Insurance on Key Person Partners and Stockholders

March 13, 2024

324 / Will the value of payments to a deceased partner’s spouse, under a partnership income continuation agreement, be includable in the partner’s estate?

<div class="Section1"> Yes. This is the result whether payments are of a guaranteed amount or a share of partnership profits for a certain number of years.<a href="#_ftn1" name="_ftnref1">1</a> The value of guaranteed payments is their present value at date of death. The value of a share in future partnership profits is based on past profits referred to as the valuation date.<a href="#_ftn2" name="_ftnref2">2</a> The payments are income in respect of a decedent.<a href="#_ftn3" name="_ftnref3">3</a> Consequently, a beneficiary will be entitled to an income tax deduction for any estate tax attributable to including the value of payments in a decedent’s gross estate.<a href="#_ftn4" name="_ftnref4">4</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Rev. Rul. 66-20, 1966-1 CB 214; Rev. Rul. 71-507, 1971-2 CB 331; Est. of Riegelman v. Commissioner, 253 F.2d 315 (2d Cir. 1958); McClennen v. Commissioner, 131 F.2d 165 (1st Cir. 1942); Est. of Beal v. Commissioner, 47 TC 269 (1966); Winkle v. U.S., 160 F. Supp. 348 (W.D. Pa. 1958). <a href="#_ftnref2" name="_ftn2">2</a>. Est. of Hull v. Commissioner, 38 TC 512 (1962). <a href="#_ftnref3" name="_ftn3">3</a>. IRC §§ 691, 753, 736(a). <a href="#_ftnref4" name="_ftn4">4</a>. IRC § 691(c). </div>

March 13, 2024

321 / If life insurance is owned by and payable to a partnership or corporation to fund purchase of an owner’s business interest, are proceeds includable in the insured owner’s estate?

<div class="Section1"> No. Because proceeds are not payable to an insured’s estate and the insured has no incidents of ownership in the policy, at least in the insured’s capacity as an individual, the proceeds are not includable in the insured’s gross estate.<a href="#_ftn1" name="_ftnref1">1</a> The same result should occur where a business owns the insurance but proceeds are payable to a trustee who must use them to purchase an insured’s business interest for the partnership or corporation. The value of a business interest is, of course, includable in an insured’s gross estate.<a href="#_ftn2" name="_ftnref2">2</a> In valuing an insured’s business interest, the part of the proceeds that is proportionate to the insured’s interest in the business will be included unless the proceeds are excluded from the purchase price under the terms of an agreement and the agreement is effective in fixing the value of the business interest for estate tax purposes ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="322">322</a>).<a href="#_ftn3" name="_ftnref3">3</a> Where an insured is a controlling stockholder, incidents of ownership in insurance owned by the corporation are not attributable to the insured so as to cause death proceeds to be includable in the decedent’s gross estate under IRC Section 2042 ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="319">319</a>).<a href="#_ftn4" name="_ftnref4">4</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 2042; Est. of Knipp v. Commissioner, 25 TC 153 (1955), acq. in result, 1959-1 CB 4; Rev. Rul. 83-147, 1983-2 CB 158. <a href="#_ftnref2" name="_ftn2">2</a>.     Wilson v. Crooks, 52 F.2d 692 (W.D. Mo. 1931); Est. of Ealy v. Commissioner, 10 TCM 431 (1951); Est. of Riecker v. Commissioner, 3 TCM 1293 (1944); Est. of Atkins v. Commissioner, 2 TC 332 (1943); Est. of Knipp, supra. <a href="#_ftnref3" name="_ftn3">3</a>.     Newell v. Commissioner, 66 F.2d 102 (7th Cir. 1933); Kennedy v. Commissioner, 4 BTA 330 (1926); see also Est. of Salt v. Commissioner, 17 TC 92 (1952); Est. of Littick v. Commissioner, 31 TC 181 (1958), acq. in result 1984-2 CB 1; Rubel v. Rubel, 75 So. 2d 59 (Miss. 1954). <a href="#_ftnref4" name="_ftn4">4</a>.     Treas. Reg. § 20.2042-1(c)(6); Rev. Rul. 82-85, 1982-1 CB 137. See also Est. of Huntsman v. Commissioner, 66 TC 861 (1976), acq. 1977-1 CB 1. </div></div>

March 13, 2024

319 / If a corporation purchases life insurance on the life of a key person to indemnify it against loss on account of the key person’s death, are proceeds includable in the insured’s estate?

