Source: http://www.journalofaccountancy.com/Issues/2008/Jan/LifeInsuranceWhatsItWorthAndWhoSays.htm
Timestamp: 2016-02-06 11:25:55
Document Index: 90834814

Matched Legal Cases: ['§ 101', '§ 170', 'art 1', '§ 1', '§ 1', '§ 170']

{articleTitle} {articleAbstract} FeaturePERSONAL FINANCIAL PLANNING / TAX
Forensic and Valuation ServicesTax
insurance policies to not-for-profit
organizations can benefit both
the organization and the donor, the latter
in the form of an often sizeable income
tax deduction. However, under the new
requirements of the Pension Protection Act
of 2006 (PPA), determining the fair market
value of policies will require the help of
an appraiser with the appropriate
expertise and experience. Cash-value policies,
such as whole life, are valued at fair
market value, limited by their
cost basis. A paid-up policy is valued at
its replacement cost. A policy that is not
fully paid up is valued at the lesser of
premiums paid or its interpolated terminal
reserve amount. The PPA now requires
to be appraised by a qualified
appraiser according to generally accepted
appraisal standards. The Uniform Standards
of Professional Appraisal Practice
(USPAP), developed by the Appraisal
Standards Board of the Appraisal
Foundation, is considered as satisfying
this requirement. A qualified appraiser
is one who, among other things, performs
appraisals regularly and is
qualified by experience, education and
other factors to appraise the type of
property in question. He or she must have
earned an appraisal designation from a
recognized professional appraiser
organization or meet minimum requirements
for education and experience. For returns
filed since February 2007, such education
includes relevant college or
professional-level coursework. Experience
must include at least two years of buying,
selling or valuing similar property. In addition, the PPA
for appraisals that cause a tax
understatement. Alan Breus, CLU, ChFC, is
principal of The Breus Group of San Jose,
Calif., a qualified member of the
Appraisers Association of America and an
insurance adviser to Northwestern
University. He can be reached at alanb@thebreusgroup.com or www.thebreusgroup.com. N
ot everyone can make a multimillion-dollar
bequest to his or her alma mater, but many alums
have an insurance policy for which they might
easily be persuaded to name their school or
another not-for-profit organization as owner and
beneficiary. University development
offices and other prospective nonprofit
beneficiaries are well aware of this, and many
encourage gifts of policies. What they and
prospective donors might be less sure of—and
consequently need your help in deciding—is how to
properly value donated life insurance interests
for tax purposes. And you may need to brush up on
the new provisions for qualified appraisals under
the Pension Protection Act of 2006 (PPA). Qualified appraisals are a concern for
taxpayers donating noncash charitable gifts of all
kinds. The questions of appraiser qualification
and responsibility remain an area of concern for
the IRS due to a long history of valuation
problems dealing with gifted life insurance. Life
insurance can be prone to incorrect valuation
because of the plethora of types of policies
available, ownership and beneficiary issues and
misunderstanding of valuation methods of how to
apply fair market valuation principles. Many CPAs may be more attuned to providing an
estimate of the value of business interests and
other types of assets rather than those required
for life insurance policies. This article,
therefore, is intended to help you and your
clients navigate this murky minefield and offers
suggestions on how to find a qualified appraiser
who can complete and sign the revised Form 8283
for charitable donations of life insurance
interests. THE COMMODITY ITSELF For
donors, gifted life policies can be a source of
tax deductions and can help meet estate and
personal financial planning objectives. In some
cases, these policies also allow for the building
of a less costly legacy with worn-out assets that
may no longer be needed. More than 70% of life
insurance policies, including group and
secondary-market policies, lapse for nonpayment
because they no longer meet any pressing estate
planning or business planning needs. As noted by
the Insurance Information Institute (www.iii.org), a
per-year lapse ratio of 7.7% (38.5% lapses in five
years) is the industry standard, down from 8.75%
per year for the period 1995–2000. Additional
material suggests the lapse rate is 3% per year
for individuals over 65. DEATH, TAXES AND PLANNED GIVING Both these superannuated as well
as newly written life insurance policies are a
great source of new money for not-for-profits.
Empirical mortality tables have the uncanny knack
of being correct. It’s not a matter of whether the
insured is going to die, it’s when, and if the
portfolio of policies is sufficiently diversified,
we even know what year that might be within a
reasonable margin. Regardless of whether the
policy is term insurance, some form of cash-value
insurance, assignable old group policies or even
the senior settlement payouts from the secondary
market, life insurance is a viable tool to the
planned-giving community. In general, the
deductible amount of a donated life insurance
interest is its fair market value, which is the
amount an insurance company would charge for a
comparable contract. If the policy has a cash
surrender value, that amount is considered the
fair market value if the donee intends to cash out
the policy rather than hold it as an investment.
