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THE EFFECTIVE USE OF LIFE INSURANCE
AS AN ESTATE PLANNING TOOL
Independent Research Project
Prof. W. Reed Quilliam, Jr.
Benny Campbell
December 5, 1980
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I.
Introduction
Life insurance can be an effective tool in attaining
1
the goals of any estate plan.
Insurance creates an "in-
stant" estate for a person of modest means.
For the more
affluent individual, insurance provides liquid funds to
meet expenses arising at death.
Insurance may also fur-
nish an attractive funding medium for buy-sell agreements
involving closely-held businesses.
In short, a comprehen-
sive life insurance plan can minimize estate taxes, facilitate the distribution of wealth, and provide security for
a family's financial affairs.
This paper v/ill examine
important principles in the treatment of life insurance for
tax purposes that are critical to practitioners involved in
estate planning.
II.
A.
Life Insurance as a Unique Asset
The Life Insurance Contract
Effective use of life insurance as an estate planning
tool depends in large part upon an understanding of the contract characterization of life insurance policies.
A life
insurance policy is essentially a contract between the insurer and the policy owner, who may or may not be the life
2
insured.
The contract is unilateral in nature;
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the insurer
alone makes a legally enforcible promise.
In general, the
insurer cannot terminate the policy as long as the policyholder continues to pay premiums.
The policyholder,
however, need not promise to make future premium payments.
Payment is merely a condition precedent to the continuation
of the contract.
When planning considerations involve existing policies,
it becomes necessary to examine the validity of each contract.
Although the formation of a life insurance contract
is governed by the same principles applicable to other types
3
of contracts,
modifications of general contract law exist
peculiar to insurance.
In particular, a life insurance
4
policy is legally unenforcible absent an "insurable interest."
An insurable interest is present when the person effecting
the insurance has an economic
interest in the continued sur5
vival of the life insured.
The presence of an insurable
interest is determined at the inception of the contract, and
the interest need not exist at the time the contract matures
as a claim.
It is well established that an individual has an insurable interest in his own life.
Insurance on the life of
another, however, is sustained only if there is a demonstrable,
reasonable expectation of benefit from the continued existence
of the insured, or an expectation of loss because of his
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isj
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demise.
The expectation need not be based on an interest
enforcible at law.
Nevertheless, the anticipated benefit
or loss must be supported at least by a factual expectation.
Precedent and statute have established that close relationship by blood or marriage is enough to constitute an in7
surable interest.
Certain contractual or commercial
relationships may also be sufficient.
A creditor, for
example, has an insurable interest in the life of his
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debtor.
An element of actuarial risk is present in every life
9
insurance policy.
The insured wishes to provide his
beneficiary with a sum certain in the event of his death,
while the insurer desires to make the amount available only
upon collection of a predetermined amount of premium
payments computed by use of actuarial tables based on
historical and mathematical research.
therefore, is that of premature death.
The risk involved,
It is the function
of the life insurance contract to shift the risk of premature death from the insured to the insurer.
This risk-
shifting characteristic has been emphasized by courts in
classifying the proceeds from a particular
policy as life
10
insurance for federal tax purposes.
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id
B.
Types of Life Insurance
The creativeness of current policy writers has made
insurance underwriting flexible and appealing to the public.
Although insurance companies have developed varied designations, life insurance policies can be divided into three
basic types:
(1) term;
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(2) ordinary or whole-life;
and
(3) endowment.
A term policy is a contract that furnishes insurance
12
for a stipulated period of time.
Premiums are paid by
the policyholder during the specified term in exchange for
the insurer's promise to pay a designated beneficiary in
the event the insured dies within that period.
The in-
surance is automatically discontinued at the end of the
term.
The cost of term insurance is based on the predicted
death rate for the age of each insured.
Accordingly, as
the insured grows older, the risk of death increases,
resulting in an increase in the amount of premiums payable.
Unlike term insurance, an ordinary or whole-life policy
pays proceeds upon the death of the insured without regard
13
to the time that death occurs.
In addition to death
benefits, such policies provide rights and benefits during
the life of the insured.
Because of the manner in which
premium payments are made, whole-life policies include a
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forced savings feature.
Under the "level" payment plan
typical of most whole-life policies, premiums do not increase as the probability of death increases.
Rather,
annual premiums remain constant while the policy is in
effect.
In the early years of the policy, therefore,
premium payments must exceed the amounts needed to cover
the existing risk of death
(the term insurance rate) in
order to provide funds for later years when premiums will
not be sufficient to meet the increasing risk.
The re-
sulting cash reserve, often referred to as the "cash
surrender value," is the basis of the many options
available to a whole-life policyholder.
Among available
options, the policy owner can terminate the contract in
exchange for the cash surrender value or paid-up insurance
at a reduced face amount.
The owner may wish to pledge
the policy to a commercial lender as collateral for a
loan.
Alternatively, he can borrow from the insurance
company an amount equal to the cash surrender value,
usually at lower interest than the prevailing commercial
rate.
The endowment insurance contract is essentially a
savings plan with insurance to protect against premature
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death.