<div class="Section1"> If, at an insured’s death, a policy was owned by and payable to a corporation and the insured possessed no incidents of ownership in the policy ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="85">85</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="86">86</a>), proceeds are not includable in the insured’s gross estate. If the insured possessed at his or her death any incidents of ownership in the policy, the proceeds are includable in his or her gross estate even though the corporation has been named owner and beneficiary.<a href="#_ftn1" name="_ftnref1">1</a> Death proceeds of life insurance owned by and payable to a corporation are considered, along with the other non-operating assets, as a relevant factor in valuing a corporation’s stock for estate tax purposes (but see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="321">321</a>).<a href="#_ftn2" name="_ftnref2">2</a> Consequently, where an insured is a stockholder, the value of proceeds will be reflected in valuing stock includable in the insured’s gross estate.<a href="#_ftn3" name="_ftnref3">3</a> It is not correct to value the stock first, without considering the insurance proceeds, and then simply add the amount of proceeds to that value.<a href="#_ftn4" name="_ftnref4">4</a> Factoring life insurance proceeds into the valuation of stock may or may not result in an increase in value equal to the full value of the insurance proceeds, depending on the valuation method.<a href="#_ftn5" name="_ftnref5">5</a> An offset may be available where there is an obligation to pay insurance proceeds to another party under a buy-sell agreement.<a href="#_ftn6" name="_ftnref6">6</a> It may be possible to obtain some reduction in the value of stock to reflect loss to the business of the key person’s services.<a href="#_ftn7" name="_ftnref7">7</a> The executor must offer proof to establish that the insured’s death actually did cause a loss. A loss does not result per se from the death of the owner and manager of a corporation.<a href="#_ftn8" name="_ftnref8">8</a> It has been held that no decrease in value for loss of an insured’s services will be allowed if the stock is personal holding company stock where the assets consist almost entirely of stocks and bonds; a corporation must be an operating business requiring management, with going value and goodwill.<a href="#_ftn9" name="_ftnref9">9</a> If an insured is a controlling stockholder, that is, one who owns stock amounting to more than 50 percent of the total combined voting power of the corporation, then to the extent proceeds are payable other than to or for the benefit of the corporation, any incidents of ownership in the insurance held by the corporation as to the proceeds will be attributed to the insured and thereby will cause the proceeds to be includable in the insured’s gross estate.<a href="#_ftn10" name="_ftnref10">10</a> In Revenue Ruling 82-141,<a href="#_ftn11" name="_ftnref11">11</a> X corporation owned insurance on the life of its controlling stockholder, D. The corporation assigned all of its incidents of ownership in the policy to A. D died within three years of the assignment, and proceeds of the policy were paid to A. The IRS held that the proceeds were includable in D’s estate under IRC Section 2035 ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="96">96</a>) by reason of attribution to D of the incidents of ownership held by the corporation. The ruling failed to identify the policy’s beneficiary before the assignment. The IRS also held that proceeds were includable in an insured’s estate under IRC Section 2035 where a corporation transferred a policy insuring the controlling shareholder to a third person within three years of the insured’s death even though the insured disposed of the insured’s stock after the transfer of the policy and prior to the insured’s death.<a href="#_ftn12" name="_ftnref12">12</a> Proceeds also were includable in an insured’s estate where a corporation retained ownership of a policy and an insured transferred enough stock so as to cease being a controlling shareholder within three years of death ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="325">325</a>).<a href="#_ftn13" name="_ftnref13">13</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 2042(2); Est. of Piggott v. Commissioner, 340 F.2d 829 (6th Cir. 1965), aff’g TC Memo 1963-61; Hall v. Wheeler, 174 F. Supp. 418 (D. Me. 1959); Kearns v. U.S., 399 F.2d 226 (Ct. Cl. 1968); Est. of Cockrill v. O’Hara, 302 F. Supp. 1365 (M.D. Tenn. 1969). <a href="#_ftnref2" name="_ftn2">2</a>.     Treas. Reg. § 20.2031-2(f). <a href="#_ftnref3" name="_ftn3">3</a>.     Est. of Blair v. Commissioner, 4 BTA 959 (1926), nonacq. 1927-1 CB 7; Est. of Doerken v. Commissioner, 46 BTA 809 (1926); In re Patton’s Will, 278 N.W. 866 (Wis. 1938); In re Reed’s Est., 153 N.E. 47 (N.Y. 1926); Kennedy v. Commissioner, 4 BTA 330 (1926); Est. of Carew v. Commissioner, 311 A2d 185 (N.J. 1973). <a href="#_ftnref4" name="_ftn4">4</a>.     Est. of Huntsman v. Commissioner, 66 TC 861 (1976), acq. 1977-1 CB 1. <a href="#_ftnref5" name="_ftn5">5</a>.     Est. of Blount v. Commissioner, TC Memo 2004-116. <a href="#_ftnref6" name="_ftn6">6</a>.     Est. of Blount v. Commissioner, 428 F.3d 1338 (11th Cir. 2005). <a href="#_ftnref7" name="_ftn7">7</a>.     Rev. Rul. 59-60, 1959-1 CB 237; Newell v. Commissioner, 66 F.2d 102 (7th Cir. 1933); Est. of Huntsman, 66 TC 861 (1976), acq. 1977-1 CB 1. <a href="#_ftnref8" name="_ftn8">8</a>.     Est. of Scherer v. Commissioner, 1940 P-H BTA Memorandum Decisions ¶ 40,530. <a href="#_ftnref9" name="_ftn9">9</a>.     In re Patton’s Will, 278 N.W. 866 (Wisc. 1938). <a href="#_ftnref10" name="_ftn10">10</a>.   Treas. Reg. § 20.2042-1(c)(6). <a href="#_ftnref11" name="_ftn11">11</a>.   1982-2 CB 209. <a href="#_ftnref12" name="_ftn12">12</a>.   Rev. Rul. 90-21, 1990-1 CB 172, Situation 1. <a href="#_ftnref13" name="_ftn13">13</a>.   Rev. Rul. 90-21, 1990-1 CB 172, Situation 2. </div></div>

