
From the U.S. Code Online via GPO Access
[wais.access.gpo.gov]
[Laws in effect as of January 2, 2001]
[Document not affected by Public Laws enacted between
  January 2, 2001 and January 28, 2002]
[CITE: 26USC264]

 
                     TITLE 26--INTERNAL REVENUE CODE
 
                        Subtitle A--Income Taxes
 
                  CHAPTER 1--NORMAL TAXES AND SURTAXES
 
               Subchapter B--Computation of Taxable Income
 
                      PART IX--ITEMS NOT DEDUCTIBLE
 
Sec. 264. Certain amounts paid in connection with insurance 
        contracts
        

(a) General rule

    No deduction shall be allowed for--
        (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) Any amount paid or accrued on indebtedness incurred or 
    continued to purchase or carry a single premium life insurance, 
    endowment, or annuity contract.
        (3) Except as provided in subsection (d), any amount paid or 
    accrued on indebtedness incurred or continued to purchase or carry a 
    life insurance, endowment, or annuity contract (other than a single 
    premium contract or a contract treated as a single premium contract) 
    pursuant to a plan of purchase which contemplates the systematic 
    direct or indirect borrowing of part or all of the increases in the 
    cash value of such contract (either from the insurer or otherwise).
        (4) Except as provided in subsection (e), any interest paid or 
    accrued on any indebtedness with respect to 1 or more life insurance 
    policies owned by the taxpayer covering the life of any individual, 
    or any endowment or annuity contracts owned by the taxpayer covering 
    any individual.

Paragraph (2) shall apply in respect of annuity contracts only as to 
contracts purchased after March 1, 1954. Paragraph (3) shall apply only 
in respect of contracts purchased after August 6, 1963. Paragraph (4) 
shall apply with respect to contracts purchased after June 20, 1986.

(b) Exceptions to subsection (a)(1)

    Subsection (a)(1) shall not apply to--
        (1) any annuity contract described in section 72(s)(5), and
        (2) any annuity contract to which section 72(u) applies.

(c) Contracts treated as single premium contracts

    For purposes of subsection (a)(2), a contract shall be treated as a 
single premium contract--
        (1) if substantially all the premiums on the contract are paid 
    within a period of 4 years from the date on which the contract is 
    purchased, or
        (2) if an amount is deposited after March 1, 1954, with the 
    insurer for payment of a substantial number of future premiums on 
    the contract.

(d) Exceptions

    Subsection (a)(3) shall not apply to any amount paid or accrued by a 
person during a taxable year on indebtedness incurred or continued as 
part of a plan referred to in subsection (a)(3)--
        (1) if no part of 4 of the annual premiums due during the 7-year 
    period (beginning with the date the first premium on the contract to 
    which such plan relates was paid) is paid under such plan by means 
    of indebtedness,
        (2) if the total of the amounts paid or accrued by such person 
    during such taxable year for which (without regard to this 
    paragraph) no deduction would be allowable by reason of subsection 
    (a)(3) does not exceed $100.
        (3) if such amount was paid or accrued on indebtedness incurred 
    because of an unforeseen substantial loss of income or unforeseen 
    substantial increase in his financial obligations, or
        (4) if such indebtedness was incurred in connection with his 
    trade or business.

For purposes of applying paragraph (1), if there is a substantial 
increase in the premiums on a contract, a new 7-year period described in 
such paragraph with respect to such contract shall commence on the date 
of first such increased premium is paid.

(e) Special rules for application of subsection (a)(4)

                    (1) Exception for key persons

        Subsection (a)(4) shall not apply to any interest paid or 
    accrued on any indebtedness with respect to policies or contracts 
    covering an individual who is a key person to the extent that the 
    aggregate amount of such indebtedness with respect to policies and 
    contracts covering such individual does not exceed $50,000.

