Tax Court - Income from extinguished insurance policy loans includes both loan principal and capitalized interest 

February 13:  The U.S. Tax Court held that an individual who borrowed against his life insurance policy and did not repay the loans realized income, when the policy was terminated, equal to the extinguished loan principal plus capitalized interest. Black v. Commissioner, T.C. Memo 2014-27 (February 12, 2014)

Read the T.C. Memo opinion [PDF 87 KB]

Summary

The taxpayer borrowed against a life insurance policy, but failed to repay the loans. The policy was terminated, and the loans were then satisfied by the insurance policy proceeds.


The IRS issued a notice of deficiency to the taxpayer, contending that the amount of income realized upon termination of the insurance policy included both: (1) the policy loan principal; and (2) capitalized interest on the policy loan. The taxpayer countered that the amount realized included only the loan principal.


The Tax Court agreed with the IRS and upheld the deficiency determination, finding that capitalized interest that had accrued on the taxpayer’s loans against his life insurance policy was includible in determining the gross distribution and the taxable amount arising from the termination of the policy. The court also affirmed the taxpayer’s liability for an accuracy-related penalty under section 6662(a).

KPMG observation

This is one of many recent cases in which a taxpayer challenges the treatment of policy loan forgiveness as income. Tax professionals have questioned whether the IRS is taking a more aggressive stance in enforcing its position and/or whether policy owners are truly not aware of the potential tax consequences of taking policy loans and disposing of the contract prior to its maturity.



For more information, contact a tax professional with KPMG’s Washington National Tax:


Jean Baxley

(202) 533-3008




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