Under this type of insurance, the policy-
holder pays a fixed premium for a specified period.
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/5
In
the event of premature death, the face amount of the policy
is payable to a designated beneficiary.
Unlike term and
whole-life insurance, however, endowment insurance permits
the insured to receive the face amount if he is alive at
the termination of the policy.
Because of the inherent
savings element, premium rates for endowment policies are
greater than for other types of insurance.
In essence,
the endowment policy provides less insurance per premium
dollar paid.
Life insurance has a relatively low yield when
viewed as a pure investment.
The net rate of return on
the accumulated savings element has typically ranged be15
tween four and six percent.
On this basis, some ad-
vocate that potential policyholders should purchase only
term insurance.
This contention is grounded on the pre-
mise that term insurance is sufficient to cover the
"death risk," while investment of the difference between
the cost of the term policy and a whole-life (or endowment) policy will yield a greater rate of return.
The
contrary argument is that, apart from purely economic
considerations, a whole-life policy is preferable because
it provides permanent insurance while furnishing benefits
during the life of the insured and a means of forced
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savings.
It is the more reasoned view, however, that the
particular type of insurance that should be purchased
varies with each individual.
Indeed, an estate plan often
requires the use of more than one type of insurance—a
whole-life policy to meet permanent insurance needs, and a
term policy to satisfy temporary requirements.
C.
Settlement Options
Settlement options available in the insurance contract
permit the payee, the beneficiary, or the life insured
where proceeds arise from cash surrender or endowment
maturity, to receive payments on bases other than lump
16
sum.
Most policies provide for three settlement options:
(1) the interest-only option;
option;
(2) the annuity certain
and (3) the life income option.
Absent the
election of one of these options, proceeds are payable
17
solely by lump sum settlement.
Lump sum payment is
appropriate when the policyholder has created a trust or
wants the beneficiary to receive the cash outright.
However, there are two principle disadvantages to lump
sum settlements.
First, there is the possibility that
the primary beneficiary will die shortly after the death
of the insured.
The proceeds will, therefore, pass
through the beneficiary's estate creating unnecessary
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probate and estate taxes.
Second, if the payment is not
placed in trust, the beneficiary may squander the cash or
lose it through bad investments.
The interest-only option is a temporary arrangement
under which the insurer retains the proceeds subject to
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the beneficiary's immediate right of withdrawal.
Periodic interest payments are made by the insurer during
the life of the beneficiary.
Upon his death, the pro-
ceeds are paid to a designated secondary beneficiary.
This option is offered as a convenience when the beneficiary
is too unsettled to make investment decisions, or when
the executor requires additional time to sort out estate
assets and obligations.
Under the annuity certain settlement option, proceeds
are payable in equal installments over a fixed period until
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both principal and interest are exhausted.
Payment is
guaranteed without regard to survivorship by the beneficiary.
This option is best utilized by the insured who desires to
provide the beneficiary with fixed income for a definite
period of time (as when he wants to furnish income to his
children while they are in school).
The third form, the life income option, provides for
a series of level periodic payments consisting of principal
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and interest, some or all of which are contingent upon the
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continued survival of the beneficiary.
Under this mode
of settlement, the beneficiary essentially is gambling
that he will live beyond the age projected by the insurer's
mortality table?.
III.
Taxation and Life Insurance
Perhaps the most critical area of concern in life
insurance planning is the taxability of life insurance under
federal law.
The discussion that follows will highlight
important principles of federal income, estate, and gift
taxation of life insurance that are critical to estate
planners.
A.
Federal Income Tax Patterns
The specific federal income tax statutes governing the
taxation of life insurance proceeds are sections 101 and
72 of the Internal Revenue Code of 1954.
More peripheral
matters, such as the taxation of premiums as compensation
and the deductibility of interest on indebtedness related
to the insurance are governed by sections 61, 163 and 264.
Life insurance proceeds payable by reason of death
are generally exempt from federal income taxation under
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section 101(a).
The exclusion applies without regard
to the nature of the beneficiary.
It is limited, however,
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to the lump sum amount payable at death.
Accordingly,
death benefits paid in installments are prorated in order
to determine the portion of a given payment that is excludible.
If the proceeds are held by the insurer for
future distribution under an interest-only option, the
full interest payment is taxable to the beneficiary under
section 101(c), regardless of whether the owner or the
22
beneficiary elected the option.
Where proceeds are
payable under a life income or annuity certain option, the
portion-representing principal at death is received
23 tax free
while the amount representing interest is taxed.
In
addition to the exclusion of life insurance proceeds paid
by reason of death of the insured, an exclusion from gross
income is expressly granted the surviving spouse of the
insured.
Under section 101(d)(1)(B), a surviving spouse
is entitled to exclude annually $1,000 of interest 24
payments
made under life income or annuity certain options.
The
additional exclusion does not apply to interest payments
under an interest-only option.
A similar pattern of taxation applies to life insurance
in the form of death benefits received by the beneficiaries
or the estate of an employee and paid by or on behalf of
an employer by reason of death of the employee.
