
From the U.S. Code Online via GPO Access
[wais.access.gpo.gov]
[Laws in effect as of January 2, 2001]
[Document affected by Public Law 106-554 Section 1(a)(7)]
[Document affected by Public Law 106-554 Section 1(a)(7)]
[CITE: 26USC7702A]

 
                     TITLE 26--INTERNAL REVENUE CODE
 
                Subtitle F--Procedure and Administration
 
                         CHAPTER 79--DEFINITIONS
 
Sec. 7702A. Modified endowment contract defined


(a) General rule

    For purposes of section 72, the term ``modified endowment contract'' 
means any contract meeting the requirements of section 7702--
        (1) which--
            (A) is entered into on or after June 21, 1988, and
            (B) fails to meet the 7-pay test of subsection (b), or

        (2) which is received in exchange for a contract described in 
    paragraph (1) or this paragraph.

(b) 7-pay test

    For purposes of subsection (a), a contract fails to meet the 7-pay 
test of this subsection if the accumulated amount paid under the 
contract at any time during the 1st 7 contract years exceeds the sum of 
the net level premiums which would have been paid on or before such time 
if the contract provided for paid-up future benefits after the payment 
of 7 level annual premiums.

(c) Computational rules

                           (1) In general

        Except as provided in this subsection, the determination under 
    subsection (b) of the 7 level annual premiums shall be made--
            (A) as of the time the contract is issued, and
            (B) by applying the rules of section 7702(b)(2) and of 
        section 7702(e) (other than paragraph (2)(C) thereof), except 
        that the death benefit provided for the 1st contract year shall 
        be deemed to be provided until the maturity date without regard 
        to any scheduled reduction after the 1st 7 contract years.

            (2) Reduction in benefits during 1st 7 years

        (A) In general

            If there is a reduction in benefits under the contract 
        within the 1st 7 contract years, this section shall be applied 
        as if the contract had originally been issued at the reduced 
        benefit level.

        (B) Reductions attributable to nonpayment of premiums

            Any reduction in benefits attributable to the nonpayment of 
        premiums due under the contract shall not be taken into account 
        under subparagraph (A) if the benefits are reinstated within 90 
        days after the reduction in such benefits.

                  (3) Treatment of material changes

        (A) In general

            If there is a material change in the benefits under (or in 
        other terms of) the contract which was not reflected in any 
        previous determination under this section, for purposes of this 
        section--
                (i) such contract shall be treated as a new contract 
            entered into on the day on which such material change takes 
            effect, and
                (ii) appropriate adjustments shall be made in 
            determining whether such contract meets the 7-pay test of 
            subsection (b) to take into account the cash surrender value 
            under the old contract.

        (B) Treatment of certain benefit increases

            For purposes of subparagraph (A), the term ``material 
        change'' includes any increase in the death benefit under the 
        contract or any increase in, or addition of, a qualified 
        additional benefit under the contract. Such term shall not 
        include--
                (i) any increase which is attributable to the payment of 
            premiums necessary to fund the lowest level of the death 
            benefit and qualified additional benefits payable in the 1st 
            7 contract years (determined after taking into account death 
            benefit increases described in subparagraph (A) or (B) of 
            section 7702(e)(2)) or to crediting of interest or other 
            earnings (including policyholder dividends) in respect of 
            such premiums, and
                (ii) to the extent provided in regulations, any cost-of-
            living increase based on an established broad-based index if 
            such increase is funded ratably over the remaining period 
            during which premiums are required to be paid under the 
            contract.

       (4) Special rule for contracts with death benefits of 
                               $10,000 or less

        In the case of a contract--
            (A) which provides an initial death benefit of $10,000 or 
        less, and
            (B) which requires at least 7 nondecreasing annual premium 
        payments,

    each of the 7 level annual premiums determined under subsection (b) 
    (without regard to this paragraph) shall be increased by $75. For 
    purposes of this paragraph, the contract involved and all contracts 
    previously issued to the same policyholder by the same company shall 
    be treated as one contract.

