Tax Management Estates Gifts and Trusts Journal

 

September 12, 2002, Vol. 27 No. 05

 

ARTICLES

 

The Economic Growth and Tax Relief Reconciliation Act of 2001 -- To Do or Not To Do List

 

 

 

 

 

 

 

 

Tax Management Estates Gifts and Trusts Journal

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PLR 200120007 Gives Boost to Estate Planning with Life Insurance

 

 

 

 

 

 

 

 

 

 

 

 

by Jonathan E. Gopman, Esq.
Greenberg Traurig, P.A.
Boca Raton, Florida
and Paul B. McCawley, Esq.
Greenberg Traurig, P.A.
Fort Lauderdale, Florida

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INTRODUCTION

 

 

 

 

 

 

 

 

 

 

 

 

Generally, the proceeds of a life insurance policy are not included in gross income under 101(a)(1).1 However, 101(a)(2) provides an exception to this rule when a life insurance policy is transferred for valuable consideration. This exception is referred to as the "transfer for value rule." If the transfer for value rule applies, the transferee who has paid valuable consideration for the policy will have to recognize income in an amount that exceeds the sum of the consideration paid and any other amounts subsequently paid by the transferee under the policy.  Section 101(a)(2), however, provides several exceptions to the transfer for value rule.  One such exception involves a transfer to "the insured." The other exceptions are a transfer in which the transferee takes a carry-over basis from the transferor; a transfer to a partner of the insured; a transfer to a partnership in which the insured is a partner; and a transfer to a corporation in which the insured is a shareholder or officer.

 

 

 

 

 

 

 

 

 

 

 

 

In the estate planning context, there may be numerous reasons for selling an existing life insurance policy to or between family entities or trusts.  For instance, an existing trust may contain provisions that would cause its assets to be includible in the grantor's gross estate under 2036, 2038 and/or 2042 because the grantor retains a prohibited power or interest.  If this is the case, the grantor may need to consider techniques to eliminate this problem.  Additionally, the terms of an existing trust may no longer meet the grantor's objectives or the needs of his or her family.  A client may own an insurance policy in his or her individual name.  If the policy is gratuitously transferred to or for the benefit of his or her family, the client must live for a three-year period following the date of the transfer to avoid inclusion in the gross estate.2 Selling the policy for its fair market value to the client's family or to a trust for the benefit of the client's family may be a technique that can be used to avoid this three-year inclusion rule.3 Additionally, the insurance policy may be owned by a corporation or other business from which it is desirable to shift the ownership.  Whenever the sale of a life insurance policy is contemplated in any of the foregoing situations, avoiding the transfer for value rule should always be a primary concern.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PLR 200120007

 

 

 

 

 

 

 

 

 

 

 

 

In PLR 200120007, which involved transfer for value issues under 101(a), the taxpayers achieved some favorable results related to the transfer of life insurance policies for estate planning objectives. In this ruling, the taxpayers, "H" and "W," had previously established five trusts, referred to as "Trust 1," "Trust 2," "Trust 3," "Trust 4" and "Trust 5."

 

 

 

 

 

 

 

 

 

 

 

 

(1) Trust 1 was established by H.  The trustee of Trust 1 was one of H's children, "D1," and an unrelated person, "T." Trust 1 owned two joint and survivor policies, "Policy X1" and "Policy Y1," on the lives of H and W, and a minimum amount of cash.  The taxpayers represented that Trust 1 was a grantor trust with respect to H pursuant to 677(a)(3).4 During her life, D1 was the sole beneficiary of Trust 1 and at her death she was granted a special power to appoint the trust assets to or among H's other issue.5 The agreement establishing Trust 1 gave the trustees the power to purchase insurance on the lives of H and W.

