EXPANSION OF DENIAL OF DEDUCTION FOR CERTAIN AMOUNTS PAID IN CONNECTION WITH INSURANCE.

SEC. 1084. EXPANSION OF DENIAL OF DEDUCTION FOR CERTAIN AMOUNTS PAID IN CONNECTION WITH INSURANCE. (a) Denial of Deduction for Premiums.— (1) In general.—Paragraph (1) of section 264(a) is amended to read as follows: “(1) Premiums on any life insurance policy, or endowment or annuity contract, if the taxpayer is directly or indirectly a beneficiary under the policy or contract.”. (2) Exceptions.—Section 264 is amended by redesignating subsections (b), (c), and (d) as subsections (c), (d), and (e), respectively, and by inserting after subsection (a) the following new subsection: “(b) Exceptions to Subsection (a)(1).—Subsection (a)(1) shall not apply to— “(1) any annuity contract described in section 72(b)(5), and “(2) any annuity contract to which section 72(u) applies.”. (b) Interest on Policy Loans.— (1) In general.—Paragraph (4) of section 264(a) is amended by striking “individual, who” and all that follows and inserting “individual.”.111 STAT. 952 (2) Coordination with transfers for value.—Paragraph (2) of section 101(a) is amended by adding at the end the following new flush sentence: “The term ‘other amounts’ in the first sentence of this paragraph includes interest paid or accrued by the transferee on indebtedness with respect to such contract or any interest therein if such interest paid or accrued is not allowable as a deduction by reason of section 264(a)(4).”. (c) Pro Rata Allocation of Interest Expense to Policy Cash Values.—Section 264 is amended by adding at the end the following new subsection: “(f) Pro Rata Allocation of Interest Expense to Policy Cash Values.— “(1) In general.—No deduction shall be allowed for that portion of the taxpayer’s interest expense which is allocable to unborrowed policy cash values. “(2) Allocation.—For purposes of paragraph (1), the portion of the taxpayer’s interest expense which is allocable to unborrowed policy cash values is an amount which bears the same ratio to such interest expense as— “(A) the taxpayer’s average unborrowed policy cash values of life insurance policies, and annuity and endowment contracts, issued after June 8, 1997, bears to “(B) the sum of— “(i) in the case of assets of the taxpayer which are life insurance policies or annuity or endowment contracts, the average unborrowed policy cash values of such policies and contracts, and “(ii) in the case of assets of the taxpayer not described in clause (i), the average adjusted bases (within the meaning of section 1016) of such assets. “(3) Unborrowed policy cash value.—For purposes of this subsection, the term ‘unborrowed policy cash value’ means, with respect to any life insurance policy or annuity or endowment contract, the excess of— “(A) the cash surrender value of such policy or contract determined without regard to any surrender charge, over “(B) the amount of any loan with respect to such policy or contract. “(4) Exception for certain policies and contracts.— “(A) Policies and contracts covering 2o-percent owners, officers, directors, and employees.—Paragraph (1) shall not apply to any policy or contract owned by an entity engaged in a trade or business if such policy or contract covers only 1 individual and if such individual is (at the time first covered by the policy or contract)— “(i) a 20-percent owner of such entity, or “(ii) an individual (not described in clause (i)) who is an officer, director, or employee of such trade or business. A policy or contract covering a 20-percent owner of such entity shall not be treated as failing to meet the requirements of the preceding sentence by reason of covering the joint lives of such owner and such owner’s spouse. “(B) Contracts subject to current income inclusion.—Paragraph (1) shall not apply to any annuity contract to which section 72(u) applies.111 STAT. 953 “(C) Coordination with paragraph (2).—Any policy or contract to which paragraph (1) does not apply by reason of this paragraph shall not be taken into account under paragraph (2). “(D) 20-percent owner.—For purposes of subparagraph (A), the term ‘20-percent owner’ has the meaning given such term by subsection (e)(4). “(5) Exception for policies and contracts held by natural persons; treatment of partnerships and s corporations.— “(A) Policies and contracts held by natural persons.— “(i) In general.—This subsection shall not apply to any policy or contract held by a natural person. “(ii) Exception where business is beneficiary.—If a trade or business is directly or indirectly the beneficiary under any policy or contract, such policy or contract shall be treated as held by such trade or business and not by a natural person. “(iii) Special rules.— “(I) Certain trades or businesses not taken into account.—Clause (ii) shall not apply to any trade or business carried on as a sole proprietorship and to any trade or business performing services as an employee. “(II) Limitation on unborrowed cash value.—The amount of the unborrowed cash value of any policy or contract which is taken into account by reason of clause (ii) shall not exceed the benefit to which the trade or business is directly or indirectly entitled under the policy or contract. “(iv) Reporting.—The Secretary shall require such reporting from policyholders and issuers as is necessary to carry out clause (ii). Any report required under the preceding sentence shall be treated as a statement referred to in section 6724(d)(1). “(B) Treatment of partnerships and s corporations.