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IRS Provides Clarification on How Amendments to IRC § 1016 Affect Prior Life Insurance Basis Rulings
The IRS recently issued Rev. Rul. 2020-05, which clarifies how amendments to IRC § 1016 by the Tax Cuts and Jobs Act (“TCJA”) apply to determine an insured’s basis in a life insurance contract and the amount of income recognized by an insured/seller when a life insurance policy is sold.
Generally, the adjusted basis for determining gain or loss from the sale or exchange of property is the property’s cost adjusted as provided in IRC § 1016. Specifically, IRC § 1016(a) provides that proper adjustment must be made for expenditures, receipts, losses, or other items properly chargeable to a capital account.
However, § 13521 of the TCJA amended IRC § 1016(a) to provide that, in determining the basis of a life insurance contract or an annuity contract, no adjustment is made for mortality, expense, or other reasonable charges incurred under the contract (the “Amendment”). This Amendment is effective for transactions entered into on or after August 26, 2009.
Prior to the Amendment, Rev. Rul. 2009-13 and Rev. Rul. 2009-14 applied IRC § 1016 to determine the adjusted basis of life insurance contracts under IRC § 1011 and IRC § 1012 in several factual situations, as provided below.
Rulings Prior to Amendment
In Situation 2 of Rev. Rul. 2009-13, an individual insured (A) sold his life insurance contract to an unrelated person (B) for $80,000. Before selling the contract, A had paid $64,000 in premiums, and the cost of insurance was $10,000. Under Rev. Rul. 2009-13, A’s adjusted basis in the contract was $54,000 (premiums – cost of insurance). Therefore, A was required to recognize $26,000 in income on the sale of the contract ($80,000 – $54,000).
In Situation 3 of Rev. Rul. 2009-13, A purchased a level premium fifteen-year term life insurance contract. A held the contract for approximately 7.5 years and had paid total premiums of $45,000 when he sold the contract for $20,000 to B an unrelated party. A’s adjusted basis in the contract as of the date of the sale was $250 because he was required to adjust his $45,000 cost basis by $44,750 (the cost of insurance protection). Therefore, A was required to recognize $19,750 of income on the sale of the contract ($20,000 – $250).
In Situation 2 of Rev. Rul. 2009-14, the facts are the same as in Situation 3 of Rev. Rul. 2009-13, except that B purchased the contract for $20,000 from A and then, at the end of the following year, sold the contract to C, a person unrelated to either A or B, for $30,000. Before selling the contract, B paid a total of $9,000 in premiums (total basis $29,000). Unlike A, B is not required to reduce his cost basis by the cost of insurance because B was not the insured or related to the insured and enjoyed no insurance protection from the contract. Therefore, B was required to recognize $1,000 in income from the $30,000 contract sale ($30,000 – $29,000).
Clarification Following Amendment
The IRS has ruled that the analysis and holdings relating to A’s adjusted basis in the contracts referenced in Situations 2 and 3 in Rev. Rul. 2009-13 and the analysis relating to B’s adjusted basis in the contract in Situation 2 in Rev. Rul. 2009-14 are inconsistent with the language of IRC § 1016(a)(1)(B) added by the TCJA. Under IRC § 1016(a)(1)(B), the cost basis of a life insurance contract is not reduced by the cost of insurance, regardless of why the contract is purchased. As a result, under Rev. Rul. 2020-05, Rev. Rul. 2009-13 and Rev. Rul. 2009-14 were modified to the extent they are inconsistent with the rule set forth in IRC § 1016(a)(1)(B).
For example, in Situations 2 and 3 in Rev. Rul. 2009-13, A is no longer required to reduce A’s basis in the contract by the cost of insurance. Accordingly, in Situation 2 of Rev. Rul. 2009-13, A’s adjusted basis in the contract equals the premiums paid. Therefore, A must recognize $16,000 (not $26,000) of income on the sale of the contract ($80,000 amount realized on sale less $64,000 adjusted basis).
Further, in Situation 3 of Rev. Rul. 2009-13, A’s adjusted basis in the contract will now be equal to the premiums paid. A will recognize a $25,000 loss on the sale of the contract ($20,000 amount realized on the sale less $45,000 adjusted basis). A will not be permitted to deduct the loss unless the loss is incurred under IRC § 165(c)(1) or IRC § 165(c)(2).
In Situation 2 of Rev. Rul. 2009-14, B was not required to reduce B’s basis in the contract by the cost of insurance because B was not the insured or related to the insured and enjoyed no insurance protection from the contract. Accordingly, the outcome for B in Situation 2 of Rev. Rul. 2009-14 does not change, under IRC § 1016 as amended by the TCJA. Thus, B’s situation in Situation 2 of Rev. Rul. 2009-14 is no longer distinguishable from that of A in Situation 3 of Rev. Rul. 2009-13 with regards to the treatment of cost of insurance charges.
Consistent with the effective date of the Amendment to IRC § 1016(a), this ruling is effective for transactions entered into on or after August 26, 2009.
A change in the internal revenue laws that is made retroactive to earlier tax years does not automatically permit a claim for a refund for such a year when the claim is barred by the limitations period, and Congress did not express an intent to waive or extend the limitations period for the retroactive change made to IRC § 1016.
Click here to see the full version of Rev. Rul. 2020-05.
La. Supreme Court Rules that Wal-Mart.com Not Responsible for Collecting Sales Tax from Small Online Businesses
On January 29, 2020, the Supreme Court of Louisiana ruled that because Wal-Mart.com USA, LLC (“Wal-Mart.com”) was not a “dealer” under Louisiana Revised Statute 47:301(4)(l) with regard to sales made by third-party retailers through its website, and because Wal-Mart.com did not contractually assume the statutory obligation of its third-party retailers to collect and remit sales taxes, Wal-Mart.com was not required to collect and remit sales taxes generated by third-party sales through its online marketplace.
