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From Taxable to Tax-Exempt Corp

Travel back with me to 1986, if you will, and the repeal of the General Utilities doctrine. The Tax Reform Act of 1986[i] added Sec. 337(d) to the Code and directed the Treasury to prescribe the regulations necessary to carry out the purposes of the doctrine’s repeal.[ii]

The Technical and Miscellaneous Revenue Act of 1988 amended Sec. 337(d) to specify that the section authorizes regulations to “ensure that these purposes shall not be circumvented * * * through the use of a * * * tax-exempt entity.”

Continue Reading Converting a Taxable Corp Into a Tax-Exempt Entity Via a Bargain Sale – or is it Something More?
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Tax Deficiency

Over their career, every tax practitioner has had many client-taxpayers against whom a government’s taxing authority – be it federal, state, or local – has asserted and then assessed a tax deficiency.

There are many reasons why a taxpayer – whether an individual, corporation, partnership, estate or trust – has unpaid tax liabilities. For example, the taxpayer has: miscalculated the amount of tax owed, carelessly omitted an item of income, mistakenly deducted a non-deductible expense, or claimed a tax treatment for an item on their tax return with which the government disagreed.

Continue Reading Applying the Federal Priority Statute to The Attorney as Client’s “Corporate Executive”
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Non-Recognition Exchanges

Under the Code and the Regulations issued thereunder, the gain or loss arising from the conversion of property into cash is treated as income realized or as loss sustained by the owner of the converted property,[i] which the owner must generally account for in determining their federal income tax liability for the year of the conversion.[ii]

Likewise, the gain or loss arising from a property owner’s exchange of such property for other property that differs “materially in kind” from the property exchanged should, as in the case of a sale for cash, be treated as a taxable event, the gain or loss from which must be accounted for in determining the owner’s gross income for the year of the exchange.[iii] 

Continue Reading Tax-free Conversion of Corporation Into Partnership Via “C” Reorganization
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Limited Partner Exclusion

Last week, the federal Court of Appeals for the Fifth Circuit ruled that the U.S. Tax Court had misinterpreted the Code’s self-employment tax rules as they apply to individuals who hold limited partnership interests in a state law limited partnership notwithstanding that such individuals also render services to the partnership of a nature that is integral to the limited partnership’s business.[i]

In doing so, the Court relied upon a narrow and dated reading of the Code that disregarded the current “practice” of many businesses in the financial sector, including investment firms, that organize as limited partnerships for the purpose of avoiding the imposition of the self-employment tax upon the entire limited partner distributive share of those individual limited partners who are actively engaged in the operation and management of the partnership’s business.

Continue Reading “Limited Partner”? The Exclusion of Net Earnings from Self-Employment
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Near Death Experience

Stick a fork in it. It’s kaput.[i] At least that’s what many of us thought; and, for all intents and purposes, it was.

However, like a scene from a bad zombie movie,[ii] the corpse-like Corporate Transparency Act (the “CTA”) may have just been resuscitated, at least temporarily.[iii]

This legal reanimation of the CTA coincides, “fortuitously” you might say, with the effective date of New York’s own version of the federal law, the LLC Transparency Act (the “LLCTA”),[iv] which became effective on January 1,2026.

LLCTA

For the most part, New York’s LLCTA is based upon the federal CTA; for example, it defines the key terms “beneficial owner”[v] and “reporting company” by reference to the CTA and its implementing regulations,[vi] though the New York statute does not reach beyond limited liability companies (“LLCs”).

Although the effective date of the New York disclosure rule had been known since it was amended in March 2024,[vii] the law’s actual coverage became somewhat uncertain following the issuance by the Financial Crimes Enforcement Network (“FinCEN”) of an “interim final rule” – i.e., implementing regulations – on March 26, 2025 (see below), which limited the definition of “reporting company” for purposes of the CTA to mean only entities that are formed under the law of a foreign country.

NY Amendment?

In response to FinCEN’s interim final rule, and to ensure the LLCTA would continue to cover the beneficial owners of domestic business entities, the New York Legislature, in June 2025, passed amendments to the LLCTA that would have directly incorporated the CTA’s statutory definitions – including, for example, that for a reporting company – but without reference to any implementing federal regulations, in order to “inoculate the LLC Transparency Act from shifting federal guidelines or attempts to repeal the CTA.”[viii]

After a period of uncertainty and speculation, Governor Hochul vetoed the proposed amendment on December 19, 2025 – less than two weeks before the effective date of the LLCTA – thereby continuing New York’s “conformity” to the federal regulatory interpretation of the CTA, which limits that law’s coverage to foreign (non-U.S.) LLCs authorized to do business in the State.[ix]

Thus, we began 2026 with some certainty regarding the scope of the federal CTA and of New York’s LLCTA.

Or did we?

Unresolved Challenges?

To better understand where we are today, it would help to review some relevant history.

As we’ll see shortly, it didn’t take long after the enactment of the CTA for businesses to challenge its constitutionality in the federal courts on the grounds that the CTA exceeded: (i) Congress’s enumerated powers to regulate interstate commerce[x] and to “lay and collect taxes,”[xi] and its interest in advancing the national security and foreign policy interests of the U.S.; and (ii) its authority to enact such laws as are “necessary and proper”[xii] to carry out the foregoing powers.

