Monday, March 14, 2022
Tax Court in Brief: Estate of Levine v. Commissioner | Split-Dollar Life Insurance and Estate Planning
Short Summary: This case involves a split-dollar life insurance estate-planning arrangement. Marion Levine (Levine) entered into a transaction in which her revocable trust paid premiums on life insurance policies taken out on her daughter and son-in-law that were purchased and held by a separate and irrevocable life-insurance trust that was settled under South Dakota law. Levine’s revocable trust had the right to be repaid for the premiums. Decisions for investments within the irrevocable life-insurance trust, including for its termination, could be made only by its investment committee, which consisted of one person—Levine’s long-time friend and business partner. Levine died, and the policies had not terminated or paid out at that time as her daughter and son-in-law were still living. The question was what has to be included in her taxable estate because of this transaction: (1) the value of her revocable trust’s right to be repaid in the future (i.e., $2,282,195), or (2) the cash-surrender values of those life-insurance policies at the time of Levine’s death (i.e., $6,153,478)?Primary Holdings:
- The split-dollar arrangement in this case met the specific requirements of the Treasury Regulations. The policies in question were purchased and owned by the irrevocable trust, not Levine, and the arrangement expressly gave the power to terminate only to the trust’s investment committee. Thus, neither IRC Section 2036(a)(2)—the general “catch-all” statute for estate assets—nor Section 2038—the “claw-back” provision for certain estate assets transferred before death—do not require inclusion of the policies’ cash-surrender values because Levine did not have any right, whether by herself or in conjunction with anyone else, to terminate the policies.
- As such, and as of her death, Levine possessed a receivable created by the split-dollar life insurance, which was the right to receive the greater of premiums paid or the cash surrender values of the policies when they are terminated.
- Contrary to the Commissioner’s position, the transaction was not merely a scheme to reduce Levine’s potential estate-tax liability and there was a legitimate business purpose. There was nothing behind the “transaction’s façade” that would suggest that appearance of the express written terms of agreement and arrangement do not “match reality.”
- Pursuant to applicable state law, the trust’s investment committee—albeit one person—owed fiduciary duties to the trust and beneficiaries other than Levine, Levine’s daughter, and son-in-law, and the evidence illustrated that the written agreements afforded Levine no power to alter, amend, revoke or terminate the irrevocable trust such that its assets should be included in Levine’s estate pursuant to Sections 2036(a)(2) or 2038.
- The only asset from the split-dollar arrangement that Levine’s revocable trust owned at the time of her death was the split-dollar receivable.Key Points of Law:
- Irrevocable life-insurance trusts are typically used as a vehicle to own life-insurance policies to reduce gift and estate taxes. If done properly, a life-insurance trust can take a policy out of its settlor’s estate and allow the proceeds to flow to beneficiaries tax free. Split-dollar life-insurance trusts are a tool to remove death benefits from a settlor’s taxable estate—or at least defer payment of any tax owed.
- Split-dollar arrangements entered into or materially modified after September 17, 2003 are governed by Reg. § 1.61-22. A split-dollar life-insurance arrangement between an owner and a non-owner of a life-insurance contract in which: (i) either party to the arrangement pays, directly or indirectly, all or a portion of the premiums; (ii) a party making the premium payments is entitled to recover all or a portion of those premium payments, and repayment is to be made from or secured by the insurance proceeds; and (iii) the arrangement is not part of a group-term life insurance plan (other than one providing permanent benefits). Id. § 1.61-22(b)(1)-(1)(iii).
- Gifts of valuable property for which the donor receives less valuable property in return are called “bargain sales.” The value of gifts made in bargain sales is usually measured as the difference between the fair market value of what is given and what is received. However, the Treasury Regulations provide a different measure of value when split-dollar life insurance is involved. See Reg. § 1.61-22(d)(2).
- There are two different and mutually exclusive regulatory regimes applicable to split-dollar insurance trusts—called the “economic benefit regime” and the “loan regime”—and that govern the income- and gift-tax consequences of split-dollar arrangements. These two regimes determine who “owns” the life insurance policy that is part of the arrangement. The general rule is that the person named as the owner is the owner. Non-owners are any person other than the owner who has a direct or indirect interest in the contract. However, if the only right or economic benefit provided to the donee under a split-dollar life-insurance arrangement is an interest in current life-insurance protection, then the donor is treated as the owner of the contract. This is the economic-benefit regime.
- Where a split-dollar life insurance trust meets the requirements of Treas. Reg. § 1.61-22 the IRS and the courts must look to the default rules of the Code’s estate-tax provisions to figure out how to account for the effect of the split-dollar arrangement on the gross value of the particular estate.
- The Code defines a taxable estate as the value of a decedent’s gross estate minus applicable deductions. See 26 U.S.C. § 2051. Section 2033 provides that a decedent’s gross estate includes the value of any property that a decedent had an interest in at the time of her death. Sections 2034 through 2045 identify what other property to include in an estate.
- For example, Section 2036(a) is a catchall designed to prevent a taxpayer from avoiding estate tax simply by transferring assets before the taxpayer’s death. Pursuant to the related Treasury Regulations, “[a]n interest or right is treated as having been retained or reserved if at the time of the transfer there was an understanding, express or implied, that the interest or right would later be conferred.” Treas. Reg. § 20.2036-1(c)(1)(i). Similarly, Section 2038 allows for a “claw-back” into a decedent’s estate the value of property that was transferred in which the decedent retained an interest or right—either alone or in conjunction with another—to alter, amend, revoke, or terminate the transferee’s enjoyment of the transferred property.
- Both sections 2036 and 2038 include an exception for transfers that are “a bona fide sale for an adequate and full consideration in money or money’s worth.” 26 U.S.C. § 2036(a), §2038(a)(1).
See Tax Court in Brief: Estate of Levine v. Commissioner | Split-Dollar Life Insurance and Estate Planning, Freeman Law: Tax Court in Brief (2022).
Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.