB&I (geographic vs. subject matter jurisdiction) • Pay proxy tax for policyholders (taking into account statute of limitations) ABA Section of Taxation Midyear Meeting 2014

19. Questions? ABA Section of Taxation Midyear Meeting 2014