ing Research Memo -2 2o2dc

Certified Public ants To: Bill Duncan – Tax Partner in Charge From: Susana Armenta – Assistant Tax Specialist Date: November, 26, 2013 Subject: Research Project – Case Number 9

Facts: Maximum Corporation is owned by the Bent family. Corporation holds a $1 million whole life insurance policy on the officer/shareholders, policy proceeds payable to the Corporation. Ida services as President of the Corporation, brother Jack serves as Vice President, and younger brother Ken is the Treasurer. Jack had a heart attack six months ago and, although he has recovered nicely, his long-term health is doubt. Jack’s wife died two years ago and he has decided to retire and enjoy what is left of his life. The cash surrender value of the $1 million life insurance policy on Jack’s life is $100,000. The corporation no longer has a business reason for retaining this policy once Jack’s departure from the company is affected. Jack is unable to purchase additional life insurance now that he has suffered a heart attack and would like to acquire this policy. Queries: Query 1: If the company gives the policy to Jack as a retirement bonus, would it receive a tax deduction? Query 2: If so, would the deduction be equal to the policy’s surrender value or the total of the s paid by the company in the past? Query 3: Are there other factors that could make the “bonus” non-deductible? For example, its size or the fact that Jack is related to the remaining officers. Research Issue: If the company receives a tax deduction, would the deduction be equal to the policy’s surrender value or the total of the s paid by the company in the past? Conclusion: Maximum Corporation would receive a tax deduction equal to the surrender value of the policy, or $100,000, assuming it is reasonable compensation. Arguments and Authorities: Under Section 83(a) of the Internal Revenue Code, Jack must recognize income equal to “the excess of the fair market value of” the policy “over the amount (if any) paid for such property.” In this case, this should equal the policy’s surrender value because that is the fair market value and he did not pay anything for it.

Under I.R.C. Section 83(h), Maximum Corporation, the employer in this situation, is “allowed as a deduction … an amount equal to the amount included under subsection (a).” Since Jack has to recognize $100,000 of income under subsection (a), the company will also get a deduction equal to $100,000. Similarly, Section 1.83-6(a)(5) of the regulations of the I.R.S. addresses deductions for employers based on the transfer of life insurance contracts to employees. The “general rule” given in subsection (i) is that “a deduction is allowable under paragraph (a)(1) of this section to person for whom the services were performed. The amount of the deduction, if allowable, is equal to the sum of the amount included as compensation in the gross income of the service provider under §1.61-22(g)(1) and the amount determined under §1.61-22(g)(1)(ii).” This is another way of saying that the employer gets a deduction equal to the amount of income recognized by the employee. In this case, since Jack has to recognize $100,000 of income, Maximum Corporation should get a $100,000 deduction.