Third-Party Purchaser’s E&P Reduced by Interest on Loan Incurred to Acquire Life Insurance Policy

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Revenue Ruling 2009-25 (the “Ruling”), 2009-38 I.R.B., addresses the issue of when interest that is disallowed as a deduction under Section 264(a)(4) of the Internal Revenue Code (the “Code”) is taken into account in determining earnings and profits (“E&P”) of a third-party purchaser (the “Purchaser”) of a life insurance contract. The Ruling concludes that interest, even though disallowed under Code Section 264(a)(4), reduces the Purchaser’s E&P for the tax year in which the interest would have been allowable as a deduction. However, the Ruling also determines that when the death benefit is received under a life insurance contract, E&P cannot be further reduced.

The Ruling is likely to be most relevant to a U.S. shareholder of a controlled foreign corporation (“CFC”) that has “subpart F” income. Although E&P is used to determine whether a corporation’s distributions to shareholders are treated as “dividend” income for U.S. federal income tax purposes, the same concept is also relevant to the U.S. shareholders of a CFC, who must annually include their pro rata shares of the corporation’s subpart F income in their U.S. tax returns up to the amount of the CFC’s E&P. In confirming that the E&P of a CFC is reduced currently by items of disallowed interest expense, the IRS took a position that is consistent with the view of E&P as a reflection of the CFC’s ability to pay dividends.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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