What the IRS Manual Tells Staffers About Life and Annuities

What You Need to Know

Tax collectors see whole life as an asset.
They classify term life premiums as a necessary expense.
They are getting to know life settlements and viatical settlements.

Internal Revenue Service officials reveal some of their views about life insurance and annuities in the Internal Revenue Manuals, a guide for tax collectors.

One section, Part 5. Collecting Process, tells IRS employees what to do when they’re searching taxpayers’ finances for “reasonable collection potential.”

For IRS employees, the reasonable collection potential search is a broad, highly regulated version of what financial professionals do when they are trying to figure out how much clients or prospects can use to fund their financial plans.

But, instead of using the cash or other assets located to pay for a mutual fund, annuity or life insurance policy, the IRS employee uses the assets located to send cash to the U.S. Treasury and help pay for U.S. federal government programs and services, such as the U.S. Army, interstate highways and space stations.

Life insurers often note that, when consumers are dealing with ordinary bill collectors, life insurance policies and annuities are often off-limits.

The IRS tax collectors come under different rules and are not so dainty.

“Life insurance as an investment is not considered a necessary expense,” officials say in the manual. “Whole life policies should be reviewed as an asset for borrowing against or liquidating.”

But, officials also note that “reasonable premiums for term life policies may be allowed when the policy is for the life of the taxpayer.”

What it means: Financial professionals with clients using aggressive strategies for managing tax obligations might want to know how IRS tax collectors might see the clients’ life and annuity arrangements.

The history: The IRS began developing its forms and procedures in 1912, when the country established a federal income tax.

The agency created the Internal Revenue Manual in 1952.

The IRS once kept the manual secret. It began making most of the manual public around 1973, as a result of rulings on three Freedom of Information Act suits, according to a Marquette Law Review article by Earl Thompson.

Life and annuity references: The IRS refers directly to life insurance in Part 5 chapters such as Chapter 8.5, which deals with the financial analysis process the IRS uses when calculating how much a taxpayer will have to pay through an “offer in compromise,” or a settlement that disposes of a taxpayer’s liabilities for less than the full amount owed.

The IRS also deals with life insurance and annuities in Chapter 15.1, which discusses the general IRS approach for determining how much ability a taxpayer has to pay delinquent taxes.