Any life insurance contract transferred from an employer or a tax-qualified plan to an employee must be taxed at its full fair market value, according to final regulations issued by the Treasury Department and the IRS.

The regulations are aimed at shutting down abusive transactions involving "Section 412(i) plans" and similar arrangements. A Section 412(i) plan is a tax-qualified retirement plan funded solely by a life insurance contract or an annuity. An employer deducts contributions used to pay premiums. The plan may hold the contract until the employee dies, or it may distribute or sell the contract to the employee at a specific point (e.g., upon retirement).

Under abusive arrangements, the cash surrender value is temporarily depressed to a level far below the premiums paid. The contract is structured so that the cash surrender value increases significantly once the contract is transferred to the employee, creating a mismatch between the employer's deduction and the employee's recognition of income, according to the Treasury.

The regulations are effective for transfers made on or after February 13, 2004.