[Federal Register Volume 69, Number 31 (Tuesday, February 17, 2004)]
[Proposed Rules]
[Pages 7384-7389]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-3402]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-126967-03]
RIN 1545-BC20


Value of Life Insurance Contracts When Distributed From a 
Qualified Retirement Plan

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed amendments to the regulations 
under section 402(a) of the Internal Revenue Code regarding the amount 
includible in a distributee's income when life insurance contracts are 
distributed by a qualified retirement plan and the treatment of 
property sold by a qualified retirement plan to a plan participant or 
beneficiary for less than fair market value. This document also 
contains proposed amendments to the regulations under sections 79 and 
83 conforming the language in those regulations to the language in the 
proposed amendments to the section 402(a) regulations. These 
regulations will affect administrators of, participants in, and 
beneficiaries of qualified employer plans. These regulations also 
provide guidance to employers who provide group-term life insurance to 
their employees that is includible in the gross income of the employees 
and to employers who transfer life insurance contracts to persons in 
connection with the performance of services. This document also 
provides notice of a public hearing on these proposed regulations.

DATES: Written or electronic comments must be received by May 17, 2004. 
Requests to speak and outlines of topics to be discussed at the public 
hearing scheduled for June 9, 2004, at 10 a.m., must be received by May 
19, 2004.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-126967-03), room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
126967-03), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington DC. Alternatively, taxpayers may submit 
comments electronically directly to the IRS Internet site at http://www.irs.gov/regs. The public hearing will be held in the Auditorium, 
Internal Revenue Building, 1111 Constitution Avenue, NW., Washington, 
DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed amendments to 
the section 79 regulations, Betty Clary at (202) 622-6080; concerning 
the proposed amendments to the section 83 regulations, Robert Misner at 
(202) 622-6030; concerning the proposed amendments to the 402 
regulations, Linda Marshall at (202) 622-6090; concerning submissions 
and the hearing and/or to be placed on the building access list to 
attend the hearing, Robin Jones at (202) 622-7180 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains proposed amendments to the Income Tax

[[Page 7385]]

