The US Treasury Department and the Internal Revenue Service on Monday finalized a regulation designed to limit the use of life insurance and annuity contracts as a way to avoid current taxation of investment earnings.
The regulation, together with other guidance previously issued, will prevent taxpayers from turning otherwise taxable investments in hedge funds and other entities into tax-deferred or tax-free investments by purchasing the investments through a life insurance or annuity contract.
This has been accomplished by removing provisions of the Income Tax Regulations that apply a look-through rule to assets of a nonregistered partnership for purposes of satisfying the diversification requirements of section 817(h) of the Internal Revenue Code.
Treasury guidance released alongside the new regulation explained that:
"Life insurance and annuity contracts receive favorable tax treatment in recognition of the importance of protecting loved ones against the potentially devastating financial consequences of death or the risk of exhausting savings while in retirement. The regulation finalized today...provides guidance that will help taxpayers purchasing a life insurance or annuity contract to be secure in the knowledge that the contract complies with the tax laws."
It continued:
"This regulation is part of the effort to modernize the rules for these contracts in recognition of the developments that have occurred in the financial markets in recent years. The regulation finalized today was originally proposed in 2003. In response to comments from the public, the transition period for existing contracts that are affected by the regulation is four calendar quarters, which is two calendar quarters longer than the period originally proposed."
The full text of the regulation limiting the use of life insurance products for tax avoidance can be found in the Tax News Resources section.
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