The ex-
clusion of such employer-paid death benefits is limited to
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$5,000 per employee and amounts with respect to which the
employee did not possess immediately prior to death any
25
nonforfeitable right to payment while living.
The proceeds of an insurance policy may lose their
tax-exempt status if the policy has been transferred for
value.
Section 101(a)(2) provides that where any interest
in a life insurance contract is transferred for a valuable
consideration, the amount of proceeds excluded from gross
income is limited to such consideration plus the net
26
premiums subsequently paid by the transferee.
The
balance of the net proceeds is taxed as ordinary income.
However, the full exemption remains available if the transferee's basis is determined27 in whole or in part by reference
to the transferor's basis,
or if the transferee is in
the exempt group of transferees—the insured, a partner of
the insured, a partnership in which the insured is a partner,
or a corporation in which the insured is a shareholder or an
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officer.
Note that the insured's spouse and co-share-
holders of the insured are not in the exempt group.
Life insurance proceeds may also be subject29 to income
taxation if the proceeds are paid as "alimony."
Section
71 provides that alimony payments are those periodic payments made pursuant to a court decree or separation agreement in discharge of a legal obligation arising from the
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30
marriage relationship.
In order to avoid taxation, the ex-
husband's insurance policy should not be used to guarantee
alimony payments after his death.
A policyholder may realize income tax consequences
arising from his ownership of the life insurance policy.
Amounts received during the life of the insured rather
than by reason of his death are taxed in accordance with
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the rules set forth in section 72.
If the owner of a
whole-life policy surrenders the contract and elects to
take lifetime maturity proceeds or the cash surrender value,
amounts received are includible in his gross income to the
extent that they exceed the aggregate premiums or other
32
consideration paid for the policy.
This excess is
33
treated as ordinary income, rather than as a capital gain.
Policy dividends, however, are not included in gross in34
come.
If a life insurance policy is issued on a "parti-
cipating" basis, the policyholder is entitled to dividends
declared by the insurance company.
These dividends reflect
the nontaxable return of the difference between the premium
charged and the cost of the policy.
Premiums paid on personal life insurance are considered
35
a personal expense and, as such, are not deductible.
In
contrast, a policyholder can take a deduction under section
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163 for the interest paid on a policy loan.
Only the
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person who owns the policy is entitled to the deduction.
Consequently, if a policyholder procures a policy loan and
subsequently assigns the policy, he is not entitled to
deduct the interest accruing after the assignment.
Premiums paid by an employer upon insurance owned by
an employee or by a person or entity designated by the
employee, whether upon the life of the employee or someone
else, are deductible by the employer as compensation to the
extent .that the payments do not exceed the section 16 2
38
limit of reasonableness.
In such a case, the premium
39
payments constitute section 61 income to the employee.
The situation is less clear-cut when the employer owns the
policy and the employer merely designates one or more objects
of the employee-insured 1 s bounty as beneficiaries.
If the
beneficiary designation is irrevocable and of such an order
that the employer cannot by sole action destroy the rights
of the beneficiary, it is likely that the entire amount of
the premium will be taxed to the employee.
In that event,
the potential employer deduction for a like amount will
probably exist, subject to recapture as income of any
amount actually received upon a subsequent surrender of the
contract or termination of the arrangement.
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A mere
revocable designation of beneficiary by the employer,
however, should not result in either an inclusion in the
income of the employee-insured or a corresponding
deduction by the employer.
Such a revocable designation
creates a mere expectancy.
Where the employee has a
contractual right to nominate a beneficiary, the tax effect
is somewhat different.
There is, of course, an inclusion
in income of the employee, but it is not an inclusion of
the premium paid by the employer.
Rather, it is an in-
clusion of the value properly attributed to the economic
benefit conferred upon the employee.
If the benefit con-
ferred is merely the right to indemnity in the event of
death, the appropriate value would appear to be the tabular
value per $1,000 of one-year term life insurance benefit
40
computed in accordance with Revenue Ruling 55-747
—the
same value attributable to comparable interests under
true "split-dollar" arrangements and under qualified insured
pension or profit-sharing trust arrangements.
Group-term life insurance is subject to the same
principle of taxation of value to the insured-employee
and deduction by the employer.
However, a special exemp-
tion incorporated in section 7 9 excludes from the gross
income of the employee the cost of the first $50,000 of
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group-term life insurance.
The employer can deduct
premiums paid on such policies provided the payments represent reasonable compensation and the employer is not the
beneficiary.
No deduction is allowed for premiums paid
on any insurance policy covering the life of any officer,
employee or person financially interested in the taxpayer's trade or business when the taxpayer is directly or
42
indirectly a beneficiary under the policy.
B.
1.
Life Insurance and the Federal Estate Tax
Taxation of Life Insurance Under Section 2042
As is the case regarding other types of property, life
insurance may be included in the estate of the decedent
under a number of the estate tax provisions of the Internal
Revenue Code.
In recognition of the unique characteristics
of life insurance as an asset, however, the Code includes
a section dealing solely with insurance.
Under section
2042, the gross estate includes the proceeds of insurance
on the life of the decedent if (1) the proceeds are receivable
by or for the benefit of the decedent's estate, or (2) the
43
decedent possessed "incidents of ownership" in the policy.
