Rev Proc 2001-42

Part III. Administrative, Procedural, and Miscellaneous
Limitations on Passive Activity
Losses and Credits—Treatment
of Self-Charged Items of Income
and Expense

26 CFR § 301.7121–1: Closing agreements.
(Also Part 1, section 7702A)

Notice 2001–47

SECTION 1. PURPOSE

On April 5, 1991, the Treasury Department and the Internal Revenue Service published in the Federal Register a notice of proposed rulemaking (PS–39–89, 1991–1 C.B.
983 [56 Fed. Reg. 14034]) relating to the
treatment of self-charged items of income
and expense for purposes of applying the
limitations on passive activity losses and
passive activity credits under § 469 of the Internal Revenue Code. The comment period
for those regulations ended in 1991 and several comments were received.
Treasury and the Service intend to finalize regulations under § 1.469–7.
Given the length of time since the regulations were proposed and the number of
amendments that have been made to the
statutory provisions since that time, Treasury and the Service believe that an additional comment period is appropriate.
Consideration will be given to all comments previously submitted in response to
the notice of proposed rulemaking published in 1991 as well as to any additional
written comments on proposed regulations § 1.469–7 that are submitted timely
to the Service in response to this notice.
Written (a signed original and eight (8)
copies) or electronic comments must be received by November 5, 2001. Send written
comments to: Internal Revenue Service,
NT 2001–47, CC:PSI:3, P.O. Box 7604,
Ben Franklin Station, Washington, DC.
Comments may be hand delivered Monday
through Friday between the hours of 8 a.m.
and 5 p.m. to the courier’s desk at 1111
Constitution Avenue, NW, Washington, DC.
Alternatively, taxpayers may submit comments electronically to Notice.Com
[email protected]. All submissions will be open to public inspection.
The principal author of this notice is
Paul B. Myers of the Office of Associate
Chief Counsel (Passthroughs and Special
Industries). For further information regarding this notice, contact Paul B. Myers
or Danielle Grimm at (202) 622-3080 (not
a toll-free call).

This revenue procedure provides the
procedures by which an issuer may remedy an inadvertent non-egregious failure
to comply with the modified endowment
contract rules under § 7702A of the Internal Revenue Code.

September 4, 2001

Rev. Proc. 2001–42

SECTION 2. BACKGROUND
.01 Definition of a modified endowment
contract (“MEC”).
(1) Section 7702A(a) provides that a
life insurance contract is a MEC if the
contract—
(a) is entered into on or after June
21, 1988, and fails to meet the “7-pay
test” of § 7702A(b), or
(b) is received in exchange for a
contract described in paragraph (a) of this
section 2.01(1).
(2) A contract fails to meet the 7-pay
test if the accumulated amount paid under
the contract at any time during the first 7
contract years exceeds the sum of the net
level premiums which would have to be
paid on or before such time if the contract
were to provide for paid-up “future benefits” (as defined in §§ 7702A(e)(3) and
7702(f)(4)) after the payment of 7 level
annual premiums.
(3) Section 72(e)(11) provides that,
for purposes of determining amounts includible in gross income, all MECs issued
by the same company to the same contract
holder during any calendar year are
treated as one MEC.
.02 Tax treatment of amounts received
under a MEC. Section 72(e)(10) provides
that a MEC is subject to the rules of
§ 72(e)(2)(B), which tax non-annuity distributions on an income-out-first basis,
and the rules of § 72(e)(4)(A) (as
modified by §§ 72(e)(10)(A)(ii) and
72(e)(10)(B)), which generally deem
loans and assignments or pledges of any
portion of the value of a MEC to be nonannuity distributions. Moreover, under
§ 72(v), the portion of any annuity or nonannuity distribution received under a
MEC that is includible in gross income is