      (5) Regulatory authority for certain collection expenses

        The Secretary may by regulations prescribe rules for taking into 
    account expenses solely attributable to the collection of premiums 
    paid more frequently than annually.

       (6) Treatment of certain contracts with more than one 
                                   insured

        If--
            (A) a contract provides a death benefit which is payable 
        only upon the death of 1 insured following (or occurring 
        simultaneously with) the death of another insured, and
            (B) there is a reduction in such death benefit below the 
        lowest level of such death benefit provided under the contract 
        during the 1st 7 contract years,

    this section shall be applied as if the contract had originally been 
    issued at the reduced benefit level.

(d) Distributions affected

    If a contract fails to meet the 7-pay test of subsection (b), such 
contract shall be treated as failing to meet such requirements only in 
the case of--
        (1) distributions during the contract year in which the failure 
    takes effect and during any subsequent contract year, and
        (2) under regulations prescribed by the Secretary, distributions 
    (not described in paragraph (1)) in anticipation of such failure.

For purposes of the preceding sentence, any distribution which is made 
within 2 years before the failure to meet the 7-pay test shall be 
treated as made in anticipation of such failure.

(e) Definitions

    For purposes of this section--

                           (1) Amount paid

        (A) In general

            The term ``amount paid'' means--
                (i) the premiums paid under the contract, reduced by
                (ii) amounts to which section 72(e) applies (determined 
            without regard to paragraph (4)(A) thereof) but not 
            including amounts includible in gross income.

        (B) Treatment of certain premiums returned

            If, in order to comply with the requirements of subsection 
        (b), any portion of any premium paid during any contract year is 
        returned by the insurance company (with interest) within 60 days 
        after the end of such contract year, the amount so returned 
        (excluding interest) shall be deemed to reduce the sum of the 
        premiums paid under the contract during such contract year.

        (C) Interest returned includible in gross income

            Notwithstanding the provisions of section 72(e), the amount 
        of any interest returned as provided in subparagraph (B) shall 
        be includible in the gross income of the recipient.

                          (2) Contract year

        The term ``contract year'' means the 12-month period beginning 
    with the 1st month for which the contract is in effect, and each 12-
    month period beginning with the corresponding month in subsequent 
    calendar years.

                           (3) Other terms

        Except as otherwise provided in this section, terms used in this 
    section shall have the same meaning as when used in section 7702.

(Added Pub. L. 100-647, title V, Sec. 5012(c)(1), Nov. 10, 1988, 102 
Stat. 3662; amended Pub. L. 101-239, title VII, Secs. 7647(a), 
7815(a)(1), (4), Dec. 19, 1989, 103 Stat. 2382, 2414; Pub. L. 106-554, 
Sec. 1(a)(7) [title III, Sec. 318(a)(1), (2)], Dec. 21, 2000, 114 Stat. 
2763, 2763A-645.)


                               Amendments

    2000--Subsec. (a)(2). Pub. L. 106-554, Sec. 1(a)(7) [title III, 
Sec. 318(a)(1)], inserted ``or this paragraph'' before period at end.
    Subsec. (c)(3)(A)(ii). Pub. L. 106-554, Sec. 1(a)(7) [title III, 
Sec. 318(a)(2)], substituted ``under the old contract'' for ``under the 
contract''.
    1989--Subsec. (c)(3)(B). Pub. L. 101-239, Sec. 7815(a)(1), 
substituted ``benefit increases'' for ``increases in future benefits'' 
in heading and amended text generally. Prior to amendment, text read as 
follows: ``For purposes of subparagraph (A), the term `material change' 
includes any increase in future benefits under the contract. Such term 
shall not include--
        ``(i) any increase which is attributable to the payment of 
    premiums necessary to fund the lowest level of future benefits 
    payable in the 1st 7 contract years (determined after taking into 
    account death benefit increases described in subparagraph (A) or (B) 
    of section 7702(e)(2)) or to crediting of interest or other earnings 
    (including policyholder dividends) in respect of such premiums, and
        ``(ii) to the extent provided in regulations, any cost-of-living 
    increase based on an established broad-based index if such increase 
    is funded ratably over the remaining life of the the contract.''
    Subsec. (c)(4). Pub. L. 101-239, Sec. 7815(a)(4), substituted ``of 
$10,000 or less'' for ``under $10,000'' in heading and ``the same 
policyholder'' for ``the same insurer'' in concluding provisions.
    Subsec. (c)(6). Pub. L. 101-239, Sec. 7647(a), added par. (6).


