[Code of Federal Regulations]
[Title 26, Volume 11]
[Revised as of April 1, 2003]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1275-1]
[Page 540-546]
TITLE 26--INTERNAL REVENUE
CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(CONTINUED)
PART 1--INCOME TAXES--Table of Contents
Sec. 1.1275-1 Definitions.
(a) Applicability. The definitions contained in this section apply
for purposes of sections 163(e) and 1271 through 1275 and the
regulations thereunder.
(b) Adjusted issue price--(1) In general. The adjusted issue price
of a debt instrument at the beginning of the first accrual period is the
issue price. Thereafter, the adjusted issue price of the debt instrument
is the issue price of the debt instrument--
[[Page 541]]
(i) Increased by the amount of OID previously includible in the
gross income of any holder (determined without regard to section
1272(a)(7) and section 1272(c)(1)); and
(ii) Decreased by the amount of any payment previously made on the
debt instrument other than a payment of qualified stated interest. See
Sec. 1.1275-2(f) for rules regarding adjustments to adjusted issue price
on a pro rata prepayment.
(2) Bond issuance premium. If a debt instrument is issued with bond
issuance premium (as defined in Sec. 1.163-13(c)), for purposes of
determining the issuer's adjusted issue price, the adjusted issue price
determined under paragraph (b)(1) of this section is also decreased by
the amount of bond issuance premium previously allocable under
Sec. 1.163-13(d)(3).
(3) Adjusted issue price for subsequent holders. For purposes of
calculating OID accruals, acquisition premium, or market discount, a
holder (other than a purchaser at original issuance) determines adjusted
issue price in any manner consistent with the regulations under sections
1271 through 1275.
(c) OID. OID means original issue discount (as defined in section
1273(a) and Sec. 1.1273-1).
(d) Debt instrument. Except as provided in section 1275(a)(1)(B)
(relating to certain annuity contracts; see paragraph (j) of this
section), debt instrument means any instrument or contractual
arrangement that constitutes indebtedness under general principles of
Federal income tax law (including, for example, a certificate of deposit
or a loan). Nothing in the regulations under sections 163(e), 483, and
1271 through 1275, however, shall influence whether an instrument
constitutes indebtedness for Federal income tax purposes.
(e) Tax-exempt obligations. For purposes of section 1275(a)(3)(B),
exempt from tax means exempt from Federal income tax.
(f) Issue.
(1) Debt instruments issued on or after March 13, 2001.
(2) Debt instruments issued before March 13, 2001.
(3) Transition rule.
(4) Cross-references for reopening and aggregation rules.
(g) Debt instruments issued by a natural person. If an entity is a
primary obligor under a debt instrument, the debt instrument is
considered to be issued by the entity and not by a natural person even
if a natural person is a co-maker and is jointly liable for the debt
instrument's repayment. A debt instrument issued by a partnership is
considered to be issued by the partnership as an entity even if the
partnership is composed entirely of natural persons.
(h) Publicly offered debt instrument. A debt instrument is publicly
offered if it is part of an issue of debt instruments the initial
offering of which--
(1) Is registered with the Securities and Exchange Commission; or
(2) Would be required to be registered under the Securities Act of
1933 (15 U.S.C. 77a et seq.) but for an exemption from registration--
(i) Under section 3 of the Securities Act of 1933 (relating to
exempted securities);
(ii) Under any law (other than the Securities Act of 1933) because
of the identity of the issuer or the nature of the security; or
(iii) Because the issue is intended for distribution to persons who
are not United States persons.
(i) [Reserved]
(j) Life annuity exception under section 1275(a)(1)(B)(i)--(1)
Purpose. Section 1275(a)(1)(B)(i) excepts an annuity contract from the
definition of debt instrument if section 72 applies to the contract and
the contract depends (in whole or in substantial part) on the life
expectancy of one or more individuals. This paragraph (j) provides rules
to ensure that an annuity contract qualifies for the exception in
section 1275(a)(1)(B)(i) only in cases where the life contingency under
the contract is real and significant.