Life insurance payable to the estate of the insured
(i.e., receivable by the executor) is taxed to the estate
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155
under section 2042(1).
A substantive test of payment
to or for the benefit of the estate applies.
Thus, the
regulations provide that proceeds of the policy may be
considered payable to the estate even though the executor
45
is not specifically designated as beneficiary.
For
example, if the proceeds are receivable by a beneficiary
other than the estate but are subject to an obligation,
legally binding upon the beneficiary, to pay taxes, debts
and other changes enforcible against the estate, the amount
required for the payment in full of such claims is includible
46
in the gross estate.
Yet, proceeds may be payable to
the insured's estate in name alone and not in substance.
Such is the case whenever a policy payable to the insured's
executor or his trustee is not subject to administration
and distribution as part of his estate but, under state
law, inures to the exclusive benefit of his widow and
children free of the claims of creditors.
In this in-
stance, the insurance is deemed payable to beneficiaries
47
other than the estate of the life insured.
Similarly,
it is apparent that insurance payable to a trustee or an
individual object of the insured's bounty who chooses to
lend the proceeds to or purchase assets from the executor
is neither receivable by the executor nor payable to the
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estate.
Such proceeds no more constitute an asset of the
estate than do funds borrowed from a bank for the same
purpose.
To summarize, the test of includibility under
section 2042 (1) essentially turns on whether the estate is
considered to be the beneficial recipient of the insurance
proceeds or is merely a conduit for the ultimate beneficiary.
Proceeds payable to beneficiaries other than the
insured's estate are subject to tax under section 2042(2)
if the insured possessed one or more "incidents of owner48
ship" in the insurance at the time of his death.
The
Code does not require that the insured retained incidents
of ownership during the full term of the policy, or that
the ownership rights were exercisible by him alone and in
all events.
It is enough that he possessed them at the
crucial moment in time.
Although no definitive statement appears in the Code,
it is clear that the term "incidents of ownership" was not
intended to be limited in meaning to ownership of the policy
in the technical, legal sense.
In general, the term refers
to the right of the insured or his estate to receive the
49
economic benefits of the policy.
As expressed in the
regulations, these benefits include (1) the power to change
the beneficiary of the policy;
or cancel the policy;
(2) the power to surrender
(3) the power to borrow against the
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policy;
(4) the power to assign the policy or to revoke an
assignment;
or (5) the power to pledge the policy as
50
security for a loan.
Under prior law, insurance was
taxable to the estate of the insured if the insured had
paid the policy premiums.
This premium payment test was
51
eliminated by the drafters of the 19 54 Code.
The term "incidents of ownership" includes, by express
provision, reversionary interests arising either by the
express terms of the policy or other instruments or by
operation of law and having a value in excess of five per
cent of the value of the policy immediately prior to the
52
death of the insured.
A "reversionary interest" is de-
fined by the statute to include the possibility that the
policy or its proceeds may return to the insured or his
5
3
estate or become subject to a power of disposition by him.
In determining the value of a reversionary interest for
this purpose, the statute mandates the use of usual methods
of valuation utilizing tables of mortality and actuarial
principles applied without regard to the fact of the decedent's
54
death.
In addition, the statute requires that the value of
a possibility that the policy or its proceeds may be subject
to a power of disposition by the decedent be determined as
if it were a possibility that the policy proceeds may return
to the decedent or his estate.
On this latter point, the
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regulations afford some relief by requiring that incidents
of ownership held by others immediately before the death
of the decedent and capable of affecting the value of the
reversionary interest be specifically taken into consideration.
Thus, a decedent will not be deemed to have a reversionary
interest in excess of five per cent of the value of the
policy if some other person had the power to obtain the cash
surrender value immediately prior to the decedent's death.
The regulations state expressly that the terms "reversionary.- interest" and "incidents of ownership" do not include
the possibility that the decedent might receive a policy or
its proceeds by inheritance through the estate of another
person or as a surviving spouse under a statutory right of
56
election.
Moreover, the effect of state or other appli-
cable law upon the terms of the policy must be taken into
account in determining whether a decedent
possessed any
57
incidents of ownership in the policy.
As a result, an
insured domiciled in a community-property state in which he
is deemed to hold title to the community assets in his capacity as manager of the community is not deemed to possess
an incident of ownership in his wife's half of the communityowned policy of insurance on his life, even though during
his life he possessed the power of surrender58 as agent for
her with respect to her half of the policy.
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Although taxpayers may continue to rely on the aforementioned examples of incidents of ownership, a controversy
has recently arisen regarding the tax treatment of two
types of interests in life insurance policies.
The
regulations assert that incidents of ownership include
powers that the decedent may have as a trustee to change
the beneficiary or cancel or surrender an insurance policy,
even though the exercise of such powers would confer no
59
benefit directly on the decedent.
The validity and
scope of this regulatory provision are presently in doubt,
because several court decisions interpreting this
60 provision
have reached irreconcilably different results.