—In the case of a partnership or S corporation, this subsection shall be applied at the partnership and corporate levels. “(6) Special rules.— “(A) Coordination with subsection (a) and section 265.—If interest on any indebtedness is disallowed under subsection (a) or section 265— “(i) such disallowed interest shall not be taken into account for purposes of applying this subsection, and “(ii) the amount otherwise taken into account under paragraph (2)(B) shall be reduced (but not below zero) by the amount of such indebtedness. “(B) Coordination with section 263a.—This subsection shall be applied before the application of section 263A (relating to capitalization of certain expenses where taxpayer produces property). “(7) Interest expense.—The term ‘interest expense’ means the aggregate amount allowable to the taxpayer as a deduction 111 STAT. 954for interest (within the meaning of section 265(b)(4)) for the taxable year (determined without regard to this subsection, section 265(b), and section 291). “(8) Aggregation rules.— “(A) In general.—All members of a controlled group (within the meaning of subsection (d)(5)(B)) shall be treated as 1 taxpayer for purposes of this subsection. “(B) Treatment of insurance companies.—This subsection shall not apply to an insurance company subject to tax under subchapter L, and subparagraph (A) shall be applied without regard to any member of an affiliated group which is an insurance company.”. (b) Treatment of Insurance Companies.— (1)(A) Clause (ii) of section 805(a)(4)(C) is amended by inserting “, or out of the increase for the taxable year in policy cash values (within the meaning of subparagraph (F)) of life insurance policies and annuity and endowment contracts to which section 264(f) applies,” after “tax-exempt interest”. (B) Clause (iii) of section 805(a)(4)(D) is amended by striking “and” and inserting “, the increase for the taxable year in policy cash values (within the meaning of subparagraph (F)) of life insurance policies and annuity and endowment contracts to which section 264(f) applies, and”. (C) Paragraph (4) of section 805(a) is amended by adding at the end the following new subparagraph: “(F) Increase in policy cash values.—For purposes of subparagraphs (C) and (D)— “(i) In general.—The increase in the policy cash value for any taxable year with respect to policy or contract is the amount of the increase in the adjusted cash value during such taxable year determined without regard to— “(I) gross premiums paid during such taxable year, and “(II) distributions (other than amounts includible in the policyholder’s gross income) during such taxable year to which section 72(e) applies. “(ii) Adjusted cash value.—For purposes of clause (i), the term ‘adjusted cash value’ means the cash surrender value of the policy or contract increased by the sum of— “(I) commissions payable with respect to such policy or contract for the taxable year, and “(II) asset management fees, surrender charges, mortality and expense charges, and any other fees or charges specified in regulations prescribed by the Secretary which are imposed (or which would be imposed were the policy or contract canceled) with respect to such policy or contract for the taxable year.”. (2)(A) Subparagraph (B) of section 807(a)(2) is amended by striking “interest,” and inserting “interest and the amount of the policyholder’s share of the increase for the taxable year in policy cash values (within the meaning of section 805(a)(4)(F)) of life insurance policies and annuity and endowment contracts to which section 264(f) applies,”.111 STAT. 955 (B) Subparagraph (B) of section 807(b)(1) is amended by striking “interest,” and inserting “interest and the amount of the policyholder’s share of the increase for the taxable year in policy cash values (within the meaning of section 805(a)(4)(F)) of life insurance policies and annuity and endowment contracts to which section 264(f) applies,”. (3) Paragraph (1) of section 812(d) is amended by striking “and” at the end of subparagraph (B), by striking the period at the end of subparagraph (C) and inserting “, and”, and by adding at the end the following new subparagraph: “(D) the increase for any taxable year in the policy cash values (within the meaning of section 805(a)(4)(F)) of life insurance policies and annuity and endowment contracts to which section 264(f) applies.”. (4) Subparagraph (B) of section 832(b)(5) is amended by striking “and” at the end of clause (i), by striking the period at the end of clause (ii) and inserting “, and”, and by adding at the end the following new clause: “(iii) the increase for the taxable year in policy cash values (within the meaning of section 805(a)(4)(F)) of life insurance policies and annuity and endowment contracts to which section 264(f) applies.”. (c) Conforming Amendment.—Subparagraph (A) of section 265(b)(4) is amended by inserting “, section 264,” before “and section 291”. (d) Effective Date.—The amendments made by this section shall apply to contracts issued after June 8, 1997, in taxable years ending after such date. For purposes of the preceding sentence, any material increase in the death benefit or other material change in the contract shall be treated as a new contract but the addition of covered lives shall be treated as a new contract only with respect to such additional covered lives. For purposes of this subsection, an increase in the death benefit under a policy or contract issued in connection with a lapse described in section 501(d)(2) of the Health Insurance Portability and Accountability Act of 1996 shall not be treated as a new contract.