The fiscal cliff deal cleared up every estate planning tax question ever, right? Or not. Because for as much fanfare as the new estate tax received, there are still a lot of sticky tax-related questions out there. Like what, exactly, constitutes an estate? Do life insurance proceeds count? What about employer-provided income benefits? How are annuities treated? Here are 10 big estate planning tax questions, answered.
Q. If life insurance proceeds are payable to an insured's estate, is their value includable in the insured's estate?
A. Yes. The entire value of the proceeds must be included in the insured's gross estate even if the insured possessed no incident of ownership in the policy, and paid none of the premiums.[1] But proceeds payable to an executor in his or her individual capacity rather than as executor for the insured's estate were not treated as payable to the insured's estate by the Tax Court.[2]
[1] .IRC Sec. 2042(1); Est. of Bromley v. Comm., 16 BTA 1322 (1929).
[2] .Est. of Friedberg v. Comm., TC Memo 1992-310.
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Q. When are life insurance proceeds that are payable to a beneficiary other than the insured's estate includable in the insured's estate?
A. Proceeds are includable in an insured's gross estate if the insured legally possessed and could legally exercise any incidents of ownership at the time of the insured's death. It does not matter that the insured did not have possession of the policy and therefore was unable to exercise his or her ownership rights at the time of his or her death,[1] or that the insured was unable as a practical matter to effect any change in the policy because the policy was collaterally assigned.[2]
The proceeds are includable even if the insured cannot exercise his or her ownership rights alone, but only in conjunction with another person.[3] It has been held that an insured did not possess incidents of ownership where the insured had paid no premiums, did not regard the policy as the insured's own, and had made an irrevocable designation of beneficiary and mode of payment of proceeds.[4] But even if the proceeds are payable to a beneficiary other than the insured's estate, and the insured possesses no incidents of ownership in the policy, the proceeds are nevertheless includable in the insured's gross estate if they are receivable for the benefit of the insured's estate. Even though the insured retains no incidents of ownership in the policy, the proceeds may be includable in the insured's estate if the insured has transferred the policy within three years before the insured's death.
[1] .Comm. v. Est. of Noel, 380 U.S. 678 (1965).
[2] .Est. of Goodwyn v. Comm., TC Memo 1973-153.
[3] .IRC Sec. 2042(2); Goldstein's Est. v. U.S., 122 F. Supp. 677 (Ct. Cl. 1954).
[4] .Morton v. U.S., 29 AFTR 2d 72-1531 (4th Cir. 1972).
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Q. If an employer provides, under a nonqualified agreement or plan, an income benefit only for certain survivors designated by family or marital relationship to the employee, how is the benefit treated for estate tax purposes in the employee's estate?
A. The threshold issue is whether the survivor income benefit plan is treated as insurance or as an annuity.
If it is treated as life insurance, includability of the value of the survivor benefit in the employee's estate is determined under the rules applicable to death proceeds of insurance. The controlling statute in this case is usually IRC Section 2042, although IRC Section 2035 comes into play if the decedent insured has assigned any of his or her rights in the benefit within three years of death. If the plan is treated as an annuity, includability is usually determined under IRC Section 2039(a), but not under IRC Section 2042.
Case law and IRS rulings dealing with the estate taxation of survivor income benefits tend to support the view of the Second Circuit. In All v. McCobb,[1] the Second Circuit held that a survivor income benefit plan that was uninsured and unfunded lacked the necessary insurance elements of risk-shifting and risk-distribution to be treated as insurance. Est. of Lumpkin v. Comm.,[2] Est. of Connelly v. U.S.,[3] and Est. of Smead v. Comm.[4]all involve insured plans that the courts treated as group insurance.
In Let. Rul. 8046110, a plan funded by group life insurance was treated as insurance. Following Rev. Rul. 69-54, the IRS ruled that because the decedent insured died possessing the right to convert his group life insurance into individual insurance, an incident of ownership, the sum used by the insurance company in determining the amount of the survivor annuity payable was includable in the decedent's estate.[5] Rev. Rul. 77-183,[6] Est. of Schelberg v. Comm.,[7] and Est. of Van Wye v. U.S.,[8] all involved uninsured and unfunded plans that the courts treated as annuities.
