USA Life Insurance transfer and gifting - basis question

[Josh E]

I have a client that had their partnership take out a whole life insurance policy on a key employee in 2013. The partnership owned the policy and was the beneficiary of the policy. This employee moved on several years ago, but remained on good terms with the partnership owner. The owner would like to gift the policy to this individual so that they have control going forward, including the ability to designate their family as the beneficiaries instead of the partnership.

I am thinking this would be a two part transaction, with the partner withdrawing the policy from the partnership, and then personally gifting it to the other individual. My uncertainty is in regards to accounting for the basis. Let's say the partnership's cost-basis is $200,000 and the present cash value and cash-surrender values are both $150,000. From what I have been able to research, the withdrawal of the policy from the partnership would use the cost-basis of the premiums paid, in this case being $200,000. The premiums were paid in prior years, were non-deductible expenses, and increased partner basis $200,000. Would the policy withdrawal debit partner withdrawals $200,000 and credit the capital account $200,000 resulting in a wash for the partnership?

It looks like ordinarily the partner's basis would be the cost-basis of the policy ($200,000), and the individual that receives the policy as a gift would have the same basis of $200,000. Is this true even if the present value/fmv is only $150,000? I can see that the TCJA caused a change in policy basis for policies enacted after 2009, and I think cost-basis is correct, but I am not 100%.

I appreciate any clarifications!

 

[DrStrangeLove]

There is a possible wrinkle in this plan: the policy may not be transferable in this situation. (Full disclosure: I'm a life actuary of many years' experience. I currently work for a small life insurer in the Midwest.) There is substantial variation in COLI/BOLI used to mitigate key person risk, and it may matter here. The underwriting the insurer uses for COLI is generally different/less intense that for individual life for the same face amount, because for COLI, you can assume that a person is relatively healthy (enough to work in a high position in a company) and the protection needed is relatively high (that is, the face amount is a large dollar amount compared to the average policy issued in order to mitigate the impact to a business).

The client needs to talk to the insurer to see: 1.) is transfer to the insured allowed by the policy?; 2.) does the insurer require additional/new underwriting to transfer the policy to the insured?; 3.) does transfer require a reduction in face amount or conversion to a different policy form?; 4.) given that the insured moved on years ago and is no longer employed there, is the policy still in force/enforceable? The insured is no longer a key person at the payor's company, and some insurers/products terminate coverage when the insured leaves the firm that bought the insurance.

It's worth at least the cost of a phone call to check with the insurer, just so your client doesn't try to gift something that may be worthless or non-transferable.

 

[Josh E]

Those are good questions to raise. Thank you! I have been working with their insurance agent on this, and they say there won't be any issues like these, or any similar issues/problems on their end. Also, not mentioned in the original post, but a gift tax return will be filed once the transfer occurs.