Regulations (26 CFR part 1) under section 402(a) of the Internal 
Revenue Code (Code) relating to the amount includible in a 
distributee's income when a life insurance contract, retirement income 
contract, endowment contract, or other contract providing life 
insurance protection is distributed by a retirement plan qualified 
under section 401(a) of the Code and to the sale of property by a 
retirement plan to a plan participant or beneficiary for less than the 
fair market value of the property. This document also contains proposed 
amendments to the regulations under sections 79 and 83 relating, 
respectively, to employer-provided group-term life insurance and life 
insurance contracts transferred in connection with the performance of 
services.
    Section 402(a) provides generally that any amount actually 
distributed to any distributee by any employees' trust described in 
section 401(a) which is exempt from tax under section 501(a) shall be 
taxable to the distributee, in the taxable year of the distributee in 
which distributed, under section 72.
    Section 1.402(a)-1(a)(1)(iii) of the current regulations provides, 
in general, that a distribution of property by a section 401(a) plan 
shall be taken into account by the distributee at its ``fair market 
value.'' Section 1.402(a)-1(a)(2) of the regulations provides, in 
general, that upon the distribution of an annuity or life insurance 
contract, the ``entire cash value'' of the contract must be included in 
the distributee's income. The current regulations do not define ``fair 
market value'' or ``entire cash value'' and questions have arisen 
regarding the interaction between these two provisions and whether 
``entire cash value'' includes a reduction for surrender charges.
    Prohibited Transaction Exemption (PTE) 77-8 (1977-2 C.B. 425), 
subsequently amended and redesignated as Prohibited Transaction 
Exemption 92-6, was jointly issued in 1977 by the Department of Labor 
and the Internal Revenue Service. PTE 77-8 permits an employee benefit 
plan to sell individual life insurance contracts and annuities to (1) a 
plan participant insured under such policies, (2) a relative of such 
insured participant who is the beneficiary under the contract, (3) an 
employer any of whose employees are covered by the plan, or (4) another 
employee benefit plan, for the cash surrender value of the contracts, 
provided the conditions set forth in the exemption are met.
    The preamble to PTE 77-8 (citing Rev. Rul. 59-195; 1959-1 C.B. 18) 
notes that, for Federal income tax purposes, the value of an insurance 
policy is not the same as, and may exceed, its cash surrender value, 
and that a purchase of an insurance policy at its cash surrender value 
may therefore be a purchase of property for less than its fair market 
value. The regulations under section 402 do not address the 
consequences of a sale of property by a section 401(a) plan to a plan 
participant or beneficiary for less than the fair market value of that 
property. In this regard, the preamble to PTE 77-8 states that the 
Federal income tax consequences of such a bargain purchase must be 
determined in accordance with generally applicable Federal income tax 
rules but that any income realized by a participant or relative of such 
participant upon such a purchase under the conditions of PTE 77-8 will 
not be deemed a distribution from the plan to such participant for 
purposes of subchapter D of chapter 1 of the Internal Revenue Code 
(i.e., sections 401 to 424 of the Code) relating to qualified pension, 
profit-sharing, and stock bonus plans.
    Section 79 of the Code generally requires that the cost of group-
term life insurance coverage provided by an employer on the life of an 
employee that is in excess of $50,000 of coverage be included in the 
income of the employee. Pursuant to Sec. 1.79-1(b) of the regulations, 
under specified circumstances, group-term life insurance may be 
combined with other benefits, referred to as permanent benefits. A 
permanent benefit is defined in Sec. 1.79-0 of the regulations as an 
economic value extending beyond one policy year (for example, a paid-up 
or cash surrender value) that is provided under a life insurance 
policy. The regulations further provide that certain features are not 
permanent benefits, including (a) a right to convert (or continue) life 
insurance after group life insurance coverage terminates, (b) any other 
feature that provides no economic benefit (other than current insurance 
protection) to the employee, and (c) a feature under which term life 
insurance is provided at a level premium for a period of five years or 
less.
    Permanent benefits provided to an employee are subject to taxation 
under rules described in Sec. 1.79-1(d) of the regulations. Under those 
rules, the cost of the permanent benefits, reduced by the amount paid 
for those benefits by the employee, is included in the employee's 
income. The regulations provide the cost of the permanent benefits can 
be no less than an amount determined under a formula set forth in the 
regulations. One of the factors used in this formula is ``the net level 
premium reserve at the end of that policy year for all benefits 
provided to the employee by the policy or, if greater, the cash value 
of the policy at the end of that policy year.''
    Section 83(a) provides that when property is transferred to any 
person in connection with the performance of services, the service 
provider must include in gross income (as compensation income) the 
excess of the fair market value of the property, determined without 
regard to lapse restrictions, and determined at the first time that the 
transferee's rights in the property are either transferable or not 
subject to a substantial risk of forfeiture, over the amount (if any) 
paid for the property. Section 1.83-3(e) of the regulations generally 
provides that in the case of ``a transfer of a life insurance contract, 
retirement income contract, endowment contract, or other contract 
providing life insurance protection, only the cash surrender value of 
the contract is considered to be property.''
    In TD 9092, published in the Federal Register on September 17, 2003 
(68 FR 54336), relating to split-dollar life insurance arrangements, 
Sec. 1.83-3(e) was amended to add the following sentence: 
``Notwithstanding the previous sentence, in the case of a transfer of a 
life insurance contract, retirement income contract, endowment 
contract, or other contract providing life insurance protection, or any 
undivided interest therein, that is part of a split-dollar life 
insurance arrangement (as defined in Sec. 1.61-22(b)(1) or (2)) that is 
entered into, or materially modified (within the meaning of Sec. 1.61-
22(j)(2)), after September 17, 2003, the policy cash value and all 
other rights under such contract (including any supplemental agreements 
thereto and whether or not guaranteed), other than current life 
insurance protection, are treated as property for purposes of this 
section.''

Explanation of Provisions

A. Overview

    These proposed amendments to the regulations under section 402(a) 
clarify that the requirement that a distribution of property must be 
included in the distributee's income at fair market value is 
controlling in those situations where the existing regulations provide 
for the inclusion of the entire cash value. Thus, these proposed 
regulations provide that, in those cases where a qualified plan 
distributes a life insurance contract, retirement income contract, 
endowment contract, or other contract providing life insurance 
protection, the fair market value of such a contract (i.e., the value 
of all rights under the contract, including any supplemental agreements

