Trusts

<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 />

<div class="Section1"><br /> <br /> No.<br /> <br /> The grantor is taxed on trust income used for the payment of insurance premiums on the life of the grantor or the <em>grantor’s spouse.</em> If the insurance is on the life of someone other than the grantor or the grantor’s spouse, however, this provision does not apply. Thus, a grandmother can fund a trust carrying insurance on the life of her son in favor of her grandchildren without being taxed on the trust income under IRC Section 677(a)(3).<br /> <br /> </div>

<div class="Section1">Generally, a life insurance trust is taxed on: (1) income that, under the terms of the trust, is accumulated for future distribution to someone other than the grantor, and (2) income that the trustee has discretion to accumulate or distribute, but that is not paid or credited to a beneficiary in the taxable year.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.     IRC § 641; Treas. Reg. § 1.641(a)-2.<br /> <br /> </div>

<div class="Section1">Yes.<a href="#_ftn1" name="_ftnref1">¹</a> The value of the gift will be the fair market value of the policy as of the date of the transfer ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="119">119</a>). There is no gift if the trust is revocable.<a href="#_ftn2" name="_ftnref2">²</a> An employee&rsquo;s assignment of a group life policy to an irrevocable trust was held not to be a taxable gift because the policy had no ascertainable value ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="119">119</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="159">159</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="212">212</a>).<a href="#_ftn3" name="_ftnref3">³</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; Treas. Reg. &sect;&nbsp;25.2511-1(h)(8).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;25.2511-2(c).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp;&nbsp;&nbsp; Rev. Rul. 76-490, 1976-2 CB 300.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Trust beneficiaries are liable for tax stemming from income that is distributed to them, or should have been distributed to them, in the taxable year, to the extent that the income does not exceed the trust’s “distributable net income” for the year.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> To deter taxpayers from shifting tax liability to a lower bracket beneficiary, trust income taxable to a beneficiary under 18 years of age can be taxed at the marginal tax rate of the beneficiary’s parents. For tax years beginning in 2018 and 2019, parents had the option of electing to tax the unearned income of minors at the income tax rate that applies to trusts and estates. The SECURE Act eliminated this option, which was originally created by the 2017 tax reform law, for tax years beginning after 2019.<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 §§ 652, 662.<br /> <br /> </div>