No estate tax cases or rulings have been found that deal with uninsured funded plans.
[1] .321 F.2d 633 (2nd Cir. 1963).
[2] .474 F.2d 1092 (5th Cir. 1973).
[3] .551 F.2d 545 (3rd Cir. 1977).
[4] .78 TC 43 (1982), acq. in result, 1984-2 CB 2.
[5] .See Treas. Reg. §20.2042-1(a)(3).
[6] .1977-1 CB 274.
[7] .70 TC 690 (1978), rev'd on other grounds, 79-2 USTC ¶13,321 (2nd Cir. 1979).
[8] .82-2 USTC ¶13,485 (6th Cir. 1982).
A. Yes, assuming the insured lives for at least three years after the assignment, the insured assigns all incidents of ownership, and the assignee is not legally obligated to use the proceeds for the benefit of the insured's estate.[1]
If the form of the assignment reserves any incidents of ownership to the insured, the proceeds may be included in the insured's gross estate despite the insured's clear intention to transfer all ownership rights.[2] It has been held that where the insured had paid no premiums and had never treated the policy as his or her own, the insured's irrevocable designation of beneficiaries and mode of payment of proceeds was an effective assignment of all of the insured's incidents of ownership in the policy.[3] The amount of any premiums paid on the assigned policy by the insured may be included to the extent they are paid within three years of death.
A reversionary interest in a policy is an incident of ownership if, immediately before the insured's death, the value of the reversionary interest is worth more than five percent of the value of the policy.[4] The insured will have no such reversionary interest, however, if the policy is purchased and owned by another person, or if the policy is absolutely assigned to another person by the insured. Regulations state that the term "reversionary interest" does not include the possibility that a person might receive a policy or its proceeds by inheritance from another person's estate, by exercising a surviving spouse's statutory right of election, or under some similar right. They also state that, in valuing a reversionary interest, interests held by others that would affect the value must be taken into consideration. For example, a decedent would not have a reversionary interest in a policy worth more than five percent of the policy's value, if, immediately before the decedent's death, some other person had the unrestricted power to obtain the cash surrender value of the policy; the value of the reversionary interest would be zero.[5]
An insured was treated as holding a reversionary interest in a policy held in a trusteed buy-sell arrangement where the insured was considered to have transferred the policy to the trust and retained the right to purchase the policy for its cash surrender value upon termination of the buy-sell agreement.[6] However, a policy held in a trusteed buy-sell arrangement would not be includable in an insured's estate under IRC Section 2042 where (1) proceeds would be received by a partner's estate only in exchange for purchase of the partner's stock, and (2) all incidents of ownership would be held by the trustee of the irrevocable life insurance trust.[7]
[1] .Treas. Regs. §§20.2042-1(b)(1), 20.2042-1(c)(1); Lamade v. Brownell, 245 F. Supp. 691 (M.D. Pa. 1965).
[2] .Est. of Piggott v. Comm., 340 F.2d 829 (6th Cir. 1965).
A. Proceeds ordinarily are not includable in the insured's gross estate if the insured has never owned the policy and the proceeds are not payable to or for the benefit of his estate.[1] If the terms of the policy give the insured any legal incidents of ownership, however, the proceeds may be included in the insured's gross estate even though a third party purchased the policy and always has retained physical possession of it.[2]
Even though a policy says clearly that incidents of ownership belong to the insured, if it also is clear from facts outside the policy that it was the intention and belief of the parties involved in purchasing the insurance that these ownership rights were to be, and were, placed in another, courts may allow the "intent facts" to override the "policy facts." That is, they may find that the insured did not actually possess the incidents of ownership the policy said were exercisable by the insured.[3]
On the other hand, even though the policy does not give the insured any incidents of ownership, an incident of ownership may be given to the insured by an outside document, such as a corporate resolution, a trust indenture, or another agreement between the insured and the third party.[4] The fact that the insured has had no opportunity to exercise the legal incidents of ownership is immaterial.[5] Also, if the insured causes insurance to be bought on his or her life by another with funds supplied by the insured and then dies within three years of the purchase, the proceeds may be includable in the insured's estate. In Est. of Margrave v. Comm.,[6] the Eighth Circuit affirmed a 9-7 decision of the Tax Court holding that the proceeds of a wife-owned policy, payable revocably to the trustee of a revocable trust created by the insured husband, were not includable in the insured's estate under either IRC Section 2042 or IRC Section 2041 (general power of appointment). The IRS has agreed to follow the holding in Margrave.[7]
[1] .IRC Sec. 2042.
