Section 101(a)(2) of the Internal Revenue Code provides that if a life insurance policy or any interest in a policy is transferred for a valuable consideration, any death proceeds in excess of the consideration will be taxable as ordinary income to the recipient. This will not be true, however, under the following exceptions:

• If the sale or transfer is to the insured.
• If the sale or transfer is to a partner of the insured.

This also includes to a partnership in which the insured is a partner or to a corporation in which the insured is an officer or shareholder provided the transfer does not change the asset’s tax basis.

The transfer may not change a policy from one corporation to another in a tax-free reorganization or when the policy is or has been acquired by gift.

When a policy is transferred more than once but the last transfer falls under one of the above exceptions, the proceeds will be fully tax exempt, regardless of any previous transfers for value.

If a corporation transfers a policy on an employee’s life to the insured’s spouse or other family member, the transfer will be deemed a transfer for value. This may be true even if they pay nothing for the policy.

A transfer for value is any transfer for a valuable consideration of a right to receive all or a part of the proceeds of a life insurance policy. The naming of a beneficiary may be considered a transfer for value if it is in exchange for a valuable consideration.

Special care is required in connection with the arrangement of life insurance under marital agreements to avoid creating a transfer for value that will cause the proceeds to be subject to federal income tax.