I have to admire Scott V. White for taking his case to Tax Court. I don’t care what the law is. He should have won, although like most of the people who get blindsided by life insurance company 1099’s he lost. Mr. White bought a Mass Mutual Life Insurance policy through his employer in 1992. The decision does not indicate what the face amount of the policy was. Mr. White paid about $22,000 in premiums through payroll withholding. Apparently, in his mind, he abandoned the policy when he moved on to another job. There was enough value in the policy to keep it in force for over a decade.
Finally in 2008, Mass Mutual sent Mr. White a 1099 that showed a gross distribution of over $25,167.01. Since his investment in the contract was about $22,077.09 that left a taxable amount of $3,089.92. Mr. White asked Mass Mutual to explain:
Petitioner wrote to Mass Mutual and requested a “letter/statement” explaining the $3,089.92 and the code 7 on the Form 1099-R. Mass Mutual explained in its response that petitioner’s life insurance policy lapsed on September 25, 2008, with an outstanding loan. According to Mass Mutual, petitioner’s “net cost basis” was $22,077.09 and his “Loan and Loan Interest Amount” was $25,167.01, leaving a “Taxable Gain” of $3,089.92. Mass Mutual further stated that the distribution code 7 in box 7 indicated that his distribution was a “normal distribution” and that it was not subject to early withdrawal penalties.
Mass Mutual also sent petitioner a second letter explaining his insurance policy provisions. In that second letter Mass Mutual advised petitioner that his policy was issued with an automatic premium loan provision. Under this provision, according to Mass Mutual, if any premium payment is not made by the end of the grace period, the amount due will automatically become a loan against the cash value of the policy, provided there is sufficient value in the policy. Mass Mutual advised that interest accrues on the loans and, if not paid when due, is added to the loan balance. The letter further informed petitioner that when his policy no longer had enough value to support a loan to cover the premium obligation, the policy lapsed with a loan outstanding, creating taxable income to him that Mass Mutual was required to report to the Internal Revenue Service.
I probably would have said to heck with it at that point and paid the $577 in extra tax, that, in my mind, is absolutely unfair. Mr. White took it to the Tax Court. He had a very simple point:
Petitioner argues that he never received any money from Mass Mutual and he does not understand how he could owe tax on money he has not received. The record does not contain a copy of the insurance policy, nor does it reflect an accounting of payments, loans, interest, or dividends.
He lost, as do most people who bring these cases. The defenders of this unfair result will point out that Mr. White did have a benefit from the “loans” against the value of the policy. That “benefit” was insurance coverage for over decade. The flaw in that argument is that it is insurance coverage that he was not aware that he had. So had he died, say in 2002, his beneficiaries would not have known to put in a claim.
Companies like Mass Mutual are being “encouraged” by state treasurers to run the records of their insureds against the Social Security Death Master File. That’s an awful lot of trouble to go to. It is just so much simpler to keep going with the automatic policy loans until the policy burns itself out. If the company found out that the insured had died, it would have to look for the beneficiaries and if they could not be found turn over policy proceeds to one of the states as unclaimed property. According to this story, some companies use the Social Security death file as a source to make sure that they are not continuing annuity payments, but for determining that life insurance payments need to be made, not so much. The West Virginia State Treasurer recently filed a lawsuit against ten companies including Mass Mutual on this issue.
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Originally published on Forbes.com Nov 4th, 2012