Estate planning is a complicated business. Before you sit down with clients, find out what Uncle Sam will demand if a life insurance policy or an annuity is part of their estate, or part of a recent inheritance.
2. What are the incidents of ownership that, if held by an insured, will cause life insurance proceeds to be includable in the insured’s estate?
Proceeds are includable in an insured’s gross estate if the insured possesses any of the following incidents of ownership at his or her death:
- the right to change the beneficiary;
- the right to surrender or cancel the policy;
- the right to assign the policy;
- the right to revoke an assignment;
- the right to pledge the policy for a loan; or
- the right to obtain a policy loan.
The reservation of a right to make premium loans has been held to be an incident of ownership. A right to change contingent beneficiaries, who are to receive benefits after the primary beneficiary’s death, also is an incident of ownership.
3. What are the incidents of ownership of employer-paid death benefits that would cause life insurance proceeds to be includable in the insured’s estate?
An employee insured’s right to designate the beneficiary of an employer-paid death benefit is not treated as an incident of ownership in the insurance funding the benefit if the employer is sole owner of the policy and sole beneficiary for its exclusive use. The IRS has taken the position that if the insured under a corporation-owned policy has an agreement with the corporation giving the insured the first right to purchase the policy for its cash surrender value if the corporation decides to discontinue the coverage, the purchase option is an incident of ownership. The Tax Court has held, however, that the insured’s contingent purchase option as described in Revenue Ruling 79-46 is not an incident of ownership within the meaning of IRC Section 2042(2).
4. Can an insured remove existing life insurance from his or her gross estate by an absolute assignment of the policy but retaining a reversionary interest?
A reversionary interest in a policy is an incident of ownership if, immediately before the insured’s death, the value of the reversionary interest is worth more than five percent of the value of the policy. The insured will have no such reversionary interest, however, if the policy is purchased and owned by another person, or if the policy is absolutely assigned to another person by the insured. Regulations state that the term “reversionary interest” does not include the possibility that a person might receive a policy or its proceeds by inheritance from another person’s estate, by exercising a surviving spouse’s statutory right of election, or under some similar right. They also state that, in valuing a reversionary interest, interests held by others that would affect the value must be taken into consideration. For example, a decedent would not have a reversionary interest in a policy worth more than 5 percent of the policy’s value, if, immediately before the decedent’s death, some other person had the unrestricted power to obtain the cash surrender value of the policy; the value of the reversionary interest would be zero.
An insured was treated as holding a reversionary interest in a policy held in a trusteed buy-sell arrangement where the insured was considered to have transferred the policy to the trust and retained the right to purchase the policy for its cash surrender value upon termination of the buy-sell agreement. However, a policy held in a trusteed buy-sell arrangement would not be includable in an insured’s estate under IRC Section 2042 where (1) proceeds would be received by a partner’s estate only in exchange for purchase of the partner’s stock, and (2) all incidents of ownership would be held by the trustee of the irrevocable life insurance trust.
6. May a charitable contribution deduction be taken for the gift of a life insurance policy or premium? May a charitable contribution deduction be taken for the gift of a maturing annuity or endowment contract?
Yes, subject to the limits on deductions for gifts to charities.
7. When can death proceeds of community property life insurance payable to someone other than the surviving spouse be includable in the surviving spouse’s gross estate?
If the insured elects to have death proceeds held under an interest or installment option for the insured’s surviving spouse with proceeds remaining at the surviving spouse’s death payable to another, a portion of such remaining proceeds may be includable in the surviving spouse’s gross estate under IRC Section 2036 as a transfer by the surviving spouse of his or her community property interest with life income retained. Such a transfer will be imputed to the surviving spouse if under state law the insured’s death makes the transfer absolute. The amount includable is the value of the surviving spouse’s community half of the remaining proceeds going to the beneficiary of the remainder interest, less the value (at the insured’s death) of the surviving spouse’s income interest in the insured’s community half of the proceeds. In states where the noninsured spouse has a vested interest in the proceeds of community property life insurance (e.g., California and Washington), a gift of the surviving spouse’s community property interest should not be imputed to the surviving spouse unless the surviving spouse has consented to or has acquiesced in the insured’s disposition of the proceeds. But see, Est. of Bothun v. Comm., decided under California law, where an IRC Section 2036 transfer was imputed to the surviving spouse-primary beneficiary when, because the surviving spouse failed to survive a fifteen-day delayed payment clause, proceeds were paid to the contingent beneficiary. The opinion contained no suggestion of any evidence that the noninsured spouse had consented to the delayed payment clause.
9. What are the estate tax results when a decedent has been receiving payments under an annuity contract?
If a decedent was receiving a straight life annuity, there is no property interest remaining at the decedent’s death to be included in the decedent’s gross estate.
If a contract provides a survivor benefit (as under a refund life annuity, joint and survivor annuity, or installment option), tax results depend on whether the survivor benefit is payable to a decedent’s estate or to a named beneficiary and, if payable to a named beneficiary, on who paid for the contract.
10. In the case of a joint and survivor annuity, what value is includable in the gross estate of the annuitant who dies first?
The value of a survivor’s annuity is includable in the deceased annuitant’s gross estate in proportion to his or her contribution to the purchase price of the contract. (This rule applies to contracts purchased after March 3, 1931).
11. Are death proceeds payable under a single premium annuity and life insurance combination includable in an annuitant’s gross estate?