How Did We Get Here?

In December 2020, Congress sent the CTA to the President for his signature. Although the Administration supported the CTA,[xiii] it was included in the bill for the National Defense Authorization Act, which the President vetoed for reasons unrelated to the CTA. As we know, his veto was overridden[xiv] and the bill thereby became law, effective January 1, 2021.[xv]

You’ll recall that the CTA required “reporting companies” to submit specified beneficial ownership information (“BOI”) to FinCEN.[xvi]

However, the statutory requirement for reporting companies to submit BOI was to take effect “on the effective date of the regulations” implementing the reporting obligations.[xvii]

Under the CTA, reporting companies created or registered to do business after the effective date were required to submit the requisite information to FinCEN at the time of creation or registration, while reporting companies in existence before the effective date would have a specified period within which to report.[xviii]

FinCEN issued final BOI reporting rules on September 30, 2022, with an effective date of January 1, 2024.[xix]

Soon after the “final” reporting rules were issued, the first of several legal challenges to the CTA was initiated when, in November 2022, National Small Business United filed a complaint in the U.S. District Court for the Northern District of Alabama claiming the CTA exceeded Congress’s enumerated powers[xx] and, therefore, was unconstitutional (the “NSBU litigation”).

On March 1, 2024 – only two months after the reporting rules became effective – the U.S. District Court in the NSBU litigation concluded that the CTA was “unconstitutional because it cannot be justified as an exercise of Congress’s enumerated powers” – it did not regulate commercial or economic activity but only the act of incorporation. With that, the District Court enjoined FinCEN from enforcing the Act against the plaintiffs.[xxi]

On March 11, the Justice Department filed a Notice of Appeal to the Eleventh Circuit Court of Appeals on behalf of the Treasury;[xxii] the Circuit Court granted expedited review and scheduled oral Arguments for September 27, 2024.

That same day, FinCEN issued a notice in which it stated that, while the NSBU litigation was ongoing, FinCEN would continue to implement the Act as required by Congress, while complying with the District Court’s order; thus, other than the individuals and entities subject to the District Court’s injunction, all other reporting companies were still required to comply with the CTA and file BOI reports as provided in FinCEN’s regulations.[xxiii]

On April 29, 2024, a bill was introduced in the House to repeal the CTA;[xxiv] the bill was referred to the House Committee on Financial Services. A similar bill was introduced into the Senate on May 9; it was referred to the Senate Committee on Banking, Housing, and Urban Affairs.[xxv] Not surprisingly, no further action has been taken on either bill.

On May 20, 2024, twenty-two States joined in filing an amicus brief with the Eleventh Circuit in which they urged the Court to affirm the March 1 decision by the District Court in Alabama, based largely on principles of federalism.[xxvi]

On July 18, the Eleventh Circuit scheduled oral argument in the NSBU litigation for September 27, 2024, and on August 14 the Court requested that the parties submit supplemental briefs regarding whether the District Court erred “in not holding the plaintiffs to their burden of showing that there are no constitutional applications of the Corporate Transparency Act.”[xxvii]

On September 27, a three-judge panel of the Eleventh Circuit heard oral arguments in the NSBU litigation.[xxviii]

On November 5, 2024, the Republicans won the White House, and the 119th Congress[xxix] was set to begin with a narrow Republican majority in both Chambers.

On December 17, House Speaker Johnson unveiled a continuing resolution that would have extended by one year the deadline for existing companies to report their BOI to FinCEN, as required under the CTA.[xxx]

On December 27, in response to an order issued by a panel of the Fifth Circuit, FinCEN issued an alert stating: “In light of a recent federal court order, reporting companies are not currently required to file beneficial ownership information with FinCEN and are not subject to liability if they fail to do so while the order remains in force. However, reporting companies may continue to voluntarily submit beneficial ownership information reports.”[xxxi]

A Different Approach

On March 2, 2025, the Treasury Department announced, with respect to the CTA, that it would not enforce any penalties or fines associated with the BOI reporting rule under the existing regulatory deadlines, and that it would not enforce any penalties or fines against U.S. citizens or U.S. reporting companies or their beneficial owners after the issuance of proposed rulemaking that would narrow the scope of the disclosure rule to foreign reporting companies only.[xxxii] 

Consistent with the foregoing announcement, on March 21 FinCEN announced that it was issuing an interim final rule that would remove the requirement for U.S. companies and U.S. persons to report BOI to FinCEN under the CTA.[xxxiii]

The Interim Final Rule

The interim final rule was issued on March 26 and eliminated the requirement for U.S. companies and U.S. persons to report BOI to FinCEN under the CTA.[xxxiv]

Specifically, FinCEN revised the definition of “reporting company” in its implementing regulations to mean only those entities that are formed under the law of a foreign country and that have registered to do business in the any U.S. State by the filing of a document with a secretary of state or similar office. FinCEN also exempted entities previously known as “domestic reporting companies” from BOI reporting requirements.

Thus, through this interim final rule, all entities created in the U.S. and their beneficial owners were exempted from the requirement to report BOI to FinCEN.