212

subject to a 10% additional tax unless the
distribution is made on or after the date on
which the taxpayer attains age 59 1/2, is attributable to the taxpayer’s becoming disabled (within the meaning of § 72(m)(7)),
or is part of a series of substantially equal
periodic payments (not less frequently than
annually) made for the life (or life expectancy) of the taxpayer or the joint lives
(or joint life expectancies) of such taxpayer
and the taxpayer’s beneficiary.
.03 Need for a correction mechanism.
(1) The Internal Revenue Service
(“Service”) became aware of situations in
which, as a result of inadvertent non-egregious failures to comply with the MEC
rules, life insurance premiums had been
collected which exceed the 7-pay limit
provided by § 7702A(b). This could produce significant unforeseen tax consequences for the contract holders. To allow
issuers to remedy such situations, Rev.
Proc. 99–27, 1999–1 C.B. 1186, set forth
the circumstances under which the Service
would enter into closing agreements which
would provide that contracts identified in
the closing agreements would not be
treated as MECs. Rev. Proc. 99–27 applied only to requests for relief that were
received by the Service on or before May
31, 2001, generally permitted an issuer to
make only one request for correction, and
excluded certain contracts from the procedure’s correction mechanism.
(2) Some issuers were unable to
comply with the May 31, 2001, deadline
in Rev. Proc. 99–27 or filed a timely submission for some contracts but desire to
file supplemental submissions for additional contracts. Also, issuers desire to
correct contracts that were not correctable
under Rev. Proc. 99–27. To allow issuers
to remedy such situations, the Service
under the circumstances described below
will enter into closing agreements which
will provide that contracts identified in
the closing agreements will not be treated
as MECs.
SECTION 3. DEFINITIONS
The following definitions and rules
apply solely for purposes of this revenue
procedure.
.01 Testing period. The 7-year period
described in § 7702A(b) or such addi-

2001–36 I.R.B.

tional period as may be required under
§ 7702A(c)(3) if a contract undergoes a
material change.
.02 Amount paid. The amount paid
under a contract in any “contract year” (as
defined in § 7702A(e)(2)) equals the premiums paid for the contract during the
year, reduced by amounts to which
§ 72(e) applies (determined without regard to § 72(e)(4)(A)) but not including
amounts includible in gross income. For
this purpose, premiums paid do not include—
(1) any portion of any premium paid
during the contract year that is returned
(with interest) to the contract holder
within 60 days after the end of the contract year in order to comply with the 7pay test, or
(2) the “cash surrender value” (as defined in § 7702(f)(2)(A)) of another life
insurance contract (other than a contract
that fails the 7-pay test) exchanged for the
contract.
.03 7-pay premium. (1) In general. Except as otherwise provided in section
3.03(2) of this revenue procedure, the 7pay premium for a contract is the net level
premium (computed in accordance with
the rules in § 7702A(c)) that would have to
be paid for the contract if the contract were
to provide for paid up future benefits after
the payment of 7 level annual premiums.
(2) 7-pay premium for a contract
that undergoes a material change. If a
contract (other than a contract that fails
the 7-pay test) is materially changed, the
contract is treated as newly issued on the

2001–36 I.R.B.

date of the material change and the 7-pay
premium for the changed contract is an
amount equal to the excess, if any, of—
(a) the net level premium (computed in accordance with the rules in
§ 7702A(c)) that would have to be paid
for the changed contract if the contract
were to provide for paid up future benefits
after the payment of 7 level annual premiums, over
(b) a “proportionate share of the
cash surrender value” (as defined in section 3.04 of this revenue procedure) under
the contract.
.04 Proportionate share of cash surrender value. The proportionate share of the
cash surrender value of a contract is the
amount obtained by multiplying—
(1) the “cash surrender value” (as defined in § 7702(f)(2)(A)) of the contract,
by
(2) a fraction, the numerator of
which is the net level premium (computed
in accordance with the rules in
§ 7702A(c)) that would have to be paid
for the changed or new contract if such
contract were to provide for paid up future benefits after the payment of 7 level
annual premiums, and the denominator of
which is the net single premium (determined using the rules in § 7702) for such
contract at that time.
.05 Overage. A contract’s overage is
the amount of the excess, if any, of—
(1) the sum of amounts paid under
the contract during the testing period for
the contract year and all prior contract
years, over