[2] .U.S. v. Rhode Island Hosp. Trust Co., 355 F.2d 7 (1st Cir. 1966).
[3] .National Metropolitan Bank v. U.S., 87 F. Supp. 773 (Ct. Cl. 1950); Schongalla v. Hickey, 149 F.2d 687 (2d Cir. 1945), cert. denied 326 U.S. 736; Watson v. Comm., TC Memo 1977-268; First Nat'l Bank of Birmingham v. U.S., 358 F.2d 625 (5th Cir. 1966); Let. Rul. 8610068.
[4] .Est. of Thompson v. Comm., TC Memo 1981-200; St. Louis Union Trust Co. (Orthwein) v. U.S., 262 F. Supp. 27 (E.D. Mo. 1966); Est. of Tomerlin v. Comm., TC Memo 1986-147.
[5] .Comm. v. Est. of Noel, 380 U.S. 678 (1965).
[6] .71 TC 13 (1978), aff'd 45 AFTR 2d ¶148,393 (8th Cir. 1980).
[7] .Rev. Rul. 81-166, 1981-1 CB 477.
A. If, under a cross-purchase arrangement, proceeds are not payable to an insured's estate, and an insured has no incidents of ownership in the policies on his or her life, proceeds are not includable in his or her gross estate.[1]
The Tax Court has held that a provision in an agreement prohibiting a policy owner from surrendering the policy, borrowing against the policy, or changing the beneficiary of the policy without the insured's consent did not give the insured incidents of ownership in the policy.[2] The value of an insured's partnership interest or corporate stock is includable.[3] The value of any unmatured policies an insured owns on the life of his or her associates also will be includable.
If proceeds are payable to an insured's estate, or if an insured has incidents of ownership in a policy on his or her life, proceeds are includable in his or her gross estate.
Where proceeds are includable in the gross estate but the estate is obligated to apply them to the purchase price of the insured's business interest, the value of the business interest will be includable in the gross estate only to the extent that it exceeds the value of the proceeds. In other words, there will be no double taxation.[4]
There is some legal authority to the effect that terms of a policy can be modified by terms of a business agreement. Thus, where an agreement gives all beneficial ownership in proceeds to an insured's co-partners and obligates the parties to apply them to the purchase of the insured's business interest, proceeds are not included in the insured's gross estate despite a policy provision giving the insured the right to change the beneficiary.[5]
[1] .IRC Sec. 2042; Rev. Rul. 56-397, 1956-2 CB 599.
[2] .Est. of Infante v. Comm., TC Memo 1970-206 (appeal dismissed).
[3] .Est. of Riecker v. Comm., 3 TCM 1293 (1944).
[4] .Est. of Mitchell v. Comm., 37 BTA 1 (1938), acq.; Est. of Tompkins v. Comm., 13 TC 1054 (1949), acq.; Est. of Ealy v. Comm.,10 TCM 431; Dobrzensky v. Comm., 34 BTA 305 (1936), nonacq. 1936-2 CB 39; Boston Safe Deposit & Trust Co. v. Comm., 30 BTA 679 (1934), nonacq. 1934-2 CB 34.
[5] .Est. of Fuchs v. Comm., 47 TC 199 (1966), acq. 1967-2 CB 2; First Nat'l Bank of Birmingham v. U.S., 358 F.2d 625 (5th Cir. 1966).