March 13, 2024

323 / How is a closely held business interest valued for federal estate tax purposes where there is no purchase agreement?

<div class="Section1"> 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.”<a href="#_ftn1" name="_ftnref1">1</a> 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.<a href="#_ftn2" name="_ftnref2">2</a> 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.<a href="#_ftn3" name="_ftnref3">3</a> 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.<a href="#_ftn4" name="_ftnref4">4</a> Just because an interest being valued is a minority interest does not mean that a minority discount is available.<a href="#_ftn5" name="_ftnref5">5</a> One case, however, valued stock with voting rights at no more than stock without voting rights.<a href="#_ftn6" name="_ftnref6">6</a> 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.<a href="#_ftn7" name="_ftnref7">7</a> 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.<a href="#_ftn8" name="_ftnref8">8</a> 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 <a href="javascript:void(0)" class="accordion-cross-reference" id="300">300</a>) 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.<a href="#_ftn9" name="_ftnref9">9</a> 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.<a href="#_ftn10" name="_ftnref10">10</a> A minority discount was allowed even when the person to whom the interest was transferred already was a controlling shareholder.<a href="#_ftn11" name="_ftnref11">11</a> Deathbed transactions have, however, been aggregated into a single integrated transfer to which a control premium attached rather than minority discounts. In one such case, 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.<a href="#_ftn12" name="_ftnref12">12</a> 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.<a href="#_ftn13" name="_ftnref13">13</a> 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.<a href="#_ftn14" name="_ftnref14">14</a> Courts have also 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.<a href="#_ftn15" name="_ftnref15">15</a> 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.<a href="#_ftn16" name="_ftnref16">16</a> See note at Q <a href="javascript:void(0)" class="accordion-cross-reference" id="322">322</a> concerning proposed regulations under IRC Sections 2701 et seq. The controversial Section 2704 proposed regulations were eventually withdrawn by the Treasury Department. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     Treas. Reg. § 20.2031-1(b). <a href="#_ftnref2" name="_ftn2">2</a>.     Treas. Reg. § 20.2031-2. See also Rev. Rul. 59-60, 1959-1 CB 237. <a href="#_ftnref3" name="_ftn3">3</a>.     TAM 9436005. <a href="#_ftnref4" name="_ftn4">4</a>.     TAM 9403005. <a href="#_ftnref5" name="_ftn5">5</a>.     Godley v. Commissioner, 286 F.3d 210, 2002-1 USTC ¶ 60,436 (4th Cir. 2002) (partnerships held housing projects subject to long term government contracts). <a href="#_ftnref6" name="_ftn6">6</a>.     Est. of Simplot v. Commissioner, 249 F.3d 1191 (9th Cir. 2001). <a href="#_ftnref7" name="_ftn7">7</a>.     