Bank Owned Life Insurance in the M&A Arena

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Joseph M. Press, CPA, CFE

Many banks now own BOLI (bank owned life insurance). While the day-to-day accounting and handling of death benefits received are fairly straight forward for financial reporting and tax purposes, an institution on the selling side of an M&A transaction with BOLI may face additional tax considerations based on the structure and terms of the sale agreement. This article will address some of those tax considerations.

Transactions structured as a stock purchase or merger for both book and tax purposes.

In a transaction that is structured as a stock purchase or merger for both book and tax purposes, the shareholders are considered to be selling their interest in the institution. For its part, the institution is not selling any of its assets, including the BOLI. In this case, the tax will be at the shareholder level based on the gain (loss) realized on the difference between the sales proceeds received and the shareholder’s tax basis of the stock.

What if we had a transaction structured as described above, but the buyer is not interested in the BOLI and insists the selling institution surrender the policies before the deal closes? Under this scenario, the selling institution would realize ordinary income calculated as the cash surrender value less the aggregate premiums paid on the policy. The taxation of this BOLI transaction is governed by Internal Revenue Code Section 72. Also, some BOLI is considered to be a Modified Endowment Contract (MEC) for tax purposes and early redemption can trigger an additional 10% excise tax.

Transactions structured or otherwise treated as purchase of assets and assumption of liabilities (P&A)

In a P&A transaction, the selling institution will be deemed to have sold all of its assets, including the BOLI, to the buyer. Under this transaction, the seller recognizes gain based on the difference between the purchase price allocated to the policy(s) and the aggregate premiums paid on the policy, minus the cost-of-insurance charges. The gain is characterized as ordinary income up to the inside buildup on the policy. The excess gain, if any, would be treated as a long-term capital gain. The taxation of this BOLI transaction is not governed by IRC 72, but the various rules for recognizing gain and loss on the sale of assets.

While the taxation of BOLI in an M&A transaction would not normally be a large item, knowing the tax outcome will help minimize unwanted surprises.

The principles set forth in this article are further articulated in Revenue Ruling 2009-13.