[[Page 7386]]

thereto and whether or not guaranteed) is generally included in the 
distributee's income and not merely the entire cash value of the 
contracts.
    These proposed regulations also provide that if a qualified plan 
transfers property to a plan participant or beneficiary for 
consideration that is less than the fair market value of the property, 
the transfer will be treated as a distribution by the plan to the 
participant or beneficiary to the extent the fair market value of the 
distributed property exceeds the amount received in exchange. Thus, in 
contrast to the statement to the contrary in the preamble to PTE 77-8, 
any bargain element in the sale would be treated as a distribution 
under section 402(a). It is also intended that any bargain element 
would be treated as a distribution for other purposes of the Code, 
including the limitations on in-service distributions from certain 
qualified retirement plans and the limitations of section 415.
    These proposed regulations also amend the current regulations under 
sections 79 and 83 to clarify that fair market value is also 
controlling with respect to life insurance contracts under those 
sections and, thus, that all of the rights under the contract 
(including any supplemental agreements thereto and whether or not 
guaranteed) must be considered in determining that fair market value. 
With respect to section 79, these proposed regulations would amend Sec. 
1.79-1(d) to remove the term cash value from the formula for 
determining the cost of permanent benefits and substitute the term fair 
market value. With respect to section 83, these proposed regulations 
would amend Sec. 1.83-3(e) generally to apply the definition of 
property for new split-dollar life insurance arrangements to all 
situations involving the transfer of life insurance contracts. Section 
83(a) requires that the excess of the fair market value of the property 
over the amount paid for the property be included in income. The 
current definition of property outside the context of a split-dollar 
life insurance arrangement may lead taxpayers to believe that it is 
appropriate upon receiving a transfer of a life insurance contract to 
include only its cash surrender value on the day of the transfer when, 
due to supplemental agreements, the fair market value of the 
transferred property is much greater. The purpose of the changes to 
these regulations is to clarify that, unless specifically excepted from 
the definition of permanent benefits or fair market value, the value of 
all features of a life insurance policy providing an economic benefit 
to a service provider (including, for example, the value of a springing 
cash value feature) must be included in determining the employee's 
income.
    The proposed regulations will not affect the relief granted by the 
provisions of Section IV, paragraph 4 of Notice 2002-8 (2002-1 C.B. 
398) to the parties to any insurance contract that is part of a pre-
January 28, 2002, split-dollar life insurance arrangement. Also, 
consistent with the effective date of the final split-dollar life 
insurance regulations, Sec. 1.61-22, these proposed regulations will 
not apply to the transfer of a life insurance contract which is part of 
a split-dollar life insurance arrangement entered into on or before 
September 17, 2003, and not materially modified after that date. 
However, taxpayers are reminded that, in determining the fair market 
value of property transferred under section 83, lapse restrictions 
(such as life insurance contract surrender charges) are ignored.

B. Determination of Fair Market Value

    As noted above, Sec. 1.402(a)-1(a)(1)(iii) does not define fair 
market value. In Rev. Rul. 59-195, the Service ruled that, in 
situations similar to those in which an employer purchases and pays the 
premiums on an insurance policy on the life of one of its employees and 
subsequently sells such policy, on which further premiums must be paid, 
the value of such policy for computing taxable gain in the year of 
purchase should be determined under the method of valuation prescribed 
in Sec. 25.2512-6 of the Gift Tax Regulations. Under this method, the 
value of such a policy is not its cash surrender value but the 
interpolated terminal reserve at the date of sale plus the 
proportionate part of any premium paid by the employer prior to the 
date of the sale which is applicable to a period subsequent to the date 
of the sale. Section 25.2512-6 of the Gift Tax Regulations also 
provides that if ``because of the unusual nature of the contract such 
approximation is not reasonably close to the full value, this method 
may not be used.'' Thus, this method may not be used to determine the 
fair market value of an insurance policy where the reserve does not 
reflect the value of all of the relevant features of the policy.
    In Q&A-10 of Notice 89-25 (1989-1 C.B. 662), the IRS addressed the 
question of what amount is includible in income under section 402(a) 
when a participant receives a distribution from a qualified plan that 
includes a life insurance policy with a value substantially higher than 
the cash surrender value stated in the policy. The Notice noted the 
practice of using cash surrender value as fair market value for these 
purposes and concluded that this practice is not appropriate where the 
total policy reserves, including life insurance reserves (if any) 
computed under section 807(d), together with any reserves for advance 
premiums, dividend accumulations, etc., represent a much more accurate 
approximation of the policy's fair market value.
    Since Notice 89-25 was issued, life insurance contracts have been 
marketed that are structured in a manner which results in a temporary 
period during which neither a contract's reserves nor its cash 
surrender value represent the fair market value of the contract. For 
example, some life insurance contracts may provide for large surrender 
charges and other charges that are not expected to be paid because they 
are expected to be eliminated or reversed in the future (under the 
contract or under another contract for which the first contract is 
exchanged), but this future elimination or reversal is not always 
reflected in the calculation of the contract's reserve. If such a 
contract is distributed prior to the elimination or reversal of those 
charges, both the cash surrender value and the reserve under the 
contract could significantly understate the fair market value of the 
contract. Thus, in some cases, it would not be appropriate to use 
either the net surrender value (i.e. the contract's cash value after 
reduction for any surrender charges) or, because of the unusual nature 
of the contract, the contract's reserves to determine the fair market 
value of the contract. Accordingly, Q&A-10 of Notice 89-25 should not 
be interpreted to provide that a contract's reserves (including life 
insurance reserves (if any) computed under section 807(d), together 
with any reserves for advance premiums, dividend accumulations, etc.) 
are always an accurate representation of the contract's fair market 
value.
    For example, it would not be appropriate to use a contract's 
reserve or the net surrender value of the contract as fair market value 
at the time of distribution if under that contract those amounts are 
significantly less than the aggregate of: (1) The premiums paid from 
the date of issue through the date of distribution, plus (2) any 
amounts credited (or otherwise made available) to the policyholder with 
respect to those premiums (including interest, dividends, and similar 
income items), or, in the case of variable contracts, all adjustments 
made with respect to the premiums paid during that period that reflect 
investment return and the current market value of segregated asset 
accounts, minus (3) reasonable mortality charges and reasonable charges 
(other