(2) the sum of the 7-pay premiums
for the contract year and all prior contract
years of the testing period.
.06 Overage earnings. The overage
earnings for a contract year is the amount
obtained by multiplying—
(1) the sum of a contract’s overage
for the contract year and its cumulative
overage earnings for all prior contract
years, by—
(2) the earnings rate set forth in section 3.07 of this revenue procedure.
.07 Earnings rates. (1) Contracts other
than variable contracts. Except as otherwise provided in sections 3.07(3) and
3.07(8) of this revenue procedure, the
earnings rate applicable to a contract year
is the “general account total return” (as
defined in section 3.07(2) of this revenue
procedure) for the calendar year in which
the contract year begins.
(2) General account total return.
The general account total return is the calendar year arithmetic average of the
monthly interest rates described as
Moody’s Corporate Bond Yield Average Monthly Average Corporates as published
by Moody’s Investors Service Inc., or any
successor thereto.
(3)Variable contracts described in
§ 817(d). (a) Pre-2001 contract years.
The earnings rate applicable to a contract
year that begins before January 1, 2001, is
the rate set forth in the following table for
the calendar year in which the contract
year begins.

Calendar Year

Earnings Rate

1988

13.5%

1989

17.4%

1990

1.4%

1991

25.4%

1992

5.9%

1993

13.9%

1994

-1.0%

1995

23.0%

1996

14.3%

1997

17.8%

1998

19.7%

1999

12.8%

2000

-5.5%

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September 4, 2001

(b) Post-2000 contract years. Except as otherwise provided in section
3.07(8), the earnings rate applicable to a
contract year that begins after December
31, 2000, is equal to the sum of—
(i) 10 percent of the general
account total return (as defined in section
3.07(2) of this revenue procedure), and
(ii) 90 percent of the “separate
account total return” (as defined in section
3.07(4) of this revenue procedure) for the
calendar year in which the contract year
begins.
(4) Separate account total return.
Except as otherwise provided in section
3.07(8), the separate account total return
equals—
(a) 75 percent of the “equity fund
total return” (as defined in section 3.07(5)
of this revenue procedure), plus
(b) 25 percent of the “bond fund
total return” (as defined in section 3.07(6)
of this revenue procedure), less
(c) 1.1 percentage point.
(5) Equity fund total return. The equity fund total return equals—
(a) the “calendar year percentage
return” (as defined in section 3.07(7) of
this revenue procedure) represented by
the end-of-year values of the Standard
and Poor’s (S&P) 500 Total Return Index,
with daily dividend reinvestment, as published by The McGraw-Hill Companies,
Inc., or any successor thereto, less
(b) 1.5 percentage point.
(6) Bond Fund Total Return. The
bond fund total return equals—
(a) the “calendar year percentage
return” (as defined in section 3.07(7) of
this revenue procedure) represented by
the end-of-year values of the Merrill
Lynch Corporate Bond Master Bond
Index, Total Return, as published by Merrill Lynch & Company, Inc., or any successor thereto, less
(b) 1.0 percentage point.
(7) Calendar year percentage return.
The calendar year percentage return for
an index described in section 3.07(5) or
section 3.07(6) of this revenue procedure
is calculated by—
(a) dividing the end-of-year value
of the index for the calendar year by the
end-of-year value of the index for the immediately preceding calendar year, and
(b) subtracting 1 from the result
obtained under paragraph (a) of this section 3.07(7).

September 4, 2001

(8) If the general account total return
or the separate account total return for a
calendar year cannot be determined because the calendar year in which the contract year begins has not ended, then the
earnings rate for the contract year (or portion thereof) is determined using the general account total return and, if applicable,
the average separate account total return,
for the 3 calendar years immediately preceding the calendar year in which the contract year begins.
.08 Proportionate share of overage
earnings allocable to taxable distributions. The proportionate share of overage
earnings allocable to taxable distributions
under a contract is the amount obtained
by multiplying—
(1) the total amount of the taxable
distributions under the contract, by
(2) a fraction, the numerator of
which is the contract’s cumulative overage earnings and the denominator of
which is the total income on the contract.
.09 Total income on a contract. The
total income on a contract as of any date
is an amount equal to the excess, if any,
of—
(1) the contract’s cash surrender
value (as defined in § 7702(f)(2)(A)) on
such date, over
(2) the premiums paid under the contract before such date, reduced by
amounts to which § 72(e) applies (determined without regard to § 72(e)(4)(A))
but not including amounts includible in
the contract holder’s gross income.
.10 Distribution frequency factor. The
distribution frequency factor for a contract is—
(1) .8, if—
(a) the interest rate with respect to
any portion of a policy loan that could be
made under the contract at any time (including policy loans that could be made
after a contractually specified date in the
future) is guaranteed not to exceed the
sum of:
(i) 1 percentage point, plus
(ii) the rate at which earnings
are credited to the portion of the contract’s
cash surrender value (as defined in
§ 7702(f)(2)(A)) that is allocable to such
portion of the policy loan; or
(b) the contract holder has an option to make a partial withdrawal of the
contract’s cash surrender value that reduces the “death benefit” (as defined in

