284 / If an employer or an employer’s qualified plan sells or distributes a policy on an employee’s life to an insured’s spouse or to another member of an insured’s family, will the transfer cause loss of the tax exemption for the death proceeds?

Yes, generally, unless the transferee is a partner of the insured. This transfer does not come within any of the exceptions to the transfer for value rule ( Q 279). If a sale is involved, death proceeds will be taxable to the extent that they exceed the consideration paid by the purchaser plus net premiums, if any, paid after the sale. Any interest paid or accrued by the transferee on policy indebtedness may be added to the exempt amount under certain circumstances ( Q 279).

A transfer to an insured, followed by a gift from the insured to the insured’s spouse or family member ( Q 280) or a sale to the insured’s spouse after July 18, 1984, ( Q 106) would avoid taxation of proceeds under the transfer for value rule. A federal appeals court refused to treat a direct transfer by an employer to the wife of an insured employee for a consideration as two transfers merged into one: a transfer to the insured employee and then a gift from him to his wife.¹