Life Insurance

Life insurance is a contract under which, in exchange for premium payments, an insurance company agrees to pay a death benefit if the person whose life is insured dies while the contract is in force. There are two general categories of life insurance: term coverage and permanent coverage. Term coverage is for a specific period of time, which can last for as little as one year or possibly as long as 30 years. Permanent insurance is intended to cover an insured for the rest of the insured s life. Permanent life insurance can be financed with a single premium, a fixed number of premiums over several years, or premiums paid over the remainder of the insured s life.

<div class="Section1"><br /> <br /> The effect of an IRC Section 1035 exchange on the grandfathered status of a policy issued prior to June 21, 1988, and thus not subject to the seven pay test of IRC Section 7702A, is not entirely clear.<a href="#_ftn1" name="_ftnref1">¹</a> In a private ruling, the IRS has taken the position that a life insurance contract received in an IRC Section 1035 exchange for a life insurance contract issued before June 21, 1988, will be considered as issued and entered into on the date that it is received in exchange for the previous contract and, thus, apparently will be subject to the seven pay test.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> If an MEC requiring the payment of at least seven annual premiums was entered into after June 20, 1988, but before November 10, 1988, and was then exchanged within the three months following November 10, 1988, for a contract that meets the requirements of the seven pay test, the new contract is not treated as an MEC if the taxpayer recognized gain, if any, on the exchange.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     H.R. Conf. Rep. No. 100-1104 (TAMRA ’88), <em>reprinted in</em> 1988-3 CB 596.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.     Let. Rul. 9044022.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.     TAMRA ’88 § 5012(e)(4).<br /> <br /> </div>

<div class="Section1">There are several special rules that apply to chronically ill insureds. Generally, the tax treatment outlined above will not apply to any payment received for any period unless such payment is for costs incurred by the payee (who has not been compensated by insurance or otherwise) for qualified long-term care services provided to the insured for the period. Additionally, the terms of the contract under which such payments are made must comply with:<br /> <blockquote>(1)&nbsp;&nbsp;&nbsp;&nbsp; the requirements of IRC Section&nbsp;7702B(b)(1)(B) (defining &ldquo;long-term care<br /> contract&rdquo;);<br /> <br /> (2)&nbsp;&nbsp;&nbsp;&nbsp; the requirements of IRC Sections 7702B(g) and 4980C ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="477">477</a>) that the IRS specifies as applying to such a purchase, assignment, or other arrangement (relating to consumer protection provisions);<br /> <br /> (3)&nbsp;&nbsp;&nbsp;&nbsp; standards adopted by the NAIC that apply specifically to chronically ill insureds (if such standards are adopted, similar standards under number (2) above cease to apply); and<br /> <br /> (4)&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;standards adopted by the state in which the policyholder resides (if such standards are adopted, the analogous requirements under number (2) and, subject to IRC Section&nbsp;4980C(f), standards under number (3) above cease to apply).<a href="#_ftn1" name="_ftnref1">¹</a></blockquote><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect;&nbsp;101(g)(3)(B).<br /> <br /> </div></div><br />

<div class="Section1">The unsatisfactory answer appears to be that a determination of the fair market value of the insurance claim or claims at the date of death or at the alternate valuation date must be made from the facts and circumstances of the particular case.<a href="#_ftn1" name="_ftnref1">¹</a> This problem is most likely to be encountered when an insured’s death occurs during the policy’s contestable period and there is a question whether the insured made material misrepresentations in applying for the insurance or whether the insured’s death resulted from suicide.</div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     <em>American Nat’l Bank &amp; Trust Co. v. U.S.</em>, 594 F.2d 1141 (7th Cir. 1979); Let. Rul. 8308001.<br /> <br /> </div>

<div class="Section1">They are treated in the same manner as other insurance. Proceeds are includable in the insured&rsquo;s estate if the proceeds are payable to or for the benefit of the insured&rsquo;s estate, or if the insured has any incidents of ownership in the policy at the time of his or her death ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="81">81</a>).<a href="#_ftn1" name="_ftnref1">¹</a><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect;&nbsp;2042.<br /> <br /> </div></div><br />