 

 

 

 

 

 

 

 

 

 

 

 

(2) Trust 2 was established by H.  The trustees of Trust 2 were D1 and T.  Trust 2 also owned two joint and survivor policies, "Policy X2" and "Policy Y2," on the lives of H and W, and a minimum amount of cash.  The taxpayers represented that Trust 2 was a grantor trust with respect to H pursuant to 677(a)(3). H's other children, "D2" and "D3," were discretionary beneficiaries of Trust 2, together with H's other issue, other than D1.  D1 was not a beneficiary of Trust 2.  The agreement establishing Trust 2 also gave the trustees the power to purchase insurance on the lives of H and W.

 

 

 

 

 

 

 

 

 

 

 

 

(3) Trust 3 was established by H.  The trustees of Trust 3 were T and Bank.  Trust 3 owned a percentage interest in a limited liability company (the "LLC"). The taxpayers represented that Trust 3 was a grantor trust with respect to H.  D1, D2, and D3 were all beneficiaries of Trust 3.

 

 

 

 

 

 

 

 

 

 

 

 

(4) Trust 4 was established by W.  The trustees of Trust 4 were T and Bank.  Trust 4 owned a percentage interest in LLC.  The taxpayers represented that Trust 4 was a grantor trust with respect to W.  D1, D2, and D3 were all beneficiaries of Trust 4.

 

 

 

 

 

 

 

 

 

 

 

 

(5) Trust 5 was established by H and W.  The trustees of Trust 5 were T and D1.  Trust 5 owned cash and a percentage interest in LLC.  Trust 5 was not a grantor trust.  D1, D2, and D3 were all beneficiaries of Trust 5.

 

 

 

 

 

 

 

 

 

 

 

 

The other interests in the LLC were owned by H and W.  The LLC owned all of the non-voting stock in a family owned and controlled corporation ("Family Corporation") and was taxed as a partnership for federal income tax purposes.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Policy X1 was originally purchased by Trust 1, and Trust 1 paid all of the premiums on Policy X1.  Similarly, Policy X2 was originally purchased by Trust 2, and Trust 2 paid all of the premiums on Policy X2. Policy Y1 (owned by Trust 1) and Policy Y2 (owned by Trust 2) were each subject to split-dollar agreements with Family Corporation.  Under each split-dollar plan the trusts had to pay the portion of each premium related to the term insurance while the remaining portion of each premium was paid by Family Corporation. At the death of the survivor of H and W, Family Corporation was entitled to receive the funds it advanced to pay premiums under the split-dollar plans less any indebtedness it owed on either policy to the insurance company. The rest of the death benefits were payable to the respective trusts.

 

 

 

 

 

 

 

 

 

 

 

 

H and W wanted to ensure that proceeds of each of the insurance policies would be divided equally among their three children.  This could not occur while Policy X1 and Policy Y1 were owned by Trust 1 and the other policies were owned by Trust 2 because D1 was not a beneficiary of Trust 2 and D2 and D3 were not beneficiaries of Trust 1.  Therefore, the trustees of Trust 1 and Trust 2 proposed the following transactions:

 

 

 

 

 

 

 

 

 

 

 

 

(1) Trust 1 and Trust 2 would borrow sufficient amounts from their respective X Policies to reduce the value of these policies and enable Trust 5 to purchase the X Policies with the cash available to Trust 5.

 

 

 

 

 

 

 

 

 

 

 

 

(2) Trust 1 would transfer Policy X1 to Trust 5 for cash consideration equal to the interpolated terminal reserve value of Policy X1 on the date of the proposed transfer plus the proportionate amount of the premium last paid before the date of the proposed transfer that covers the period extending beyond the date of the proposed transfer minus any outstanding indebtedness on the contract at the date of the transfer (referred to as the "Reg Value" in the ruling).6

 

 

 

 

 

 

 

 

 

 

 

 

(3) Trust 2 would transfer Policy X2 to Trust 5 for cash consideration equal to the Reg Value of Policy X2 at the time of transfer.

 

 

 

 

 

 

 

 

 

 

 

 

(4) Trust 1 would transfer its interest in Policy Y1 to Trust 3 for cash consideration equal to Policy Y1's Reg Value at the time of the transfer less the amount owed to Family Corporation pursuant to the split dollar arrangement.