(2) General rule--(i) Rule. For purposes of section
1275(a)(1)(B)(i), an annuity contract depends (in whole or in
substantial part) on the life expectancy of one or more individuals only
if--
(A) The contract provides for periodic distributions made not less
frequently than annually for the life (or joint
[[Page 542]]
lives) of an individual (or a reasonable number of individuals); and
(B) The contract does not contain any terms or provisions that can
significantly reduce the probability that total distributions under the
contract will increase commensurately with the longevity of the
annuitant (or annuitants).
(ii) Terminology. For purposes of this paragraph (j):
(A) Contract. The term contract includes all written or unwritten
understandings among the parties as well as any person or persons acting
in concert with one or more of the parties.
(B) Annuitant. The term annuitant refers to the individual (or
reasonable number of individuals) referred to in paragraph (j)(2)(i)(A)
of this section.
(C) Terminating death. The phrase terminating death refers to the
annuitant death that can terminate periodic distributions under the
contract. (See paragraph (j)(2)(i)(A) of this section.) For example, if
a contract provides for periodic distributions until the later of the
death of the last-surviving annuitant or the end of a term certain, the
terminating death is the death of the last-surviving annuitant.
(iii) Coordination with specific rules. Paragraphs (j) (3) through
(7) of this section describe certain terms and conditions that can
significantly reduce the probability that total distributions under the
contract will increase commensurately with the longevity of the
annuitant (or annuitants). If a term or provision is not specifically
described in paragraphs (j) (3) through (7) of this section, the annuity
contract must be tested under the general rule of paragraph (j)(2)(i) of
this section to determine whether it depends (in whole or in substantial
part) on the life expectancy of one or more individuals.
(3) Availability of a cash surrender option--(i) Impact on life
contingency. The availability of a cash surrender option can
significantly reduce the probability that total distributions under the
contract will increase commensurately with the longevity of the
annuitant (or annuitants). Thus, the availability of any cash surrender
option causes the contract to fail to be described in section
1275(a)(1)(B)(i). A cash surrender option is available if there is
reason to believe that the issuer (or a person acting in concert with
the issuer) will be willing to terminate or purchase all or a part of
the annuity contract by making one or more payments of cash or property
(other than an annuity contract described in this paragraph (j)).
(ii) Examples. The following examples illustrate the rules of this
paragraph (j)(3):
Example 1. (i) Facts. On March 1, 1998, X issues a contract to A for
cash. The contract provides that, effective on any date chosen by A (the
annuity starting date), X will begin equal monthly distributions for A's
life. The amount of each monthly distribution will be no less than an
amount based on the contract's account value as of the annuity starting
date, A's age on that date, and permanent purchase rate guarantees
contained in the contract. The contract also provides that, at any time
before the annuity starting date, A may surrender the contract to X for
the account value less a surrender charge equal to a declining
percentage of the account value. For this purpose, the initial account
value is equal to the cash invested. Thereafter, the account value
increases annually by at least a minimum guaranteed rate.
(ii) Analysis. The ability to obtain the account value less the
surrender charge, if any, is a cash surrender option. This ability can
significantly reduce the probability that total distributions under the
contract will increase commensurately with A's longevity. Thus, the
contract fails to be described in section 1275(a)(1)(B)(i).
Example 2. (i) Facts. On March 1, 1998, X issues a contract to B for
cash. The contract provides that beginning on March 1, 1999, X will
distribute to B a fixed amount of cash each month for B's life. Based on
X's advertisements, marketing literature, or illustrations or on oral
representations by X's sales personnel, there is reason to believe that
an affiliate of X stands ready to purchase B's contract for its commuted
value.
(ii) Analysis. Because there is reason to believe that an affiliate
of X stands ready to purchase B's contract for its commuted value, a
cash surrender option is available within the meaning of paragraph
(j)(3)(i) of this section. This availability can significantly reduce
the probability that total distributions under the contract will
increase commensurately with B's longevity. Thus, the contract fails to
be described in section 1275(a)(1)(B)(i).