Q. How is a closely held business interest valued for federal estate tax purposes where there is no purchase agreement?
A. Valuation of closely held corporate stock requires a determination of fair market value. Estate tax regulations define this as "the price at which the property would change hands between a willing buyer and a willing seller, neither being under compulsion to buy or sell and both having reasonable knowledge of the relevant facts."[1]
Factors that should be considered when determining fair market value include the company's net worth, prospective earnings and dividend paying capacity, goodwill, the economic outlook in the particular industry and its management, the degree of control of the business represented by the block of stock to be valued, and the value of securities of corporations engaged in the same or similar lines of business that are listed on a stock exchange.[2]
If a block of stock represents a controlling interest in a corporation, a control premium generally adds to the value of the stock. If, however, shares constitute a minority ownership interest, a minority discount often is used. A premium also may attach for swing vote attributes where one block of stock may exercise control by joining with another block of stock.[3] One memorandum valued stock included in a gross estate at a premium as a controlling interest, while applying a minority discount to a marital deduction portion that passed to a surviving spouse.[4]
Just because an interest being valued is a minority interest does not mean that a minority discount is available.[5] One case, however, valued stock with voting rights at no more than stock without voting rights.[6]
The Tax Court has held that if real estate is specially valued for estate tax purposes under IRC Section 2032A, an estate may not take a minority discount with respect to stock in a corporation that held the real estate.[7]
In a split decision, however, the Tenth Circuit Court of Appeals has ruled that minority discounts and special use valuation under IRC Section 2032A are not mutually exclusive; it would apply the minority discount to the fair market value of the real estate as owned through a partnership and then apply the $750,000 cap on special use valuation to the difference between fair market value as discounted and special use value of the real estate.[8]
The Fifth Circuit Court of Appeals has ruled that shares of stock in a decedent's estate were to be valued as a minority interest when the decedent owned less than 50 percent, despite the fact that control of the corporation was within the decedent's family. This was true even when, immediately before death, the decedent and the decedent's spouse owned more than 50 percent of the stock as community property. The court also ruled that family attribution (Q 225) would not apply to lump a decedent's stock with that of related parties for estate tax valuation purposes both because of prior case law and because applying attribution would be inconsistent with the willing buyer-willing seller rule.[9]
A minority discount will not be disallowed solely because a transferred interest would be part of a controlling interest if the interest were aggregated with interests held by family members.[10]
A minority discount was allowed even when the person to whom the interest was transferred already was a controlling shareholder.[11]
A couple of deathbed transactions, however, were aggregated into a single integrated transfer to which a control premium attached rather than minority discounts where a parent, a 60 percent shareholder, sold a 30 percent interest in a corporation to a child, a 20 percent shareholder and the parent had the corporation redeem the remaining 30 percent interest in the corporation held by the parent.[12]
The Tax Court has determined that an estate would not be allowed a minority discount where a decedent transferred a small amount of stock immediately prior to death for the sole purpose of reducing her interest from a controlling interest to a minority interest for valuation purposes.[13]
Similarly, the IRS has disallowed minority discounts while disregarding partnerships or limited liability companies created on a decedent's deathbed presumably to obtain minority discounts.[14]
A couple of courts have rejected the idea that a partnership can be ignored for purposes of IRC Section 2703.
A partnership or LLC entity may be included in a gross estate under IRC Section 2036 without the benefit of discounts under a number of circumstances. For example, if a decedent puts everything he or she owns into the entity, retains complete control over the income of the entity, uses the entity as a personal pocket book, or fails to follow entity formalities, the entity may be included in his or her gross estate.[15]
One case has held that IRC Section 2036 did not apply because the court concluded that the transfer to a partnership was a bona fide sale for adequate consideration.[16]
[1] .Treas. Reg. §20.2031-1(b).
[2] .Treas. Reg. §20.2031-2. See also Rev. Rul. 59-60, 1959-1 CB 237.
[3] .TAM 9436005.
[4] .TAM 9403005.
[5] .Godley v. Comm., 2002-1 USTC ¶60,436 (4th Cir. 2002) (partnerships held housing projects subject to long term government contracts).
[6] .Est. of Simplot v. Comm., 2001-1 USTC ¶60,405 (9th Cir. 2001).
[7] .Est. of Maddox v. Comm., 93 TC 228 (1989).
[8] .Est. of Hoover v. Comm., 95-2 USTC ¶60,217 (10th Cir. 1995) (acq. 1998-2 CB xix), rev'g 102 TC 777 (1994).
[9] .Est. of Bright v. Comm., 658 F.2d 999 (5th Cir. 1981).
[10] .Rev. Rul. 93-12, 1993-1 CB 202.
[11] .TAM 9432001.
[12] .TAM 9504004.
[13] .Est. of Murphy v. Comm., TC Memo 1990-472.