     (2) Interest rate cap on key persons and pre-1986 contracts

        (A) In general

            No deduction shall be allowed by reason of paragraph (1) or 
        the last sentence of subsection (a) with respect to interest 
        paid or accrued for any month beginning after December 31, 1995, 
        to the extent the amount of such interest exceeds the amount 
        which would have been determined if the applicable rate of 
        interest were used for such month.

        (B) Applicable rate of interest

            For purposes of subparagraph (A)--
            (i) In general

                The applicable rate of interest for any month is the 
            rate of interest described as Moody's Corporate Bond Yield 
            Average-Monthly Average Corporates as published by Moody's 
            Investors Service, Inc., or any successor thereto, for such 
            month.
            (ii) Pre-1986 contracts

                In the case of indebtedness on a contract purchased on 
            or before June 20, 1986--
                    (I) which is a contract providing a fixed rate of 
                interest, the applicable rate of interest for any month 
                shall be the Moody's rate described in clause (i) for 
                the month in which the contract was purchased, or
                    (II) which is a contract providing a variable rate 
                of interest, the applicable rate of interest for any 
                month in an applicable period shall be such Moody's rate 
                for the third month preceding the first month in such 
                period.

          For purposes of subclause (II), the term ``applicable period'' 
            means the 12-month period beginning on the date the policy 
            is issued (and each successive 12-month period thereafter) 
            unless the taxpayer elects a number of months (not greater 
            than 12) other than such 12-month period to be its 
            applicable period. Such an election shall be made not later 
            than the 90th day after the date of the enactment of this 
            sentence and, if made, shall apply to the taxpayer's first 
            taxable year ending on or after October 13, 1995, and all 
            subsequent taxable years unless revoked with the consent of 
            the Secretary.

                           (3) Key person

        For purposes of paragraph (1), the term ``key person'' means an 
    officer or 20-percent owner, except that the number of individuals 
    who may be treated as key persons with respect to any taxpayer shall 
    not exceed the greater of--
            (A) 5 individuals, or
            (B) the lesser of 5 percent of the total officers and 
        employees of the taxpayer or 20 individuals.

                        (4) 20-percent owner

        For purposes of this subsection, the term ``20-percent owner'' 
    means--
            (A) if the taxpayer is a corporation, any person who owns 
        directly 20 percent or more of the outstanding stock of the 
        corporation or stock possessing 20 percent or more of the total 
        combined voting power of all stock of the corporation, or
            (B) if the taxpayer is not a corporation, any person who 
        owns 20 percent or more of the capital or profits interest in 
        the taxpayer.

                        (5) Aggregation rules

        (A) In general

            For purposes of paragraph (4)(A) and applying the $50,000 
        limitation in paragraph (1)--
                (i) all members of a controlled group shall be treated 
            as one taxpayer, and
                (ii) such limitation shall be allocated among the 
            members of such group in such manner as the Secretary may 
            prescribe.

        (B) Controlled group

            For purposes of this paragraph, all persons treated as a 
        single employer under subsection (a) or (b) of section 52 or 
        subsection (m) or (o) of section 414 shall be treated as members 
        of a controlled group.

(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.

    If the amount described in subparagraph (A) with respect to any 
    policy or contract does not reasonably approximate its actual value, 
    the amount taken into account under subparagraph (A) shall be the 
    greater of the amount of the insurance company liability or the 
    insurance company reserve with respect to such policy or contract 
    (as determined for purposes of the annual statement approved by the 
    National Association of Insurance Commissioners) or shall be such 
    other amount as is determined by the Secretary.

          (4) Exception for certain policies and contracts

        (A) Policies and contracts covering 20-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.

        (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).

        (E) Master contracts

            If coverage for each insured under a master contract is 
        treated as a separate contract for purposes of sections 817(h), 
        7702, and 7702A, coverage for each such insured shall be treated 
        as a separate contract for purposes of subparagraph (A). For 
        purposes of the preceding sentence, the term ``master contract'' 
        shall not include any group life insurance contract (as defined 
        in section 848(e)(2)).

      (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).

        (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 for 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 (e)(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.