 

 

 

 

 

 

 

 

 

 

 

 

(5) Trust 2 would transfer its interest in Policy Y2 to Trust 4 for cash consideration equal to Policy Y2's Reg Value less the amount owed to Family Corporation pursuant to the split dollar arrangement.

 

 

 

 

 

 

 

 

 

 

 

 

The ruling held that the transfer for value rule would not apply to any of these proposed transfers for the following reasons:

 

 

 

 

 

 

 

 

 

 

 

 

(1) Trust 5 was a partner of both the insureds, H and W, by virtue of their membership in LLC at the time of the proposed transfers.  Thus, the proposed transfers of the X Policies to Trust 5 satisfied the requirements of the exception to the transfer for value rule in 101(a)(2)(B), that is, a transfer to a partner of the insured.

 

 

 

 

 

 

 

 

 

 

 

 

(2) Both Trust 1 and Trust 3 are treated as grantor trusts owned by H for federal income tax purposes (as represented by the taxpayers).  Therefore, the "transfer" of Trust 1's interest in Policy Y1 to Trust 3 was disregarded for federal income tax purposes and the transfer for value rule will not apply.7

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(3) Trust 2 is a grantor trust with respect to H and Trust 4 is a grantor trust with respect to W.  Accordingly, the transfer of Trust 2's interest in Policy Y2 to Trust 4 was not ignored for federal income tax purposes.  However, H was treated as transferring H's interest in Policy Y2 to W because the trusts involved in this transaction are grantor trusts with respect to H and W.  Therefore, for federal income tax purposes under 1041(b)(1),8 W is treated as acquiring by gift the interest in Policy Y2 acquired by Trust 4 in the sale, and not for value. Thus, the transfer-for-value rule did not apply to the transfer of Trust 2's interest in Policy Y2 to Trust 4.9

 

 

 

 

 

 

 

 

 

 

 

 

PLR 200120007 is significant for several reasons.  First, although many commentators previously believed it was possible to use a grantor trust to avoid the transfer for value rule,10 there was no authority directly on point when the grantor trust did not contain any provisions that would cause inclusion of the trust assets in the grantor's gross estate for federal estate tax purposes.11 The Service had also previously refused to rule on this issue in PLR 9413045.  Therefore, PLR 200120007 now indicates a willingness by the Service to accept the use of a grantor trust to avoid the transfer for value rule.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PLR 9413045

 

 

 

 

 

 

 

 

 

 

 

 

In PLR 9413045, Husband established an irrevocable trust (the "Husband's Trust") and his Wife established an irrevocable trust (the "Wife's Trust").  Husband appointed Wife as trustee of Husband's Trust and Wife appointed Husband as trustee of Wife's Trust.  As trustee of Wife's Trust, Husband purchased a second-to-die life insurance policy insuring the lives of Husband and Wife.  Similarly, as trustee of Husband's Trust, Wife purchased a second-to-die life insurance policy insuring the lives of Husband and Wife.  As trustee of Wife's Trust, Husband possessed powers which would cause any insurance policy on his life held in Wife's Trust to be includible in his gross estate under 2042. Wife also possessed similar powers as trustee of Husband's Trust. To eliminate the incidents of ownership possessed by Husband and Wife, Husband and Wife established a new trust ("the Estate Reduction Trust"), naming an unrelated party as trustee.  Husband and Wife possessed no powers over (or interest in) the income or principal of the Estate Reduction Trust. The only power Husband and Wife possessed with respect to the Estate Reduction Trust was the power "with or without approval or consent of any person in a fiduciary capacity, to reacquire all or any part of the trust corpus by substituting other property of an equivalent value in place of such reacquired trust corpus." In addition, if the Estate Reduction Trust constituted a grantor trust under 671-677, each year Husband and Wife would receive an amount equal to the incremental income tax liability imposed because of grantor trust status.12

 

 

 

 

 

 

 

 

 

 

 

 

The Estate Reduction Trust purchased each of the two second-to-die policies from Husband's Trust and Wife's Trust for the Reg Value.  Among the rulings requested, Husband asked the Service to hold that Husband and Wife would be treated as the owners of the Estate Reduction Trust for federal income tax purposes pursuant to 675.  Husband also asked the Service to rule that the transfer for value would not apply to the sale of each policy to the "insured."