However, entities that met the new definition of a “reporting company” and did not qualify for an exemption from the reporting requirements were required to report their BOI to FinCEN under new deadlines.

These foreign entities, however, were not be required to report any U.S. persons as beneficial owners, and U.S. persons were not required to report BOI with respect to any such entity in which they were a beneficial owner.[xxxv]

Why the Change?

The interim final rule is ostensibly rooted in the Treasury Department’s authority under the CTA to exempt any “entity or class of entities” for which the Secretary of the Treasury, with the written concurrence of the Attorney General and the Secretary of Homeland Security, has determined that “requiring beneficial ownership information from the entity or class of entities” – in this case, the class comprising domestic reporting companies and their beneficial owners – “would not serve the public interest” and “would not be highly useful in national security, intelligence, and law enforcement agency efforts to detect, prevent, or prosecute money laundering, the financing of terrorism, proliferation finance, serious tax fraud, or other crimes.”[xxxvi]

By contrast, the Treasury Department determined that foreign reporting companies – other than those the beneficial owners of which are all U.S. persons – present heightened national security and illicit finance risks.

At the same time, however, the Administration continued to support the constitutionality of the CTA in actions regarding the law’s application to domestic companies.[xxxvii]

How do we reconcile this support with the Treasury Department’s narrow implementation of the CTA?

Did it reflect the Administration’s unstated determination that the broadly drafted CTA may be difficult to defend under the Constitution’s interstate commerce and taxing clauses, whereas a narrower implementation that was limited to foreign entities, and that focused on issues relating to national security and foreign commerce, had a higher probability of withstanding any challenge?   

Or was there a change in stance toward the CTA? As Treasury Secretary Bessent was quoted in the March 2 FinCEN announcement, “Today’s action is part of President Trump’s bold agenda to unleash American prosperity by reining in burdensome regulations, in particular for small businesses that are the backbone of the American economy.”

Then, toward the end of 2025, the Eleventh Circuit Court of Appeals issued its opinion in the NSBU litigation.[xxxviii]

The Eleventh Circuit

The issue before the Court was whether the CTA is constitutional.

According to the Court, most states do not require businesses to report information about their owners. The Court explained that bad actors were using the anonymity afforded by state corporate laws to commit financial crimes, such as money laundering and financing terrorism; i.e., crimes “affecting interstate and international commerce.” Congress, the Court continued, found that this information gap hampered law enforcement’s efforts to fight such crimes.  

To prevent these anonymous business dealings, the Court stated, Congress passed the CTA, which requires certain corporate entities to report their “beneficial owners” – i.e., the actual people who exercise control over the entity – to the Treasury Department.

The Court stated that, in order to be constitutional, every federal law must be consistent with one of Congress’s enumerated powers and must not violate any of the Constitution’s guarantees of individual rights.

The plaintiff, National Small Business United – a business association representing “over 65,000 businesses . . . located in all 50 states,” with members from every sector of the U.S. economy – argued that the CTA failed on both counts. It claimed that the CTA was not an appropriate exercise of Congress’s power to regulate interstate commerce[xxxix] and was therefore facially unconstitutional. In the alternative, the plaintiff asserted that the CTA violated the Fourth Amendment’s prohibition on unreasonable searches and was facially unconstitutional for that reason.

The District Court had concluded that the CTA did not regulate economic activity and, on that basis, granted summary judgment for the plaintiff.  

According to the District Court, neither the commerce, taxing, and necessary and proper clauses, nor Congress’s foreign affairs and national security powers, justified the CTA. Regarding the Commerce Clause, the court ruled that the CTA primarily regulates the non-commercial act of incorporation and that the connection between the act of incorporation and the activities Congress sought to curb was too attenuated. The court also emphasized the lack of any “jurisdictional hook” in the CTA that limited its reach to interstate commerce.

The Court of Appeals disagreed with the lower court’s decision, and found that, by effectively prohibiting anonymous business dealings, the CTA facially regulated economic activities having a “substantial aggregate impact” on interstate commerce.

According to the Court, the CTA is a constitutional exercise of Congress’s power under the Commerce Clause. By regulating activity that is economic in nature,[xl] it effectively “prohibits anonymous corporate dealings, regulates commercial entities that are active in the stream of commerce,” and requires them to report information related to their ownership.

The Court also determined that Congress had rationally concluded, based on input from numerous national security and law enforcement experts about how anonymous shell companies affect interstate and international commerce, that anonymous corporate dealings have a substantial aggregate effect on interstate commerce.

Moreover, as a uniform and limited reporting requirement, the CTA did not facially violate the Fourth Amendment.[xli]

Accordingly, the Court of Appeals reversed the District Court.

Where Does That Leave Us?

The Circuit Court’s opinion supports the scope of the CTA as enacted, as well as FinCEN’s original interpretation of the legislation – both of which are being supported by the Administration in ongoing litigation.

In contrast, there is FinCEN’s interim final rule and the stated justification for its limited implementation of the CTA.

Query how the Court’s decision may affect the outcomes of the ongoing challenges to the CTA on constitutional grounds in other circuits.

Query also whether the Court’s decision may embolden the Administration to use its regulatory authority under the CTA to expand its implementation to cover domestic reporting entities.