In
addition, the courts are in disagreement concerning the
treatment of interests that grant the decedent the power
to elect a settlement option altering periodic benefits
payable to his beneficiary under a group-term life insurance
61
policy.
The current controversy was initiated by the Sixth
62
Circuit in Estate of Fruehauf v. Commissioner.
Decedent's
wife, Vera Fruehauf, was owner and beneficiary of six
insurance policies on the life of the decedent.
Vera
died testate fourteen months prior to her husband's death,
bequeathing her residuary estate, which included the six
63
policies, to a testamentary trust.
Income from the trust
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was payable to the decedent for life, with a remainder to
Vera's issue.
Decedent was named coexecutor of Vera's
64
estate and cotrustee of the testamentary trust.
The
executors and trustees were authorized to retain the
policies or to surrender them for their cash value.
In
addition, they were permitted to borrow against the policies
in order to pay the policy premiums.
The administration
of Vera's estate was not completed prior to the decedent's
death, and no distribution had been made to the testamentary
65
trust.
Decedent's executors did not include the proceeds
of the six insurance policies in decedent's gross estate.
Accordingly, the Commissioner determined that there was a
deficiency in the reported estate tax.
In sustaining the Commissioner's position, the Tax Court
held that the decedent's power over the trust property as
coexecutor and cotrustee constituted an incident of owner-
66
ship in the policies.
On appeal, the Sixth Circuit
narrowed the Tax Court's holding.
The court of appeals
stated that section 2042 does not cause the inclusion of
insurance proceeds in the gross estate of an insured when
the insured possessed powers in the nature of incidents of
ownership solely in a fiduciary capacity, unless the insured
himself created the fiduciary powers or 67
had a beneficial interest in the exercise of those powers.
In Fruehauf,
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v/jfc.
the decedent was the income beneficiary of his wife's
testamentary trust.
If, as cotrustee, he had surrendered
the policies for their cash value and invested the proceeds, decedent would have increased the amount of income
distributable to him.
The Sixth Circuit, therefore,
held that because of the decedent's beneficial interest in
the exercise of the fiduciary powers that he possessed at
his death, the proceeds of the policies were includable
68
in his gross estate under section 2042(2).
Thfe Second Circuit's decision in Estate of Skifter v.
69
Commissioner
is consistent with the position adopted by
the Sixth Circuit in Fruehauf.
The Second Circuit,
however, substantially refined the analysis supporting the
Fruehauf principle.
Decedent Skifter purchased nine policies insuring his
life.
He then assigned the policies to his wife, retaining
70
no interest or power.
Several months after the assign-
ment, decedent's wife died.
Pursuant to the terms of her
will, the policies were placed in a testamentary trust.
As trustee, Skifter was granted broad authority regarding
the management and control of the trust
assets, including
the discretionary power to pay all or part of the
71 trust
corpus to the income beneficiary (his daughter).
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Decedent died four years after the death of his wife,
and the Commissioner sought to include the proceeds of
the nine policies in his gross estate.-
The Tax Court,
however, excluded the policy proceeds, holding that the
decedent had no beneficial interest in the exercise of his
72
powers as trustee.
The Second Circuit affirmed.
In
interpreting the language of section 2042(2), the appeals
73
court inferred from a Senate Finance Committee report
that Congress intended that section to give insurance
policies estate tax treatment that roughly parallels treatment accorded other types of property
under sections 2036,
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2037, 2038, and 2041 of the Code.
In the court's view,
an interest that would cause inclusion under one of these
related sections would, by analogy, constitute an incident
of ownership under section 2 042.
In response to the court's analysis, the Commissioner
contended that the decedent's power to distribute principal
to the income beneficiaries was a power 75
to alter, amend, or
terminate the trust under section 2038.
Thus, the
Commissioner argued that section 2038, acting through section 2042, would require inclusion of the policy proceeds.
The appeals court, however, distinguished cases 76
cited by
the Commissioner in support of his contentions,
noting
that unlike Skifter, those cases involved powers retained
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107.
by the decedent at the time of the original transfer.
In addition, the court stated that contrary to a traditional
section 2038 analysis, Skitter's powers as trustee could
not be construed as a substitute for a testamentary
78
disposition.
The Commissioner also argued that Regulation § 20.2042-1(c)(4)
required inclusion of the policy proceeds in Skifter's gross
79
estate.
The Second Circuit, however, declared that although
Regulation § 20.2042-1(c) (4) provides that an incident of
ownership can exist in an insurance policy on the decedent's
life that is held in trust, the regulation applies to reservations of powers by the trustee and not to such powers80 conferred on the decedent in a manner beyond his control.
The
court also recognized the "economic benefits" language of
Regulation § 20.2042-1 (c) (2) and conceded that it was impossible for the decedent to have benefited
either himself
81
or his estate under the arrangement.
Because the decedent
did not himself create the fiduciary powers or have a beneficial
interest in the exercise of those powers, the proceeds from
the insurance policies were not includable in the decedent's
gross estate.
The Fifth Circuit adopted the Commissioner's
position
82
in Estate of Lumpkin v. Commissioner,
rejecting the arguments
advanced by the Sixth and Second Circuits in Fruehauf and
Skifter.
