rp-08-24.pdf

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Part III

Administrative, Procedural & Miscellaneous

Section 1035
(Also § 72)

Rev. Proc. 2008-24

SECTION 1. PURPOSE
This revenue procedure addresses the tax treatment of certain tax-free
exchanges of annuity contracts under § 72 and § 1035 of the Internal Revenue
Code. The interim guidance provided by Notice 2003-51, 2003-2 C.B. 362, is
superseded.
SECTION 2. BACKGROUND
.01 Section 1035(a)(3) provides that no gain or loss shall be recognized
on the exchange of an annuity contract for another annuity contract. The
legislative history of § 1035 states that exchange treatment is appropriate for
"individuals who have merely exchanged one insurance policy for another better
suited to their needs." H.R. Rep. No. 1337, 83d Cong., 2d Sess. 81 (1954).
Section 1.1035-1 of the Income Tax Regulations provides that "the exchange,
without recognition of gain or loss, of an annuity contract for another annuity

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contract under § 1035(a)(3) is limited to cases where the same person or
persons are the obligee or obligees under the contract received in the exchange
as under the original contract."
.02 Section 72(e) governs the federal tax treatment of distributions from
an annuity contract that are not received as an annuity. Under § 72(e)(2), such
amounts generally are taxed on an income-first basis. Section 72(e)(12)
provides that all annuity contracts issued by the same company to the same
policyholder during any calendar year are treated as a single annuity contract for
purposes of § 72(e).
.03 Section 72(q)(1) imposes a 10 percent penalty on withdrawals or
surrenders of annuity contracts, unless one of the exceptions enumerated in
§ 72(q)(2) applies.
.04 In Conway v. Commissioner
, 111 T.C. 350 (1998), acq., 1999-2 C.B.
xvi, the Tax Court held that the direct exchange by an insurance company of a
portion of an existing annuity contract to an unrelated insurance company for a
new annuity contract was a tax-free exchange under § 1035. Such a transaction
is sometimes referred to as a "partial exchange." The Internal Revenue Service
(Service) acquiesced in Conway v. Commissioner
. 1999-2 C.B. xvi. See also
Rev. Rul. 2007-24, 2007-21 I.R.B. 1282 (receipt of a check under a nonqualified
annuity contract and endorsement of the check to a second company as
consideration for a second annuity contract treated as a distribution under
§ 72(e), rather than as a tax-free exchange under § 1035); Rev. Rul. 2003-76,
2003-2 C.B. 355 (direct transfer of a portion of an annuity contract for a new

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annuity contract treated as a tax-free exchange under § 1035); Rev. Rul.
2002-75, 2002-2 C.B. 812 (assignment of an entire annuity contract for deposit
into a preexisting annuity contract treated as a tax-free exchange under § 1035).
.05 Notice 2003-51 provided interim guidance on partial exchanges.
Specifically, section 4 of the notice stated that "the Service, using general
principles of tax law, will consider all the facts and circumstances to determine
whether a partial exchange and a subsequent withdrawal from, or surrender of,
either the surviving annuity contract or the new annuity contract within 24 months
of the date on which the partial exchange was completed should be treated as an
integrated transaction, and thus whether the two contracts should be viewed as a
single contract to determine the tax treatment of a surrender or withdrawal under
§ 72(e)." If however, a taxpayer could demonstrate that one of the conditions of
§ 72(q)(2), or any other similar life event, such as a divorce or the loss of
employment, occurred between the partial exchange and the surrender or
distribution, and that the surrender or distribution was not contemplated at the
time of the partial exchange, the taxpayer would not be treated as having entered
into the surrender or distribution for tax avoidance purposes.
.06 Treasury and the Service have determined that it is in the interest of
sound tax administration to adopt the provisions of Notice 2003-51, with
changes, in the form of a revenue procedure. See
§601.601(d)(2)(vi) of the
Procedure and Administration Regulations. In doing so, Treasury and the
Service have determined that the 24-month period referred to in section 4 of
Notice 2003-51 should be shortened to 12 months, and the subjective

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requirement that certain surrenders or distributions not have been
"contemplated" at the time of the exchange should be removed. In addition,
Treasury and the Service have determined it is appropriate to make the following
clarifications to the rules of Notice 2003-51: First, if the direct transfer of a
portion of an annuity contract for a second annuity contract does not qualify as a
tax-free exchange under § 1035 and the rules of this revenue procedure, it will be
treated as a taxable distribution followed by a payment for the second contract.
Second, the rule treating a transfer as a tax-free exchange if one of the
§ 72(q)(2) conditions is met cannot be satisfied based on a payment described in
§§ 72(q)(2)(D) (distribution that is part of a series of substantially equal periodic
payments) or (I) (distribution under an immediate annuity). See
Rev. Proc.
2008-3, 2008-1 I.R.B. 110, section 5.02 (identifying "partial annuitization" as an
area under study in which rulings or determination letters will not be issued until
the Service resolves the issue through publication). Third, the Service will not
require aggregation pursuant to the authority of § 72(e)(12) or otherwise of two
contracts that are the subject of a tax-free exchange under § 1035 and section
4.01 of this revenue procedure, even if both contracts were issued by the same
insurance company.
SECTION 3. SCOPE
.01 This revenue procedure applies to the direct transfer of a portion of
the cash surrender value of an existing annuity contract for a second annuity
contract, regardless of whether the two annuity contracts are issued by the same
or different companies.

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.02 This revenue procedure does not apply to transactions (sometimes
referred to as "partial annuitizations") in which the holder of an annuity contract
irrevocably elects to apply only a portion of the contract to purchase a stream of
annuity payments under the contract, leaving the remainder of the contract to
accumulate income on a tax-deferred basis.
SECTION 4. PROCEDURE
.01 A transfer that is within the scope of this revenue procedure will be
treated as a tax-free exchange under § 1035 if either--
(a) no amounts are withdrawn from, or received in surrender of, either of
the contracts involved in the exchange during the 12 months beginning on the
date on which amounts are treated as received as premiums or other
consideration paid for the contract received in the exchange (the date of the
transfer); or
(b) the taxpayer demonstrates that one of the conditions described by
§ 72(q)(2)(A), (B), (C), (E), (F), (G), (H) or (J), or any similar life event (such as
divorce or loss of employment), occurred between (i) the date of the transfer, and
(ii) the date of the withdrawal or surrender.
.02 A transfer that is within the scope of this revenue procedure but not
treated under § 4.01 as a tax-free exchange under § 1035 will be treated as a
distribution, taxable under § 72(e), followed by a payment for the second
contract.
.03 The Service will not require aggregation pursuant to the authority of
§ 72(e)(12), or otherwise, of two annuity contracts that are the subject of a tax-

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free exchange under § 1035 and section 4.01 of this revenue procedure, even if
both contracts are issued by the same insurance company, but will instead treat
the contracts as separate annuity contracts. See
Rev. Rul. 2003-76.
SECTION 5. EFFECTIVE DATE
This revenue procedure is effective for transfers described in section 3 of
this revenue procedure that are completed on or after June 30, 2008.
SECTION 6. EFFECT ON OTHER DOCUMENTS
Notice 2003-51 is superseded.
DRAFTING INFORMATION
The principal author of this revenue procedure is John E. Glover of the
Office of the Associate Chief Counsel (Financial Institutions & Products). For
further information regarding this revenue procedure, contact Mr. Glover at (202)
622-3970 (not a toll-free call).