Est. of Maddox v. Commissioner, 93 TC 228 (1989). <a href="#_ftnref8" name="_ftn8">8</a>.     Est. of Hoover v. Commissioner, 69 F.3d 1044 (10th Cir. 1995), acq. 1998-2 CB xix, rev’g 102 TC 777 (1994). <a href="#_ftnref9" name="_ftn9">9</a>.     Est. of Bright v. Commissioner, 658 F.2d 999 (5th Cir. 1981). <a href="#_ftnref10" name="_ftn10">10</a>.   Rev. Rul. 93-12, 1993-1 CB 202. <a href="#_ftnref11" name="_ftn11">11</a>.   TAM 9432001. <a href="#_ftnref12" name="_ftn12">12</a>.   TAM 9504004. <a href="#_ftnref13" name="_ftn13">13</a>.   Est. of Murphy v. Commissioner, TC Memo 1990-472. <a href="#_ftnref14" name="_ftn14">14</a>.   TAMs 9719006, 9723009, 9725002, 9730004, 9735003, 9736004, 9842003. <a href="#_ftnref15" name="_ftn15">15</a>.   Est. of Bigelow v. Commissioner, 503 F. 3d 955, 2007-2 USTC ¶ 60,548 (9th Cir. 2007), aff’g TC Memo 2005-65; Est. of Strangi v. Commissioner, 417 F. 3d 468, 2005-2 USTC ¶ 60,506 (5th Cir. 2005), aff’g TC Memo 2003-145; Est. of Bongard v. Commissioner, 124 TC 95 (2005); Turner v. Commissioner, 382 F. 3d 367, 2004-2 USTC ¶ 60,489 (3d Cir. 2004), aff’g TC Memo 2002-246; Kimbell v. U.S., 244 F. Supp. 2d 700, 2003-1 USTC ¶ 60,455 (N.D. Tex. 2003), rev’d, 371 F. 3d 257, 2004-1 USTC ¶ 60,486 (5th Cir. 2004); Est. of Abraham v. Commissioner, TC Memo 2004-39; Est. of Hilgren v. Commissioner, TC Memo 2004-46 (discount for business loan agreement was allowed). <a href="#_ftnref16" name="_ftn16">16</a>.   Kimbell v. U.S., 371 F. 3d 257, 2004-1 USTC ¶ 60,486 (5th Cir. 2004), rev’g 244 F. Supp. 200 2003-1 USTC ¶ 60,455 (N.D. Tex. 2003). </div></div>

March 13, 2024

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?

<div class="Section1"> A close reading of IRC Section 2042(2) ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="81">81</a>) leads to the conclusion that if an insured in a split dollar plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4017">4017</a>), including a reverse split dollar plan ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="4025">4025</a>), 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 <a href="javascript:void(0)" class="accordion-cross-reference" id="326">326</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="328">328</a>.) 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 <a href="javascript:void(0)" class="accordion-cross-reference" id="328">328</a>.) 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 <a href="javascript:void(0)" class="accordion-cross-reference" id="4025">4025</a>). Estate tax results also are not altered depending on the source or purpose of premium payments.<a href="#_ftn1" name="_ftnref1">1</a> 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 <a href="javascript:void(0)" class="accordion-cross-reference" id="200">200</a>. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     Rev. Rul. 76-274, 1976-2 CB 278. </div></div>

March 13, 2024

327 / Are proceeds of life insurance under a split dollar plan or under a reverse split dollar plan includable in an insured’s gross estate in the context of an employer-employee relationship?