[14] .TAMs 9719006, 9723009, 9725002, 9730004, 9735003, 9736004, 9842003.
[15] .Est. of Strangi v. Comm., 2005-2 USTC ¶60,506 (5th Cir. 2005), aff'g TC Memo 2003-145; Est. of Bongard v. Comm., 124 TC 95 (2005); Est. of Bigelow v. Comm., 2007-2 USTC ¶60,548 (9th Cir. 2007), aff'g TC Memo 2005-65; Kimbell v. U.S., 2003-1 USTC ¶60,455 (N.D. Tex. 2003), rev'd 2004-1 USTC ¶60,486 (5th Cir. 2004); Est. of Abraham v. Comm., TC Memo 2004-39; Est. of Hilgren v. Comm., TC Memo 2004-46 (discount for business loan agreement was allowed); Est. of Thompson v. Comm., 2004-2 USTC ¶60,489 (3rd Cir. 2004), aff'g TC Memo 2002-246.
[16] .Kimbell v. U.S., 2004-1 USTC ¶60,486 (5th Cir. 2004), rev'g 2003-1 USTC ¶60,455 (N.D. Tex. 2003).
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Q. How is a closely held business interest valued for federal estate tax purposes where there is a purchase agreement?
A. For purchase agreements entered into after October 8, 1990, or substantially modified after that date, the value of a closely held business interest is to be determined without regard to any purchase agreement exercisable at less than fair market value, determined without regard to the purchase agreement, unless the purchase agreement:
(1)is a bona fide business arrangement;
(2)is not a device to transfer property to members of the decedent's family for less than full or adequate consideration in money or money's worth; and
(3)has terms comparable to those entered into by persons in an arm's length transaction.[1]
Whether or not an agreement is subject to IRC Section 2703, case law has established the additional following rules:
(1)an estate must be obligated to sell at death under either a mandatory purchase agreement or an option held by the business or survivors;
(2)the price must be fixed by the terms of the agreement or the agreement must contain a formula or method for determining the price;
(3)the agreement must prohibit an owner from disposing of his or her interest during life without first offering it to the other party or parties at no more than the contract price;
(4)the price must be fair and adequate when the agreement is made.[2]
If a business purchase agreement calls for shares to be purchased from an estate with installment purchase notes bearing a rate of interest lower than the market rate at the date of death, an executor may be allowed to discount the value of the shares by the difference between the interest rate called for in the buy-sell agreement and the prevailing rate at the date of death.[3]
A first-offer agreement, under which survivors have no enforceable right to purchase the business interest and can purchase the interest only if the executor wishes to sell and does not fix the value of the interest for estate tax purposes.[4]
If an agreement is between closely related persons and is merely a scheme for avoiding estate taxes, the price set in the agreement will not control.[5]
A buy-sell agreement is not binding unless it represents a bona fide business agreement and is not testamentary in nature.[6] An agreement may be found to be a scheme for avoiding estate taxes even where it serves a bona-fide business purpose.[7]
No effect will be given to an option or contract under which a decedent is free to dispose of the interest or shares at any price he or she chooses during life.[8]
On the other hand, an agreement that restricts sale during life, but not at death, also will fail to fix the estate tax value.[9]
[1] .See IRC Sec. 2703.
[2] .May v. McGowan, 194 F.2d 396 (2nd Cir. 1952); Comm. v. Child's Est., 147 F.2d 368 (3rd Cir. 1945); Comm. v. Bensel, 100 F.2d 639 (3rd Cir. 1938); Lomb v. Sugden, 82 F.2d 166 (2nd Cir. 1936); Wilson v. Bowers, 57 F.2d 682 (2nd Cir. 1932); Est. of Littick v. Comm., 31 TC 181 (1958), acq. in result 1984-2 CB 1; Est. of Salt v. Comm., 17 TC 92 (1951), acq.; Brodrick v. Gore, 224 F.2d 892 (10th Cir. 1955); Fiorito v. Comm., 33 TC 440 (1959), acq.; Est. of Weil v. Comm., 22 TC 1267 (1954), acq.; Est. of Bischoff v. Comm., 69 TC 32 (1977); see also Treas. Reg. §20.2031-2(h); Treas. Reg. §20.2031-3.
