LTR 9636033


Section 2042 -- Life Insurance

UIL Number(s) 2042.05-00, 2511.00-00

Summary

PAYMENTS UNDER PRIVATE SPLIT-DOLLAR ARRANGEMENT ARE NOT GIFTS.

The Service has ruled that a private reverse split-dollar arrangement will not result in deemed gifts of premium payment or inclusion of the proceeds in the insured's estate.

An insured and his wife reside in a community property state. The insured created an irrevocable trust naming his brother trustee. During the insured's life, the trustee could pay, in his discretion, income and principal to the insured's issue. After the insured's death, payment could also be made to his wife. The trust will terminate at the later of the wife's death or when all children reach age 25.

The trustee used cash in the trust to buy life insurance on the insured's life. The trustee then entered into a collateral assignment reverse split dollar agreement with the wife. Under the agreement, the trustee was designated owner of the policy and will pay the portion of the premium equal to the lesser of the P.S. 58 rate or the insured's one-year term rates. The wife will pay the balance of the premium from her separate property. If the agreement is terminated prior to the insured's death, his wife will receive the cash value of the policy. If the agreement terminates as a result of the insured's death, his wife or her estate will receive the greater of the policy's cash value just prior to the taxpayer's death or the total premiums paid.

The Service has ruled that the payment of premiums by the trustee and the wife will not result in a gift to the trust by the wife or a deemed gift to the trust by the insured under section 2511. The Service also concluded that the insurance proceeds payable to the trust and to the wife under the split-dollar agreement will not be includable in the insured's gross estate under section 2042, reasoning that the insured retained no incidents of ownership in the policy.

Full Text



Date: March 12, 1996

Refer Reply to: CC:DOM:P&SI:4 / TR-31-2556-95

Re: * * *

LEGEND:

Dear * * *

[1] This is in response to your letter dated November 3, 1995, and other submissions in which you request rulings concerning the gift and estate tax consequences of a private reverse split-dollar life insurance arrangement with an irrevocable trust.

[2] The taxpayer and his spouse reside in a community property state. The taxpayer created an irrevocable trust in September 1995. His brother was named trustee. The terms of the trust specifically preclude the taxpayer and his spouse from acting as trustees. The trust is irrevocable and the taxpayer has retained no powers or authority over either the trust or the trust property or the administration thereof.

[3] The trust instrument provides that, during the lifetime of the taxpayer, the net income and principal of the trust are to be paid at the discretion of the trustee to the taxpayer's issue. At the taxpayer's death, the trustee may, at his discretion, distribute the income and principal of the trust to the taxpayer's spouse and his issue. The trust is to terminate at the later to occur of the death of the taxpayer's spouse or the date when all of the taxpayer's children reach the age of 25.

[4] The taxpayer initially funded the trust with a cash gift. The contribution was made from his separate funds. With this initial contribution, the trustee purchased a life insurance policy on the taxpayer's life. The trustee has entered into a collateral assignment split-dollar agreement with the taxpayer's spouse.

[5] Under the collateral assignment split-dollar agreement, the trustee is designated the owner of the policy and will pay that portion of the annual policy premiums equal to the lesser of 1) the applicable amount provided in the P.S. 58 tables set forth in Rev. Rul. 55-747, 1955-2 C.B. 228, and 2) the current published premium rates for individual one-year term life insurance available to all standard risks of the insurance company issuing the policy. The spouse will pay the remaining portion of the annual premium from her separate property. The entire premium will be remitted by the spouse, and the trustee is obligated to reimburse the spouse within 31 days for the trustee's portion of the premium.

[6] The split-dollar agreement may be terminated at will by either the trustee or the spouse. The agreement will also terminate upon the bankruptcy of the spouse, the failure of the trustee to reimburse the spouse, the failure of the spouse to pay the premiums, or the death of the insured. If the agreement is terminated prior to the taxpayer's death, the spouse will be entitled to receive an amount equal to the cash value of the policy (net of any policy or premium loans or other indebtedness received by the spouse that is secured by the policy). If the agreement is terminated as a result of the taxpayer's death, the spouse (or her estate if she is not then living) will be entitled to receive an amount equal to the greater of the cash value of the policy immediately prior to the taxpayer's death, or the total premiums that she has paid, less any outstanding policy or premium loans or other indebtedness received by the spouse that is secured by the policy.