214

§ 7702(f)(3)) under the contract by less
than an amount determined by multiplying—
(i) the death benefit under the
contract immediately before the withdrawal, by
(ii) the percentage obtained
by dividing the withdrawn amount by the
contract’s cash surrender value (as defined in § 7702(f)(2)(A)) immediately before
the withdrawal; and
(2) .5 for all other contracts.
.11 Applicable percentage. (1) In general. The applicable percentage for a contract is—
(a) 15%, if the death benefit under
the contract is less than $50,000,
(b) 28%, if the death benefit under
the contract is equal to or exceeds
$50,000 but is less than $180,000, and
(c) 36%, if the death benefit under
the contract is equal to or exceeds
$180,000.
(2) Determination of amount of
death benefit. For purposes of determining the applicable percentage, the death
benefit under the contract will be the
death benefit (as defined in section
7702(f)(3)) as of any date within 120 days
of the date of the request for closing
agreement, or the last day the contract is
in force.
.12 Reported amount. The reported
amount for a contract is the amount that—
(1) the issuer reports on a timely
filed information return as includible in
the contract holder’s gross income, or
(2) the contract holder includes in
gross income on a timely filed income tax
return.
.13 Aggregation of contracts. All
MECs issued by the same issuer to the
same contract holder during any calendar
year are treated as one MEC.
SECTION 4. SCOPE
.01 Applicability. Except as provided
in section 4.02 of this revenue procedure,
the issuer of a contract can use this revenue procedure to remedy the failure of
the contract to comply with the requirements of § 7702A.
.02 Inapplicability. The Service may
exclude a contract from the correction
mechanism provided under this revenue
procedure if the contract’s status as a
MEC resulted from a failure to comply
with the requirements of § 7702A that—

2001–36 I.R.B.

(1) are attributable to one or more
defective interpretations or positions that
the Service determines to be a significant
feature of a program to sell investment
oriented contracts, or
(2) arises where the controlling
statutory provision, as supplemented by
any legislative history or guidance published by the Service, is clear on its face
and the Service determines that failure to
follow the provision results in a significant increase in the investment orientation
of a contract.
.03 Example. Pursuant to section 4.02,
the Service generally will not apply the
correction mechanism under this revenue
procedure to a MEC if the contract provides for paid-up future benefits after the
payment of less than 7 level annual premiums.
SECTION 5. PROCEDURE
.01 Request for a ruling. An issuer that
seeks relief under this revenue procedure
must submit a request for a ruling that
meets the requirements of Rev. Proc.
2001–1, 2001–1 I.R.B. 1 (or any successor). Additionally, the submission must
contain the following information:
(1) a specimen copy of each contract
form;
(2) the policy number and original
issue date for each contract;
(3) the taxpayer identification number of each contract holder;
(4) the “death benefit” (as defined in
section 7702(f)(3)) under each contract
for purposes of determining the 7-pay
premium for the contract;
(5) the 7-pay premium assumed by
the issuer when the contract was issued;
(6) the cash surrender value (within
the meaning of § 7702(f)(2)(A)) of each
contract at the end of each contract year;
(7) a description of the defect[s] that
caused the contract[s] to fail to comply
with the 7-pay test, including an explanation of how and why the defect[s] arose;
(8) a description of the administrative procedures the issuer has implemented to ensure that none of its contracts
will inadvertently fail the 7-pay test in the
future;
(9) a description of any material
change[s] in the benefits under (or in the
other terms of) any contract together with
the date[s] on which the material
change[s] occurred;

2001–36 I.R.B.