<div class="Section1"> It should be noted that the term “reverse split dollar” is not contained in the split dollar regulations. Once a common term, today it is still sometimes used to define arrangements where the employee owns the policy and endorses the death benefit to the employer – instead of the more typical arrangement where the employer owns the policy and endorses the death benefit to the employee or a beneficiary named by the employee. See also IRS Notice 2002-59, which addresses the valuation of term insurance under a so-called reverse split dollar arrangement. In Schwager v. Commissioner,<a href="#_ftn1" name="_ftnref1">1</a> a sole proprietor applied for and owned a policy on a split dollar or endorsement plan on the life of an employee. The beneficiary of proceeds equal to the cash value at death was designated in the policy as the part A beneficiary and in this case was the employer. The beneficiary of proceeds in excess of the cash value, the part B beneficiary, was the employee’s wife. By policy amendment, the part B beneficiary could not be changed without the insured’s consent. The Tax Court decided that the insured’s right to consent to a change of beneficiary was an incident of ownership and held that the portion of proceeds paid to his widow was includable in his estate. The opinion does not make it clear that only the portion of proceeds payable to the insured’s widow was includable in the estate, but counsel for the taxpayer has confirmed that was the case. Apparently, the IRS did not try for the includability of more. In Estate of Tomerlin v. Commissioner,<a href="#_ftn2" name="_ftnref2">2</a> a corporation owned insurance on the life of a decedent, a 50 percent shareholder of the corporation. The policy provided that the corporation was the sole owner of the policy and that the death proceeds were to be divided between the corporation and the decedent’s children. The corporation was to receive the proceeds equal to the premiums it had paid and the decedent’s children were to receive the balance. The decedent had been given incidents of ownership in the policy by agreement with the corporation, including the right to designate beneficiaries of the policy. The IRS sought includability in the decedent’s estate under IRC Section 2042(2) of the portion of the proceeds payable to the decedent’s children, and the court found for the IRS. In private letter Ruling 9026041, the IRS held that the full value of proceeds of a life insurance policy were subject to an endorsement reverse split dollar agreement and included in the estate of the insured key person. The insured key person would hold incidents of ownership in the policy. The estate would be allowed to deduct the portion of the proceeds that would be payable to the corporate participant in the reverse split dollar arrangement. </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. 64 TC 781 (1975). <a href="#_ftnref2" name="_ftn2">2</a>. TC Memo 1986-147. </div>

March 13, 2024

329 / Does a life insurance funded buy-sell agreement fix the value of a business interest for gift tax purposes?

<div class="Section1"> No. A buy-sell agreement is not necessarily based on the fair market value of the business. A buy-sell agreement is simply an agreement between friendly parties to address the smooth transition of ownership due to a business owner’s termination of employment, death, or sale of the individual’s business interest.<a href="#_ftn1" name="_ftnref1">1</a> The IRS is much more likely to respect a buy-sell valuation as fair market value when the agreement is between unrelated parties. An agreement restricting lifetime sale may be considered with all other pertinent factors, however, and may tend to lower the value of a close corporation or other business interest.<a href="#_ftn2" name="_ftnref2">2</a> On the other hand, failure to exercise rights under a buy-sell agreement could result in a taxable gift. </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Effect of Purchase Price, Buy-Sell Agreements, and Key Person Insurance on Valuation, Gunnar J. Gitlin (Business Valuations in Divorce Cases – 2012), p. 63. <a href="#_ftnref2" name="_ftn2">2</a>. Spitzer v. Commissioner, 153 F.2d 967 (8th Cir. 1946); Est. of James v. Commissioner, 148 F.2d 236 (2d Cir. 1945); Commissioner v. McCann, 146 F.2d 385 (2d Cir. 1944), nonacq. 1943 CB 36; Krauss v. U.S., 140 F.2d 510 (5th Cir. 1944); Kline v. Commissioner, 130 F.2d 742 (3d Cir. 1942); Rev. Rul. 189, 1953-2 CB 294. </div>

March 13, 2024

320 / If partners or stockholders enter into a buy-sell agreement and each purchases life insurance on each other’s lives to fund the agreement, are proceeds includable in an insured’s gross estate?

