IRS removes a death benefit tax trap from life insurance policy swaps

Treasury and the IRS published final regulations on July 9 covering Section 1035 exchanges of life insurance contracts. Michael Cohn at Accounting Today reported the release. The 2019 rules counted an ordinary policy swap as a transfer of an interest in a life insurance contract, which could convert a tax-free death benefit into taxable income. That trap is closed. The new rules strike the reference, rewrite how excludable proceeds are figured on an exchanged contract, and adjust the definition of a reportable policy sale.

A separate exception covers corporate reorganizations where company-owned life insurance is 5 percent or less of gross assets. Insurers will pass information between themselves rather than file a new form. The rules apply to exchanges on or after July 9, 2026, and taxpayers may elect to apply them back to exchanges after December 31, 2017.