 

 

 

 

 

 

 

 

 

 

 

 

The Service refused to rule on the grantor trust status of the Estate Reduction Trust stating that the issue involved "an area that is under extensive study." 13 Because the Service was unable to rule on the status of the Estate Reduction Trust as a grantor trust, it also would not rule on the transfer for value issue stating that such a ruling would involve ruling on a "hypothetical situation." 14

 

 

 

 

 

 

 

 

 

 

 

 

In PLR 9413045, the taxpayers also requested rulings that the second-to-die policy purchased by the trustee of the Estate Reduction Trust from Husband, as trustee of Wife's Trust, would not be included in Husband's gross estate under 2035(a) if the Husband died within three years of the purchase, and that the second-to-die policy purchased by the trustee of the Estate Reduction Trust from Wife, as trustee of Husband's Trust, would not be included in Wife's gross estate under 2035 if Wife died within three years of the purchase.  The three-year rule in 2035 was an issue because Husband possessed powers that would cause any insurance policy on his life held in Wife's Trust to be includible in his gross estate under 2042, and Wife also possessed powers that would cause any insurance policy on her life held in Husband's Trust to be includible in her gross estate under 2042.  In this regard, prior 2035(b)(1) provided that "transferred property will not be included in the transferor's gross estate if the property was transferred in a bona fide sale for adequate and full consideration in money or money's worth." 15 The Service held that consideration constitutes "adequate consideration" for estate and gift tax purposes only if the consideration flows to the transferor and enhances the transferor's net estate.16 Under the facts presented, the Service stated that the amount paid to Husband's Trust and Wife's Trust may not be included in the gross estate of Husband or Wife at their respective deaths, and, accordingly, these amounts would not ordinarily constitute adequate consideration for purposes of 2035.  However, under the "unique facts" of this ruling, the consideration paid for the policies was subject to transfer tax when the funds were transferred to Husband's Trust and Wife's Trust, and, accordingly, these amounts would be reflected in Husband's and Wife's transfer tax base. Under these circumstances, the ruling held that the adequate consideration requirement was satisfied.  Therefore, 2035 was not applicable to the facts of PLR 9413045 and the respective policies would not be included in either Husband's gross estate or Wife's gross estate if they died within three years of the sale.

 

 

 

 

 

 

 

 

 

 

 

 

Perhaps the difference between PLR 200120007 and PLR 9413045 was the fact that the Service was asked to rule on the grantor trust status of the trust in PLR 9413045 whereas, in PLR 200120007, the taxpayers represented that four of the trusts were wholly owned grantor trusts.  While this seems to be the plausible explanation for the disparate result in these two rulings, the authors understand from conversations with other practitioners at the time that PLR 9413045 was issued that taxpayers hoping to apply for a favorable ruling with similar facts had agreed to represent that the trusts were wholly owned grantor trusts.  Nevertheless, at the time of PLR 9413045, the Service refused to issue rulings on the transfer for value rule involving a sale to a grantor trust.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

THE SWANSON CASE

 

 

 

 

 

 

 

 

 

 

 

 

In Swanson,17 the issue was whether the life insurance proceeds received by a trust were excludable from gross income under 101(a)(2)(B).  Swanson seemed to be the one case on point for planning in this area.  However, the facts in Swanson presented an analytical problem that caused some practitioners to question the efficacy of using a grantor trust to avoid the transfer for value rule, at least where the trust would be designed to avoid inclusion in the grantor's gross estate.18

