An adage in the life insurance
business has it that clients have no objection to life insurance, but they
often have trouble finding the dollars to pay for it.
Through the years, planners
have devised a number of innovative methods to help clients pay for their life
insurance premiums. In this regard, private (aka "family") split dollar needs
to be on the short list of every planner who considers him or herself
sophisticated.
In this
LISI, veteran commentator Howard
Zaritsky provides subscribers with a timely discussion of a recent private
ruling involving a post-final regulation, family split dollar arrangement.
Howard, author of
Tax Planning With Life Insurance: Analysis and Forms: 2nd Edition,
is well-known to LISI members. He has
been a lecturer at major tax and estate planning institutes, including the New
York University Institute on Federal Taxation and the University of Miami
(Heckerling) Estate Planning Institute where he is a member of the advisory
committee. He is the author or co-author of numerous articles and treatises,
including Generation-Skipping Transfer Taxes: Analysis and Forms (with C.
Harrington & L. Plainer); Structuring Buy-Sell Agreements (2d end);
Structuring Estate Freezes After Chapter 14 (3d ed.) (with R. Alcott); Federal
Income Taxation of Estates and Trusts (2d ed.) (with N. Lane); Tax Planning
for Family Wealth Transfers (3d ed.); [all published by RIA Group].
EXECUTIVE SUMMARY:
In Private Letter Ruling
200910002, the IRS took the position that payments by the grantors of an
irrevocable life insurance trust of part of the premiums on a second-to-die
policy held by the trustee were not taxable gifts because of a family split
dollar arrangement between the grantors and the trust. The Service also found
that the grantors held no incidents of ownership over the trust's policy.
FACTS:
THE TRUST
Harry and Wanda, a married
couple, created an irrevocable life insurance trust for their descendants,
other than their children. The trust required the trustee to distribute
income annually to a class of beneficiaries consisting of the grantors' living
issue excluding their children.
Each income beneficiary also
had Crummy power – a non-cumulative power to withdraw their share of any
contributions to the trust. The trustee also could distribute corpus to a
member of the class to provide for the beneficiary's health, education,
support, and maintenance.
If a member of the class died
survived by issue, the surviving issue would become members of the class. The
trust was to continue until the death of the later to die of Harry and Wanda
or, if later, when the number of class members equaled 40.
The trust would terminate
earlier if needed to avoid the application of the rule against perpetuities.
Upon termination, the trustee would divide the trust fund into as many equal
shares as there were then-living children of the grantors and deceased
children who left issue then surviving.
Each share created on account
of a living or deceased child would then be re-divided into as many equal
shares as there were then living children of the child and deceased
grandchildren who left issue then surviving.
Each share created for a
grandchild that is age 35 at termination would be distributed outright. If a
grandchild was not age 35, then the share would continue in trust for the
grandchild. If a deceased grandchild was survived by issue, then the
grandchild's share was to be distributed outright, per stirpes.
Neither H nor W could be a
trustee, and neither had any powers over the trust.
THE INSURANCE POLICY
The trust bought a
second-to-die life insurance policy on the lives of Harry and Wanda.
THE SPLIT DOLLAR
ARRANGEMENT
Harry, Wanda and the trustee
proposed to enter into a split-dollar life insurance agreement. Under the
terms of that agreement, the trust will continue to own the policy and will
pay during the joint lives of Harry and Wanda, the value of the current life
insurance protection, determined for this purpose as the insurance company's
current published premium rate for annually renewable term insurance generally
available for standard risks.
After the death of the first
to die of Harry and Wanda, the trust's payments under the policy will be the
lesser of:
1) the applicable amount provided in Notice 2001-10, 2001-1 C.B. 549, or
subsequent IRS guidance, or
2) the insurer's current published premium rate for annually renewable
term insurance generally available for standard risks.
Harry and Wanda would pay the
balance of the premiums.
The trust will collaterally
assign to Harry and Wanda the following rights:
1) if the split-dollar agreement terminates on the death of the
survivor of Harry and Wanda, survivor's estate would have the right to receive
the greater of the cash surrender value of the policy or the cumulative
premiums paid by Harry and Wanda; and
2) if the agreement ends during the lifetime of Harry and Wanda,
or the survivor, then within 60 days of termination, Harry and Wanda (or the
survivor) will have the right to receive from the trust an amount equal to the
greater of (a) the cash surrender value of the policy, or (b) the
premiums paid by Harry and Wanda, to the extent that the trust had other
assets sufficient to pay such amounts.