[[Page 7387]]

than mortality charges) actually charged from the date of issue to the 
date of distribution and expected to be paid.
    The following example provides an illustration of a contract where 
it would not be appropriate to use a contract's reserve or its net 
surrender value as its fair market value:
    A participates in a plan intended to satisfy the requirements of 
section 401(a). In Year 1, the plan acquires a life insurance contract 
on A's life that is not a variable contract and with a face amount of 
$1,400,000. In that year and for the next four years, the plan pays 
premiums of $100,000 per year on the contract. The contract provides 
for a surrender charge that is fixed for the first five years of the 
contract and decreases ratably to zero at the end of ten years. The 
contract also imposes reasonable mortality and other charges as defined 
by section 7702(c)(3)(B)(i) and (ii) of the Code.
    The contract provides a stated cash surrender value for each of the 
first ten years (the first five years are guaranteed), as set forth in 
the table below. The reserves under the contract, including life 
insurance reserves and reserves for advance premiums, dividend 
accumulations, etc. (calculated using the rules in section 807(d) of 
the Code) at the end of the fifth year are $150,000.

------------------------------------------------------------------------
                                                              Cash value
                                                              determined
                                                      Net       without
                 Year                    Premium   surrender   reduction
                                                     value        for
                                                               surrender
                                                                charges
------------------------------------------------------------------------
1.....................................   $100,000  .........  ..........
2.....................................    100,000  .........  ..........
3.....................................    100,000  .........  ..........
4.....................................    100,000  .........  ..........
5.....................................    100,000   $100,000    $450,000
6.....................................  .........    195,000     475,000
7.....................................  .........    290,000     500,000
8.....................................  .........    385,000     525,000
9.....................................  .........    480,000     550,000
10....................................  .........    575,000     575,000
------------------------------------------------------------------------

At the end of Year 5, A retired and received a distribution of the 
insurance contract that was purchased on his life.
    These regulations clarify that the contract is included in A's 
income at its fair market value rather than the $100,000 cash surrender 
value. Furthermore, A could not treat the $150,000 reserve as of the 
end of the fifth year as the fair market value, because this amount is 
less than the amount a willing buyer would pay a willing seller for 
such a contract, with neither party being under a compulsion to buy and 
sell and both having reasonable knowledge of the relevant facts.

Proposed Effective Dates

    The amendments to Sec. 1.402(a)-1(a)(2) of the regulations are 
proposed to be applicable to any distribution of a transferable 
retirement income, endowment, or other life insurance contract 
occurring on or after February 13, 2004. The amendment to Sec. 1.79-1 
is proposed to be applicable to permanent benefits provided on or after 
February 13, 2004. The amendment to Sec. 1.83-3(e) is proposed to be 
applicable to any transfer occurring after February 13, 2004. The 
amendments to Sec. 1.402(a)-1(a)(1)(iii) of the regulations are 
proposed to be applicable to any transfer of property by a plan to a 
plan participant or beneficiary for less than fair market value where 
the transfer occurs on or after the date of publication in the Federal 
Register of the final regulations adopting these amendments. Taxpayers 
may rely upon these proposed regulations for guidance pending the 
issuance of final regulations.

