325 / Are proceeds of life insurance under a split dollar plan or under a reverse split dollar plan includable in an insured’s gross estate?

A close reading of IRC Section 2042(2) ( Q 81) leads to the conclusion that if an insured in a split dollar plan ( Q 4017), including a reverse split dollar plan ( Q 4025), has any incident of ownership in the policy at death, including the right to name a beneficiary of proceeds in excess of cash value or a right to name a beneficiary of the cash value in the case of a reverse split dollar plan, the entire proceeds would be includable in the insured’s gross estate. IRC Section 2042(2) provides, in pertinent part, that the value of a gross estate includes the value of all property to the extent “of the amount receivable by all other beneficiaries as insurance under policies on the life of the decedent with respect to which the decedent possessed at his death any of the incidents of ownership, exercisable either alone or in conjunction with any other person.” Notice in particular the phrases “all” other beneficiaries, that is, beneficiaries other than the insured’s estate, and “any” of the incidents of ownership. The language certainly seems inclusive enough to call for the conclusion suggested. (See Revenue Rulings 79-129, and 82-145, discussed in Q 326 and Q 328.) Moreover, this seems to be the position of the Tax Court on the proper application of IRC Section 2042(2) to split dollar life insurance. (See the discussion of Estate of Levy v. Commissioner, Q 328.)

Estate tax results depend on the substance of the arrangement, meaning that it is important to examine who actually holds which incidents of ownership, rather than placing importance on whether an endorsement form or collateral assignment form is used ( Q 4025). Estate tax results also are not altered depending on the source or purpose of premium payments.¹

Does A Plan Create True Indebtedness?

In a usual split dollar plan, the portion of premiums paid by an employer or the individual who occupies this position in the arrangement is not a true loan. Although the employer or its successor expects ultimately to recover the amount from death proceeds, the usual agreement does not obligate the insured to repay the funds from any source other than the policy or otherwise to treat that amount as a debt.

For estate tax purposes, it may make a real difference whether or not a split dollar plan creates a true indebtedness. If there is an indebtedness, and if the entire proceeds are brought into an insured’s gross estate under the incidents of ownership rule, the estate will be allowed a deduction under IRC Section 2053 for the amount of debt repaid from insurance proceeds. In this case, the net result will be the same as if only the portion of proceeds payable to the insured’s beneficiary were included in the insured’s gross estate in the first place. If there is no true indebtedness and if the entire proceeds are brought into an insured’s gross estate under the incidents of ownership rule, the portion of the proceeds going to the employer or to whoever occupies its place in the arrangement cannot be taken as an IRC Section 2053 deduction by the estate.

For estate taxation on the death of a third party owner of a policy on the split dollar plan, see Q 200.