<div class="Section1">A person who has exclusive power to vest the corpus (principal) or income of a trust in the grantor (even though the power cannot be exercised in the case of a minor because no guardian has been appointed), or who has released such a power but retained controls similar to those that would subject the grantor to tax, is taxed on the income of the trust ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="146">146</a>).<a href="#_ftn1" name="_ftnref1">¹</a> If the grantor is taxable on the trust income, however, the other person will not be taxed under this rule, at least with respect to a power to vest income. When a grantor transfers a business interest to a trust, the trust, under certain circumstances, may be viewed by the IRS as a business organization itself.<a href="#_ftn2" name="_ftnref2">²</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;678; Rev. Rul. 81-6, 1981-1 CB 385.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; <em>See</em> Rev. Rul. 75-258, 1975-2 CB 503.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> No, such proceeds generally are tax-exempt income to the trustee and to the beneficiary when distributed ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="63">63</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="65">65</a>).<br /> <br /> When proceeds are retained by the trust, earnings on the proceeds are taxed in the same manner as other trust income.<a href="#_ftn1" name="_ftnref1">¹</a> The $1,000 annual interest exclusion, available where insurance proceeds are payable to a surviving spouse of an insured who died before October 23, 1986, under a life income or installment option, is not available if the proceeds are payable to a trust ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="71">71</a>). Under some circumstances, proceeds of a policy transferred for value to a trust may not be wholly tax-exempt ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="279">279</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="282">282</a>).<br /> <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; Treas. Reg. &sect;&nbsp;1.101-1.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Income tax savings can be achieved by the creation of an unfunded life insurance trust. Additionally, a life insurance policy creates no currently taxable income regardless of whether it is placed in trust. Income tax savings can result only when income-producing property is placed in trust to fund the premium payments, and only if tax liability is shifted from the grantor to a lower bracket taxpayer &ndash; that is, to the trust or to a trust beneficiary.<br /> <br /> A funded revocable trust will not result in income tax savings. If the trust is revocable, the income from the funding property will be taxed to the grantor. Even if the trust is irrevocable, however, there are other conditions that will cause the trust income to be taxed to the grantor.<br /> <br /> Generally speaking, trust income is taxable to the grantor if the:<br /> <blockquote>(1)&nbsp;&nbsp;&nbsp;&nbsp; grantor or trustee, or both, can revoke the trust without the beneficiary&rsquo;s consent;<br /> <br /> (2)&nbsp;&nbsp;&nbsp;&nbsp; trust income is, or in the discretion of the grantor or a non-adverse party, or both, may be (a) distributed to the grantor or the grantor&rsquo;s spouse, (b) accumulated for future distribution to the grantor or the grantor&rsquo;s spouse ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="148">148</a>), or (c) applied to pay premiums on insurance on the life of the grantor or the grantor&rsquo;s spouse ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="147">147</a>);<br /> <br /> (3)&nbsp;&nbsp;&nbsp;&nbsp; income is or may be used for the support of the grantor&rsquo;s spouse or is actually used for the support of a person whom the grantor is legally obligated to support, or is or may be applied in discharge of any other obligation of the grantor;<br /> <br /> (4)&nbsp;&nbsp;&nbsp;&nbsp; grantor retains certain administrative powers or the power to control beneficial enjoyment of trust principal or income; or<br /> <br /> (5)&nbsp;&nbsp;&nbsp;&nbsp; value of a reversionary interest, at the inception of the trust, exceeds 5 percent of the value of the trust.<a href="#_ftn1" name="_ftnref1">¹</a></blockquote><br /> If the income of the trust is payable to a lineal descendant of the grantor and the trust provides that the grantor&rsquo;s reversionary interest takes effect only on the death of the beneficiary before the beneficiary attains age 21, the income of the trust will not be taxed to the grantor even though the value of the grantor&rsquo;s reversionary interest exceeds 5 percent of the value of the trust.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> One of the more common planning strategies involves the &ldquo;so-called&rdquo; sale of life insurance to an &ldquo;intentionally defective trust&rdquo; or &ldquo;IDIT.&rdquo; The sale to the IDIT can be a very effective estate planning technique, but it should be remembered that income tax earned by the IDIT will remain taxable to the grantor of the trust. While this may not seem problematic at the time the IDIT is created, in some instances, without proper planning and successful investment within the IDIT, situations sometimes arise where the income tax attributable from the IDIT to the grantor can become burdensome. It may be advisable to consider drafting the IDIT so that the grantor trust power (i.e., the retained power causing grantor trust status for income taxes) can be &ldquo;turned off&rdquo; at a future point if it no longer makes sense that the grantor pay the trust&rsquo;s income taxes. Creating an IDIT should only be done with the assistance of a competent tax advisor.<br /> <br /> <hr><br /> <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;&sect;&nbsp;671-677; Rev. Rul. 75-257, 1975-2 CB 251.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; IRC &sect;&nbsp;673(b).