(Aug. 16, 1954, ch. 736, 68A Stat. 77; Pub. L. 88-272, title II, 
Sec. 215(a), (b), Feb. 26, 1964, 78 Stat. 55; Pub. L. 99-514, title X, 
Sec. 1003(a), (b), Oct. 22, 1986, 100 Stat. 2388; Pub. L. 104-191, title 
V, Sec. 501(a), (b), Aug. 21, 1996, 110 Stat. 2090; Pub. L. 105-34, 
title X, Sec. 1084(a), (b)(1), (c), title XVI, Sec. 1602(f)(1)-(3), Aug. 
5, 1997, 111 Stat. 951, 952, 1094, 1095; Pub. L. 105-206, title VI, 
Sec. 6010(o)(1)-(3)(A), (4)(A), (5), July 22, 1998, 112 Stat. 816; Pub. 
L. 105-277, div. J, title IV, Sec. 4003(i), Oct. 21, 1998, 112 Stat. 
2681-910.)

                       References in Text

    The date of the enactment of this sentence, referred to in subsec. 
(e)(2)(B)(ii), probably means the date of enactment of Pub. L. 105-34, 
which was approved Aug. 5, 1997.

                          Codification

    Another section 1084(b) of Pub. L. 105-34 amended sections 805, 807, 
812, and 832 of this title. Another section 1084(c) of Pub. L. 105-34 
amended section 265 of this title.


                               Amendments

    1998--Subsec. (a)(3). Pub. L. 105-206, Sec. 6010(o)(1), substituted 
``subsection (d)'' for ``subsection (c)''.
    Subsec. (a)(4). Pub. L. 105-206, Sec. 6010(o)(2), substituted 
``subsection (e)'' for ``subsection (d)''.
    Subsec. (f)(3). Pub. L. 105-277 inserted concluding provisions.
    Subsec. (f)(4)(E). Pub. L. 105-206, Sec. 6010(o)(3)(A), added 
subpar. (E).
    Subsec. (f)(5)(A)(iv). Pub. L. 105-206, Sec. 6010(o)(4)(A), struck 
out at end ``Any report required under the preceding sentence shall be 
treated as a statement referred to in section 6724(d)(1).''
    Subsec. (f)(8)(A). Pub. L. 105-206, Sec. 6010(o)(5), substituted 
``subsection (e)(5)(B)'' for ``subsection (d)(5)(B)''.
    1997--Subsec. (a)(1). Pub. L. 105-34, Sec. 1084(a)(1), amended par. 
(1) generally. Prior to amendment, par. (1) read as follows: ``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, when the taxpayer is directly or 
indirectly a beneficiary under such policy.''
    Subsec. (a)(4). Pub. L. 105-34, Sec. 1602(f)(1), added subpars. (A) 
and (B) and concluding provisions and struck out former subpars. (A) and 
(B) and concluding provisions which read as follows:
    ``(A) is an officer or employee of, or
    ``(B) is financially interested in,
any trade or business carried on by the taxpayer.''
    Pub. L. 105-34, Sec. 1084(b)(1), substituted ``individual.'' for 
``individual, who--
        ``(A) is or was an officer or employee, or
        ``(B) is or was financially interested in,
any trade or business carried on (currently or formerly) by the 
taxpayer.''
    Subsecs. (b), (c). Pub. L. 105-34, Sec. 1084(a)(2), added subsec. 
(b) and redesignated former subsec. (b) as (c). Former subsec. (c) 
redesignated (d).
    Subsec. (d). Pub. L. 105-34, Sec. 1084(a)(2), redesignated subsec. 
(c) as (d). Former subsec. (d) redesignated (e).
    Subsec. (d)(2)(B)(ii). Pub. L. 105-34, Sec. 1602(f)(2), amended 
concluding provisions generally. Prior to amendment, concluding 
provisions read as follows: ``For purposes of subclause (II), the 
taxpayer shall elect an applicable period for such contract on its 
return of tax imposed by this chapter for its first taxable year ending 
on or after October 13, 1995. Such applicable period shall be for any 
number of months (not greater than 12) specified in the election and may 
not be changed by the taxpayer without the consent of the Secretary.''
    Subsec. (d)(4)(B). Pub. L. 105-34, Sec. 1602(f)(3), substituted 
``interest in the taxpayer'' for ``interest in the employer''.
    Subsec. (e). Pub. L. 105-34, Sec. 1084(a)(2), redesignated subsec. 
(d) as (e).
    Subsec. (f). Pub. L. 105-34, Sec. 1084(c), added subsec. (f).
    1996--Subsec. (a)(4). Pub. L. 104-191, Sec. 501(a)(1), (b)(1), in 
introductory provisions, substituted ``Except as provided in subsection 
(d), any'' for ``Any'' and inserted ``, or any endowment or annuity 
contracts owned by the taxpayer covering any individual,'' after ``the 
life of any individual''.
    Pub. L. 104-191, Sec. 501(a)(2), struck out ``to the extent that the 
aggregate amount of such indebtedness with respect to policies covering 
such individual exceeds $50,000'' after ``carried on by the taxpayer'' 
in concluding provisions.
    Subsec. (d). Pub. L. 104-191, Sec. 501(b)(2), added subsec. (d).
    1986--Subsec. (a). Pub. L. 99-514 added par. (4) and last sentence 
providing that par. (4) shall apply with respect to contracts purchased 
after June 20, 1986.
    1964--Subsec. (a). Pub. L. 88-272 added par. (3) and sentence 
providing that par. (3) shall apply only to contracts purchased after 
August 6, 1963.
    Subsec. (c). Pub. L. 88-272 added subsec. (c).