In Lumpkin, decedent had been employed by Humble
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Oil & Refining Company, and was covered under a noncontributory group-term life insurance policy insuring
the lives of Humble's employees.
Proceeds were payable
to a class of beneficiaries described in the policy;
employees had no power to designate recipients of the
policy benefits.
The only power possessed by an employee
over the proceeds was the power to elect under an optional
settlement provision to alter the timing and manner of
83
benefit distribution.
In ..reversing the Tax Court's decision in favor of the
decedent's estate, the Fifth Circuit held that the value of
84
the insurance benefits was taxable under section 2042(2).
The Lumpkin court concurred with the Second Circuit's view
in Skifter that Congress intended section 2042 to provide
life insurance policies with roughly equivalent estate 85
tax treatment to that accorded other types of property.
The Fifth Circuit, however, differentiated sections 2036
and 2038 from section 2042 by stating that under the former
two sections the decedent must have made an incomplete
transfer of property, while no transfer is necessary under
86
the latter.
Accordingly, if the decedent possessed a
"substantial degree of control" over the time and manner of
enjoyment of the policy proceeds, the value of the proceeds
- 25
OR
will be included in the decedent's gross estate regardless
87
of the capacity in which the control was possessed.
Relying on the same cases distinguished by the Second Circuit
88
in Skifter,
the Fifth Circuit noted that the decedent's
power to affect the enjoyment of the proceeds constituted a 89
substantial degree of control under sections 2036 and 2038.
Therefore, because Congress intended parallel treatment for
all three sections, the Fifth Circuit held that the power was
90
also an incident of ownership under section 2042.
91
In-Rose v. United States,
the Fifth Circuit again
applied the principles expressed in Lumpkin.
Decedent's
brother created trusts for the benefit of the decedent's
92
children, naming the decedent as trustee.
Subsequently,
the decedent purchased three insurance policies on his own
life and placed them in the trusts.
The decedent, as
93
trustee, was the beneficial owner of the policies.
The Fifth Circuit recognized and accepted the Second
Circuit's determination that section 2042 is to be read in
94
consonance with other estate tax provisions.
Yet, the
court stated that:
Congress through § 2042 has given
discrete statutory treatment to policies
of insurance.
Sections 2036, 2037, 2038,
2041 and 2042 may be consanguineous, but
each has an individual personality with
genetic variations . . . .
Life insurance
is a specie of its own, it occupies a
- 32 -
96
special place in the tax field, and we
cannot simply graft terms from one
provision onto another.
Whether the
insurance sheaves found in the decedent's
hands are selected stalks from oncelarger bundles, or whether they represent
all that the taxpayer ever cultivated from
the seed he had, the Congressional direction is to tax whatever is possessed at
the end of the season.
Utilizing the "substantial control" test articulated in
Lumpkin, the court determined that the decedent possessed
96
incidents of ownership in the policies.
The court held
that fiduciary restraints on the exercise of the decedent's
incidents of ownership did not deprive him of the control
97
required for inclusion of the proceeds in his gross estate.
The Fifth Circuit held that Regulation § 20.2042-1(c)(4),
which the Second Circuit read
restrictively in Skifter,
98
required the same result.
The Fifth Circuit reaffirmed its position in Terriberry
99
v. United States.
The wife of the decedent owned insurance
policies on the decedent's life.
The policies were placed
in a revocable trust with decedent and his wife as co100
trustees.
In this capacity, the decedent was empowered
to alter the time and manner of enjoyment of the policy proceeds by electing a settlement option.
Although the trust
instrument expressly prohibited
101 the decedent from exercising
any incidents of ownership,
the court held that section
2042 required inclusion of the proceeds in the decedent's
- 32 -
28
102
gross estate.
103
Over a strong dissent,
the Fifth
Circuit determined that the wife's absolute power as
settlor to revoke the trust or remove her husband as trustee
did not demand a contrary result.
Because the settlor's
powers were not exercised prior to her husband's death,
the court held that the decedent possessed the ability
104
to exercise the settlement option at the time of his death.
The Third Circuit recently held, under facts similar
to those in Lumpkin, that the mere right to elect an
optional mode of settlement is not an incident of ownership
under section 2042(2).
In Estate of Connelly v. United
105
States,
the Third Circuit criticized Lumpkin, stating
that the Fifth Circuit had incorrectly interpreted the effect
106
of section 2042.
Employing the "economic benefit" theory
expressed in Skifter, the court determined that section 2042(2)
did not require inclusion of the policy proceeds in the
107
decedent's gross estate.
The position of the Second, Third, and Sixth Circuits
are clearly incompatible with the Fifth Circuit's view.
Un-
like the other courts, the Fifth Circuit purports to follow
congressional intent by treating insurance as a "specie of
108
its own."
The Fifth Circuit disregards fiduciary
constraints, examining only the degree of control that the
decedent possessed.
- 32 -
98
As evidenced in Connelly, the apparent trend is away
from the Fifth Circuit's harsh, inclusionary line of
reasoning.