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> If the grantor is taxed as the owner of the trust, the grantor apparently is allowed an interest deduction, in the rare instances when a deduction is allowable, to the same extent as any other owner of the policy ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="3">3</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="30">30</a>). The IRC provides that when the grantor (or any other person) is treated as the owner of any part of a trust, the trust&rsquo;s deductions, as well as income and credits against tax, attributable to that part of the trust will be taken into account in computing that person&rsquo;s taxable income.<a href="#_ftn1" name="_ftnref1">¹</a> Trusts that are treated as owned by the grantor are sometimes referred to as &ldquo;defective&rdquo; because, as a general rule, the pass-through of trust income is undesirable. A &ldquo;defective&rdquo; trust may be useful, however, if a deduction can be passed through to the grantor. (Where favorable estate tax results are sought, attention also should be given to the matters discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="178">178</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="186">186</a>.)<br /> <br /> The IRS has ruled privately that where nonadverse trustees had authority to use trust income to pay premiums on policies on the grantor&rsquo;s life (not irrevocably payable for a charitable purpose), or had discretion to pay trust income or principal to the grantor&rsquo;s spouse, the grantor would be taxed as owner of the trust and could take the trust&rsquo;s deductions.<a href="#_ftn2" name="_ftnref2">²</a><br /> <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;671.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp;&nbsp;&nbsp; Let. Ruls. 8118051, 8007080, 7909031.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Yes, unless the policy is irrevocably payable to a charity.<a href="#_ftn1" name="_ftnref1">¹</a> It is immaterial whether the insurance is taken out by the grantor before the trust is created or by the trustee after it is created.<a href="#_ftn2" name="_ftnref2">²</a> The rule applies to income used to pay the investment portion of the premium as well as to income used for pure insurance protection.<a href="#_ftn3" name="_ftnref3">³</a> It also applies to income used for policies dedicated to business uses as well as to those for personal estate planning purposes.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> Moreover, trust income is taxable to the grantor if, without the approval or consent of an adverse party, it <em>may</em> be used for the payment of premiums on insurance on the grantor’s life, even though it is not actually used for this purpose. Thus, where policies on the grantor’s life are placed in the trust, trust income is taxable to the grantor to the extent that the trustee has discretionary power to use it for premium payments.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> If the policies are owned by the grantor or by someone other than the trust, however, the trust income is taxable to the grantor only if it actually is used to pay premiums, or if the trustee is specifically authorized to use it for this purpose.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> When the trustee is empowered to purchase insurance on the grantor’s life, but does not do so, the grantor is not taxed merely because of the trustee’s power; there must be policies existing in the tax year during which it would have been possible for the trustee to pay premiums.<a href="#_ftn7" name="_ftnref7">⁷</a> When a trust beneficiary has voluntarily used income received from the trust to pay premiums on insurance on the grantor’s life, the income has not been taxed to the grantor.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> Because the law states that the trust income will be taxed to the grantor if it is used to pay the premiums “without the approval or consent of any adverse party,”<a href="#_ftn9" name="_ftnref9">⁹</a> some have suggested that it may be possible, in some cases, to use trust income for such premium payments. If a beneficiary uses the trust income to pay premiums subject to the grantor’s direction or pursuant to an understanding with the grantor, however, the income will be taxable to the grantor.<a href="#_ftn10" name="_ftnref10">¹⁰</a> Thus, where the income of a trust for the benefit of the grantor’s children is to be used for premium payments on insurance on the grantor’s life, the income will be taxable to the grantor even though each beneficiary is to consent in writing (revocable at will) to have his or her share of the income applied to the payment of premiums.<a href="#_ftn11" name="_ftnref11">¹¹</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 § 677(a)(3); <em>Burnet v. Wells</em>, 289 U.S. 670 (1933).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.       <em>Stockstrom v. Commissioner</em>, 3 TC 664 (1944).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.       <em>Heffelfinger v. Commissioner</em>, 87 F.2d 991 (8th Cir. 1937), <em>cert. denied</em>, 302 U.S. 690 (1937).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.       <em>Vreeland v. Commissioner</em>, 16 TC 1041 (1951).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.       <em>Rieck v. Commissioner</em>, 118 F.2d 110 (3d Cir. 1941).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.       <em>Iverson v. Commissioner</em>, 3 TC 756 (1944); <em>Weil v. Commissioner</em>, 3 TC 579 (1944), acq.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.       <em>Rand v. Commissioner</em>, 116 F.2d 929 (8th Cir. 1941), <em>cert. denied</em>, 313 U.S. 594 (1941); <em>Corning v. Commissioner</em>, 104 F.2d 329 (6th Cir. 1939).<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.       <em>Booth v. Commissioner</em>, 3 TC 605 (1944), acq.<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.       IRC § 677(a).<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>.     <em>Foster v. Commissioner</em>, 8 TC 197 (1947), acq.<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>.     Rev. Rul. 66-313, 1966-2 CB 245.<br /> <br /> </div>