                    Effective Date of 1998 Amendments

    Amendment by Pub. L. 105-277 effective as if included in the 
provision of the Taxpayer Relief Act of 1997, Pub. L. 105-34, to which 
such amendment relates, see section 4003(l) of Pub. L. 105-277, set out 
as a note under section 86 of this title.
    Amendment by Pub. L. 105-206 effective, except as otherwise 
provided, as if included in the provisions of the Taxpayer Relief Act of 
1997, Pub. L. 105-34, to which such amendment relates, see section 6024 
of Pub. L. 105-206, set out as a note under section 1 of this title.


                    Effective Date of 1997 Amendment

    Amendment by section 1084(a), (b)(1), (c) of Pub. L. 105-34 
applicable to contracts issued after June 8, 1997, in taxable years 
ending after such date, with special provisions relating to changes in 
contracts to be treated as new contracts, see section 1084(d) of Pub. L. 
105-34, set out as a note under section 101 of this title.
    Amendment by section 1602(f)(1)-(3) of Pub. L. 105-34 effective as 
if included in the provisions of the Health Insurance Portability and 
Accountability Act of 1996, Pub. L. 104-191, to which such amendment 
relates, see section 1602(i) of Pub. L. 105-34, set out as a note under 
section 26 of this title.


                    Effective Date of 1996 Amendment

    Section 501(c) of Pub. L. 104-191, as amended by Pub. L. 105-34, 
title XVI, Sec. 1602(f)(4), Aug. 5, 1997, 111 Stat. 1095, provided that:
    ``(1) In general.--The amendments made by this section [amending 
this section] shall apply to interest paid or accrued after October 13, 
1995.
    ``(2) Transition rule for existing indebtedness.--
        ``(A) In general.--In the case of--
            ``(i) indebtedness incurred before January 1, 1996, or
            ``(ii) indebtedness incurred before January 1, 1997 with 
        respect to any contract or policy entered into in 1994 or 1995,
    the amendments made by this section shall not apply to qualified 
    interest paid or accrued on such indebtedness after October 13, 
    1995, and before January 1, 1999.
        ``(B) Qualified interest.--For purposes of subparagraph (A), the 
    qualified interest with respect to any indebtedness for any month is 
    the amount of interest (otherwise deductible) which would be paid or 
    accrued for such month on such indebtedness if--
            ``(i) in the case of any interest paid or accrued after 
        December 31, 1995, indebtedness with respect to no more than 
        20,000 insured individuals were taken into account, and
            ``(ii) the lesser of the following rates of interest were 
        used for such month:
                ``(I) The rate of interest specified under the terms of 
            the indebtedness as in effect on October 13, 1995 (and 
            without regard to modification of such terms after such 
            date).
                ``(II) The applicable percentage of the rate of interest 
            described as Moody's Corporate Bond Yield Average-Monthly 
            Average Corporates as published by Moody's Investors 
            Service, Inc., or any successor thereto, for such month.
    For purposes of clause (i), all persons treated as a single employer 
    under subsection (a) or (b) of section 52 of the Internal Revenue 
    Code of 1986 or subsection (m) or (o) of section 414 of such Code 
    shall be treated as 1 person. Subclause (II) of clause (ii) shall 
    not apply to any month before January 1, 1996.
        ``(C) Applicable percentage.--For purposes of subparagraph (B), 
    the applicable percentage is as follows:

For calendar year:                                    The percentage is:
  1996..................................................... 100 percent  

  1997......................................................  90 percent  

           1998....................................................  80 
                                                              percent.''


                    Effective Date of 1986 Amendment

    Section 1003(c) of Pub. L. 99-514 provided that: ``The amendments 
made by this section [amending this section] shall apply to contracts 
purchased after June 20, 1986, in taxable years ending after such 
date.''


                    Effective Date of 1964 Amendment

    Section 215(c) of Pub. L. 88-272 provided that: ``The amendments 
made by this section [amending this section] shall apply with respect to 
amounts paid or accrued in taxable years beginning after December 31, 
1963.''


       Spread of Income Inclusion on Surrender, Etc. of Contracts

    Section 501(d) of Pub. L. 104-191, as amended by Pub. L. 105-34, 
title XVI, Sec. 1602(f)(5), Aug. 5, 1997, 111 Stat. 1095, provided that:
    ``(1) In general.--If any amount is received under any life 
insurance policy or endowment or annuity contract described in paragraph 
(4) of section 264(a) of the Internal Revenue Code of 1986--
        ``(A) on the complete surrender, redemption, or maturity of such 
    policy or contract during calendar year 1996, 1997, or 1998, or
        ``(B) in full discharge during any such calendar year of the 
    obligation under the policy or contract which is in the nature of a 
    refund of the consideration paid for the policy or contract,
then (in lieu of any other inclusion in gross income) such amount shall 
be includible in gross income ratably over the 4-taxable year period 
beginning with the taxable year such amount would (but for this 
paragraph) be includible. The preceding sentence shall only apply to the 
extent the amount is includible in gross income for the taxable year in 
which the event described in subparagraph (A) or (B) occurs.
    ``(2) Special rules for applying section 264.--A contract shall not 
be treated as--
        ``(A) failing to meet the requirement of section 264(c)(1) of 
    the Internal Revenue Code of 1986, or
        ``(B) a single premium contract under section 264(b)(1) of such 
    Code,
solely by reason of an occurrence described in subparagraph (A) or (B) 
of paragraph (1) of this subsection or solely by reason of a lapse 
occurring after October 13, 1995, by reason of no additional premiums 
being received under the contract.
    ``(3) Special rule for deferred acquisition costs.--In the case of 
the occurrence of any event described in subparagraph (A) or (B) of 
paragraph (1) of this subsection with respect to any policy or 
contract--
        ``(A) section 848 of the Internal Revenue Code of 1986 shall not 
    apply to the unamortized balance (if any) of the specified policy 
    acquisition expenses attributable to such policy or contract 
    immediately before the insurance company's taxable year in which 
    such event occurs, and
        ``(B) there shall be allowed as a deduction to such company for 
    such taxable year under chapter 1 of such Code an amount equal to 
    such unamortized balance.''

                  Section Referred to in Other Sections

    This section is referred to in sections 101, 265, 419, 805, 807, 
812, 832, 6724 of this title.