(10) for any contract with regard to
which a contract holder directly or indirectly received (or was deemed to have
received) any distribution to which § 72
applies—
(a) the date and amount of each
distribution,
(b) the amount of the distribution
includible in the contract holder’s gross
income,
(c) the amount of gross income reported to the contract holder and to the
Service on a timely filed information return as a result of the distribution,
(d) the date on which the contract
holder attained [or will attain] age 59 1/2,
(e) whether the distribution is attributable to the contract holder becoming
disabled (within the meaning of
§ 72(m)(7)), and,
(f) whether the distribution is part
of a series of substantially equal periodic
payments (not less frequently than annually) made for the life (or life expectancy)
of the contract holder or the joint lives (or
joint life expectancies) of the contract
holder and his or her beneficiary;
(11) a template (see, for example,
section 5.03(3) of this revenue procedure)
setting forth the following information for
each contract:
(a) the cumulative amounts paid
under the contract within each contract
year of the testing period,
(b) the contract’s cumulative 7pay premium,
(c) the overage, if any, for each
contract year,
(d) the earnings rate applicable for
each contract year;
(e) the overage earnings for each
contract year; and,
.02 Closing agreement. The issuer also
must submit a proposed closing agreement, executed by the issuer, in substantially the same form as the model closing
agreement in section 6 of this revenue
procedure. The amount shown in section
1(A) of the closing agreement is the sum
of the amounts required to be paid (determined under section 5.03 of this revenue
procedure) for all of the contracts covered
by the agreement.
.03 Determination of amount required
to be paid with regard to a contract.
(1) General rule. Except as provided in section 5.03(2) of this revenue
procedure, the amount required to be paid

215

with regard to a contract is the sum of—
(a) the income tax (determined
using the applicable percentage for the
contract under section 3.11 of this revenue
procedure) and the additional tax under
section 72(v) with regard to amounts
(other than reported amounts (as defined
in section 3.12 of this revenue procedure))
received (or deemed received) under the
contract during the period commencing
with the date 2 years before the date on
which the contract first failed to satisfy the
MEC rules and ending on the effective
date of the closing agreement;
(b) any interest computed under
§ 6621(a)(2) as if the amounts determined
under section 5.03(1)(a) of this revenue
procedure are underpayments by the contract holder[s] for the tax year[s] in which
the amounts are received (or deemed received); and
(c) an amount, not less than $0,
obtained by multiplying—
(i) the excess, if any, of the contract’s cumulative overage earnings over
the proportionate share of overage earnings allocable to taxable distributions
under the contract, by
(ii) the applicable percentage
for the contract, and by
(iii) the distribution frequency
factor for the contract under section 3.10
of this revenue procedure.
(2) Special rule for contracts with de
minimis overage earnings. If the overage
earnings of a contract at all times during
the testing period do not exceed $75, then
the amount required to be paid with regard to the contract is determined without
regard to paragraphs (a) and (b) of section
5.03(1) of this revenue procedure.
(3) Examples of the determination of
the amount required to be paid with regard to a contract.
(a) Example 1. A, an individual,
purchases a life insurance contract other
than a contract described in section
3.07(3) or 4.02 of this revenue procedure. The death benefit of the contract
exceeds $180,000 on every day within
120 days of the date of the request for
closing agreement. The net level premium (assuming paid-up future benefits
after seven annual premium payments)
for the contract is $10,490. The contract
provides that, within 60 days after the
end of a contract year, the issuer will return (with interest) the amount of any ex-

September 4, 2001

cess premium that would cause the contract to be a MEC under § 7702A.
The interest rate on all portions of any
policy loans will always exceed the rate at
which interest is credited to the contract’s
associated cash value by more than 1 percentage point. A partial withdrawal of the
cash surrender value (within the meaning
of § 7702(f)(2)(A)) always reduces the
death benefit by an amount not less than

the amount determined by multiplying the
death benefit immediately before the
withdrawal by the percentage obtained by
dividing the withdrawn amount by the
cash surrender value immediately before
the withdrawal.
A pays a premium of $10,000 when the
contract is issued on January 1, 1991. At
the beginning of each of the next 6 contract years, A pays additional premiums of

Contract
Year

Cumulative
Amounts
Paid

Cumulative
7-Pay
Premiums

1 (1991)

10,000

10,490

0

9.2%

0

2 (1992)

20,750

20,980

0

8.6%

0

3 (1993)

31,550

31,470

80

7.5%

6.00

4 (1994)

42,250

41,960

290

8.3%

24.57

5 (1995)

53,750

52,450

1,300

7.8%

103.78

6 (1996)