Time will tell.

The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the firm.

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[i] Of course, the title reference to “mostly dead” comes from Miracle Max in The Princess Bride: “There’s a big difference between mostly dead and all dead. Mostly dead is slightly alive.”

[ii] Are there any good ones?

[iii] As we’ll see shortly, it appears the Eleventh Circuit was not provided a copy of the CTA’s Do Not Resuscitate order. These things happen.

[iv] LLCL Sec. 1106. Enacted December 22, 2023. S. 995B/A.3484-A.

[v] LLCL Sec. 1106(a):

“‘Beneficial owner’ shall have the same meaning as defined in 31 U.S.C. § 5336(a)(3), as amended, and any regulations promulgated thereunder.”

[vi] LLCL Sec. 1106(b):

“‘Reporting company’ shall have the same meaning as defined in 31 U.S.C. § 5336(a)(11), as amended, and any regulations promulgated thereunder, but shall only include limited liability companies formed or
authorized to do business in New York state.”

[vii] The LLCTA was originally set to go into effect in late 2024.

[viii] See the Sponsor Memo to S8432.

[ix] Shortly thereafter, New York’s Department of State posted guidance on its website to assist foreign LLCs with reporting their beneficial ownership in accordance with the LLCTA. https://dos.ny.gov/beneficial-owner-disclosure.

[x] The Constitution of the United States, Article I, Section 8, Clause 3.

[xi] The Constitution of the United States, Article I, Section 8, Clause 1.

[xii] The Constitution of the United States, Article I, Section 8, Clause 18.  

[xiii] https://thefactcoalition.org/fact-sheet-a-brief-summary-of-the-corporate-transparency-act-of-2019-title-lxiv-of-the-ndaa-h-r-6395/.

[xiv] The House voted 322-87, and the Senate voted 81-13, to override the veto.

[xv] The Constitution of the United States, Article I, Section 7, Clause 2.

[xvi] 31 U.S.C. 5336.

[xvii] 31 U.S.C. 5336(b)(5): ‘‘(5) EFFECTIVE DATE — The requirements of this subsection shall take effect on the effective date of the regulations prescribed by the Secretary of the Treasury under this subsection, which shall be promulgated not later than 1 year after the date of enactment of this section.”

[xviii] 31 U.S.C. 5336(b)(1)(B), (C).

[xix] Published Document: 2022-21020 (87 FR 59498). As issued, the rules required (a) companies formed before January 1, 2024 to file a BOI report with FinCEN by December 31, 2024, and (b) companies created on or after the rule’s effective date (of January 1, 2024) and before January 1, 2025, to file within 30 calendar days of notice of their creation.

About one year later, the reporting rules were amended to provide an extended filing deadline of 90 calendar days for reporting companies created on or after January 1, 2024 and before January 1, 2025; entities created on or after January 1, 2025 would continue to have 30 calendar days from notice of their creation to file their BOI reports with FinCEN. Published Document: 2023-26399 (88 FR 83499).

[xx] The Constitution of the United States, Article I, Section 8.

[xxi] National Small Business United, d/b/a National Small Business Association, et al., v. Janet Yellen, in her official capacity as Secretary of the Treasury, et al., No. 5:22-cv-01448 (N.D. Ala.).

[xxii] National Small Business United et al. v. U.S. Department of the Treasury et al., case number 24-10736, in the U.S. Court of Appeals for the Eleventh Circuit.

[xxiii] https://www.fincen.gov/news/news-releases/updated-notice-regarding-national-small-business-united-v-yellen-no-522-cv-01448

[xxiv] H.R.8147, the “Repealing Big Brother Overreach Act”. 

[xxv] S.4297.

[xxvi] https://assets.law360news.com/1839000/1839407/https-ecf-ca11-uscourts-gov-n-beam-servlet-transportroom-servlet-showdoc-011013344879.pdf,: Alabama, Arkansas, Florida, Georgia, Idaho, Iowa, Kansas, Kentucky, Louisiana, Mississippi, Missouri, Montana, Nebraska, Ohio, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, West Virginia, and Wyoming.

[xxvii] https://www.courtlistener.com/docket/68332749/national-small-business-united-v-us-department-of-the-treasury/ 

[xxviii] Supplemental authorities were filed in the Eleventh Circuit’s NSBU case on December 4 and 5.

[xxix] The 2025–2027 term.

[xxx] You may recall that the then President-elect opposed this Continuing Resolution, Sec. 122 of which read as follows:

Section 5336(b)(1)(B) of title 31, United States Code, is amended by striking ‘‘before the effective date of the regulations prescribed under this subsection shall, in a timely manner, and not later than 2 years after the effective date of the regulations prescribed under this subsection,’’ and inserting ‘‘before January 1, 2024, shall, not later than January 1, 2026,’’

[xxxi] FinCEN referenced an order issued by a panel of the Fifth Circuit vacating an earlier panel’s December 23 order that had granted a stay of the preliminary injunction in the Texas Top Cop Shop case, thereby restoring the injunction issued by the District Court in that case and relieving reporting companies from the requirement to file BOI with FinCEN.