                    Effective Date of 2000 Amendment

    Pub. L. 106-554, Sec. 1(a)(7) [title III, Sec. 318(a)(3)], Dec. 21, 
2000, 114 Stat. 2763, 2763A-645, provided that: ``The amendments made by 
this subsection [amending this section] shall take effect as if included 
in the amendments made by section 5012 of the Technical and 
Miscellaneous Revenue Act of 1988 [Pub. L. 100-647].''


                    Effective Date of 1989 Amendment

    Section 7647(b) of Pub. L. 101-239 provided that: ``The amendment 
made by subsection (a) [amending this section] shall apply to contracts 
entered into on or after September 14, 1989.''
    Amendment by section 7815(a)(1), (4) of Pub. L. 101-239 effective, 
except as otherwise provided, as if included in the provision of the 
Technical and Miscellaneous Revenue Act of 1988, Pub. L. 100-647, to 
which such amendment relates, see section 7817 of Pub. L. 101-239, set 
out as a note under section 1 of this title.


                             Effective Date

    Section 5012(e) of Pub. L. 100-647, as amended by Pub. L. 101-239, 
title VII, Sec. 7815(a)(2), Dec. 19, 1989, 103 Stat. 2414, provided 
that:
    ``(1) In general.--Except as otherwise provided in this subsection, 
the amendments made by this section [enacting this section and amending 
sections 26 and 72 of this title] shall apply to contracts entered into 
on or after June 21, 1988.
    ``(2) Special rule where death benefit increases by more than 
$150,000.--If the death benefit under the contract increases by more 
than $150,000 over the death benefit under the contract in effect on 
October 20, 1988, the rules of section 7702A(c)(3) of the 1986 Code (as 
added by this section) shall apply in determining whether such contract 
is issued on or after June 21, 1988. The preceding sentence shall not 
apply in the case of a contract which, as of June 21, 1988, required at 
least 7 level annual premium payments and under which the policyholder 
makes at least 7 level annual premium payments.
    ``(3) Certain other material changes taken into account.--A contract 
entered into before June 21, 1988, shall be treated as entered into 
after such date if--
        ``(A) on or after June 21, 1988, the death benefit under the 
    contract is increased (or a qualified additional benefit is 
    increased or added) and before June 21, 1988, the owner of the 
    contract did not have a unilateral right under the contract to 
    obtain such increase or addition without providing additional 
    evidence of insurability, or
        ``(B) the contract is converted after June 20, 1988, from a term 
    life insurance contract to a life insurance contract providing 
    coverage other than term life insurance coverage without regard to 
    any right of the owner of the contract to such conversion.
    ``(4) Certain exchanges permitted.--In the case of a modified 
endowment contract which--
        ``(A) required at least 7 annual level premium payments,
        ``(B) is entered into after June 20, 1988, and before the date 
    of the enactment of this Act [Nov. 10, 1988], and
        ``(C) is exchanged within 3 months after such date of enactment 
    for a life insurance contract which meets the requirements of 
    section 7702A(b),
the contract which is received in exchange for such contract shall not 
be treated as a modified endowment contract if the taxpayer elects, 
notwithstanding section 1035 of the 1986 Code, to recognize gain on such 
exchange.
    ``(5) Special rule for annuity contracts.--In the case of annuity 
contracts, the amendments made by subsection (d) [amending section 72 of 
this title] shall apply to contracts entered into after October 21, 
1988.''

                  Section Referred to in Other Sections

    This section is referred to in sections 72, 264, 817A of this title.
