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SEC. 501. DENIAL OF DEDUCTION FOR INTEREST ON LOANS WITH RESPECT TO COMPANY-OWNED LIFE INSURANCE.

Title[ Title V\Subtitle A Contents

Subtitle A--Company-Owned Life Insurance

(a) In General.--Paragraph (4) of section 264(a) is amended--

(1) by inserting ``, or any endowment or annuity contracts owned by the taxpayer covering any individual,'' after ``the life of any individual'', and

(2) by striking all that follows ``carried on by the taxpayer'' and inserting a period.

(b) Exception for Contracts Relating to Key Persons; Permissible

Interest Rates.--Section 264 is amended--

(1) by striking ``Any'' in subsection (a)(4) and inserting

``Except as provided in subsection (d), any'', and

(2) by adding at the end the following new subsection:

``(d) Special Rules For Application of Subsection (a)(4).--

``(1) Exception for key persons.--Subsection (a)(4) shall

not apply to any interest paid or accrued on any indebtedness

with respect to policies or contracts covering an individual who

is a key person to the extent that the aggregate amount of such

indebtedness with respect to policies and contracts covering

such individual does not exceed $50,000.

``(2) Interest rate cap on key persons and pre-1986

contracts.--

``(A) In general.--No deduction shall be allowed by

reason of paragraph (1) or the last sentence of

subsection (a) with respect to interest paid or accrued

for any month beginning after December 31, 1995, to the

extent the amount of such interest exceeds the amount

which would have been determined if the applicable rate

of interest were used for such month.

``(B) Applicable rate of interest.--For purposes of

subparagraph (A)--

``(i) In general.--The applicable rate of

interest for any month is the rate of interest

described as Moody's Corporate Bond Yield Average-

Monthly Average Corporates as published by Moody's

Investors

Service, Inc., or any successor thereto, for such

month.

``(ii) Pre-1986 contracts.--In the case of

indebtedness on a contract purchased on or before

June 20, 1986--

``(I) which is a contract providing

a fixed rate of interest, the applicable

rate of interest for any month shall be

the Moody's rate described in clause (i)

for the month in which the contract was

purchased, or

``(II) which is a contract providing

a variable rate of interest, the

applicable rate of interest for any

month in an applicable period shall be

such Moody's rate for the third month

preceding the first month in such

period.

For purposes of subclause (II), the taxpayer shall

elect an applicable period for such contract on

its return of tax imposed by this chapter for its

first taxable year ending on or after October 13,

1995. Such applicable period shall be for any

number of months (not greater than 12) specified

in the election and may not be changed by the

taxpayer without the consent of the Secretary.

``(3) Key person.--For purposes of paragraph (1), the term

`key person' means an officer or 20-percent owner, except that

the number of individuals who may be treated as key persons with

respect to any taxpayer shall not exceed the greater of--

``(A) 5 individuals, or

``(B) the lesser of 5 percent of the total officers

and employees of the taxpayer or 20 individuals.

``(4) 20-percent owner.--For purposes of this subsection,

the term `20-percent owner' means--

``(A) if the taxpayer is a corporation, any person

who owns directly 20 percent or more of the outstanding

stock of the corporation or stock possessing 20 percent

or more of the total combined voting power of all stock

of the corporation, or

``(B) if the taxpayer is not a corporation, any

person who owns 20 percent or more of the capital or

profits interest in the employer.

``(5) Aggregation rules.--

``(A) In general.--For purposes of paragraph (4)(A)

and applying the $50,000 limitation in paragraph (1)--

``(i) all members of a controlled group shall

be treated as one taxpayer, and

``(ii) such limitation shall be allocated

among the members of such group in such manner as

the Secretary may prescribe.

``(B) Controlled group.--For purposes of this

paragraph, all persons treated as a single employer

under subsection (a) or (b) of section 52 or subsection

(m) or (o) of section 414 shall be treated as members of

a controlled group.''.

(1) In general.--The amendments made by this section shall

apply to interest paid or accrued after October 13, 1995.

(2) Transition rule for existing indebtedness.--

(A) In general.--In the case of--

(i) indebtedness incurred before January 1,

1996, or

(ii) indebtedness incurred before January 1,

1997 with respect to any contract or policy

entered into in 1994 or 1995,

the amendments made by this section shall not apply to

qualified interest paid or accrued on such indebtedness

after October 13, 1995, and before January 1, 1999.

(B) Qualified interest.--For purposes of

subparagraph (A), the qualified interest with respect to

any indebtedness for any month is the amount of interest

(otherwise deductible) which would be paid or accrued

for such month on such indebtedness if--

(i) in the case of any interest paid or

accrued after December 31, 1995, indebtedness with

respect to no more than 20,000 insured individuals

were taken into account, and

(ii) the lesser of the following rates of

interest were used for such month:

(I) The rate of interest specified

under the terms of the indebtedness as

in effect on October 13, 1995 (and

without regard to modification of such

terms after such date).

(II) The applicable percentage of

the rate of interest described as

Moody's Corporate Bond Yield Average-

Monthly Average Corporates as published

by Moody's Investors Service, Inc., or

any successor thereto, for such month.

For purposes of clause (i), all persons treated as a

single employer under subsection (a) or (b) of section

52 of the Internal Revenue Code of 1986 or subsection

(m) or (o) of section 414 of such Code shall be treated

as 1 person. Subclause (II) of clause (ii) shall not

apply to any month before January 1, 1996.

paragraph (B), the applicable percentage is as follows:

For calendar year: The percentage is:

1996........................................100 percent

1997.........................................90 percent

1998.........................................80 percent.

(3) Special rule for grandfathered contracts.--This section

shall not apply to any contract purchased on or before June 20,

1986, except that section 264(d)(2) of the Internal Revenue Code

of 1986 shall apply to interest paid or accrued after October

13, 1995.

(d) Spread of <<NOTE: 26 USC 264 note.>> Income Inclusion on

Surrender, Etc. of Contracts.--

(1) In general.--If any amount is received under any life

insurance policy or endowment or annuity contract described in

paragraph (4) of section 264(a) of the Internal Revenue Code of

1986--

(A) on the complete surrender, redemption, or

maturity of such policy or contract during calendar year

1996, 1997, or 1998, or

(B) in full discharge during any such calendar year

of the obligation under the policy or contract which is

in the nature of a refund of the consideration paid for

the policy or contract,

then (in lieu of any other inclusion in gross income) such

amount shall be includible in gross income ratably over the 4-

taxable year period beginning with the taxable year such amount

would (but for this paragraph) be includible. The preceding

sentence shall only apply to the extent the amount is includible

in gross income for the taxable year in which the event

described in subparagraph (A) or (B) occurs.

(2) Special rules for applying section 264.--A contract

shall not be treated as--

(A) failing to meet the requirement of section

264(c)(1) of the Internal Revenue Code of 1986, or

(B) a single premium contract under section

264(b)(1) of such Code,

solely by reason of an occurrence described in subparagraph (A)

or (B) of paragraph (1) of this subsection or solely by reason

of no additional premiums being received under the contract by

reason of a lapse occurring after October 13, 1995.

(3) Special rule for deferred acquisition costs.--In the

case of the occurrence of any event described in subparagraph

(A) or (B) of paragraph (1) of this subsection with respect to

any policy or contract--

(A) section 848 of the Internal Revenue Code of 1986

shall not apply to the unamortized balance (if any) of

the specified policy acquisition expenses attributable

to such policy or contract immediately before the

insurance company's taxable year in which such event

occurs, and

(B) there shall be allowed as a deduction to such

company for such taxable year under chapter 1 of such

Code an amount equal to such unamortized balance.

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