[xxxii] https://home.treasury.gov/news/press-releases/sb0038#:~:text=The%20Treasury%20Department%20is%20announcing,January%202%2C%202026

[xxxiii] https://www.fincen.gov/news/news-releases/fincen-removes-beneficial-ownership-reporting-requirements-us-companies-and-us

[xxxiv] https://www.federalregister.gov/documents/2025/03/26/2025-05199/beneficial-ownership-information-reporting-requirement-revision-and-deadline-extension

According to the Preamble to the interim final rule:

“On January 20, 2025, there was a change in presidential administrations, which has resulted in a reassessment of the balance struck by the Reporting Rule. On January 31, 2025, President Trump issued Executive Order (E.O.) 14192, Unleashing Prosperity Through Deregulation, which announced an Administration policy “to significantly reduce the private expenditures required to comply with Federal regulations to secure America’s economic prosperity and national security and the highest possible quality of life for each citizen” and “to alleviate unnecessary regulatory burdens placed on the American people.” Consistent with the exemptive authority provided in the CTA and the direction of the President, the Secretary has reassessed the balance between the usefulness of collecting BOI and the regulatory burdens imposed by the scope of the Reporting Rule.”

[xxxv] FinCEN also issued some helpful questions and answers (Q&As) in anticipation of inquiries relating to the interim final rule. https://www.fincen.gov/boi/ifr-qa

[xxxvi] 31 U.S.C. 5336(a)(11)(B)(xxiv).

[xxxvii] For example, it filed a brief with the Fifth Circuit in February of 2025, in the Texas Top Cop Shop case, in which it sought a stay of the nationwide injunction against the federal government’s enforcement of the CTA issued by the district court. https://www.taxnotes.com/research/federal/court-documents/court-petitions-and-briefs/government-urges-court-reverse-transparency-act-injunction/7r16q. 

[xxxviii] https://media.ca11.uscourts.gov/opinions/pub/files/202410736.pdf

[xxxix] The Constitution of the United States, Article I, Section 8, Clause 3.

[xl] A law can regulate economic activity, the Court stated, even if the connection between the challenged law and commerce isn’t “airtight.” It is enough that the regulated activity involves “some sort of economic endeavor” with “an apparent commercial character.”

[xli] The Fourth Amendment protects “[t]he right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures.”

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Tax Savings and Deal Economics

It is a basic tax principle that the more (or the sooner) a seller pays in taxes on the sale of its business, the less will be the economic benefit the seller realizes from the sale. Similarly, the fewer the tax savings that the buyer realizes from the acquisition of the business, the less will be the economic benefit the buyer realizes from the acquisition.[i]

Allocation of Purchase Price

In most cases, these “truths” are first considered in determining the form of the transaction – a purchase and sale of assets or of stock. They become prominent again in the context of allocating the consideration[ii] actually, or deemed to have been,[iii] paid and received for the actual or deemed purchase and sale of the assets comprising the business.

Continue Reading When a Buyer’s “Tax Cost” for an Acquisition Exceeds Expectations
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The Nonprofit Sector

According to a report released earlier this year by the Federal Reserve Bank of Richmond, nonprofit organizations contribute more than 5 percent of the nation’s GDP and account for almost 10 percent of “private sector” employment.[i]

Those are impressive statistics and, understandably, may be interpreted as characteristic of an industry that constitutes a significant economic driver, at least until one realizes the significant “public” source of the nonprofit sector’s revenues.

Continue Reading OBBBA and the Self-Imposed Tax Known as Charitable Giving
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Life Insurance – It’s for the Living

If you’re reading this post, you survived the Thanksgiving holiday – hopefully, without much family drama.[i] Then again, there may have been moments, inspired by an overload of obligatory togetherness, that caused you to think about life insurance, either on your own life or on that of another.[ii]

Coincidentally, a recent decision of the U.S. Tax Court considered the situation of a Taxpayer who, about thirty years before the taxable year at issue, purchased two whole life insurance policies, one on the life of each of their two young children.[iii]

Query: was Taxpayer planning ahead for some future Thanksgiving “holiday” on which one of the pampered ingrates will finally cross the line from being just disagreeable to being downright hateful? Not quite.

Child Life Insurance

Why would a parent take out a whole life insurance policy on their minor child? For one thing, it is likely easier to acquire a policy on behalf of a child while the child is young and, hopefully, healthy. Because of the permanent nature of the policy[iv] – we’ll turn to this shortly – the early acquisition of a policy should ensure continued coverage for the child as they age, even with changes in the child’s health. Moreover, the policy should accumulate cash value over time, which may someday be accessed by the child as an adult. Finally, given the child’s age, the premiums payable to maintain the policy – initially by the parent and later by the child – should be lower and more affordable.[v]

As we’ll see shortly, Taxpayer may not have been thinking along these lines when they acquired the policies on the lives of their children. Before describing Taxpayer’s circumstances and reviewing the question before the Tax Court, however, it may be helpful to provide an overview of whole life insurance and some of the related tax considerations. 

Whole Life: An Oversimplified Summary

A whole life policy is a type of “permanent” life insurance, which means the insured individual[vi] is covered for the duration of their life as long as premiums are paid on time.[vii] Premiums on such policies may be fixed for the life of the policy. As long as the policy owner keeps making premium payments, the policy will stay in effect.

