CURRENT TAX DEVELOPMENTS

IRS Revokes Adverse Ruling on Contributions of Life Insurance

Ltr. Rul. 9147040 .

In a rather surprising move, the Service, in Ltr. Rul. 9147040 , revoked an earlier letter ruling ( Ltr. Rul. 9110016 ) in which it denied a charitable contribution deduction for the gift of a life insurance policy by a New York state taxpayer. Its revocation was based on the fact that New York state had amended its Insurance Code to allow such contributions. This new ruling is welcome news to charities, taxpayers, and tax preparers, because gifts of insurance policies have become a popular mechanism for charitable giving. 1

Facts and analysis

Under the facts of the original ruling, A, a resident of New York state, wanted to make a gift of a life insurance policy to a favorite charity (the Charity). A intended to purchase the policy herself, naming the Charity as the beneficiary, and then assign it irrevocably to the Charity. Though there was no formal agreement between A and the Charity, it was understood that A would pay the premiums on the policy.

A requested a number of rulings from the Service regarding this planned gift:

(1.) That A would be entitled to an income tax charitable deduction under Section 170(a)(1) for the amount of any premiums she paid.

(2.) That A would be entitled to a gift tax charitable deduction under Section 2522(a)(2) for any premiums she paid.

(3.) That, if A died within three years of making, the gift and the proceeds were included in her gross estate under Section 2035(a) , A's estate would be entitled to an estate tax charitable deduction under Section 2055(a)(2) .

(4.) That, if A lived more than three years after making the gift, the policy proceeds would not be included in A's estate.

The Service, in its original ruling, began by examining the New York State Insurance Code. Section 3205(b)(2) of that code prohibits anyone without an insurable interest from obtaining an insurance policy on the life of another person unless the benefits are to be paid to someone with an insurable interest. The Service determined that the transaction proposed by A would violate this statute because the Charity that would subsequently own the policy did not have an insurable interest in A's life. The fact that A initially acquired the policy would probably not circumvent the law. Instead, the Charity would be treated as if it had acquired the policy directly from the insurance company. If A proceeded in making this gift despite the New York state law, the Service reasoned that the insurance company might be able to refuse to pay the policy proceeds to the Charity. Alternatively, if the insurance company did pay the proceeds, A's estate might have a cause of action under Section 3205(b)(3) to recover the proceeds.

The Service then addressed the specific rulings requested by A. Since A's estate could have a claim against the policy proceeds, and A had the right to name the heirs of her estate (who would make such a claim), the Service determined that A would be transferring only a partial interest in the insurance policy to the Charity, and not her whole interest in the policy. Because A was not transferring her entire interest in the policy, and the partial interest did not satisfy the exceptions in Section 170(f)(3)(A) , the Service concluded that A was not entitled to a charitable deduction under Section 170 for her contribution to the Charity, and, therefore, she could not take an income tax deduction for any premiums paid. For the same reason, A was not entitled to a gift tax deduction for the premiums paid.

Addressing the estate tax issues, the Service agreed that the policy proceeds would be included in A's estate under Section 2035(a) if she died within three years of the transfer. The Service also determined that the proceeds would be included in her estate even if she died after three years had passed, if her estate could recover the proceeds. In neither case could the estate claim a charitable deduction. The proceeds either would pass directly to the estate or they would pass to the Charity because of the estate's inaction (lack of attempt to recover proceeds). They would not pass to the Charity directly from A.

Letter Ruling 9110016 caused an uproar in the estate planning community as practitioners, lawmakers, and charities around the country scrambled to examine their state's laws. On 7/15/91, the state of New York amended its Insurance Code to allow an insured to immediately transfer a newly purchased life insurance policy. The legislative history indicates that the purpose of the legislation was to “correct an erroneous interpretation of [the New York State Insurance Code] by the Internal Revenue Service in issuing [PLR 9110016],” 2 and to allow gifts to charities of life insurance policies such as A tried to make.

The Service responded by issuing Ltr. Rul. 9147040 in which it explained that the Insurance Code had been amended to allow transfers such as A wished to make, and that the amendment was retroactive. It also stated that it understood that A no longer intended to proceed with the transaction. The Service then revoked Ltr. Rul. 9110016 .

Comments

Obviously this new ruling is welcome news for potential charitable donors and estate planners in New York. Though persons in other states cannot rely on Ltr. Rul. 9147040 to support such charitable gifts, the ruling indicates that the Service will allow such contributions as long as state law does not give the insured's estate or heirs any right to recover the policy proceeds. It is still imperative that charities, estate planners, and lawmakers in other states carefully examine their state laws and try to eliminate any provisions that might prevent contributions of life insurance policies to charities.

It was interesting that the Service coupled in a separate paragraph the statement that “A no longer intends to proceed with this transaction” with the Service's declaration that the previous letter ruling was revoked. The amendment to the New York State Insurance Code was retroactive, and there is no reason why A could not now proceed with her intended gift. In fact, the transaction would now be valid and eligible for the various deductions desired even if it was completed prior to the issuance of Ltr. Rul. 9147040 . Whether A intends to pursue the transaction should be irrelevant to the Service's ruling.


1

  For a discussion of the earlier letter ruling, see Schlenger, Madden, and Hayes, Current Tax Developments, Charitable deduction disallowed for gift of life insurance, 18 EP 239 (Jul/Aug 1991) .


2

  Assembly Bill 8586, 1991-92 Reg. Sess., 1991 N.Y. Laws.

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