<div class="Section1"> 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, death benefit proceeds are not includable in his or her gross estate.<a href="#_ftn1" name="_ftnref1">1</a> 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 (but see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="86">86</a>).<a href="#_ftn2" name="_ftnref2">2</a> The value of an insured’s partnership interest or corporate stock is includable.<a href="#_ftn3" name="_ftnref3">3</a> The value of any unmatured policies an insured owns on the life of his or her associates also will be includable. 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.<a href="#_ftn4" name="_ftnref4">4</a> 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.<a href="#_ftn5" name="_ftnref5">5</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 2042; Rev. Rul. 56-397, 1956-2 CB 599. <a href="#_ftnref2" name="_ftn2">2</a>.     Est. of Infante v. Commissioner, TC Memo 1970-206 (appeal dismissed). <a href="#_ftnref3" name="_ftn3">3</a>.     Est. of Riecker v. Commissioner, 3 TCM 1293 (1944). <a href="#_ftnref4" name="_ftn4">4</a>.     Est. of Mitchell v. Commissioner, 37 BTA 1 (1938), acq.; Est. of Tompkins v. Commissioner, 13 TC 1054 (1949), acq.; Est. of Ealy v. Commissioner,10 TCM 431; Dobrzensky v. Commissioner, 34 BTA 305 (1936), nonacq. 1936-2 CB 39; Boston Safe Deposit & Trust Co. v. Commissioner, 30 BTA 679 (1934), nonacq. 1934-2 CB 34. <a href="#_ftnref5" name="_ftn5">5</a>.     Est. of Fuchs v. Commissioner, 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). </div></div>

March 13, 2024

318 / If a partnership purchases and owns life insurance on the life of a partner, are policy proceeds includable in the insured partner’s estate?

<div class="Section1"> If a partnership is both policy owner and beneficiary, insurance proceeds are not includable in an insured’s gross estate under the incidents of ownership test ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="85">85</a>).<a href="#_ftn1" name="_ftnref1">1</a> Proceeds received by a partnership will be included with other partnership assets in determining the value of a decedent’s partnership interest for estate tax purposes; consequently, his or her gross estate will reflect a share of the proceeds proportionate to the partnership interest.<a href="#_ftn2" name="_ftnref2">2</a> If an insured has personal incidents of ownership in a policy, including the right to change a beneficiary, the entire value of the proceeds will be includable in the gross estate.<a href="#_ftn3" name="_ftnref3">3</a> Where death proceeds are payable to a partner’s personal beneficiary, the insured is deemed to possess an incident of ownership in the insurance in his or her capacity as a partner for purposes of IRC Section 2042(2) regardless of the percentage of the partnership interest. Consequently, if a partnership owns insurance at the time of an insured partner’s death, the entire proceeds will be includable in the partner’s estate.<a href="#_ftn4" name="_ftnref4">4</a> For estate tax treatment of group term life insurance covering the life of a partner, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="175">175</a>. <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     Est. of Knipp v. Commissioner, 25 TC 153 (1955), acq. in result, 1959-1 CB 4; Est. of Atkins v. Commissioner, 2 TC 332 (1943); Rev. Rul. 83-147, 1983-2 CB 158. See also Let. Rul. 200017051. <a href="#_ftnref2" name="_ftn2">2</a>.     IRC § 2033. <a href="#_ftnref3" name="_ftn3">3</a>.     IRC § 2042(2); Hall v. Wheeler, 174 F. Supp. 418 (D. Me. 1959); Est. of Piggott v. Commissioner, TC Memo 1963-61, aff’d, 340 F.2d 829 (6th Cir. 1965). <a href="#_ftnref4" name="_ftn4">4</a>.     Rev. Rul. 83-147, 1983-2 CB 158; GCM 39034 (9-21-83). </div></div>

March 13, 2024

322 / How is a closely held business interest valued for federal estate tax purposes where there is a purchase agreement?