Like other forms of permanent life insurance, whole life policies include an investment feature (the “cash value”) that is managed by the issuer of the policy. A portion of each premium payment covers the cost of the policy’s death benefit while the balance contributes to the policy’s cash value. The cash value may be guaranteed to grow at a set rate each year until it is equal to the face amount of the policy; of course, the policy’s performance may surpass this rate. Importantly, neither the income earned on the cash value of the policy, nor the appreciation in the policy’s cash value, is subject to income tax while it remains within the policy’s cash value account.[viii]

In any case, when the insured dies, the insurance company will pay the death benefit (subject to certain adjustments, below) to the beneficiaries of the policy. No matter how much cash value accumulated in the policy before the death of the insured, the beneficiaries can generally collect no more than the stated death benefit. The death benefit that is paid to the beneficiary of the policy – not necessarily the same person as the owner of the policy[ix] – should not be subject to income tax.[x]  

Parties Interested in the Policy

At this point, the distinction should be made between the owner of a permanent policy and the policy’s beneficiary.

The owner is the person that controls the policy during the life of the insured.[xi] While the owner is generally responsible for paying the premiums on the policy, the owner has the right, for example, to change the beneficiaries of the policy, and also the right to surrender, sell, pledge, or otherwise dispose of the policy.[xii] Significantly for purposes of this post, the owner may have the right to borrow against the cash value of the policy.

Policy Loans

The cash value of the policy serves as collateral for any amount the owner may borrow against the policy. Any loans the policy owner has not repaid (plus interest) by the time the insured dies will be subtracted from the death benefit that is otherwise payable to the beneficiaries of the policy upon the death of the insured.[xiii]

Before the policy owner can borrow against the policy, the policy’s cash value has to reach a certain threshold – after all, the cash value will serve as the collateral for the loan. Thus, it can take time for such value to grow sufficiently, depending, for example, upon the policy’s investment performance and the amount of the loan. Once that threshold is reached, the policy owner can borrow money against the policy’s cash value.[xiv]

Of course, a borrower’s receipt of loan proceeds is not taxable to the borrower because the loan must be repaid (with interest);[xv] the borrower has not realized any accretion in value. The same principle applies with respect to an owner’s policy loan.

Surrendering the Policy

Alternatively, the policy owner may surrender the policy in exchange for its cash value.[xvi]

Where the owner surrenders the policy to the issuer in exchange for an amount of money equal to the cash surrender value of the policy, the owner must include in gross income the excess of such amount over the owner’s investment in the insurance contract (i.e., the aggregate amount of premiums or other consideration paid for the contract,[xvii] less the aggregate amount received under the contract before that date to the extent that amount was excludable from gross income).[xviii]

The income recognized by the owner on the surrender of the policy is treated as ordinary income.[xix]

With the foregoing basics under our belts, let’s consider Taxpayer’s situation.

Taxpayer’s Policies

Taxpayer had two children.[xx] As mentioned above, Taxpayer applied for and purchased two whole life insurance policies, one on the life of each child. Taxpayer was the owner and paid the annual premiums on the policies. He was also the beneficiary of each policy.

Under the terms of the policies, Taxpayer was allowed to borrow against the cash surrender value of each policy, up to a maximum amount equal to such cash surrender value. Interest was chargeable on any such loan at a variable rate (not greater than 8 percent) and was payable on the policies’ annual anniversary date. Any unpaid interest was added to the loan balance and subject to interest at the rate payable on the loan.

Either policy could be surrendered by Taxpayer to the issuer of the policy for its cash surrender value at any time before the insured child’s[xxi] death.

The cash surrender values of the policies increased over time as premiums were paid and as accumulated dividends[xxii] built up within the policies.

The Loans

After paying premiums on the two policies for about 18 years, Taxpayer borrowed an amount from each policy.

For the next ten years, Taxpayer did not pay annual premiums on either of the policies out of his own pocket. Instead, Taxpayer borrowed additional amounts from each policy to cover the annual premiums. The interest accrued on the amounts borrowed to pay the premiums was added to the outstanding loan balance on each policy.

The cash surrender values of the policies were reduced by the amounts of outstanding policy debt.

Surrender

During the year at issue, Taxpayer notified the issuer of his intent to terminate both policies and satisfy the outstanding loans.

The issuer acknowledged Taxpayer’s decision and requested that Taxpayer submit surrender forms to finalize the terminations. The issuer further advised Taxpayer that surrendering the policies could result in taxable income.

Shortly thereafter, Taxpayer sent the Issuer the necessary surrender forms for both policies, which the issuer then processed to terminate the policies. The issuer also issued two checks to Taxpayer representing the cash surrender value of each policy.

Tax Reporting

The issuer subsequently sent Taxpayer an IRS Form 1099–R for each policy on which was shown (i) the gross distribution from each policy, consisting of the outstanding policy loan balance and an amount of cash, and (ii) the taxable amount for each policy, which was equal to the amount of the gross distribution with respect to a policy reduced by the total premiums paid (or deemed paid) for such policy.

Taxpayer did not include this taxable income on his individual federal income tax return for the year at issue.

