[Federal Register Volume 60, Number 67 (Friday, April 7, 1995)]
[Proposed Rules]
[Pages 17731-17734]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-8523]
=======================================================================
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[FI-33-94]
RIN 1545-AS76
Debt Instruments with Original Issue Discount; Annuity Contracts
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
-----------------------------------------------------------------------
SUMMARY: This document contains proposed regulations relating to the
[[Page 17732]] federal income tax treatment of annuity contracts not
issued by insurance companies. Under the proposed regulations, certain
annuity contracts are taxed as debt instruments for purposes of the
original issue discount provisions of the Internal Revenue Code. The
proposed regulations provide guidance to sellers and buyers of these
contracts. This document also provides a notice of a public hearing on
the proposed regulations.
DATES: Written comments must be received by Tuesday, July 18, 1995.
Requests to appear and outlines of topics to be discussed at the public
hearing scheduled for Tuesday, August 8, 1995, at 10 a.m. also must be
received by Tuesday, July 18, 1995.
ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (FI-33-94), room 5228,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, submissions may be hand delivered between
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R (FI-33-94),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,
Washington, DC. A public hearing has been scheduled for Tuesday, August
8, 1995, at 10 a.m. in the Auditorium, Internal Revenue Building, 1111
Constitution Avenue NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Andrew C.
Kittler, (202) 622-3940, or Jeffrey W. Maddrey, (202) 622-3940;
concerning submissions and the hearing, Michael Slaughter, (202) 622-
7190 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
Sections 163(e) and 1271 through 1275 of the Internal Revenue Code
of 1986 (Code) provide rules for the treatment of debt instruments that
have original issue discount (OID). On February 2, 1994, the IRS
published in the Federal Register final regulations under these
sections (59 FR 4799). This document contains proposed amendments to
Sec. 1.1275-1(d) relating to the definition of a debt instrument for
purposes of the OID provisions of the Code.
Explanation of Provisions
Section 1275(a)(1)(A) provides that the term debt instrument means
a bond, debenture, note, or certificate or other evidence of
indebtedness. Under Sec. 1.1275-1(d), the term debt instrument means
any instrument or contractual arrangement that constitutes indebtedness
under general principles of federal income tax law (including, for
example, a certificate of deposit or a loan).
Certain annuity contracts, however, are excluded from the
definition of a debt instrument for purposes of the OID provisions.
Under section 1275(a)(1)(B)(ii), an annuity contract to which section
72 applies and which is issued by an insurance company is generally
excluded from the definition of debt instrument if the circumstances of
its issuance meet certain broad statutory requirements. By contrast,
section 1275(a)(1)(B)(i) provides a more limited exception from the
definition of debt instrument for an annuity contract to which section
72 applies and which is not issued by an insurance company. The section
1275(a)(1)(B)(i) exception applies if the annuity contract depends (in
whole or in substantial part) on the life expectancy of one or more
individuals. Thus, if a contract is both a debt instrument and an
annuity contract not issued by an insurance company, it is subject to
taxation as a debt instrument under the OID provisions rather than as
an annuity contract under section 72, unless it qualifies for the
exception provided in section 1275(a)(1)(B)(i).
If a debt instrument has OID, section 1272 generally requires the
holder of the debt instrument to include OID in income currently on a
constant yield basis, regardless of the holder's overall method of
accounting. This mandatory accrual is intended, in part, to provide an
economically accurate reflection of income and to prevent a mismatch of
issuer deductions and holder inclusions. In the case of a debt
instrument that does not pay interest on a current basis, this mismatch
would occur if the holder were allowed to defer including OID in income
until the year in which it is actually paid. See H.R. Rep. No. 413
(Part I), 91st Cong., 1st Sess. 109 (1969); H.R. Rep. No. 432 (Part
II), 98th Cong., 2d Sess. 1242-43 (1984).
By contrast, the holder of an annuity contract to which section 72
applies is allowed to defer including economically earned income until
distributions on the contract are made. Generally, under section 72(b),
the holder of an annuity contract includes the earnings on the contract
in income on a pro rata basis as distributions are made.
The disparity between the tax treatment of debt instruments and
that of annuity contracts is most pronounced in the case of an annuity
contract that provides for distributions to commence significantly
after the date of initial investment. In that case, a substantial
portion of the value of the annuity contract when distributions begin
may be attributable to income economically earned prior to that time.
If the contract is taxed as an annuity contract under section 72, the
income economically earned prior to the commencement of distributions
is not taxed to the holder until distributions are made. If the same
contract, instead, is taxed under the OID provisions as a debt
instrument, income is taxed to the holder in the year it is earned,
regardless of when distributions are made.
Differences between the tax treatment of debt instruments and
annuity contracts also exist when an annuity contract provides for
distributions commencing on or near the date of initial investment.
Although the holder of the contract has income inclusions over the
entire term of the contract, the rate of inclusion under section 72 is
different from that under the OID provisions. In general, the rules of
section 72 provide a less economically accurate recognition of income
than the OID provisions. The difference in the rate of inclusion,
however, is most significant in the case of an annuity contract that
has deferred payments or payments that increase in amount over the life
of the contract.
The IRS has determined that the exception contained in section
1275(a)(1)(B)(i) does not apply to annuity contracts that provide for
significant deferral of income, that is, those contracts that provide
for no distributions, or for relatively small distributions, in the
early years of the contract. Since 1969, when Congress first required
current inclusion of OID by holders, one of the principal purposes of
the OID rules has been to provide a more economically accurate
reflection of income. See H.R. Rep. No. 413 (Part I), 91st Cong., 1st
Sess. 109 (1969); H.R. Rep. No. 432 (Part II), 98th Cong., 2d Sess.