<div class="Section1"> 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: <blockquote>(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.<a href="#_ftn1" name="_ftnref1">1</a></blockquote> Whether or not an agreement is subject to IRC Section 2703, case law has established the additional following rules: <blockquote>(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.<a href="#_ftn2" name="_ftnref2">2</a></blockquote> 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.<a href="#_ftn3" name="_ftnref3">3</a> 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, does not fix the value of the interest for estate tax purposes.<a href="#_ftn4" name="_ftnref4">4</a> 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.<a href="#_ftn5" name="_ftnref5">5</a> A buy-sell agreement is not binding unless it represents a bona fide business agreement and is not testamentary in nature.<a href="#_ftn6" name="_ftnref6">6</a> An agreement may be found to be a scheme for avoiding estate taxes even where it serves a bona-fide business purpose.<a href="#_ftn7" name="_ftnref7">7</a> No effect will be given to an option or contract under which a decedent is free to dispose of the interest at any price he or she chooses during life.<a href="#_ftn8" name="_ftnref8">8</a> On the other hand, an agreement that restricts sale during life, but not at death, will also fail to fix the estate tax value.<a href="#_ftn9" name="_ftnref9">9</a> <hr /> Planning Point: On August 2, 2016, the Treasury Department issued controversial proposed regulations under IRC Section 2701 et seq. and IRC Section 2704. In general, IRC Section 2701 governs valuation of interests transferred between family members, outright or in trust. Note that these were proposals that never became effective. The proposed regulations were eventually withdrawn in accordance with President Trump’s Executive Order 13789. <hr /> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 2703. <a href="#_ftnref2" name="_ftn2">2</a>. May v. McGowan, 194 F.2d 396 (2d Cir. 1952); Commissioner v. Child’s Est., 147 F.2d 368 (3d Cir. 1945); Commissioner v. Bensel, 100 F.2d 639 (3d Cir. 1938); Lomb v. Sugden, 82 F.2d 166 (2d Cir. 1936); Wilson v. Bowers, 57 F.2d 682 (2d Cir. 1932); Est. of Littick v. Commissioner, 31 TC 181 (1958), acq. in result 1984-2 CB 1; Est. of Salt v. Commissioner, 17 TC 92 (1951), acq.; Fiorito v. Commissioner, 33 TC 440 (1959), acq.; Est. of Weil v. Commissioner, 22 TC 1267 (1954), acq.; Est. of Bischoff v. Commissioner, 69 TC 32 (1977); see also Treas. Reg. § 20.2031-2(h); Treas. Reg. § 20.2031-3. <a href="#_ftnref3" name="_ftn3">3</a>. Let. Rul. 8245007. <a href="#_ftnref4" name="_ftn4">4</a>. Worcester County Trust Co. v. Commissioner, 134 F.2d 578 (1st Cir. 1943); City Bank Farmers Trust Co. v. Commissioner, 23 BTA 663 (1931), acq. 1932-1 CB 2; Michigan Trust Co. v. Commissioner, 27 BTA 556 (1933). <a href="#_ftnref5" name="_ftn5">5</a>. Slocum v. U.S., 256 F. Supp. 753 (S.D.N.Y. 1966). <a href="#_ftnref6" name="_ftn6">6</a>. Est. of True v. Commissioner, 390 F.3d 1210 (10th Cir. 2004). <a href="#_ftnref7" name="_ftn7">7</a>. St. Louis County Bank v. U.S., 674 F.2d 1207, 49 AFTR 2d 82-1509 (8th Cir. 1982). <a href="#_ftnref8" name="_ftn8">8</a>. Est. of Caplan v. Commissioner, TC Memo 1974-39; Est. of Gannon v. Commissioner, 21 TC 1073 (1954); Est. of Trammell v. Commissioner, 18 TC 662 (1952), acq. 1953-1 CB 6; Est. of Mathews v. Commissioner, 3 TC 525 (1944); Hoffman v. Commissioner, 2 TC 1160 (1943); Est. of Tompkins v. Commissioner, 13 TC 1054 (1949); Rev. Rul. 59-60, 1959-1 CB 237. <a href="#_ftnref9" name="_ftn9">9</a>. Land v. U.S., 303 F.2d 170 (5th Cir. 1962). </div>