147 / If income of an irrevocable funded life insurance trust is used to pay premiums on a policy insuring the grantor’s life, is the income that is used taxable to the grantor?

Yes, unless the policy is irrevocably payable to a charity.¹ It is immaterial whether the insurance is taken out by the grantor before the trust is created or by the trustee after it is created.² The rule applies to income used to pay the investment portion of the premium as well as to income used for pure insurance protection.³ It also applies to income used for policies dedicated to business uses as well as to those for personal estate planning purposes.⁴

Moreover, trust income is taxable to the grantor if, without the approval or consent of an adverse party, it may be used for the payment of premiums on insurance on the grantor’s life, even though it is not actually used for this purpose. Thus, where policies on the grantor’s life are placed in the trust, trust income is taxable to the grantor to the extent that the trustee has discretionary power to use it for premium payments.⁵

If the policies are owned by the grantor or by someone other than the trust, however, the trust income is taxable to the grantor only if it actually is used to pay premiums, or if the trustee is specifically authorized to use it for this purpose.⁶

When the trustee is empowered to purchase insurance on the grantor’s life, but does not do so, the grantor is not taxed merely because of the trustee’s power; there must be policies existing in the tax year during which it would have been possible for the trustee to pay premiums.⁷ When a trust beneficiary has voluntarily used income received from the trust to pay premiums on insurance on the grantor’s life, the income has not been taxed to the grantor.⁸

Because the law states that the trust income will be taxed to the grantor if it is used to pay the premiums “without the approval or consent of any adverse party,”⁹ some have suggested that it may be possible, in some cases, to use trust income for such premium payments. If a beneficiary uses the trust income to pay premiums subject to the grantor’s direction or pursuant to an understanding with the grantor, however, the income will be taxable to the grantor.¹⁰ Thus, where the income of a trust for the benefit of the grantor’s children is to be used for premium payments on insurance on the grantor’s life, the income will be taxable to the grantor even though each beneficiary is to consent in writing (revocable at will) to have his or her share of the income applied to the payment of premiums.¹¹