The IRS increased Taxpayer’s income for the year the polices were surrendered by the taxable amounts shown in the Forms 1099–R.

Taxpayer petitioned the Tax Court to review the adjustments made by the IRS.  

The Tax Court

The principal issue for decision before the Court was whether the above-described distributions with respect to the two policies were includible in Taxpayer’s income for the year of surrender.

Basics

The Court began by explaining that gross income includes income “from whatever source derived,” including “[i]ncome from life insurance . . . contracts.”[xxiii] The Court stated further that gross income includes any amount received under a life insurance contract to the extent those amounts exceed the investment in the contract.[xxiv]

The Court then explained that a loan against a life insurance policy’s cash value is a loan from the issuer insurance company to the owner of the policy. Because policy loans are treated as loans, they are not taxable distributions to the owner-borrower when the funds are received.

According to the Court, a taxpayer constructively receives proceeds from a terminated life insurance policy when, and to the extent that, existing policy loans are satisfied with the policy’s available cash surrender value.

Taxpayer’s Loans

The Court observed that Taxpayer took out loans against the two policies and received the loan amounts. When Taxpayer terminated the policies, these loans were completely satisfied.

The Court found that Taxpayer constructively received proceeds in the amount of the outstanding policy loan balances in addition to receiving a check for the remaining balance of each policy’s cash surrender value.

Based on the foregoing, the Court concluded that the sum of (i) the proceeds Taxpayer actually received (the checks), plus (ii) the proceeds that Taxpayer constructively received (from the satisfaction of the outstanding balances of the policy loans), represented taxable income to Taxpayer for the year at issue to the extent that the proceeds exceeded the premiums paid.[xxv]

Obvious Outcome?

Yes. Then again, this was a nonprecedential summary opinion in a small tax case (or “S case”),[xxvi] which means it involved relatively simple, straightforward facts, and a relatively small deficiency.

Still, its facts highlighted – though it was not at issue – an important consideration in the acquisition and use of permanent life insurance and its investment element.

As stated earlier, there are bona fide reasons for the purchase of some form of permanent life insurance on the life of a family member who is much younger than the owner-beneficiary of the policy.

In the absence of any such reasons, as manifested by the post- acquisition history of such a policy, query whether the policy should be treated as a life insurance contract for purposes of the Code.

The primary purpose of a life insurance policy is to provide death benefits to the beneficiaries of the policy; in this case, to Taxpayer, the insured’s parent.[xxvii]

What about a policy that, based upon its actual history, is oriented primarily toward investment,[xxviii] even if it satisfies the “numerical tests” applied by the Code[xxix] in making this determination?

For better or worse, I’m inclined to tread warily when someone suggests using life insurance other than for its originally intended purpose.

The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the firm.

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[i] Of course, the rest of the holiday season remains.

[ii] Let’s assume you have an insurable interest in this other individual’s life.

Under N.Y. Insurance Law Sec. 3205(a)(1), the term “insurable interest” means: (A) in the case of persons closely related by blood or by law, “a substantial interest engendered by love and affection”; (B) in the case of other persons, “a lawful and substantial economic interest in the continued life, health or bodily safety of the person insured, as distinguished from an interest which would arise only by, or would be enhanced in value by, the death, disablement or injury of the insured.”

[iii] Fugler v. Comm’r, T.C. Summary Opinion 2025-10.

[iv] Whole life is just one type of permanent life insurance policy, and it may be the simplest. Others include universal life and variable life, which are more complex but afford greater flexibility.

[v] Before acquiring a policy, there is no substitute for consulting a knowledgeable, experienced, and reputable life insurance broker and adviser. If you don’t know such an individual, ask around. Don’t just accept the one person recommended by your attorney or other adviser – this individual may turn out to be the perfect choice, but you owe it to yourself to do some diligence.

[vi] I.e., the person whose death will contractually obligate the issuer of the policy to pay the policy’s stated death benefit to those persons who are identified by the insurance contract as the beneficiaries of the policy.

[vii] Permanent life insurance is designed to last the insured’s life (though some permanent policies may “mature” when the insured reaches a certain “advanced” age – often 121). Thus, a permanent policy is different than term life insurance, which covers the insured individual for a set period of time; for example, until a specific age, or for a specified number of years (often 10, 20, or 30 years).

The longer period over which the issuer of a permanent policy may be obligated to pay a death benefit is reflected in the amount of premium payable. As we’ll see, the investment element (or cash value) of a permanent policy is also reflected in the premium.

[viii] Provided the requirements of IRC Sec. 7702 are satisfied. This provision was added to the Code by the Deficit Reduction Act of 1984 (P.L. 98-369) to ensure that a policy qualifies as a “life insurance contract” and is not treated primarily as an investment vehicle. See JCS-41-84, p. 645.

[ix] This fact facilitates estate planning to ensure the policy is not included in the gross estate of the insured.

[x] Provided the policy is treated as a life insurance contract for tax purposes. IRC Sec. 101 and Sec. 7702.

Sec. 101 reads as follows: “gross income does not include amounts received (whether in a single sum or otherwise) under a life insurance contract, if such amounts are paid by reason of the death of the insured.”