Wal-Mart.com operates an online marketplace through which visitors can buy products from both Wal-Mart.com and third-party retailers who are permitted to list their products for sale on Wal-Mart.com’s online marketplace. From 2009 to 2015, Wal-Mart.com reported its online sales in Jefferson Parish and remitted the required sales tax to the Louisiana Department of Revenue and the tax collector for Jefferson Parish (“Tax Collector”). Because Wal-Mart.com’s reported online sales amount did not include proceeds from online sales made by third-party retailers through Wal-Mart.com’s online marketplace, Tax Collector filed suit in February of 2017 and alleged that Wal-Mart.com had failed to collect and remit all of the sales taxes owed for transactions subject to Jefferson Parish sales taxation.
At the trial court level, Tax Collector argued that Wal-Mart.com is a “dealer” under La. R.S. 47:301(4)(l) and thus required to collect sales tax from the third-party transactions it facilitates through its online marketplace. La. R.S. 47:337.17 provides that “[t]he tax levied by local ordinance shall be collected by the dealer from the purchaser or consumer.” La. R.S. 47:301(4)(l) defines “dealer” as:
Every person who engages in regular or systematic solicitation of a consumer market in the taxing jurisdiction by the distribution of catalogs, periodicals, advertising fliers, or other advertising, or by means of print, radio or television media, by mail, telegraphy, telephone, computer data base, cable, optic, microwave, or other communication system.
The trial court agreed with Tax Collector, finding that Wal-Mart.com was engaged in the “regular or systematic solicitation of a consumer market” in Jefferson Parish as described in La. R.S. 47:301(4)(l), that Wal-Mart.com was a dealer with regard to the third-party transactions it facilitated through its online marketplace, and that Wal-Mart.com was responsible for the sales tax obligation arising from the sales by third-party retailers through its online marketplace.
The appellate court affirmed the trial court’s judgment, and Wal-Mart.com sought relief from the Louisiana Supreme Court. The Supreme Court’s primary consideration was whether a marketplace facilitator is a dealer under La. R.S. 47:301(4)(l) and is obligated to collect and remit sales tax on the sales made by third-party retailers through its online marketplace.  The Supreme Court noted that La. R.S. 47:301(4)(l) cannot be considered in isolation and that it was necessary to consider other relevant provisions in the sales and use tax scheme.
In considering other relevant sales and use tax provisions, the Court determined that “the type of transaction at issue in this case is a ‘sale at retail'” and that “in the context of a sale at retail, La. R.S. 47:301(4)(b) defines ‘dealer’ to be the seller.” Under La. R.S. 47:304, the dealer making the sale is required to collect the tax from the purchaser. The Court noted that “relative to sales by third-party retailers on Wal-Mart.com’s online marketplace, the actual participants to the sale are the third-party retailers that actually sell the goods and the purchasers.” The Court further stated that “[c]learly, an online marketplace is not a party to the underlying sales transaction between the third-party retailers and their customers, but rather a facilitator of the sale.”
Looking to the legislative history of La. R.S. 47:301(4), the Court determined that “[t]here is no indication in La. R.S. 47:301(4)(l) that the legislature intended to expand this definition of ‘dealer’ to include more than sellers that own the property being sold and are the parties to the underlying sales transactions.” Therefore, the Court held that “the lower courts legally erred in concluding that . . . Wal-Mart.com was a ‘dealer’ under La. R.S. 47:301(4)(l) in connection with property owned by third-party retailers that was sold through Wal-Mart.com’s online marketplace.”
The Court further supported its holding by referencing the laws related to the collecting and remitting of sales tax by auctioneers, who are third parties to the transactions they facilitate. “In the case of auctioneers, the actual owner of the property turns it over to the auctioneer who conducts the sale and consummates the final transfer of title, as a third party, from the owner to the purchaser.” Because an auctioneer has a unique relationship with the owner of the property being sold, the Court noted that the legislature has enacted provisions which require an auctioneer to register as a dealer, collect all sales taxes on articles sold by him, and report and remit the amounts he collects. The Court further explained that “the laws enacted to govern the obligations of an auctioneer, who the legislature obviously believed does not qualify as a dealer under La. R.S. 47:301(4), illustrate the need for legislation to address the obligation of an online marketplace facilitator to collect sales tax on sales of third-party retailers conducted through its online marketplace.” The Court also stated that “[a]bsent similar legislation for an online marketplace, double taxation could result if both online marketplaces and third-party retailers are obligated to collect sales tax on the same transaction.”
Additionally, the Court considered the “Marketplace Retailer Agreement” that Wal-Mart.com has with its third-party retailers and determined that it did not require Wal-Mart.com to collect and remit sales taxes generated by the third-party sales.
The Court ultimately concluded that because “a marketplace facilitator is not a ‘dealer’ under La. R.S. 47:301(4)(l),” and because Wal-Mart.com had not contractually assumed the responsibility for collecting and remitting sales taxes generated by third-party sales, Wal-Mart.com was not obligated to collect and remit sales tax for third-party transactions it facilitates through its online marketplace. 
As of the publishing of this alert, more than three-quarters of states have legislation in effect that requires marketplace facilitators to collect and remit sales tax from third-party transactions.
 Normand v. Wal-Mart.com USA, LLC, 2019-00263 at *1 (La. 1/29/20).
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