64,750

62,940

1,810

7.7%

149.71

7 (1997)

74,750

73,430

1,320

7.6%

121.91

Prior to A’s payment of the $10,800
premium at the beginning of contract year
3, the cumulative premiums paid for the
contract do not exceed the contract’s cumulative 7-pay premiums. Therefore,
there are no overage earnings in contract
years 1 and 2.
Upon payment of the $10,800 premium
at the beginning of contract year 3, however, the cumulative amount paid for the
contract ($31,550) exceeds the contract’s
cumulative 7-pay premiums ($31,470) by
$80. As the earnings rate for the calendar
year in which contract year 3 begins is
7.5%, the contract’s overage earnings for
contract year 3 equal $6 ($80 x 7.5%).
For contract year 4, the overage is $290
($42,250 - $41,960). The cumulative
overage earnings for all prior contract
years equal $6.00. The earnings rate is
8.3%. The overage earnings for contract
year 4 equal $24.57 (($290 + $6) x 8.3%).
For contract year 5, the overage is
$1,300 ($53,750 - $52,450). The cumulative overage earnings for all prior contract
years equal $30.57 ($6 + $24.57). The
earnings rate is 7.8%. The overage earnings for contract year 5 equal $103.78
(($1,300 + $30.57) x 7.8%).
For contract year 6, the overage is
$1,810 ($64,750 - $62,940). The cumula-

September 4, 2001

Overage

$10,750, $10,800, $10,700, $11,500,
$11,000, and $10,000, respectively. Due
to an inadvertent error, the issuer fails to
return any of the excess premiums.
The issuer desires to enter into a closing agreement to remedy the failure to
comply with § 7702A. Pursuant to section 5.01(10) of this revenue procedure,
the issuer prepares the following template
with regard to the contract.

tive overage earnings for all prior contract
years equal $134.35 ($6 + $24.57 +
$103.78). The earnings rate is 7.7%. The
overage earnings for contract year 6 equal
$149.71 ($1,810 + $134.35) x 7.7%).
For contract year 7, the overage is
$1,320 ($74,750 - $73,430). The cumulative overage earnings for all prior contract
years equal $284.06 ($6 + $24.57 +
$103.78 + $149.71). The earnings rate is
7.6%. The overage earnings for contract
year 7 equal $121.91 (($1,320 + $284.06)
x 7.6%).
The cumulative overage earnings for
the contract equal $405.97 ($6 + $24.57 +
$103.78 + $149.71 + $121.91). Under
sections 3.10 and 3.11 of this revenue
procedure, the distribution frequency factor is .5 and the applicable percentage is
36%. Accordingly, the amount required
to be paid with regard to the contract
under section 5.03 of this revenue procedure is $73.07 ($405.97 x .5 x 36%).
(b) Example 2. The facts are the
same as in example 1 except that, at the
beginning of contract year 5, A receives
$3,000 as a policy loan. The contract’s
cash value (within the meaning of
§ 72(e)(3)(A)(i)) immediately prior to the
loan is $58,500, which exceeds A’s investment in the contract ($53,750) by $4,750.

216

Earnings
Rate

Overage
Earnings

Each year A pays the interest on the policy loan. The issuer does not file a timely
information return with regard to the
deemed distribution resulting from the
policy loan and A does not include the
distribution in gross income reported on
the income tax return for the taxable years
in which the deemed distribution is received. The total income on the contract
(as defined in section 3.09 of this revenue
procedure) is $14,500.
The amount required to be paid with regard to the contract under section 5.03 of
this revenue procedure is the sum of(1) an amount equal to the income
tax (determined using a 36% tax rate) and
the additional tax under section 72(v)
with regard to the $3,000 deemed distribution in contract year 5;
(2) interest computed under section
6621(a)(2) as if the amounts determined
under (1) were underpayments for the taxable year in which the distributions are
deemed to have occurred; and
(3) 36% of $160.99, which is the excess of the contract’s cumulative overage
earnings over the proportionate share of
the overage earnings allocable to taxable
distributions ($405.97 - $83.99), multiplied by the distribution frequency factor
(.5).

2001–36 I.R.B.