(4) Availability of a loan secured by the contract--(i) Impact on
life contingency. The availability of a loan secured by the contract can
significantly reduce
[[Page 543]]
the probability that total distributions under the contract will
increase commensurately with the longevity of the annuitant (or
annuitants). Thus, the availability of any such loan causes the contract
to fail to be described in section 1275(a)(1)(B)(i). A loan secured by
the contract is available if there is reason to believe that the issuer
(or a person acting in concert with the issuer) will be willing to make
a loan that is directly or indirectly secured by the annuity contract.
(ii) Example. The following example illustrates the rules of this
paragraph (j)(4):
Example: (i) Facts. On March 1, 1998, X issues a contract to C for
$100,000. The contract provides that, effective on any date chosen by C
(the annuity starting date), X will begin equal monthly distributions
for C's life. The amount of each monthly distribution will be no less
than an amount based on the contract's account value as of the annuity
starting date, C's age on that date, and permanent purchase rate
guarantees contained in the contract. From marketing literature
circulated by Y, there is reason to believe that, at any time before the
annuity starting date, C may pledge the contract to borrow up to $75,000
from Y. Y is acting in concert with X.
(ii) Analysis. Because there is reason to believe that Y, a person
acting in concert with X, is willing to lend money against C's contract,
a loan secured by the contract is available within the meaning of
paragraph (j)(4)(i) of this section. This availability can significantly
reduce the probability that total distributions under the contract will
increase commensurately with C's longevity. Thus, the contract fails to
be described in section 1275(a)(1)(B)(i).
(5) Minimum payout provision--(i) Impact on life contingency. The
existence of a minimum payout provision can significantly reduce the
probability that total distributions under the contract will increase
commensurately with the longevity of the annuitant (or annuitants).
Thus, the existence of any minimum payout provision causes the contract
to fail to be described in section 1275(a)(1)(B)(i).
(ii) Definition of minimum payout provision. A minimum payout
provision is a contractual provision (for example, an agreement to make
distributions over a term certain) that provides for one or more
distributions made--
(A) After the terminating death under the contract; or
(B) By reason of the death of any individual (including
distributions triggered by or increased by terminal or chronic illness,
as defined in section 101(g)(1) (A) and (B)).
(iii) Exceptions for certain minimum payouts--(A) Recovery of
consideration paid for the contract. Notwithstanding paragraphs
(j)(2)(i)(A) and (j)(5)(i) of this section, a contract does not fail to
be described in section 1275(a)(1)(B)(i) merely because it provides
that, after the terminating death, there will be one or more
distributions that, in the aggregate, do not exceed the consideration
paid for the contract less total distributions previously made under the
contract.
(B) Payout for one-half of life expectancy. Notwithstanding
paragraphs (j)(2)(i)(A) and (j)(5)(i) of this section, a contract does
not fail to be described in section 1275(a)(1)(B)(i) merely because it
provides that, if the terminating death occurs after the annuity
starting date, distributions under the contract will continue to be made
after the terminating death until a date that is no later than the
halfway date. This exception does not apply unless the amounts
distributed in each contract year will not exceed the amounts that would
have been distributed in that year if the terminating death had not
occurred until the expected date of the terminating death, determined
under paragraph (j)(5)(iii)(C) of this section.
(C) Definition of halfway date. For purposes of this paragraph
(j)(5)(iii), the halfway date is the date halfway between the annuity
starting date and the expected date of the terminating death, determined
as of the annuity starting date, with respect to all then-surviving
annuitants. The expected date of the terminating death must be
determined by reference to the applicable mortality table prescribed
under section 417(e)(3)(A)(ii)(I).
(iv) Examples. The following examples illustrate the rules of this
paragraph (j)(5):
Example 1. (i) Facts. On March 1, 1998, X issues a contract to D for
cash. The contract provides that, effective on any date D chooses (the
annuity starting date), X will begin equal monthly distributions for the
greater
[[Page 544]]
of D's life or 10 years, regardless of D's age as of the annuity
starting date. The amount of each monthly distribution will be no less
than an amount based on the contract's account value as of the annuity
starting date, D's age on that date, and permanent purchase rate
guarantees contained in the contract.
