Number: RS20923
Title: Taxes and the "Inside Build-Up" of Life Insurance: Recent Issues
Authors: David L. Brumbaugh, Government and Finance Division 
Abstract: Many life insurance policies contain both an insurance component and an investment element termed "inside build-up." The inside build-up receives favorable tax treatment under current law: a tax deferral (postponement) if a policy is surrendered for cash prior to death, or a tax exemption if paid out as part of death benefits. In the past, the tax treatment of inside build-up has received attention in the context of congressional consideration of legislation to repeal the federal estate tax. Under current law, assets transferred at death receive favorable tax treatment in the form of a "step-up" in basis. If repeal of the estate tax were to limit or repeal the step-up in basis, tax planners might consider investment in insurance policies with large inside build-ups as an alternative tax-saving strategy. Taxation of the inside build-up of insurance would rule out such a tax planning strategy and would thus reduce the revenue loss associated with repeal of the estate tax. However, provisions taxing the inside build-up of life insurance were not included in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA; P.L. 107-16) - the omnibus tax cut bill that included a phase-out of the estate tax. Subsequent legislation passed by the House (but not the Senate) to extend the estate tax repeal have not included taxation of the inside build up.
Pages: 3
Date: August 2, 2006