 

 

 

 

 

 

 

 

 

 

 

 

In Swanson, the insured transferred cash to a trust in which he was the trustee.  The trust instrument gave the insured substantial powers over the administration of the trust such that the trust was deemed to be a grantor trust as to the insured within the meaning of 674. The trust then purchased a pre-existing insurance policy on the life of the grantor from a family corporate foundation.  Upon the death of the insured, the Service attempted to include the proceeds from the policy in the gross income of the trust under the transfer for value rule in an amount which exceeded the trust's investment in the policy.  The Service argued that the grantor trust rules only required the grantor to be taxed on the income of the trust, however, for purposes of applying the transfer for value rule the trust should be treated as a separate taxpayer.  The court disagreed, holding that the transfer of the insurance policy for valuable consideration from the foundation to the trust was a transfer to the "insured" and therefore not subject to the transfer for value rule.19

 

 

 

 

 

 

 

 

 

 

 

 

Although the holding in Swanson appeared favorable for taxpayers planning in this area, it still caused planners some concern.  This concern arose because of the type of powers and control held by the insured-grantor in the Swanson case.  While these powers were not necessary to obtain grantor trust status, the powers seemed to be important to the court in reaching its decision.  In this regard, the court in Swanson stated that:

 

 

 

 

 

 

 

 

 

 

 

 

We cannot accept the government's contention that in this case Swanson, the grantor of the grantor-trusts, is not deemed the owner of the trusts for any purpose other than that of taxing trust income to him, and the trusts, therefore, retain their identity as a separate tax entity under 101(a)(2)(B).  The provision in each trust instrument that it shall be subject to interpretation or amendment by the maker (except with respect to vesting property, income or corpus in himself as an individual) gave the grantor complete control over the insurance policies in question.  Through his control over the trust, he could exercise all of the incidents of ownership over the policies.  He could, among other things, cause (1) a change in beneficiaries, (2) loans to be secured on the policies, or (3) even have the policies cancelled... We hold that in this case, since Swanson owned and controlled the trusts, the policies were transferred to the "insured" within the meaning of 101(a)(2)(B) and the net proceeds are therefore excludable from gross income under 101(a)(1). (Emphasis supplied.)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Based on the foregoing language, some practitioners have been reluctant to rely on Swanson for the proposition that a transfer to a grantor trust will be treated as a transfer to the insured for purposes of the transfer for value rule.  Nonetheless, the holding in PLR 200120007 should provide some comfort to practitioners on this issue.20

 

 

 

 

 

 

 

 

 

 

 

 

 

 

MERE PREMIUM PAYMENT CAUSING GRANTOR TRUST STATUS

 

 

 

 

 

 

 

 

 

 

 

 

Another important point that should not be overlooked in PLR 200120007 was the willingness of the Service to accept the taxpayer's representation that Trust 1 and Trust 2 were wholly owned grantor trusts as to H solely by reason of a discretionary premium payment power granted to non-adverse trustees.21 Of course, this was a critical part of the ruling.  The importance of this point should not be glossed over because in the past some commentators have questioned whether a mere premium payment power would be sufficient to cause a trust to be a wholly owned grantor trust.22 Based on extensive research in this area, the authors have always believed that a mere premium payment power in a non-adverse trustee should be sufficient to cause grantor trust status.23 Currently, the Service will not issue an advance ruling on the grantor trust tax status of a life insurance trust.24 Nonetheless, prior to this prohibition on issuing such a ruling (and even one time thereafter), the Service issued several rulings that held that a mere premium payment power granted to a non-adverse trustee was sufficient to cause grantor trust status.25

 

 

 

 

 

 

 

 

 

 

 

 

 

 

MEMBER'S STATUS AS A PARTNER

 

 

 

 

 

 

 

 

 

 

 

 

