Rev. Rul. 55-257

Advice has been requested whether, for the purpose of computing equity invested capital, accumulated earnings and profits should be determined by including therein the cash surrender value of insurance policies held by a corporation, as beneficiary, on the lives of its officers or by including therein the total premiums paid by the corporation on such policies.

Under the provisions of section 24(a)(4) of the Internal Revenue Code of 1939 and the regulations promulgated thereunder, no portion of premiums paid on any life insurance policy covering the life of any officer or employee, or of any person financially interested in any trade or business carried on by the taxpayer, may be deducted by the taxpayer in computing net income when the taxpayer is directly or indirectly a beneficiary under such policy. To the extent that an asset is created by the payment of such premiums, the taxpayer may be considered to have a basis in the asset equal to the cash surrender value of the policy. This question was considered in Century Wood Preserving Company v. Commissioner , 69 Fed.(2d) 967, wherein the court said:

The cost of an asset is the real question here. It is obvious that cost is not the total amount paid in as premiums, since continuing insurance protection is part of the consideration for the contract. The part of the premiums which represents annual insurance protection has been earned and used. The other part of the premium is an investment built up as a reserve until the policy is matured or surrendered. If it is surrendered, the holder is entitled to the cash surrender value from the insurer, or, roughly, the return of the equivalent of his investment after the cost of annual protection is deducted from the premiums.

The petitioner in this case has made no effort to show the reserve carried by the insurer on these policies. But cost is approximately reflected by the cash surrender value of the policies * * *.

The question here presented was considered by the courts and the Internal Revenue Service under the World War I excess profits tax law which contained provisions relative to historical invested capital similar to those contained in section 458 of the Internal Revenue Code of 1939. It was held that amounts paid out of earnings by a taxpayer as premiums on insurance policies carried by the taxpayer on the lives of its officers in excess of that portion which is applicable to pure term insurance is the amount to be included in invested capital as earned surplus. See E. J. Gallagher Realty Co. v. Commissioner , 4 B.T.A. 219; National Straw Works v. Commissioner 47 Fed.(2d) 844; A.R.R. 229, C.B. 3, 354 (1920); O.D. 745, C.B. 3, 355 (1920).

However, in the case of Lucas v. Kate Halloway Alexander et al. , 279 U.S. 573, Ct. D. 76, C.B. XIII-2 273 (1929), the Supreme Court of the United States adopted the reserve value, i.e. the reserve carried by the insurer on the policies, in calculating the asset value of an insurance policy. But as a practical matter, in many cases the cash surrender value closely approximates the value of the taxpayer's investment. In such instances the slight difference in amounts involved may be disregarded in the interest of administrative convenience.

In view of the above, it is held that for the purpose of computing equity invested capital under section 458(d) of the Internal Revenue Code of 1939, accumulated earnings and profits may be determined by including therein, in the absence of a more accurate value, the cash surrender value of insurance policies carried by a taxpayer, as beneficiary, on the lives of its officers