(ii) Analysis. A minimum payout provision exists because, if D dies
within 10 years of the annuity starting date, one or more distributions
will be made after D's death. The minimum payout provision does not
qualify for the exception in paragraph (j)(5)(iii)(B) of this section
because D may defer the annuity starting date until his remaining life
expectancy is less than 20 years. If, on the annuity starting date, D's
life expectancy is less than 20 years, the minimum payout period (10
years) will last beyond the halfway date. The minimum payout provision,
therefore, can significantly reduce the probability that total
distributions under the contract will increase commensurately with D's
longevity. Thus, the contract fails to be described in section
1275(a)(1)(B)(i).
Example 2. (i) Facts. The facts are the same as in Example 1 of this
paragraph (j)(5)(iv) except that the monthly distributions will last for
the greater of D's life or a term certain. D may choose the length of
the term certain subject to the restriction that, on the annuity
starting date, the term certain must not exceed one-half of D's life
expectancy as of the annuity starting date. The contract also does not
provide for any adjustment in the amount of distributions by reason of
the death of D or any other individual, except for a refund of D's
aggregate premium payments less the sum of all prior distributions under
the contract.
(ii) Analysis. The minimum payout provision qualifies for the
exception in paragraph (j)(5)(iii)(B) of this section because
distributions under the minimum payout provision will not continue past
the halfway date and the contract does not provide for any adjustments
in the amount of distributions by reason of the death of D or any other
individual, other than a guaranteed death benefit described in paragraph
(j)(5)(iii)(A) of this section. Accordingly, the existence of this
minimum payout provision does not prevent the contract from being
described in section 1275(a)(1)(B)(i).
(6) Maximum payout provision--(i) Impact on life contingency. The
existence of a maximum payout provision can significantly reduce the
probability that total distributions under the contract will increase
commensurately with the longevity of the annuitant (or annuitants).
Thus, the existence of any maximum payout provision causes the contract
to fail to be described in section 1275(a)(1)(B)(i).
(ii) Definition of maximum payout provision. A maximum payout
provision is a contractual provision that provides that no distributions
under the contract may be made after some date (the termination date),
even if the terminating death has not yet occurred.
(iii) Exception. Notwithstanding paragraphs (j)(2)(i)(A) and
(j)(6)(i) of this section, an annuity contract does not fail to be
described in section 1275(a)(1)(B)(i) merely because the contract
contains a maximum payout provision, provided that the period of time
from the annuity starting date to the termination date is at least twice
as long as the period of time from the annuity starting date to the
expected date of the terminating death, determined as of the annuity
starting date, with respect to all then-surviving annuitants. The
expected date of the terminating death must be determined by reference
to the applicable mortality table prescribed under section
417(e)(3)(A)(ii)(I).
(iv) Example. The following example illustrates the rules of this
paragraph (j)(6):
Example: (i) Facts. On March 1, 1998, X issues a contract to E for
cash. The contract provides that beginning on April 1, 1998, X will
distribute to E a fixed amount of cash each month for E's life but that
no distributions will be made after April 1, 2018. On April 1, 1998, E's
life expectancy is 9 years.
(ii) Analysis. A maximum payout provision exists because if E
survives beyond April 1, 2018, E will receive no further distributions
under the contract. The period of time from the annuity starting date
(April 1, 1998) to the termination date (April 1, 2018) is 20 years.
Because this 20-year period is more than twice as long as E's life
expectancy on April 1, 1998, the maximum payout provision qualifies for
the exception in paragraph (j)(6)(iii) of this section. Accordingly, the
existence of this maximum payout provision does not prevent the contract
from being described in section 1275(a)(1)(B)(i).
