Estate Tax Issues

March 13, 2024

93 / Are the general rules for including life insurance proceeds in the insured’s gross estate applicable to proceeds payable under a qualified pension or profit-sharing plan?

<div class="Section1">Yes, generally, for estates of decedents dying after 1984; but see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3982">3982</a> for details.</div>

March 13, 2024

97 / Is life insurance owned by a corporation on its majority shareholder included in the shareholder’s estate when the shareholder divested an interest in the corporation within three years of death?

<div class="Section1">Life insurance owned by a corporation on its majority shareholder was not included in the shareholder’s estate where the shareholder sold her interest in the corporation within three years of death. The corporation had always owned the policy, paid the premiums, and been beneficiary of the proceeds.<a href="#_ftn1" name="_ftnref1">1</a> However, where a majority shareholder reduced his interest in a corporation to 40 percent within three years of death and proceeds of life insurance owned by the corporation on such shareholder were payable to the shareholder’s daughter, proceeds were included in the shareholder’s estate.<a href="#_ftn2" name="_ftnref2">2</a> Also, where a corporation transferred a life insurance policy to the beneficiary within three years of the controlling shareholder’s death, proceeds were included in the controlling shareholder’s estate even though the shareholder transferred his interest in the corporation to his son after the corporation’s transfer of the life insurance policy and prior to his death.<a href="#_ftn3" name="_ftnref3">3</a> Where a non-majority shareholder held the right to purchase a policy on his life from a corporation upon termination of a buy-sell agreement and the shareholder caused the corporation to transfer the policy to an irrevocable trust within three years of the shareholder’s death, the proceeds were included in the shareholder’s 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>. Let. Rul. 8906002. <a href="#_ftnref2" name="_ftn2">2</a>. Rev. Rul. 90-21, 1990-1 CB 172, situation 2. <a href="#_ftnref3" name="_ftn3">3</a>. Rev. Rul. 90-21, 1990-1 CB 172, situation 1. <a href="#_ftnref4" name="_ftn4">4</a>. TAM 9127007. </div>

March 13, 2024

99 / If a donor dies within three years of making a gift of a life insurance policy on the life of another, is the value of the policy includable in the donor’s gross estate?

<div class="Section1"> No. IRC Section 2035 brings back into a decedent’s estate certain gifts made within three years of death. The bring-back rule of Section 2035 applies to a transfer of an interest in property that is included in the value of the gross estate under IRC Sections 2036, 2037, 2038, or 2042, or would have been included under any of these sections if such interest had been retained by the decedent. IRC Section 2042 has to do with proceeds of insurance on the life of the decedent. IRC Section 2033 (which includes property in which a decedent had any interest at all) governs whether the value of a policy owned by the decedent on the life of another is includable in the decedent’s estate. A transfer of an interest in property included in the value of the gross estate under Section 2033, or that would have been included under Section 2033 if the interest had been retained by the decedent, is not among the enumerated sections under the bring-back rule of Section 2035. Thus, the value of a policy owned by a decedent on the life of another and transferred by the decedent within three years of the decedent’s death (occurring after 1981) will not normally be brought back into the decedent’s estate under Section 2035. </div>

March 13, 2024

108 / What is the tax treatment when an existing life insurance policy is owned and maintained by a former spouse?

<div class="Section1"> Editor’s Note: The 2017 tax reform legislation eliminated the previously existing above-the-line deduction for alimony for tax years beginning after 2018, and provides that alimony and separate maintenance payments are no longer included in the income of the recipient. If the policy is not transferred but the former spouse is required, under the divorce decree or agreement, to own and maintain a policy as security for post-death payments, installment payments of the proceeds would be taxable as alimony. Pre-2019, payments from an insurance trust established to discharge post-death obligations were fully taxable to the recipient spouse.<a href="#_ftn1" name="_ftnref1">1</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 71 (prior to repeal by Pub. Law No. 115-97); IRC § 682; Treas. Reg. §§ 1.71-1(c)(2), 1.101-5. </div>

March 13, 2024

82 / If life insurance proceeds are payable to an insured’s estate, is the value of the proceeds includable in the insured’s estate?