[3] .Let. Rul. 8245007.
[4] .Worcester County Trust Co. v. Comm., 134 F.2d 578 (1st Cir. 1943); City Bank Farmers Trust Co. v. Comm., 23 BTA 663 (1931), acq. 1932-1 CB 2; Michigan Trust Co. v. Comm., 27 BTA 556 (1933).
[5] .Slocum v. U.S., 256 F. Supp. 753 (S.D.N.Y. 1966).
[6] .Est. of True v. Comm., 2004-2 USTC ¶60,495 (10th Cir. 2004).
[7] .St. Louis County Bank v. U.S., 49 AFTR 2d ¶1509 (8th Cir. 1982).
[8] .Est. of Caplan v. Comm., TC Memo 1974-39; Est. of Gannon v. Comm., 21 TC 1073 (1954); Est. of Trammell v. Comm., 18 TC 662 (1952), acq. 1953-1 CB 6; Est. of Mathews v. Comm., 3 TC 525 (1944); Hoffman v. Comm., 2 TC 1160 (1943); Est. of Tompkins v. Comm., 13 TC 1054 (1949); Rev. Rul. 59-60, 1959-1 CB 237; Rev. Rul. 157, 1953-2 CB 255.
[9] .Land v. U.S., 303 F.2d 170 (5th Cir. 1962).
Q. What benefits payable at death are included in the term "life insurance" for estate tax purposes?
IRC Section 2042 deals with the estate taxation of proceeds from insurance on the life of a decedent. According to regulations, the term "insurance," as used in IRC Section 2042, means life insurance of every description, including death benefits paid by fraternal societies operating under the lodge system.[1] In the case of a retirement income endowment, the death proceeds are treated as insurance proceeds under IRC Section 2042 if the insured dies before the terminal reserve value equals or exceeds the face value; if the insured dies after that time, the proceeds are treated as death proceeds of an annuity contract.[2]
With respect to the proceeds of "no-fault" automobile liability insurance, the IRS has ruled on three categories of benefits:
(1)Survivors' loss benefits. These are benefits payable only to certain named dependent survivors of the insured; if the insured dies leaving no such eligible dependents, no benefits are paid. The value of any such benefit is not includable in the insured's gross estate under IRC Section 2033 or under IRC Section 2042(2) because if the proceeds are life insurance (an issue the ruling did not decide) the insured would not have owned any incidents of ownership at his or her death.[3]
(2)Basic economic loss benefit. This benefit covers the insured's medical expenses and loss of income arising from the insured's injury while operating an automobile. The value of this benefit is includable in the insured's gross estate under IRC Section 2033, but not under IRC Section 2042(1) (life insurance proceeds payable to or for the insured's estate).[4]
(3)Death benefit. This is a benefit payable unconditionally to the estate of the insured and to the estate of any passenger in the insured's car killed in a covered accident. The value of this benefit is includable under IRC Section 2042(1) in the estate of each insured receiving the benefit.[5]
[1] .Treas. Reg. §20.2042-1(a).
[2] .Treas. Reg. §20.2039-1(d).
[3] .Rev. Rul. 82-5, 1982-1 CB 131.
[4] .Rev. Rul. 83-44, 1983-1 CB 228.
[5].Rev. Rul. 83-44, above.
Q. When are annuities or annuity payments includable in a decedent's gross estate under IRC Section 2039?
A. IRC Section 2039 deals with annuities or other payments receivable by any beneficiary under any form of contract or agreement by reason of surviving the decedent. Subsections (a) and (b) of that section state the circumstances under which such an annuity or payment is includable in the decedent's gross estate. Thus, IRC Section 2039 applies to death and survivor benefits under annuity contracts and under optional settlements of living proceeds from life insurance policies and endowment contracts.
Exclusions under various provisions of IRC Section 2039 may apply to employee annuities which are part of qualified pension and profit sharing plans; to employee annuities payable under nonqualified deferred compensation plans, including death benefit only plans; to certain tax sheltered annuity plans; and to individual retirement savings plans.
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The content in this publication is not intended or written to be used, and it cannot be used, for the purposes of avoiding U.S. tax penalties. It is offered with the understanding that the writer is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought.
