§ 7702A. — Modified endowment contract defined.
[Laws in effect as of January 7, 2003]
[Document not affected by Public Laws enacted between
January 7, 2003 and December 19, 2003]
[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 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; Pub. L. 107-147, title IV, Sec. 416(f), Mar. 9, 2002,
116 Stat. 55.)
Amendments
2002--Subsec. (c)(3)(A)(ii). Pub. L. 107-147 repealed Pub. L. 106-
554, Sec. 1(a)(7) [title III, Sec. 318(a)(2)]. See 2000 Amendment note
below.
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)], which substituted ``under the old contract'' for
``under the contract'', was repealed by Pub. L. 107-147. See
Construction of 2002 Amendment note below.
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.''
Construction of 2002 Amendment
Pub. L. 107-147, title IV, Sec. 416(f), Mar. 9, 2002, 116 Stat. 55,
provided that: ``Paragraph (2) of section 318(a) of the Community
Renewal Tax Relief Act of 2000 [H.R. 5662, as enacted by section 1(a)(7)
of Pub. L. 106-554](114 Stat. 2763A-645) [amending this section] is
repealed, and clause (ii) of section 7702A(c)(3)(A) shall read and be
applied as if the amendment made by such paragraph had not been
enacted.''
Section Referred to in Other Sections
This section is referred to in sections 72, 264, 817A of this title.