<div class="Section1">Yes. The entire value of the proceeds must be included in the insured’s gross estate even if the insured possessed no incident of ownership in the policy, and paid none of the premiums.<a href="#_ftn1" name="_ftnref1">1</a> But see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="167">167</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="168">168</a> for the rule in community property states. Proceeds payable to an executor in the executor’s individual capacity rather than as executor for the insured’s estate were not treated as payable to the insured’s estate by the Tax Court.<a href="#_ftn2" name="_ftnref2">2</a><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 2042(1); Estate of Bromley v. Commissioner, 16 BTA 1322 (1929). <a href="#_ftnref2" name="_ftn2">2</a>.     Estate of Friedberg v. Commissioner, TC Memo 1992-310. </div></div>

March 13, 2024

112 / Is the deduction under IRC Section 2053(a)(3) considered a claim against the insured’s estate?

<div class="Section1">The IRS has held that the availability of the deduction under IRC Section 2053(a)(3) depends upon the nature of the insured’s legal obligation under the divorce decree. If the insured’s obligation was simply to keep the policy in full force and effect with all premiums paid as long as the former spouse lived and remained unmarried, and the insured did that, then no obligation survived the insured’s death and the insured’s estate would not be entitled to a deduction. If, on the other hand, the divorce decree provided for the payment to the decedent’s former spouse of a specific sum of money upon the decedent’s death, and the decedent provided the funds by the purchase of life insurance, then the payment of the required amount would be a personal obligation of the decedent, so it would be payable from the decedent’s estate if the insurer was unable to meet its obligation. Under these circumstances, any proceeds payable to the former spouse to discharge the decedent’s obligation would be deductible under IRC Section 2053(a)(3).<a href="#_ftn1" name="_ftnref1">1</a></div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Rev. Rul. 76-113, 1976-1 CB 276. </div>

March 13, 2024

84 / Are the proceeds from life insurance taken out to pay an insured’s death taxes includable in the insured’s estate?

<div class="Section1"> Yes. The proceeds are includable in the insured’s gross estate if the beneficiary has a legally binding obligation to use them to pay the insured’s death taxes.<a href="#_ftn1" name="_ftnref1">1</a> For powers that may be given to a trustee, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="182">182</a>. <hr> Planning Point: Proceeds should not be includable in the gross estate merely because the beneficiary lends the proceeds to the estate, or uses the proceeds to buy assets from the estate. Liquidity can be provided to an estate in this manner. <hr> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.     Treas. Reg. § 20.2042-1(b)(1). </div></div>

March 13, 2024

98 / Are there any situations in which death proceeds of life insurance that were given away by an insured within three years of the insured’s death are not included in the insured’s gross estate?

<div class="Section1">An exception is provided to the transfers within three years of death rules for any bona fide sale for adequate and full consideration.<a href="#_ftn1" name="_ftnref1">1</a> It is unclear whether consideration equal to the interpolated terminal reserve of a policy plus any unexpired premiums is adequate to avoid the transfers within three years of death rule. TAM 8806004 interpreted full consideration as requiring that the consideration must be adequate relative to what would be included in the estate (i.e., the proceeds), not relative to what is transferred (i.e., the policy). See Estate of Pritchard v. Commissioner,<a href="#_ftn2" name="_ftnref2">2</a> where consideration equal to the cash surrender value was inadequate. However, TAM 9413045 accepted the interpolated terminal reserve plus any unexpired premiums as adequate consideration.</div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 2035(d). <a href="#_ftnref2" name="_ftn2">2</a>. 4 TC 204 (1944). </div>

March 13, 2024

104 / Can the transfer to an irrevocable life insurance trust of an amount used to make premium payments qualify for the generation-skipping transfer tax annual exclusion?

<div class="Section1"> Yes. If certain requirements are met, a transfer to an irrevocable life insurance trust can qualify for the annual exclusion (and thus avoid the generation-skipping transfer (GST) tax). A nontaxable gift, which is a direct skip, has an inclusion ratio of zero (i.e., it is not subject to GST tax). Nontaxable gifts are defined as gifts eligible for the annual exclusion ($19,000 in 2025) (doubled if gifts are split between spouses), as well as certain transfers for educational or medical expenses. However, with respect to transfers after March 31, 1988, the nontaxable gift that is a direct skip to a trust for the benefit of an individual has an inclusion ratio of zero only if (1) during the life of such individual no portion of the trust corpus or income may be distributed to or for the benefit of any other person, and (2) the trust would be included in such individual’s estate if the trust did not terminate before such individual died.<a href="#_ftn1" name="_ftnref1">1</a> Thus, separate shares or separate trusts, as described in the preceding sentence, must be created for each such individual if premium payments are to be covered by the annual exclusion for GST tax purposes. <hr /> Planning Point: Because of the separate share requirement, the annual exclusion is generally not used for generation-skipping life insurance trusts. Instead, the trust is usually protected by allocating the GST exemption to all transfers to the trust. <hr /> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 2642(c); Rev. Proc. 2024-40. </div>