Yet, until either Congress of the Supreme Court
directly considers the estate tax treatment of the types of
interests involved in the aforementioned cases, the true
tax status of such interests shall remain unresolved.
Against this background, the court in Estate of Margrave
109
v. Commissioner
considered whether the proceeds of a life
insurance policy owned by the wife of the insured and payable
to a revocable trust established by the insured were includible
in the insured's gross estate.
Decedent, Robert B. Margrave,
established the Robert B. Margrave Revocable Trust on June
110
16, 1977.
The United States National Bank of Omaha (the
Bank) was appointed as trustee.
Decedent was the income
beneficiary under the terms of the trust, retaining the unqualified right to modify or revoke the trust during his
life.111
On January 29, 1970, decedent's wife applied for
a twenty-year decreasing term insurance policy on decedent's
112
life.
In the absence of any change, the beneficiary of
113
the policy was "as designated in the application."
The
Bank, as trustee of the decedent's trust, was named
beneficiary in the application, and this designation never
114
changed.
During the life of the decedent, all benefits,
rights, and privileges available or exercisable under the
policy were vested in decedent's wife, and she paid the policy
- 29 -
115
premiums with her own funds.
Upon decedent's death in
116
1973, the policy proceeds were paid to the Bank as trustee.
Decedent's executor did not include the amount of the proceeds in decedent's gross estate, and the Commissioner determined a deficiency in the reported estate tax.
The executor
then petitioned the Tax Court for a redetermination of the
deficiency.
At trial, the Commissioner contended that the proceeds
of the policy were includible in the decedent's gross estate
117
under section 2042(2).
A divided court, however, held
that the policy proceeds were not taxable under section 2042(2),
because the decedent did 118
not possess an "incident of ownershiD"
in the insurance policy.
The majority noted that the dece-
dent's trustee had the right to receive the policy proceeds
subject to Mrs. Margrave's power, as owner of the policy, to
change the designation of the trustee as beneficiary.
The
majority, therefore, concluded that the decedent's interest
in the trust, with regard to the policy proceeds, was merely
a power over an expectancy subject to the absolute whim of
119
his wife.
Accordingly, there was no basis for inclusion
of the proceeds in the decedent's gross estate.
The majority stated that Margrave was distinguishable
120
from the cases discussed above.
Indeed, the instant
case did not involve powers exercisable by a decedent-trustee
- 30 -
100
or an insured's ability to elect a settlement option under
a group-term life insurance policy.
Yet, the majority's
analysis comports with the "economic benefit" approach
articulated in Skifter, implicitly rejecting the harsh,
inclusionary attitude of the Fifth Circuit.
As the majority noted, "[t]he regulations specify
that 'the term incidents of ownership is not limited in
its meaning to ownership of the policy in the technical
legal sense,' and that the focus is on 'the right of the
insured or his estate to the economic benefits of the
121
policy.'"
The decedent himself did not possess the
power during his life to direct the disposition of the
insurance proceeds.
Instead, the proceeds passed according
to the trust provision established by the decedent because
Mrs. Margrave had not chosen to change the beneficiary
designation.
Thus, the court concluded that Mrs. Margrave,
not her husband, possessed the "incidents of ownership."
In Margrave, the Tax Court reached a just result by
rejecting strict, inclusionary interpretations of applicable
estate tax statutes.
Under a cursory analysis, the Tax
Court's holding seems to permit insurance proceeds to pass
without estate tax, while allowing the decedent to control
their disposition.
Yet, the decedent's ability to control
the disposition of the proceeds in this case was subject to
"101
revocation at any time by his wife's power over a nontaxable
expectancy.
The court recognized that the proceeds passed
in accordance with the trust provisions established by the
decedent because Mrs. Margrave did not choose to change
the beneficiary, not because of the decedent's direction.
The court apparently would have reached a different result
if the arrangement had been the result of a predetermined
122
plan.
It is doubtful that the IRS will acquiesce in Margrave
123
in the near future.
Because of the substantial split
among the judges on the court (seven dissenting judges),
Margrave provides weak precedent for future decisions.
Therefore, in order to avoid the possibility of unnecessary
taxation, estate planners should refrain from relying
extensively upon the Tax Court's holding.
Another troublesome application of the incidents of
ownership concept relates to ownership by a corporation of
insurance upon the life of a controlling shareholder.
The
issue in this instance is whether the fact that the insured
could control the actions of the corporation, and indirectly,
the life insurance policy, meant that he held an incident
of ownership in the policy.
For many years the regulations
provided that an incident of ownership existed only if the
insured was the sole shareholder of the corporation.
- 32 -
102
After
124
an effort to reduce the percentage from 100% to 7 5%,
the regulations now take the position that stock ownership
will not constitute an incident of ownership as long as
the proceeds are payable to the corporation or, if
payable to a third party, they satisfy a valid business
purpose of the corporation (e.g., to meet a business debt
of the company so that its net worth is increased by the
125
proceeds).
In the event, however, the proceeds are not
payable to or for the benefit of the corporation, and the
insured holds more than 50% of the combined voting power
of all classes of stock, the incidents of ownership held
by the corporation will be attributed to the insured
126
through his stock ownership.