Interim Guidance for Determining Fair Market Value

    The IRS and the Treasury recognize that taxpayers could have 
difficulty determining the fair market value of a life insurance 
contract after the clarification in this preamble that Notice 89-25 
should not be interpreted to provide that a contract's reserves 
(including life insurance reserves (if any) computed under section 
807(d), together with any reserves for advance premiums, dividend 
accumulations, etc.) are always an accurate representation of the 
contract's fair market value. Accordingly, in connection with this 
guidance, the IRS has issued Rev. Proc 2004-16 (2004-10 IR.B.), which 
provides interim rules under which the cash value (without reduction 
for surrender charges) of a life insurance contract distributed from a 
qualified plan may be treated as the fair market value of that 
contract. The interim rules in Rev. Proc. 2004-16, permit the use of 
values that should be readily available from insurance companies, 
because the cash value (without reduction for surrender charges) is an 
amount that, in the case of a flexible insurance contract (including a 
variable contract), is generally reported in policyholder annual 
statements, and in the case of traditional insurance contracts, is 
fixed at issue and provided in the insurance contract.
    Under those interim rules, a plan may treat the cash value (without 
reduction for surrender charges) as the fair market value of a contract 
at the time of distribution provided such cash value is at least as 
large as the aggregate of: (1) The premiums paid from the date of issue 
through the date of distribution, plus (2) any amounts credited (or 
otherwise made available) to the policyholder with respect to those 
premiums, including interest, dividends, and similar income items 
(whether under the contract or otherwise), minus (3) reasonable 
mortality charges and reasonable charges (other than mortality 
charges), but only if those charges are actually charged on or before 
the date of distribution and are expected to be paid.
    In those cases where the contract is a variable contract (as 
defined in section 807(d)) a plan may treat the cash value (without 
reduction for surrender charges) as the fair market value of the 
contract at the time of distribution provided such cash value is at 
least as large as the aggregate of: (1) The premiums paid from the date 
of issue through the date of distribution, plus (2) all adjustments 
made with respect to those premiums during that period (whether under 
the contract or otherwise) that reflect investment return and the 
current market value of segregated asset accounts, minus (3) reasonable 
mortality charges and reasonable charges (other than mortality 
charges), but only if those charges are actually charged on or before 
the date of distribution and are expected to be paid.
    Applying those interim rules to the example above, A could treat 
the cash value (without reduction for surrender charges) of $450,000 as 
the fair market value of the contract as of the end of the fifth year, 
because, in this example, that amount exceeds the aggregate of the five 
$100,000 premiums ($500,000), plus the amounts credited to A with 
respect to those premiums, minus the reasonable mortality and other 
charges actually imposed and expected to be paid.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations, and, because 
the regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking will be submitted to the Chief Counsel for Advocacy of the 
Small Business

[[Page 7388]]

Administration for comment on its impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are submitted timely to the 
IRS. The IRS and Treasury Department specifically request comments on 
the clarity of the proposed regulations and how they may be made easier 
to understand. In addition, the Treasury Department and the IRS 
specifically request comments regarding the interim rules set forth in 
Rev. Proc. 2004-16 and proposals for appropriate permanent methods for 
valuing life insurance contracts when distributed from qualified 
retirement plans and for valuing such contracts for purposes of 
sections 79 and 83, including appropriate discounts which take into 
account the probability that contracts will be surrendered during the 
period during which surrender charges apply. The IRS and the Treasury 
are also reviewing other types of contracts, such as annuities, which 
have cash surrender value but where that cash surrender value may not 
reflect the fair market value of the contracts. Accordingly, the IRS 
and the Treasury also request comments regarding the valuation of these 
other contracts. All comments will be available for public inspection 
and copying.
    A public hearing has been scheduled for Wednesday, June 9, 2004, at 
10 a.m. in the auditorium, Internal Revenue Building, 1111 Constitution 
Avenue, NW., Washington, DC. Due to building security procedures, 
visitors must use the main building entrance on Constitution Avenue. In 
addition, all visitors must present photo identification to enter the 
building. Because of access restrictions, visitors will not be admitted 
beyond the immediate entrance area more than 30 minutes before the 
hearing starts. For more information about having your name placed on 
the list to attend the hearing, see the FOR FURTHER INFORMATION CONTACT 
section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit written 
(signed original and eight (8) copies) or electronic comments and an 
outline of the topics to be discussed and the time to be devoted to 
each topic by Wednesday, May 19, 2004. A period of 10 minutes will be 
allotted to each person for making comments. An agenda showing the 
scheduling of the speakers will be prepared after the deadline for 
receiving outlines has passed. Copies of the agenda will be available 
free of charge at the hearing.