March 13, 2024

87 / What are the incidents of ownership of employer-paid death benefits that would cause life insurance proceeds to be includable in the insured’s estate?

<div class="Section1"> An employee insured’s right to designate the beneficiary of an employer-paid death benefit is not treated as an incident of ownership in the insurance funding the benefit if the employer is sole owner of the policy and sole beneficiary for its exclusive use.<a href="#_ftn1" name="_ftnref1">1</a> (However, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3638">3638</a> through Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3640">3640</a> for potential income tax implications.) The IRS has taken the position that if the insured under a corporation-owned policy has an agreement with the corporation giving the insured the first right to purchase the policy for its cash surrender value if the corporation decides to discontinue the coverage, the purchase option is an incident of ownership.<a href="#_ftn2" name="_ftnref2">2</a> The Tax Court has held, however, that the insured’s contingent purchase option as described in Revenue Ruling 79-46 is not an incident of ownership within the meaning of IRC Section 2042(2).<a href="#_ftn3" name="_ftnref3">3</a> The IRS also has ruled that where, under an insured stock redemption agreement, a stockholder had the right to purchase the policies the corporation owned on the insured’s life if the insured ceased being a stockholder, such contingent purchase option was not an incident of ownership in the insurance.<a href="#_ftn4" name="_ftnref4">4</a> An insured who held the right to purchase a policy upon termination of a buy-sell agreement did not possess incidents of ownership so long as the contingency had not occurred, but would possess incidents once the agreement was terminated.<a href="#_ftn5" name="_ftnref5">5</a> Also, a shareholder was not treated as holding incidents of ownership in a life insurance policy where the shareholder could purchase a corporate-owned policy upon disability, or upon a cross-purchase of the shareholder’s stock if the shareholder dissented to sale of the corporation to a third party or a public offering.<a href="#_ftn6" name="_ftnref6">6</a> However, an insured was treated as holding incidents of ownership in a policy held in a trusteed buy-sell arrangement where the insured was considered to have transferred the policy to the trust and retained the right to purchase the policy for its cash surrender value.<a href="#_ftn7" name="_ftnref7">7</a> The right to receive dividends has been held not to be an incident of ownership in the policy.<a href="#_ftn8" name="_ftnref8">8</a> It has been held that if the insured has the power to terminate the interest of the primary beneficiary with only the consent of the secondary beneficiary, the insured has an incident of ownership.<a href="#_ftn9" name="_ftnref9">9</a> However, a sole shareholder would not be treated as holding incidents of ownership in a life insurance policy on the shareholder’s own life where a collateral consequence of a termination of an employee’s employment would be a termination of the employee’s option agreement to purchase the shareholder’s stock with a corresponding change in beneficiary of the insurance proceeds held in an irrevocable life insurance trust created by the employee.<a href="#_ftn10" name="_ftnref10">10</a> The assignment of a life insurance policy by a third-party owner as an accommodation to the insured to cover the insured’s debts does not in itself create in the insured an incident of ownership.<a href="#_ftn11" name="_ftnref11">11</a> But if a policy owner collaterally assigns a policy as security for a loan and then makes a gift of the policy subject to the assignment, the donor will be deemed to have retained an incident of ownership.<a href="#_ftn12" name="_ftnref12">12</a> Where an insurance funded buy-sell agreement prohibited each partner from borrowing against, surrendering, or changing the beneficiary on the policy each owned on the life of the other partner without the insured’s consent, the Tax Court held that the decedent-insured did not possess an incident of ownership in the policy insuring the decedent-insured’s life.