(7) Decreasing payout provision--(i) General rule. If the amount of
distributions during any contract year (other than the last year during
which distributions are made) may be less than the amount of
distributions during the preceding year, this possibility can
significantly reduce the probability that total distributions under the
contract
[[Page 545]]
will increase commensurately with the longevity of the annuitant (or
annuitants). Thus, the existence of this possibility causes the contract
to fail to be described in section 1275(a)(1)(B)(i).
(ii) Exception for certain variable distributions. Notwithstanding
paragraph (j)(7)(i) of this section, if an annuity contract provides
that the amount of each distribution must increase and decrease in
accordance with investment experience, cost of living indices, or
similar fluctuating criteria, then the possibility that the amount of a
distribution may decrease for this reason does not significantly reduce
the probability that the distributions under the contract will increase
commensurately with the longevity of the annuitant (or annuitants).
(iii) Examples. The following examples illustrate the rules of this
paragraph (j)(7):
Example 1. (i) Facts. On March 1, 1998, X issues a contract to F for
$100,000. The contract provides that beginning on March 1, 1999, X will
make distributions to F each year until F's death. Prior to March 1,
2009, distributions are to be made at a rate of $12,000 per year.
Beginning on March 1, 2009, distributions are to be made at a rate of
$3,000 per year.
(ii) Analysis. If F is alive in 2009, the amount distributed in 2009
($3,000) will be less than the amount distributed in 2008 ($12,000). The
exception in paragraph (j)(7)(ii) of this section does not apply. The
decrease in the amount of any distributions made on or after March 1,
2009, can significantly reduce the probability that total distributions
under the contract will increase commensurately with F's longevity.
Thus, the contract fails to be described in section 1275(a)(1)(B)(i).
Example 2. (i) Facts. On March 1, 1998, X issues a contract to G for
cash. The contract provides that, effective on any date G chooses (the
annuity starting date), X will begin monthly distributions to G for G's
life. Prior to the annuity starting date, the account value of the
contract reflects the investment return, including changes in the market
value, of an identifiable pool of assets. When G chooses the annuity
starting date, G must also choose whether the distributions are to be
fixed or variable. If fixed, the amount of each monthly distribution
will remain constant at an amount that is no less than an amount based
on the contract's account value as of the annuity starting date, G's age
on that date, and permanent purchase rate guarantees contained in the
contract. If variable, the monthly distributions will fluctuate to
reflect the investment return, including changes in the market value, of
the pool of assets. The monthly distributions under the contract will
not otherwise decline from year to year.
(ii) Analysis. Because the only possible year-to-year declines in
annuity distributions are described in paragraph (j)(7)(ii) of this
section, the possibility that the amount of distributions may decline
from the previous year does not reduce the probability that total
distributions under the contract will increase commensurately with G's
longevity. Thus, the potential fluctuation in the annuity distributions
does not cause the contract to fail to be described in section
1275(a)(1)(B)(i).
(8) Effective dates--(i) In general. Except as provided in paragraph
(j)(8) (ii) and (iii) of this section, this paragraph (j) is applicable
for interest accruals on or after February 9, 1998 on annuity contracts
held on or after February 9, 1998.
(ii) Grandfathered contracts. This paragraph (j) does not apply to
an annuity contract that was purchased before April 7, 1995. For
purposes of this paragraph (j)(8), if any additional investment in such
a contract is made on or after April 7, 1995, and the additional
investment is not required to be made under a binding contractual
obligation that was entered into before April 7, 1995, then the
additional investment is treated as the purchase of a contract after
April 7, 1995.
(iii) Contracts consistent with the provisions of FI-33-94,
published at 1995-1 C.B. 920. See Sec. 601.601(d)(2)(ii)(b) of this
chapter. This paragraph (j) does not apply to a contract purchased on or
after April 7, 1995, and before February 9, 1998, if all payments under
the contract are periodic payments that are made at least annually for
the life (or lives) of one or more individuals, do not increase at any
time during the term of the contract, and are part of a series of
distributions that begins within one year of the date of the initial
investment in the contract. An annuity contract that is otherwise
described in the preceding sentence does not fail to be described
therein merely because it also provides for a payment (or payments) made
by reason of the death of one or more individuals.