[7] In order to secure the spouse's interest in the policy, the trustee will assign to the spouse, under a collateral assignment agreement, certain rights in the policy and execute a promissory note evidencing the trust indebtedness to the spouse. Under the agreement, the following rights are assigned to the spouse: 1) the right to receive a portion of the proceeds payable on the taxpayer's death equal to the spouse's interest under the split-dollar agreement; 2) the right to receive the cash value of the policy if the policy is surrendered by the trustee, less outstanding loans made from the policy to the spouse; and, 3) the sole right to borrow against the policy. All other rights with respect to the policy are reserved to the trustee and all such rights may be exercised solely by the trustee subject to the spouse's security interest.

[8] You request that we rule as follows:


1. The payment of the policy premiums by the trustee and the
spouse, pursuant to the terms of the split-dollar agreement,
will not result in a gift to the trust by the taxpayer's
spouse or a deemed gift to the trust by the taxpayer under
section 2511 of the Internal Revenue Code.

2. The insurance proceeds payable to the trust and the
taxpayer's spouse pursuant to the split-dollar agreement,
from the life insurance policy held by the irrevocable trust
will not be includible in the taxpayer's gross estate under

section 2042.

ISSUE 1 (Gift tax Consequences of premium payments)

[9] Section 2501 imposes a tax on the transfer of property by gift by an individual. Section 2511 provides that the tax imposed by section 2501 shall apply whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible. Section 2512(b) provides that, where property is transferred for less than adequate and full consideration in money or money's worth, the amount by which the value of the property exceeds the value of the consideration is deemed a gift.

[10] Section 25.2511-2(b) of the Gift Tax Regulations provides that, as to any property, or part thereof or interest therein, of which the donor has so parted with dominion and control as to leave in him no power to change its disposition, whether for his own benefit or for the benefit of another, the gift is complete. But if upon a transfer of property (whether in trust or otherwise) the donor reserves any power over its disposition, the gift may be wholly incomplete, or may be partially complete and partially incomplete, depending upon all the facts in the particular case. Accordingly, in every case of a transfer of property subject to a reserved power, the terms of the power must be examined and its scope determined.

[11] Rev. Rul. 64-328, 1964-2 C.B. 11, holds that when there is a "split-dollar" arrangement, in which the employer pays the portion of the premiums equal to the increases in the cash surrender value and the employee pays the balance, if any, of the premiums, and in which, from the proceeds payable upon the employee's death, the employer receives at least an amount equal to the funds it has provided, with the beneficiary receiving the balance, the value of the insurance protection in excess of the premiums paid by the employee must be included in the employee's income. The ruling further states that the same income tax result follows if the transaction is cast in some other form that results in a similar benefit to the employee.

[12] Rev. Rul. 76-490, 1976-2 C.B. 300, holds that, where an employer makes premium payments on a group term life insurance policy for an employee and the employee has irrevocably assigned the insurance policy to an irrevocable trust, each premium payment made by the employer is deemed an indirect transfer by the employee to the assignee of the policy for purposes of section 2511, and is subject to the gift tax imposed by section 2501. Under the facts in the ruling, the policy was a group term life insurance policy on the life of the employee and the employer made all premium payments.

[13] Rev. Rul. 78-420, 1978-2 C.B. 68, holds that where a corporation enters into an arrangement with a spouse of an employee for the purchase of a life insurance policy insuring the life of the employee, the value of the life insurance protection provided by the corporation which is included in the income of the employee is deemed to be transferred by the employee to his spouse for purposes of section 2511 and is subject to the gift tax imposed by section 2501. In SITUATION 2 of the ruling, the spouse is the owner of the policy and has the right to select the beneficiary. The corporation provides the funds to pay part of the annual premiums to the extent of the increase in the cash surrender value of the policy each year. The spouse provides the balance of the premiums. The corporation is entitled to receive, out of the proceeds of the policy upon the death of the employee, an amount equal to the cash surrender value of the policy or at least an amount equal to the funds it has provided for premium payments.