<a href="#_ftn13" name="_ftnref13">13</a> However, it has been reported that the IRS, citing an internal ruling dated January 7, 1971, has declined to follow the decision.<a href="#_ftn14" name="_ftnref14">14</a> An insured was treated as holding incidents of ownership in a policy held in a trusteed buy-sell arrangement where the trust could only act as directed by the shareholders through the buy-sell agreement and the insured could thus withhold consent to the exercise of policy rights.<a href="#_ftn15" name="_ftnref15">15</a> Where an insured absolutely assigned a policy that required the insured’s consent before the policy could be assigned, or the beneficiary changed, to someone who had no insurable interest in the insured’s life, the IRS ruled that the insured had retained an incident of ownership.<a href="#_ftn16" name="_ftnref16">16</a> Similarly, the Tax Court has held that an employee’s right to consent to a change of beneficiary on a split dollar policy owned by the employee’s employer on the employee’s life is an incident of ownership.<a href="#_ftn17" name="_ftnref17">17</a> The Tax Court also has held that where the insured assigned policies, retaining the right to consent to the assignee’s designating as beneficiary, or assigning the policies to, anyone who did not have an insurable interest in the insured’s life, the assignee’s act of designating an irrevocable beneficiary did not eliminate the insured’s retained incidents of ownership. The Third Circuit reversed the Tax Court in this case, however, taking the position that because under the facts presented the insured could not have enjoyed any economic benefit from exercising the insured’s veto power over the designation of beneficiaries or assignees, the insured’s retained power did not amount to an incident of ownership.<a href="#_ftn18" name="_ftnref18">18</a> The insured’s right to purchase the policy from an assignee was treated as equivalent to the right to revoke an assignment, which is an incident of ownership.<a href="#_ftn19" name="_ftnref19">19</a> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>.       Estate of Morrow v. Commissioner, 19 TC 1068 (1953), acq. 1954-1 CB 5, nonacq. 1979-2 CB 2. <a href="#_ftnref2" name="_ftn2">2</a>.       Rev. Rul. 79-46, 1979-1 CB 303. <a href="#_ftnref3" name="_ftn3">3</a>.       Estate of Smith v. Commissioner, 73 TC 307 (1979), acq. in result, 1981-1 CB 2. <a href="#_ftnref4" name="_ftn4">4</a>.       Let. Rul. 8049002. <a href="#_ftnref5" name="_ftn5">5</a>.       TAM 9127007. <a href="#_ftnref6" name="_ftn6">6</a>.       Let. Rul. 9233006. <a href="#_ftnref7" name="_ftn7">7</a>.       TAM 9349002. <a href="#_ftnref8" name="_ftn8">8</a>.       Estate of Bowers v. Commissioner, 23 TC 911 (1955), acq; Old Point Nat’l Bank v. Commissioner, 39 BTA 343 (1939). <a href="#_ftnref9" name="_ftn9">9</a>.       Estate of Goodwyn v. Commissioner, TC Memo 1973-153. <a href="#_ftnref10" name="_ftn10">10</a>.     TAM 9421037. <a href="#_ftnref11" name="_ftn11">11</a>.     Estate of Goodwyn v. Commissioner, TC Memo 1973-153. <a href="#_ftnref12" name="_ftn12">12</a>.     Estate of Krischer v. Commissioner, TC Memo 1973-172. <a href="#_ftnref13" name="_ftn13">13</a>.     Estate of Infante v. Commissioner, TC Memo 1970-206 (appeal dismissed), nonacq. 1971 AOD LEXIS 310 (1971). <a href="#_ftnref14" name="_ftn14">14</a>.     55 Taxes (CCH) 146 (Feb. 1977). <a href="#_ftnref15" name="_ftn15">15</a>.     TAM 9349002 (cf. Let. Ruls. 9511009 and 9622036, in which no estate inclusion was required for life insurance held in a trust to fund a corporate buy-sell agreement). <a href="#_ftnref16" name="_ftn16">16</a>.     Rev. Rul. 75-70, 1975-1 CB 301. <a href="#_ftnref17" name="_ftn17">17</a>.     Schwager v. Commissioner, 64 TC 781 (1975). <a href="#_ftnref18" name="_ftn18">18</a>.     Estate of Rockwell v. Commissioner, 57 AFTR 2d 1491, 779 F.2d 931 (3d Cir. 1985), rev’g TC Memo 1984-654. <a href="#_ftnref19" name="_ftn19">19</a>.     TAM 9128008. </div></div>