1242-43 (1984). Given the well-established Congressional preference for
current inclusion, it would be inappropriate to interpret the exception
in section 1275(a)(1)(B)(i) as permitting section 72 rather than the
OID provisions to govern the holder's tax treatment of annuity
contracts that provide for significant deferral.
The proposed regulations provide that an annuity contract qualifies
for the exception described in section 1275(a)(1)(B)(i) only if all
payments under the contract are periodic payments that (1) are made at
least annually for the life (or lives) of one or more individuals, (2)
do not increase at any time during the term of the contract, and (3)
are part of a series of payments that begins within one year of the
date of the initial investment in the contract. [[Page 17733]] The
proposed regulations further provide that an annuity contract that is
otherwise described in the preceding sentence does not fail to qualify
for the section 1275(a)(1)(B)(i) exception merely because it also
provides for a payment (or payments) made by reason of the death of one
or more individuals.
The proposed regulations only apply to annuity contracts that are
also debt instruments under general principles of federal income tax
law. An annuity contract that is not a debt instrument for federal
income tax purposes is not subject to the OID provisions. See the
general rule of section 1275(a)(1)(A). It is, therefore, unnecessary to
inquire whether such an annuity contract is described in section
1275(a)(1)(B). For example, an annuity contract under which payments
are wholly contingent on the continued life of an individual generally
is not a debt instrument for federal income tax purposes. As a result,
such a contract will continue to be taxed as an annuity contract under
section 72. No inference is intended under the proposed regulations as
to whether a particular annuity contract constitutes a debt instrument
for federal income tax purposes.
Although the proposed regulations do not apply to an annuity
contract that is not a debt instrument because it does not provide for
a guaranteed return, the OID provisions nevertheless may apply if a
return is guaranteed by another instrument. Thus, for example, it is
anticipated that the Commissioner's anti-abuse authority under
Sec. 1.1275-2T would be invoked to apply the OID provisions to the
combination of an annuity contract that is not a debt instrument and a
life insurance contract that, together, effectively provide for a
guaranteed return.
Comments are requested on whether certain annuity contracts other
than those described in the proposed regulations should qualify for the
section 1275(a)(1)(B)(i) exception.
Proposed Effective Date
The proposed regulations are proposed to be effective for annuity
contracts held on or after the date that is 30 days after final
regulations are published in the Federal Register. However, the
proposed regulations will not apply to an annuity contract that is
purchased prior to April 7, 1995. For purposes of the proposed
regulations, any additional investment in a contract made on or after
April 7, 1995, will be treated as the purchase of a contract after
April 7, 1995, unless the investment is required to be made under a
binding contractual obligation that was entered into prior to April 7,
1995.
If an annuity contract purchased before the effective date of the
regulations is subject to the OID provisions, after the effective date
the holder of the contract may account for pre- effective date accruals
on the contract, on a prospective basis, in any reasonable manner.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do
not apply to these regulations, and, therefore, a Regulatory
Flexibility Analysis is not required. Pursuant to section 7805(f) of
the Internal Revenue Code, this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and eight (8) copies) that are submitted timely to the IRS. All
comments will be available for public inspection and copying.
A public hearing has been scheduled for Tuesday, August 8, 1995, at
10 a.m. in the Auditorium, Internal Revenue Building, 1111 Constitution
Avenue NW., Washington, DC. Because of access restrictions, visitors
will not be admitted beyond the Internal Revenue Building lobby more
than 15 minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons that wish to present oral comments at the hearing must
submit written comments, an outline of topics to be discussed and the
time to be devoted to each topic (signed original and eight (8) copies)
by Tuesday, July 18, 1995.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information: The principal author of these regulations
is Jeffrey W. Maddrey, Office of Assistant Chief Counsel (Financial
Institutions and Products). However, other personnel from the IRS
and Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.1275-1 is amended by:
1. Redesignating the text of paragraph (d) following the heading as
paragraph (d)(1) and adding a heading for newly designated paragraph
(d)(1).
2. Adding paragraph (d)(2).
The additions read as follows:
Sec. 1.1275-1 Definitions.
* * * * *
(d) Debt instrument--(1) In general. * * *
(2) Certain annuity contracts--(i) General rule. An annuity
contract qualifies for the exception described in section
1275(a)(1)(B)(i) only if all payments under the contract are periodic
payments that--
(A) Are made at least annually for the life (or lives) of one or
more individuals;
(B) Do not increase at any time during the term of the contract;
and
(C) Are part of a series of payments that begins within one year of
the date of the initial investment in the contract.
(ii) Certain death benefits permissible. An annuity contract that
is otherwise described in paragraph (d)(2)(i) of this section does not
fail to be described in that paragraph merely because it also provides
for a payment (or payments) made by reason of the death of one or more
individuals.
(iii) Effective date. This paragraph (d)(2) is effective for
annuity contracts held on or after the date that is 30 days after final
regulations are published in the Federal Register. However, this
paragraph (d)(2) does not apply to an annuity contract that is
purchased prior to April 7, 1995. For purposes of this paragraph
(d)(2)(iii), any additional investment in a contract made on or after
April 7, 1995, is treated as the purchase of a contract after April 7,
1995, unless the investment is required to be made under a binding
contractual [[Page 17734]] obligation that was entered into prior to
April 7, 1995.
* * * * *
Michael P. Dolan,
Commissioner of Internal Revenue.
[FR Doc. 95-8523 Filed 4-6 -95; 8:45 am]
BILLING CODE 4830-01-U