The proportionate share of overage
earnings allocable to taxable distributions is obtained by multiplying the
total amount of the taxable distribution
under the contract ($3,000), by a fraction, the numerator of which is the contract’s cumulative overage earnings
($405.97) and the denominator of which
is the total income on the contract
($14,500).
.04 Payment of amount. The issuer is
required to pay the amount determined
under section 5.03 of this revenue procedure within thirty (30) days of the date of
execution of the closing agreement by the
Service. Payment shall be made by check
payable to the “United States Treasury”
delivered, together with a fully executed
copy of the closing agreement, to Internal
Revenue Service, Philadelphia Service
Center, 11601 Roosevelt Boulevard,
Philadelphia, Pennsylvania 19154, Attention: Chief, Receipt and Control Branch,
DP3190.
.05 Correction of contracts. (1) General rules. If, on the date of the execution
of the closing agreement by the Service,
the testing period (as defined in section
3.01 of this revenue procedure) for a contract has more than ninety (90) days remaining, then the issuer must bring the
contract into compliance with § 7702A.
The issuer may bring a contract into compliance with § 7702A either by either increasing the contract’s death benefit or returning the contract’s excess premiums
and earnings thereon to the contract
holder. The issuer shall take the corrective action required under this section
5.05(1) within ninety (90) days of the date
of execution of the closing agreement by
the Service.
(2) No corrective action required if
Service executes closing agreement on a
date within 90 days of the expiration of
testing period. If the testing period for a
contract expires on or before the date
within 90 days of the execution of the
closing agreement by the Service, then
the issuer is not required to take any corrective action under section 5.05(1) of
this revenue procedure.
SECTION 6. MODEL CLOSING
AGREEMENT
Effective as of the date executed by
Internal Revenue Service _________

2001–36 I.R.B.

CLOSING AGREEMENT AS TO
FINAL DETERMINATION COVERING
SPECIFIC MATTERS
THIS CLOSING AGREEMENT
(“Agreement”), made pursuant to section
7121 of the Internal Revenue Code (the
“Code”) by and between [taxpayer’s
name, address, and identifying number]
(“Taxpayer”), and the Commissioner of
Internal Revenue (the “Service”).
WHEREAS,
A. Taxpayer is the issuer of one or
more modified endowment contracts, as
defined in section 7702A of the Code;
B. On
, Taxpayer pursuant
to Rev. Proc. 2001–1, 2001–1 I.R.B. 1,
submitted to the Service a request for a
ruling that
modified endowment
contracts (the “Contract[s]”), which are
identified on Exhibit A to this Agreement,
be treated as contracts that are not modified endowment contracts.
C. Taxpayer represents that the Contract[s] is [are] not described in section
4.02 of Rev. Proc. 2001–42.
D. Taxpayer represents that the cumulative “overage earnings,” within the
meaning of section 3.06 of Rev. Proc.
2001–42, for the Contract[s] equal
$_____.
E. Taxpayer represents that the total of
the amounts determined under section
5.03(1)(a), (b), and (c) of Rev. Proc.
2001–42, after taking the special rule in
section 5.03(2) of the revenue procedure
into account, with regard to the Contract[s] are $
,$
, and
$______, respectively.
F. To ensure that the Contracts are not
treated as modified endowment contracts,
Taxpayer and the Service have entered
into this Agreement.
NOW THEREFORE, IT IS HEREBY FURTHER DETERMINED AND
AGREED BETWEEN TAXPAYER AND
THE SERVICE AS FOLLOWS:
1. In consideration for the agreement of
the Service as set forth in Section 2
below, Taxpayer agrees as follows:
(A) To pay to the Service the sum of
dollars and
cents ($_____)
at the time and in the manner described in
Section 3 below;
(B) The amount paid pursuant to
Section 1(A) above is not deductible by
Taxpayer, nor is such amount refundable,
subject to credit or offset, or otherwise recoverable by Taxpayer from the Service;