Drafting Information

    The principal authors of these regulations are Robert M. Walsh, 
Employee Plans, Tax Exempt and Government Entities Division, and Linda 
Marshall, Office of Division Counsel/Associate Chief Counsel (Tax 
Exempt and Government Entities). However, other personnel from the IRS 
and Treasury participated in the development of these regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read, 
in part, as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2 Section 1.79-1, paragraph (d)(3) is revised to read as 
follows:


Sec. 1.79-1  Group-term life insurance--general rules.

* * * * *
    (d) * * *
    (3) Formula for determining deemed death benefit. The deemed death 
benefit (DDB) at the end of any policy year for any particular employee 
is equal to:
    R/Y
    where--
    R is the net level premium reserve at the end of that policy year 
for all benefits provided to the employee by the policy or, if greater, 
the fair market value of the policy at the end of that policy year; and
    Y is the net single premium for insurance (the premium for one 
dollar of paid-up, whole life insurance) at the employee's age at the 
end of that policy year.
* * * * *
    Par. 3. In Sec. 1.83-3, paragraph (e), the last two sentences are 
revised to read as follows:


Sec. 1.83-3  Meaning and use of certain terms.

    (e) * * * In the case of a transfer of a life insurance contract, 
retirement income contract, endowment contract, or other contract 
providing life insurance protection, or any undivided interest therein, 
the policy cash value and all other rights under such contract 
(including any supplemental agreements thereto and whether or not 
guaranteed), other than current life insurance protection, are treated 
as property for purposes of this section. However, in the case of the 
transfer of a life insurance contract, retirement income contract, 
endowment contract, or other contract providing life insurance 
protection, which was part of a split-dollar arrangement (as defined in 
Sec. 1.61-22(b)) entered into (as defined in Sec. 1.61-22(j)) on or 
before September 17, 2003, and which is not materially modified (as 
defined in Sec. 1.61-22(j)(2)) after September 17, 2003, only the cash 
surrender value of the contract is considered to be property.
* * * * *
    Par. 4. Section 1.402(a)-1 is amended by:
    1. Revising paragraph (a)(1)(iii).
    2. Revising the last two sentences of paragraph (a)(2).
    The revisions read as follows:


Sec. 1.402(a)-1  Taxability of beneficiary under a trust which meets 
the requirements of section 401(a).

    (a) * * *
    (1) * * *
    (iii) Except as provided in paragraph (b) of this section, a 
distribution of property by a trust described in section 401(a) and 
exempt under section 501(a) shall be taken into account by the 
distributee at its fair market value. In the case of a distribution of 
a life insurance contract, retirement income contract, endowment 
contract, or other contract providing life insurance protection, or any 
interest therein, the policy cash value and all other rights under such 
contract (including any supplemental agreements thereto and whether or 
not guaranteed) are included in determining the fair market value of 
the contract. In addition, where a trust described in section 401(a) 
and exempt under section 501(a) transfers property to a plan 
participant or beneficiary in exchange for consideration and where the 
fair market value of the property transferred exceeds the amount 
received by the trust, then the excess of the fair market value of the 
property transferred by the trust over the amount received by the trust 
is treated as a distribution by the trust to the distributee.
* * * * *
    (2) * * * If, however, the contract distributed by such exempt 
trust is a life insurance contract, retirement income contract, 
endowment contract, or other contract providing life insurance 
protection, the fair market value of such contract at the time of 
distribution must be included in the distributee's income in accordance 
with the provisions of

[[Page 7389]]

section 402(a), except to the extent that, within 60 days after the 
distribution of such contract, all or any portion of such value is 
irrevocably converted into a contract under which no part of any 
proceeds payable on death at any time would be excludable under section 
101(a) (relating to life insurance proceeds). If the contract 
distributed by such trust is a transferable annuity contract, a life 
insurance contract, a retirement income contract, endowment contract, 
or other contract providing life insurance protection (whether or not 
transferable), then notwithstanding the preceding sentence, the fair 
market value of the contract is includible in the distributee's gross 
income, unless within such 60 days such contract is also made 
nontransferable.
* * * * *

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 04-3402 Filed 2-13-04; 8:45 am]
BILLING CODE 4830-01-P