Another point in this ruling that is worthy of note is that it holds that the members of a limited liability company treated as a partnership for federal tax purposes may be "partners" for purposes of 101(a)(2)(B).  The Service previously made a similar ruling in PLR 9625013, however, it is always helpful to have another ruling on point.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PLANNING UNDER PLR 200120007

 

 

 

 

 

 

 

 

 

 

 

 

PLR 200120007 should provide additional guidance and comfort to practitioners in situations where a client desires to transfer the ownership of a life insurance policy owned by an existing trust to a new trust.26 There may be several reasons that a client may want to transfer the ownership of an existing life insurance policy owned by a trust.  First, as was the case in PLR 200120007, a client may find the dispositive terms of the existing trust undesirable and may want to create a new trust with different dispositive terms.  A client may also desire this result if, as was the case in PLR 9413045, the existing trust contains powers that will cause the trust property to be included in the insured's gross estate under 2036, 2038 and/or 2042.27 The principles set forth in PLR 200120007 may also be helpful if a corporation owns a policy and the policy is purchased by a grantor trust with respect to the insured.  Also, if the insured owns a policy individually, it might also be possible to avoid the three-year inclusion rule in 2035 by selling the policy to a grantor trust with respect to the insured for the Reg Value with respect to the policy.28

 

 

 

 

 

 

 

 

 

 

 

 

Based on PLR 200120007, these planning techniques can be accomplished by a client forming a new trust that would qualify as a grantor trust for income tax purposes. The trust should be designed to avoid inclusion in the grantor's estate for estate tax purposes.  The client should fund the new trust with sufficient cash to purchase the existing life insurance policy from the old trust, the corporation or the insured for its Reg Value.29 The new trust would purchase the policy from the existing trust for its Reg Value.30

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As far as causing a new trust to be treated as a grantor trust or determining the tax status of an existing trust, PLR 200120007 indicates that a mere premium payment power under 677(a)(3) should be sufficient to cause the trust to "violate" the grantor trust rules. Nonetheless, the authors also suggest considering the use of other techniques to cause a trust to violate the grantor trust rules if at all possible.31 If the grantor wants to reduce the taxable gift prior to funding the new trust with the purchase price, the current owner of the policy that will be sold could borrow against the policy prior to the sale to reduce the Reg Value.  Although certain risks might be involved, it may be possible to structure the sale of the policy using a promissory note.32

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Some practitioners may also be more comfortable if a partnership is formed with the new trust and the insured, thereby providing another potential exception to the transfer for value rule.33 As PLR 200120007 indicates, this planning can be accomplished by with a limited liability company as well as a partnership.34

 

 

 

 

 

 

 

 

 

 

 

 

Finally, the ruling in PLR 200120007 regarding 1041 indicates that some planning can be accomplished between spouses with respect to life insurance policies. For example, if it is desired that the trust purchasing the existing policy should not be a grantor trust with respect to the insured, the trust can be a grantor trust with respect to the insured's spouse and an exception to the transfer for value may apply based on 1041. Moreover, the spouse could simply purchase the policy individually and then transfer the policy to a third party or a trust.

 

 

 

 

 

 

 

 

 

 

 

 

Footnotes

 

 

 

 

 

 

 

 

 

 

 

 

1All section references are to the Internal Revenue Code of 1986, as amended, and the regulations thereunder, unless otherwise indicated.

 

 

 

 

 

 

 

 

 

 

 

 

2See 2035.

 

 

 

 

 

 

 

 

 

 

 

 

3See 2035(d).  The primary focus of this article is on the income tax consequences of the sale of a life insurance policy. Nevertheless, planners will also need to focus on the estate and gift tax aspects when structuring such a transaction.  Most of these issues can be found in 2035, 2036, 2038, 2042, 2511, 2512 and the regulations issued thereunder.