Otherwise, for fully paid-up whole-life polices,
fair market value is considered to be replacement
cost. A policy that is not fully paid up is
typically valued at the lesser of either total
premiums paid or the “interpolated terminal
reserve,” an amount designated by the insurer to
fulfill its obligations under the contract. It is
similar to the cash surrender value and is
available from the insurer. In any case, however,
the value can be no greater than the policy’s cost
basis. A term insurance policy’s value is
typically the amount of future premiums that would
be paid to maintain the policy. Example. Mr. A. Giver was a
partner in a company that was recently sold to a
conglomerate. His interest in the partnership was
paid out to him, and his $1 million
insurance-funded buy/sell agreement was canceled.
Giver’s partner transferred the funding policy to
him. No transfer-for-value issues arise when a
policy is transferred to the original insured—IRC
§ 101(a)(2). But after careful review, Giver
decided he had no real need to continue the
coverage. By donating the policy to his alma
mater, the University of Higher Aspirations, he
can deduct, in the case of a non-paid-up policy,
any new premiums he pays and the lesser of the
premiums he has paid or the interpolated terminal
reserve value, up to the policy’s cost basis. In the case of a paid-up policy, the deduction
is the cost of replacing the coverage with a
comparable policy, again, limited by cost basis.
If the policy were term insurance, he would have
no accumulated cost basis but can deduct all
future dollars he donates to the university for it
to pay premiums as maintenance. On an immediate
basis, Giver’s deduction is limited to his actual
cost of purchase, which may or may not be equal to
the total cost basis as noted by the insurance
company. Of course, if Giver were
medically impaired, he might go to the secondary
life insurance market and sell his policy for some
new medically underwritten original issue discount
dollar value. If the policy is sold, then Giver is
holding cash that is taxable partly as ordinary
income (amount over basis up to cash value), with
the remainder taxed as a capital asset. If
he then donates that cash to the university, he
will receive an immediate tax deduction. If he
instead takes the cash and contributes it to a
charitable remainder trust, he will receive either
an immediate income tax deduction for the
contribution or a deduction to offset the income
he has to recognize within the trust. This might
glean substantial dollars for the university and,
through the use of a charitable remainder trust,
may give our donor substantial deductions against
current income, while the donee university in this
way receives a rich and unexpected bequest. This
scenario, although interesting in concept, is
fraught with possible reporting problems, which
may end up being placed at the feet of the
qualified appraiser. DEFECTIVE DEDUCTIONS
Historically, misguided valuations and
resulting erroneous deductions have been based on
the policy’s total death benefit, or the policy
cash value or settlement value from the secondary
market, without noting how the original cost
affects the amount of the deduction. In other
cases, policies with revocable beneficiary
designations have been accepted by
less-sophisticated charitable organizations and
been deducted by the donor. And in yet other
cases, policies have been attributed to insurance
companies that have never existed. Although there is no specific format for an
appraisal of an insurance policy, it is important
to address items of information that are required
to be in the appraisal as specified in IRS Notice
2006-96. An appraisal will be treated as having
been conducted in accordance with generally
accepted appraisal standards within the meaning of
§ 170(f)(11)(E)(i)(II) if, for example, it is
consistent with the substance and principles of
Practice, as developed by the Appraisal Standards
Board of the Appraisal Foundation. Additional
information is available at www.appraisalfoundation.org.
In addition, AICPA members may be subject to
standards of valuation or calculation engagements
under Statement on Standards for Valuation
Services no. 1, Valuation of a Business,
Business Ownership Interest, Security, or
Intangible Asset. Information is
required from the insurance policy itself and the
issuing insurance company. This data is found in
the insurance policy and includes: all the
information found on the specification or summary
page, the information found on the policy data
page, the information found on the table of
premiums page (term insurance) or the table of
cash values (ordinary life), the history of
ownership and beneficiary designations, with any
and all changes and/or transfers and a recitation
of rights of conversion and/or exchange found in
the body of the policy. The information required
from the insurance company is: the owner/donor’s
adjusted cost basis, the current policy status
(including values) derived from the most current
policy statement, or in-force illustration
prepared by the insurance company. A
deduction may be disallowed because it was based
on the recommendation of an appraiser who wasn’t
properly qualified. For the charity, the only
negative consequence may be losing a valuable
relationship with its benefactor. But someone is
going to be at fault for the unhappy donor’s
plight. The solution. Congress
perceived a need for more regulation of the
appraisal process and qualification of the
appraiser, leading to the PPA’s expanded
requirements. For a general description of PPA
changes, see “
Pension Protection Act Changes Valuations for
Tax Purposes,” JofA, Sept. 07, page
40. Note especially that a taxpayer must obtain a
qualified appraisal before completing Part 1 of
Section B of Form 8283 and, for donated property
worth more than $5,000, attach the
appraiser-prepared summary of that appraisal to
the tax return (see “Form 8283” below).
