78 / Are death proceeds of life insurance wholly tax-exempt if the policy has been transferred as a gift?
Generally, the donee steps into the shoes of the donor. Thus, the entire proceeds are exempt if they would have been exempt had the policy been retained by the donor. If the donor purchases the policy from another owner and no exceptions to the transfer for value rule ( Q 77) apply, however, then only the consideration paid by the donor, plus net premiums (and certain other amounts) subsequently paid by the donor and donee, is exempt.
As an exception to this general rule, however, the proceeds will be wholly tax-exempt – despite any previous transfer for value – if the final transfer is made to the insured, a partner of the insured, a partnership in which the insured is a partner, or a corporation in which the insured is an officer or shareholder. For tax years beginning after 2017, these exceptions will not apply if the policy was transferred in a reportable policy sale.1 The IRS has ruled that when a life insurance policy subject to a policy loan is transferred, there is a transfer for value; if the transfer is partly a gift, it may come within one of the exceptions to the transfer for value rule ( Q 279).2
1. Treas. Reg. § 1.101-1(b); Hacker v. Commissioner, 36 BTA 659 (1937).