 

 

 

 

 

 

 

 

 

 

 

 

4Under 677(a)(3), a grantor is treated as the owner of any portion of a trust if the income of the trust, without the consent of any adverse party, is or may be applied to the payment of premiums on insurance policies on the life of the grantor or the grantor's spouse.  A detailed discussion of 677(a)(3) is beyond the scope of this article.  For a detailed discussion of this section of the Code as it relates to life insurance trusts, see Gopman, "The Income Tax Consequences of an Irrevocable Life Insurance Trust," 22 Tax Mgmt. Est. Gifts and Tr. J. 211 (Sept.-Oct. 1997).

 

 

 

 

 

 

 

 

 

 

 

 

5Other than these facts, the ruling did not disclose the extent of D1's interest in Trust 1 or her powers as a trustee of the trust.  It must be assumed from the ruling either that D1's interest in Trust 1 did not cause her to be considered an "adverse party" for purposes of the premium payment power, or that her power as a co-trustee to participate in the decision to apply trust income in payment of insurance premiums on the lives of H and W was sufficiently limited.  See 677(a)(3).

 

 

 

 

 

 

 

 

 

 

 

 

6Regs. 25.2512-6(a) is the starting point for valuing an insurance policy under the federal transfer tax rules.  It provides in part that:

 

 

 

 

 

 

 

 

 

 

 

 

7Although it was not stated in the ruling, this transfer also should have qualified for the transfer to a partner of the insured exception to the transfer for value rule because Trust 3 held a membership interest in the LLC at the time of the sale.

 

 

 

 

 

 

 

 

 

 

 

 

8Section 1041(a) provides that no gain or loss shall be recognized on a transfer of property from an individual to (or in trust for the benefit of) a spouse.  Section 1041(b) provides that any transfer of property described in 1041(a) will be treated as acquired by the transferee spouse by gift for income tax purposes, and the spouse will take a carry over basis in the property received.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9Although it was not stated in the ruling, this transfer also should have qualified for the transfer to a partner of the insured exception to the transfer for value rule because Trust 4 held a membership interest in the LLC at the time of the sale.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10See e.g. Price, "Transfer of Life Insurance: Seizing the Opportunities and Avoiding the Pitfalls," 27 U. Miami Heckerling Inst. on Est. Planning, Ch. 2 (1993).

 

 

 

 

 

 

 

 

 

 

 

 

11But see Swanson v. Comr., 518 F.2d 59 (8th Cir. 1975), discussed below; and Rev. Rul. 85-13, 1985-1 C.B. 184.  Cf., Rothstein v. U.S., 735 F.2d 704 (2d Cir. 1984).

 

 

 

 

 

 

 

 

 

 

 

 

12The Service presently takes the position in its Private Letter Rulings that such a provision will not cause inclusion of a trust's assets in a grantor's estate for federal estate tax purposes.  See PLRs 200120021 (discretionary tax payment provision granting discretion to a person who is not related or subordinate to the settlor to pay settlor's income tax liability generated by trust does not cause 2036 inclusion), 200030018 (mandatory tax payment provision does not cause 2036-2038 estate tax inclusion), 200030019 (mandatory tax payment provision does not cause 2036-2038 estate tax inclusion).  At best, this position seems dubious under the current state of the tax law.  Furthermore, the Service has previously intimated that inclusion of such a provision in a trust agreement could in fact cause the assets of a trust to be included in a grantor's estate for federal estate tax purposes.  See PLR 9301020.

 

 

 

 

 

 

 

 

 

 

 

 

13Citing 5.16 of Rev. Proc. 93-3, 1993-1 I.R.B. 71, 81.

 

 

 

 

 

 

 

 

 

 

 

 

14Citing 7.03 of Rev. Proc. 93-1, 1993-1 I.R.B. 7, 22.

 

 

 

 

 

 

 

 

 

 

 

 

15This exception is currently found in 2035(d).

 

 

 

 

 

 

 

 

 

 

 

 

16Merrill v. Fahs, 324 U.S. 308 (1945).

 

 

 

 

 

 

 

 

 

 

 

 

17Swanson v. Comr., 518 F.2d 59 (8th Cir. 1975).