[14] The arrangement in Rev. Rul. 78-420 arises out of the employer-employee relationship between the employee and the corporation. The arrangement is of the type contemplated by Rev. Rul. 64-328, and, consequently, the premium payments by the corporation are deemed to be compensatory in nature and income to the employee. The employee is then deemed to make a gift of this income to his spouse.

[15] Unlike the relationships contemplated in the above mentioned revenue rulings, the premium payments by the trustee of the trust, in the present case, are not compensatory in nature. The taxpayer has no employer-employee relationship with the trustee of the trust. The taxpayer made a taxable transfer to the trust at its inception and he receives nothing else of value, compensatory or otherwise, when the trustee makes the premium payments. In addition, there would be no transfer from the taxpayer to his spouse as set forth in Rev. Rul. 78-420.

[16] Under the terms of the reverse split-dollar agreement, the spouse will transfer funds to the trust to pay the portion of the premiums in excess of that paid by the trustee. These payments will be made out of her separate property. If the agreement is terminated prior to the taxpayer's death, the spouse will receive, in consideration for her earlier transfers, an amount equal to the cash value of the policy (net of any loans or other indebtedness secured by the policy). At the insured/taxpayer's death, the spouse will receive, in consideration for the earlier transfers, an amount equal to the greater of the cash value of the policy immediately prior to the taxpayer's death, or the total premiums that she has paid (net of any loans or other indebtedness secured by the policy). Accordingly, in consideration for paying a portion of the premiums, the spouse will receive, in general, the cash value of the policy. Since the spouse will be reimbursed for the premium payments, the spouse's payment of the premiums will not be subject to gift tax.

[17] We conclude that the payment of the policy premiums by the trustee and the spouse, pursuant to the terms of the split-dollar agreement, will not result in a gift to the trust by the taxpayer's spouse or a deemed gift to the trust by the taxpayer under section 2511.

ISSUE 2 (Inclusion of policy in taxpayer's gross estate)

[18] Section 2042(2) provides that the value of a decedent's gross estate shall include the proceeds of all life insurance policies on the decedent's life receivable by beneficiaries, other than the executor of the decedent's estate, to the extent that the decedent possessed at his death any incidents of ownership exercisable either alone or in conjunction with any other person. An incident of ownership includes a reversionary interest arising by the express terms of the instrument or by operation of law only if the value of such reversionary interest exceeds 5 percent of the value of the policy immediately before the death of the decedent.

[19] Section 20.2042-1(c)(2) of the Estate Tax Regulations provides that "incidents of ownership" is not limited in its meaning to ownership of a policy in the technical legal sense. Generally speaking, the term has reference to the right of the insured or his estate to the economic benefits of the policy. Thus, it includes the power to change the beneficiary, to surrender or cancel the policy, to assign the policy, to revoke an assignment, to pledge the policy for a loan, or to obtain from the insurer a loan against the surrender value of the policy.

[20] In the present case, the decedent has retained no incidents of ownership in the life insurance policy on his life. He has no powers over either the policy or the irrevocable trust that holds the policy.

[21] We conclude that the insurance proceeds payable to the trust and the taxpayer's spouse pursuant to the split-dollar agreement, from the life insurance policy held by the irrevocable trust will not be includible in the taxpayer's gross estate under section 2042.

[22] Except as we have specifically ruled herein, we express no opinion under the cited provisions or under any other provision of the Code. Specifically, we express no opinion regarding the application of section 7872 to this transaction.

[23] This ruling is based on the facts and applicable law in effect on the date of this letter. If there is a change in material fact or law (local or Federal) before the transactions considered in the ruling take effect, the ruling will have no force or effect. If the taxpayer is in doubt whether there has been a change in material fact or law, a request for reconsideration of this ruling should be submitted to this office.

[24] This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) provides that it may not be used or cited as precedent.


Sincerely yours,

Assistant Chief Counsel
(Passthroughs and Special
Industries)

By:
George Masnik
Branch Chief
Branch 4


Enclosure
Copy for 6110 purposes