All incidents of ownership
over the policy (including the sole right to surrender or cancel the policy,
and the sole right to borrow or withdraw against the policy) would be vested
in the trustees and not in H or W.
IRS BLESSES THE AGREEMENT
The IRS stated that the
payments by Harry and Wanda of the premiums will not result in a
taxable gift to the trust and that the life insurance proceeds payable to the
trust will not be includible in either spouse's gross estate under
Section 2042.
GIFT TAX TREATMENT
The IRS stated that the
agreement is a split-dollar arrangement, under Treas. Rags. § 1.61-22(b)(1),
and that it is taxed under the economic benefit rules, rather than the loan
rules, because the arrangement is:
1) entered into between a donor and a done (rather than an employer and
employee); and
2) the donor owns the
life insurance contract.
The IRS also stated that Harry
and Wanda would be treated as the owners of policy, because under the terms of
the agreement, the only economic benefit that would be provided to them is
current life insurance protection. The trust would pay the portion of the
premium equal to the cost of current life insurance protection and Harry and
Wanda would pay the balance of the premium.
The IRS concluded that Harry
and Wanda would be treated as making a gift to the trust if and to the extent
that some or all of the cash surrender value was used (either directly, or
indirectly through loans) to fund the trust's obligation to pay premiums.
Otherwise, their payments
under the agreement of the excess of the premiums over the economic value of
the current insurance protection, would not be a taxable gift to the trust or
its beneficiaries.
ESTATE TAX TREATMENT
The IRS also stated that
neither Harry nor Wanda retained any incidents of ownership over the policy.
Therefore, the only portion of the proceeds that would be included in Harry or
Wanda's gross estates would be the amount actually payable to the estate of
the survivor. That amount would be includible as an amount receivable by an
executor, under Section 2042(1).
COMMENT:
One of the most difficult
aspects of the use of an irrevocable life insurance trust is providing the
trustee with sufficient funds to pay the insurance premiums, without incurring
significant gift tax liabilities. Donors can always include Crummy powers in
the trust instrument, to take full advantage of the gift tax annual exclusion
to fund the trust, but this also often requires the allocation of GST
exemption to prevent future GST taxes, and even then the trustee may not have
enough money to pay the premiums.
The best solution to this
problem is often a family or private split-dollar life insurance arrangement,
under which the insured grantors pay all or part of the premiums, but are
assigned the right to recover their premium payments from the policy cash
values or death benefits. When done correctly, this arrangement can permit
the grantors to pay premiums without incurring a current gift tax liability.
Of course, the downside of
this transaction is that the techniques by which the grantor assures that
their payments will be returned can sometimes constitute an incident of
ownership over the policy and cause the trust assets to be included in the
grantors' gross estates. The collateral assignment approach used in this
private ruling avoided this potential problem, and made it possible for
the grantors to fund the premium payments without incurring gift tax
liabilities.
The
Service has been relatively generous when dealing with both pre-and-post final
regulation private/family split dollar arrangements. The proposed split-dollar
arrangement in this PLR, like the one at issue in PLR 200825011 (See
LISI Estate Planning Newsletter #1323),
was entered into after the effective date of the final regulations. The
arrangements in PLRs 200848002 (See
LISI Estate Planning Email Newsletter
#1382) and
200822003 were entered into before the effective date of the
final regulations, and received what many consider to be relatively favorable
tax results.
Before – or After – the final
regulations – split dollar – if arranged, executed, and operated
properly – is alive and well!
HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE
DIFFERENCE.
Howard Zaritsky
CITE AS:
LISI Estate
Planning Newsletter # 1429 (March 9, 2009) at
http://www.leimbergservices.com Copyright 2009 Leimberg Information
Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person
Prohibited – Without Express Permission.
CITES
PLR 200910002; PLR 200825011;
Rags. §§ Treas. Rags. §§ 1.61-22(b)(1), 1.61-22(b)(3)(ii)(B);
1.61-22(c)(1)(ii)(A)(2)); 1.61-22(d)(1); 1.61-22(d)(2); 1.61-22(d)(3)(i);
1.61-22(d)(3)(ii); 1.61-22(d)(4)(ii); 20.2042-1(c)(2); Rev. Rul. 79-129,
1979-1 C.B. 306; Notice 2001-10, 2001-1 C.B. 549; Zaritsky and Leimberg,
Tax Planning With Life Insurance: Analysis and Forms: 2nd Edition¶
3.03[9][b][iv] (Thomson-Reuters).