 

 

 

 

 

 

 

 

 

 

 

 

18In Swanson, the trust contained powers that would cause the assets to be included in the grantor's estate. It is important to note that not all powers which violate the grantor trust rules cause estate tax inclusion or cause a gift to be incomplete.  The provisions of the income tax and the estate and gift tax are considered separately and are not read in pari materiaKuhn v. U.S., 392 F. Supp. 1229 (S.D. Tex. 1975); Comr. v. Beck Est., 129 F.2d 243 (2d Cir. 1942).

 

 

 

 

 

 

 

 

 

 

 

 

19See 101(a)(2)(B).

 

 

 

 

 

 

 

 

 

 

 

 

20It would seem that PLR 200120007 also reached the correct result in light of Rev. Rul. 85-13, 1985-1 C.B. 184.

 

 

 

 

 

 

 

 

 

 

 

 

21P.L.R. 200228019.

 

 

 

 

 

 

 

 

 

 

 

 

22See Coleman, "The Grantor Trust: Yesterday's Disaster, Today's Delight, Tomorrow's?" 30 U. Miami Heckerling Inst. On Estate Planning Ch. 8 (1996).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

23See Note 4.

 

 

 

 

 

 

 

 

 

 

 

 

24See Rev. Proc. 81-37, 1981-2 C.B. 592 (amplifying Rev. Proc. 81-10, 1981-1 C.B. 647); See also Rev. Proc. 2002-3, 2002-1 I.R.B. 117, 3.01(43).

 

 

 

 

 

 

 

 

 

 

 

 

25See e.g., PLRs 8852003, 8126047, 8118051, 8112087, 8103074, 8014078, and 8007080.  The Service also seemed to take this position in PLR 199915045. But see Iversen v. Comr., 3 T.C. 756 (1944); Weil v. Comr., 3 T.C. 579 (1944); Genevieve F. Moore, 39 B.T.A. 808 (1939); and Frank C. Rand, 40 B.T.A. 233 (1939), aff'd 116 F.2d 929 (8th Cir. 1941), cert. denied, 313 U.S. 594 (1941).

 

 

 

 

 

 

 

 

 

 

 

 

26Additionally, both PLR 200120007 and PLR 9413045 should provide a comfort level to practitioners regarding the transfer tax aspects of this transaction provided the insurance policy is sold for its fair market value.

 

 

 

 

 

 

 

 

 

 

 

 

27In this event, consideration should be given to the 2035 issue raised in PLR 9413045.

 

 

 

 

 

 

 

 

 

 

 

 

28See 2035(d).

 

 

 

 

 

 

 

 

 

 

 

 

29Note that different methods of valuation apply for term policies and permanent policies, and the health of the insured may affect the valuation of the policy.  See Regs. 25.2512-6(a). See also, Pritchard Est. v. Comr., 4 T.C. 204 (1944) (where the insured's medical condition was "hopeless," the court found that the valuation of a policy as stated in Regs. 25.2512-6(a) would not be appropriate).

 

 

 

 

 

 

 

 

 

 

 

 

30Practitioners will need to decide the timing issues in each particular case.  For example, should the sale take place immediately after the new trust is funded or should an period of time be permitted to pass before the sale occurs?

 

 

 

 

 

 

 

 

 

 

 

 

31See Gopman & Latorre, "Grantor Trusts Offer Opportunity to Accomplish Tax Free Gift," 134 Trust & Estates 58 (Oct. 1995).

 

 

 

 

 

 

 

 

 

 

 

 

32Of course, the promissory note would need to provide for an appropriate rate of interest. See 7872.

 

 

 

 

 

 

 

 

 

 

 

 

33The authors always prefer to "layer" the potential exceptions to the transfer for value rule when assisting a client with the sale of a life insurance policy in an estate planning case.

 

 

 

 

 

 

 

 

 

 

 

 

34The authors also recommend that partnership or limited liability company should have a valid business purpose separate from the transaction involving the sale of the life insurance policy.