217

(C) For purposes of its information
reporting and withholding obligations
under the Code, no holder’s investment in
any Contract may be increased by any
portion of—
(i) the sum set forth in Section
1(A) above, or
(ii) the excess of the cumulative
overage earnings over the proportionate
share of overage earnings included in
gross income reported to the Service on a
timely filed information return or income
tax return with regard to amounts received under any Contract; and
(D) To bring Contract[s] for which
the testing period (as defined in section
3.01 of Revenue Procedure 2001–42) will
not have expired on or before the date 90
days after the execution of this Agreement
into compliance with § 7702A, either by
an increase in death benefit[s] or the return of the excess premiums and earnings
thereon to the contract holder[s].
2. In consideration of the agreement of
Taxpayer set forth in Section 1 above, the
Service and Taxpayer agree as follows:
(A) To treat each Contract as having
satisfied the requirements of section
7702A during the period from the date of
issuance of the Contract through and including the later of—
(i) date of the execution of this
Agreement, and
(ii) the date of the corrective actions described in Section 1(D) above;
(B) To treat the corrective action described in 1(D) above as having no effect
on the date the Contract was issued or entered into;
(C) To waive civil penalties for failure of Taxpayer to satisfy the reporting,
withholding, and/or deposit requirements for income subject to tax under
§ 72(e)(10) that was received or deemed
received by a contract holder under a
Contract in a calendar year ending prior
to the date of execution of this Agreement; and
(D) To treat no portion of the sum
described in Section 1(A) above as income to the holders of the Contracts.
3. The actions required of Taxpayer in
Section 1(D) above shall be taken by Taxpayer within ninety (90) days of the date
of execution of this Agreement by the
Service. Payment of the amount described in Section 1(A) above shall be
made within thirty (30) days of the date of

September 4, 2001

execution of this Agreement by the Service by check payable to the “United
States Treasury,” delivered together with
a fully executed copy of this Agreement,
to Internal Revenue Service, Philadelphia
Service Center, 11601 Roosevelt Boulevard, Philadelphia, Pennsylvania 19154,
Attention: Chief, Receipt and Control
Branch, DP3190.
4. This Agreement is, and shall be construed as being, for the benefit of Taxpayer. The holder[s] of Contract[s] covered by this Agreement are intended
beneficiaries of this Agreement. This
Agreement shall not be construed as cre-

ating any liability of an issuer to the holders of the Contract[s].
5. Neither the Service nor Taxpayer
shall endeavor by litigation or other means
to attack the validity of this Agreement.
6. This Agreement may not be cited or
relied upon as precedent in the disposition
of any other matter.
NOW THIS CLOSING AGREEMENT
FURTHER WITNESSETH, that Taxpayer and the Service mutually agree that
the matters so determined shall be final
and conclusive, except as follows:
1. The matter to which this Agreement
relates may be reopened in the event of

fraud, malfeasance, or misrepresentation
of material facts set forth herein.
2. This Agreement is subject to sections
of the Code that expressly provide that effect be given to their provisions notwithstanding any other law or rule of law except § 7122 of the Code.
3. This Agreement is subject to any legislation enacted subsequent to the date of
execution hereof if the legislation provides that it is effective with respect to
closing agreements.

IN WITNESS WHEREOF, the parties have subscribed their names in triplicate.
Taxpayer
Date Signed:

By:
_______________________________
Title/Office
Commissioner of Internal Revenue

Date Signed:

By: _______________________________
_______________________________
Title/Office

SECTION 7. EFFECTIVE DATE
This revenue procedure is effective August 6, 2001, the date this revenue procedure was made available to the public.
SECTION 8. EFFECT ON OTHER
DOCUMENTS.
This revenue procedure supersedes
Rev. Proc. 99–27.
SECTION 9. PAPERWORK
REDUCTION ACT
The collections of information contained in this revenue procedure have
been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act
(44 U.S.C. 3507) under control number
1545 –1752.
The collection of information and reporting burden are in section 5 of this rev-

September 4, 2001

enue procedure. This information will be
used to determine whether an issuer may
remedy failures to comply with the requirements of § 7702A. The likely respondents are insurance companies.
The estimated total annual reporting
burden is 1000 hours.
The estimated annual burden per respondent varies from 50 hours to 150
hours with an average of 100 hours. The
estimated number of respondents is 10.
The estimated annual frequency of the
responses is one time.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the collection of information displays a valid
OMB control number.
Books and records relating to a collection of information must be retained as
long as their contents may become material in the administration of any internal

218

revenue law. Generally tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
DRAFTING INFORMATION
For further information regarding this
revenue procedure, contact Donald Drees
of Financial Institutions and Products at
(202) 622-3970 (not a toll-free call).

2001–36 I.R.B.