<div class="Section1">There is one exception to this general rule of non-includability for accelerated death benefits. Accelerated death benefits paid to (1) any taxpayer other than the insured if (2) the taxpayer has an insurable interest in the life of the insured because the insured is a director, officer, or employee of the taxpayer or if the insured is financially interested in any trade or business of the taxpayer, are exceptions from the special treatment afforded to payment of certain accelerated death benefits (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="54">54</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="55">55</a>).<a href="#_ftn1" name="_ftnref1">¹</a><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect;&nbsp;101(g)(5).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Yes.<br /> <br /> A payee, however, generally may elect not to have anything withheld. Only the amount that it is reasonable to believe is includable in income is subject to withholding. Amounts are to be withheld from periodic payments at the same rate as wages. Payments are periodic, even if they are variable, if they are payable over a period of more than a year. If payments are not periodic, 10 percent of the includable amount is withheld. Payments to a beneficiary of a deceased payee are subject to withholding under the same rules.<a href="#_ftn1" name="_ftnref1">¹</a> An election out of withholding will be ineffective, generally, if a payee does not furnish his or her taxpayer identification number (TIN, usually the payee’s Social Security number) to the payor, or furnishes an incorrect TIN to the payor and the payor is so notified by the IRS.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 3405; Temp. Treas. Reg. § 35.3405-1T (A-9, A-10, A-12, A-17, F-19 through 24).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.     IRC § 3405(e)(12).<br /> <br /> </div>

<div class="Section1">There are exceptions to the disallowance rule for certain transfers involving charitable gift annuity contracts ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="607">607</a>) and charitable remainder trusts.<a href="#_ftn1" name="_ftnref1">¹</a><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect;&sect;&nbsp;170(f)(10)(D), 170(f)(10)(E).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Generally, no. If the insured has any incident of ownership in the policy at the time of death, the proceeds are includable in the insured’s gross estate, but a charitable deduction is allowable for their full value.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> If, however, the law in the state of the donor’s domicile does not recognize that a charity has an insurable interest in the life of the donor, complications may arise. In some states, a charity may not have an insurable interest with respect to a newly issued insurance policy given to the charity or for a policy applied for and issued to the charity as owner and beneficiary. If the charity does not have an insurable interest and the insurer or the insured’s estate raises the question of lack of an insurable interest, the insured’s estate may be able to recover the proceeds (or the premiums paid). The proceeds are includable in the insured’s estate to the extent that the proceeds could be received by the insured’s estate. No charitable deduction may be allowed if the executor recovers the proceeds for the estate or if the executor were to fail to recover the proceeds and the proceeds passed to charity.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC §§ 2042(2), 2055; <em>Commissioner v. Pupin</em>, 107 F.2d 745 (2d Cir. 1939); <em>McKelvy v. Commissioner</em>, 82 F.2d 395 (3d Cir. 1936).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.     <em>See</em> Let. Rul. 9110016 (revoked by Let. Rul. 9147040 when state law was amended to permit an insured to immediately transfer a newly purchased life insurance policy to charity).<br /> <br /> </div>

<div class="Section1">Generally, the full value of the property, in addition to the value of the policy, constitutes a gift. (<em>But see</em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="156">156</a>, relating to reversionary interest trusts.) Subsequent premium payments by the trustee from trust income will not constitute additional gifts from the grantor. This is true even though the insurance is on the life of the grantor and the grantor remains personally liable for the income tax on the trust income, which may be used to pay premiums.<a href="#_ftn1" name="_ftnref1">¹</a><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp;&nbsp;&nbsp; <em>Commissioner v. Estate of Beck</em>, 129 F.2d 243 (2d Cir. 1942); <em>Lockard v. Commissioner</em>, 166 F.2d 409 (1st Cir. 1948).<br /> <br /> </div></div><br />