(k) Exception under section 1275(a)(1)(B)(ii) for annuities issued
by an insurance company subject to tax under
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subchapter L of the Internal Revenue Code--(1) Rule. For purposes of
section 1275(a)(1)(B)(ii), an annuity contract issued by a foreign
insurance company is considered as issued by an insurance company
subject to tax under subchapter L if the insurance company is subject to
tax under subchapter L with respect to income earned on the annuity
contract.
(2) Examples. The following examples illustrate the rule of
paragraph (k)(1) of this section. Each example assumes that the annuity
contract is a contract to which section 72 applies and was issued in a
transaction where there is no consideration other than cash or another
qualifying annuity contract, pursuant to the exercise of an election
under an insurance contract by a beneficiary thereof on the death of the
insured party, or in a transaction involving a qualified pension or
employee benefit plan. The examples are as follows:
Example 1. Company X is an insurance company that is organized,
licensed and doing business in Country Y. Company X does not have a U.S.
trade or business and is not, under section 842, subject to U.S. income
tax under subchapter L with respect to income earned on annuity
contracts. A, a U.S. taxpayer, purchases an annuity contract from
Company X in Country Y. The annuity contract is not excepted from the
definition of a debt instrument by section 1275(a)(1)(B)(ii).
Example 2. The facts are the same as in Example 1, except that
Company X has a U.S. trade or business. A purchased the annuity from
Company X's U.S. trade or business. Under section 842(a), Company X is
subject to tax under subchapter L with respect to income earned on the
annuity contract. Under these facts, the annuity contract is excepted
from the definition of a debt instrument by section 1275(a)(1)(B)(ii).
Example 3. The facts are the same as in Example 2, except that there
is a tax treaty between Country Y and the United States. Company X is a
resident of Country Y for purposes of the U.S.-Country Y tax treaty.
Company X's activities in the U.S. do not constitute a permanent
establishment under the U.S.-Country Y tax treaty. Because Company X
does not have a U.S. permanent establishment, Company X is not subject
to tax under subchapter L with respect to income earned on the annuity
contract. Thus, the annuity contract is not excepted from the definition
of a debt instrument by section 1275(a)(1)(B)(ii).
Example 4. The facts are the same as in Example 1, except that
Company X is a foreign insurance corporation controlled by a U.S.
shareholder. Company X does not make an election 1 under section 953(d)
to be treated as a domestic corporation. The controlling U.S.
shareholder is required under sections 953 and 954 to include income
earned on the annuity contract in its taxable income under subpart F.
However, Company X is not subject to tax under subchapter L with respect
to income earned on the annuity contract. Thus, the annuity contract is
not excepted from the definition of a debt instrument by section
1275(a)(1)(B)(ii).
Example 5. The facts are the same as in Example 4, except that
Company X properly elects under section 953(d) to be treated as a
domestic corporation. By reason of its election, Company X is subject to
tax under subchapter L with respect to income earned on the annuity
contract. Thus, the annuity contract is excepted from the definition of
a debt instrument by section 1275(a)(1)(B)(ii).
(3) Effective date. This paragraph (k) is applicable for interest
accruals on or after June 6, 2002. This paragraph (k) does not apply to
an annuity contract that was purchased before January 12, 2001. For
purposes of this paragraph (k), if any additional investment in a
contract purchased before January 12, 2001, is made on or after January
12, 2001, and the additional investment is not required to be made under
a binding written contractual obligation that was entered into before
that date, then the additional investment is treated as the purchase of
a contract after January 12, 2001.
[T.D. 8517, 59 FR 4825, Feb. 2, 1994, as amended by T.D. 8746, 62 FR
68183, Dec. 31, 1997; T.D. 8754, 63 FR 1057, Jan. 8, 1998; T.D. 8934, 66
FR 2815, Jan. 12, 2001; T.D. 8993, 67 FR 30548, May 7, 2002]