There are some limitations. See, for example, the “transfer for value” rule under IRC Sec. 101(a)(2) and the “reportable policy sale” rule under IRC Sec. 101(a)(3).

[xi] The owner holds the so-called “incidents of ownership” with respect to a policy. In the case of a typical life insurance trust established to acquire and hold insurance on the life of the settlor of the trust, the trustee controls the policy.

[xii] The owner may “voluntarily” assign responsibility for the premium payments or restrict the exercise of their rights in the policy by contract with another party. For example, a shareholders’ agreement may require the corporation to pay the premiums on policies owned by the insured shareholders (constructive distributions by the corporation), or a split-dollar agreement may require the owner-employee to pledge the policy as collateral to ensure the premiums (plus interest) are repaid to the employer on the death of the employee.

[xiii] It is possible for the beneficiaries to end up with less than the face amount of the policy.

[xiv] The owner may also use the cash value to pay premiums.

The amount of the policy loan may be capped at a percentage of the cash value. The cash value itself may continue to grow.

[xv] It’s important to note that, typically, there is no due date for repayment of the loan – the amount of the death benefit payable on the insured’s demise will be reduced by the unpaid balance of the policy loan.

That said, in order to preserve loan treatment, interest should be paid regularly, even if such payment is charged against the policy’s cash value.

If the amount taken from the cash value of a policy is not a loan but a withdrawal, the amount by which the withdrawal exceeds the policy’s cost basis will be included in the owner’s gross income for tax purposes. Stated differently, withdrawals up to the cost basis are not taxable.

[xvi] When the owner of a policy surrenders the policy to the issuer, the policy is canceled.

[xvii] Under § 1016(a)(1)(B), following the TCJA, the cost basis of a life insurance contract is not reduced by the cost of insurance.

[xviii] Rev. Rul. 2009-13, Sit. 1.

IRC Sec. 72(e)(5)(A) requires that the amount be included in gross income but only to the extent it exceeds investment in the contract. For this purpose, IRC Sec. 72(e)(6) defines “investment in the contract” as of any date as the aggregate amount of premiums or other consideration paid for the contract before that date, less the aggregate amount received under the contract before that date to the extent that amount was excludable from gross income.

[xix] Rev. Rul. 2009-13, Sit. 1; Rev. Rul. 64-51.

[xx] We are not given their ages. The only point of reference is the number of years (approximately 25) Taxpayer had been practicing law at the time of purchasing the policies.

[xxi] Taxpayer’s children.  

[xxii] The issuer was a mutual life insurance company.

[xxiii] IRC Sec. 61(a)(9); IRC Sec. 72(a)(1).  

[xxiv] IRC Sec. 72(e)(1)(A), Sec.72(e)(3).

[xxv] IRC Sec. 61(a)(9), (a)(11). The Court stated that Taxpayer offered “unclear reasons” why this analysis was in error.

[xxvi] Designated by the “S” that appears at the end of the docket number: Docket No. 27150-21S.

[xxvii] The opinion is silent as to whether the children were important to Taxpayer’s business, or that Taxpayer was in some way dependent upon them, either at the time of purchase or at any subsequent time.

[xxviii] Taxpayer claimed that the loans were used in its mining and logging business and, so, the interest should have been deductible by Taxpayer as a business expense. The Court responded that Taxpayer failed to present any evidence that he was involved in any such business or, if so, that the loan proceeds were used in such trade or business. Thus, the Court concluded the loans were personal.

[xxix] IRC Sec. 7702. The policy was issued by one of the highest rated life insurance companies. It appears that no question was raised regarding the true nature of the policy.

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It’s not at all unusual to encounter the owner of a New York business who dreams about leaving the State. The reasons often given for the desired move include, among others, the cost of doing business in New York, the State’s over-regulation of business and, probably most of all, its hostile tax environment.[i]

Lately, however, many more New Yorkers are talking about leaving the State. When you ask them why, they’ll recite a litany of familiar reasons, including those mentioned above. Generally, they seem sincere when they tell you they’re committed to doing whatever it takes to make a new home elsewhere.[ii] That is until you explain that “whatever it takes”[iii] requires (i) a lot of patience which, it turns out, many of these individuals do not have, (ii) a lot of effort, which they are unwilling to invest, and (iii) some sacrifice, which . . . well, forget about that.

A recent decision of New York’s Tax Appeals Tribunal[iv] illustrates one couple’s attempt at leaving the State. The Taxpayers (Husband and Wife) implemented many of the steps that must typically be taken to establish a change of domicile away from New York. Unfortunately for them, they were premature in thinking they had succeeded in doing so. Their missteps may serve as a lesson for others who genuinely aspire to one day describe themselves as “former New Yorkers.”[v]

Continue Reading Escape from New York – It’s Not That Easy
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An Extension of Credit

When one person lends money to another, the lender expects the borrower to repay the loan by an agreed-upon time. In order to compensate the lender for the borrower’s use of the lender’s money (the loan proceeds), the lender will require the borrower – at least in an arm’s length setting involving unrelated persons[i] – to pay interest on the amount borrowed.

Continue Reading Exercised Appraisal Rights? Deferred Payment of Contingent Value? Don’t Forget Imputed Interest