Requirements for appraisals are listed in Treas.
Reg. § 1.170A-13(c). The PPA expanded these
requirements to include that an appraisal must be
conducted in accordance with generally accepted
appraisal standards. THE QUALIFIED APPRAISER
Treasury Regulation § 1.170A-13(c)
(5)(i) defines a qualified appraiser as one who:
Holds himself or herself out to the
public as an appraiser and performs appraisals
regularly. Is qualified to make appraisals of
the type of property being valued, as determined
by the appraiser’s background, experience,
education and membership, if any, in a
professional appraisal association. Is independent. Understands that an intentionally
false overstatement of the value of the appraised
property may subject the appraiser to civil
penalties. Under IRC § 170(f)(11),
appraisers are now required to have earned an
appraisal designation from a recognized
professional appraiser organization or otherwise
meet minimum requirements for education and
experience specified by the Secretary. Under
transitional terms of Notice 2006-96, for returns
filed after Feb. 16, 2007, minimum requirements
may be met by having successfully completed
college or professional-level coursework relevant
to the property being valued, plus two years
experience in the trade or business of buying,
selling or valuing that type of property.
Appraisers must describe this education and
experience in the appraisal. They must also
prepare their appraisal based on demonstrated
competence in valuing the type of property in the
appraisal. Appraisers who meet the
requirements may be found through organizations
listed in the resources box under “Organizations
for finding a qualified appraiser.” Relevant
education in life insurance can be attained with
the Chartered Life Underwriter, Chartered
Financial Consultant or other college-based
designation. FORM 8283 Then a C
corporation, partnership, S corporation or
individual donates property, including life
insurance, and claims a deduction of more than
$500, Form 8283, Noncash Charitable
Contributions, must be filed, with Section A
completed. If the amount is $5,000 for a single
item or group of similar items, such as books, to
several charitable donees; art valued at $20,000
or more; or property for which a $500,000
deduction is claimed (and if an exception does not
apply as stated in the instructions to Form 8283),
the donor must obtain a written appraisal and fill
out Section B of Form 8283. Section B, Part I,
contains information relating to the donated
property itself. Part II is the signature
declaration by the donor that identifies all
donated items that have been appraised at a value
of less than $500 each. Part III contains the
appraiser’s binding declaration that reflects all
of the changes in the PPA, specifically, an
acknowledgment that the appraiser may be subject
to the gross valuation misstatement penalty of
section 6695A. FINDING A QUALIFIED APPRAISER
You, the CPA, are now faced with the task of
finding a fully qualified appraiser. Barring that
step, you risk daunting penalties, including
losing the ability to practice before the IRS for
three years while paying a penalty that can be as
much as 10% of the tax underpayment or 125% of the
fee received for the appraisal, whichever is less.
Added to this is the possibility that a
disillusioned taxpayer could sue you as well as
the unqualified appraiser to pay additional tax,
penalties and interest assessed on a deficiency;
and there is no longer a reasonable cause
exception to a valuation understatement. One way
to find a qualified appraiser is to contact an
acknowledged appraisal organization for a
qualified appraiser in your area. AICPA
RESOURCES Credentials FVS Center and ABV
Credential The Forensic and Valuation Services
Center, formerly the Business Valuation
and Forensic Litigation Services Center,
offers resources, tools and information,
including membership in the FVS Section
and how to obtain the Accredited in
Business Valuation (ABV) credential. For
more information, see http://bvfls.aicpa.org/.
PFP Center and PFS
Credential The AICPA Personal Financial
Planning (PFP) Center provides a range of
valuable resources that CPAs need for
professional and ethical financial
planning. The center also contains
information about the AICPA Personal
Financial Specialist (PFS) credential and
PFP Section membership. For more
information go to http://pfp.aicpa.org.
Standard Statement on Standards for Valuation
Services no. 1, Valuation of a
Business, Business Ownership Interest,
Security, or Intangible Asset, http://bvfls.aicpa.org/Resources/Laws+Rules+Standards+and+Other+Related+Guidance/
AICPA+Valuation+Standard+and+Implementation+Toolkit
OTHER RESOURCES Organizations Appraisal Standards Board of
the Appraisal Foundation, www.appraisalfoundation.org The American College offers
the Chartered Life Underwriter and
designations, www.theamericancollege.edu
Organizations for finding a
qualified appraiser AICPA, Accredited in Business
Valuation (ABV) credential, http://bvfls.aicpa.org Appraisers Association of
America, www.appraisersassoc.org American Society of
Appraisers, www.appraisers.org International Society of
Appraisers, www.isa-appraisers.org Latest News