127
As intimated by the Tax Court in Margrave,
even
though the nominal possession of the incidents of ownership of a life insurance policy are in persons other than
the insured, the proceeds may nonetheless be taxed to
the insured's estate if there was an understanding,
whether or not enforcible, that the insured could exercise
128
a power which constituted an incident of ownership.
129
In Prichard v 0 United States,
the wife of the decedent
owned an insurance policy on the decedent's life.
The
policy was purchased for the purpose of securing a loan
to be made to the insured to finance a real estate con- 33 -
103
struction project.
Since the insured lived in a community
property state, the loan was actually to be made by the
husband-wife community.
The lender conditioned the loan
upon an assignement to it of the policy.
Accordingly,
the policy was acquired by the wife, held by her for eight
months until the loan was closed, and then assigned to
the lender as collateral.
The court of appeals in
Prichard held that the predesigned plan to use the insurance
for a purpose that constituted an economic benefit to the
insured was an incident of ownership in the insured which
caused the proceeds of the insurance to be included in his
130
gross estate.
It would appear from a review of the authorities that
where the insured died possessing only nominal incidents of
ownership, many courts will nevertheless include the insurance
proceeds in the insured's gross estate,' irrespective of the
fact that the insured had no meaningful control over the
131
policy.
In sum, to secure exclusion of insurance
proceeds from an insured's gross estate, the insured should
divorce himself from any nominal or substantive interests
in the policy.
2.
Taxation of Life Insurance Under Other
Sections
Life insurance which is not within the purview of
section 2042 may well be drawn into the decedent's gross
estate under other estate tax provisions.
As discussed
above, section 2042 only applies when the decedent is
the life insured.
Yet, a decedent may have a taxable
interest in insurance in other circumstances.
For example,
insurance on the life of another owned by the decedent at
the time of his death would be included in his gross
estate under section 2033 and not under section 2042.
In
this instance, the amount includible is the replacement
132
value of the policy.
would be inappropriate;
Inclusion of the face amount
the policy has not yet matured as
a claiiru
The policy would also
be taxable to the decedent's
133
estate under section 2036(a)(1)
if the decedent retained
an income interest in the policy, or under sections
134
135
2036(a)(2)
or 2038
if he had the power to change the
beneficiary designation.
Similarly, the insured's estate may be taxed under
estate tax provisions other than section 2042.
Although
the insured may negate the effect of section 204 2 by
divesting himself of the incidents of ownership in the policy,
section 2035 mandates inclusion of the policy proceeds in the
- 51 -
105
insured's gross estate if the transfer of the policy was made
136
within three years of death.
The decedent's motives for
the gift are no longer relevant;
the old rebuttable pre-
sumption of contemplation of death is now a conclusive
presumption with respect to gifts made after 1976.
The
amount included in the taxable estate will be the "grossed
up" figure for the gift (i.e., the amount of the gift, valued
at death, plus the gift tax paid thereon).
There are two exceptions to the three year rule.
A bona
fide sale of property for a full and adequate consideration
137
is not subject to the provisions of section 2035.
Even
if the sale is for less than a full consideration, only the
gift element of the transfer will be reached by138
section 2035
as a result of the partial consideration rule.
By making
a "sale in contemplation of death," the seller apparently
only substitutes one form of property for another, and the
value of his estate remains unchanged.
The other exception to the rule has created great
confusion.
Section 2035(b)(2) after the Tax Reform Act of
1976 provided that the three year rule did not apply to "any
gift excludible in computing taxable gifts by reason of
section 2503(b) (relating to the $3,000 annual exclusion
for purposes of the gift tax) determined without regard to
section 2513(a)."
Arguably, this language meant that any
- 36 -
1( 6
$3,000 exclusion allowed at the time of the gift was subtracted from the amount pulled back into the gross estate
at death.
For example, if the transferred property was
worth $50,000 at the time of death (or the alternative
valuation date), only $47,000 would go into the gross
estate if the $3,000 exclusion was allowed for the gift.
Suppose the property was worth $2,50 0 at the time of
the gift, and $5,000 at death.
The staff of the Joint
Committee on Taxation indicated that $2,500 was excludible,
139
and $2,.500 was includible.
The Revenue Act of 1978,
however, provided that the entire gift is excluded if the
140
gift does not require a gift tax return to be filed.
All gifts must be reported in a gift tax return except
present interest gifts to a
donee that aggregate $3,000
141
or less during the calendar year.
Thus, section
2035 (d) (2) now finds that there is no exclusion at death
for gifts in excess of $3,000 reached by section 2035.
For the $50,000 gift above, the full $50,000 would be included in the gross estate.
For the $2,500 gift, nothing
would be included regardless of the date-of-death value.
Unfortunately, the "small-gifts exclusion" of section
2035(b)(2) does not apply to "any transfer with respect to
142
a life insurance policy."
Thus, the transfer of a
policy with a value of $1,000 before death and a full value
"107
of $10,000 at death would be included in the gross estate
at $10,000 if the transferor-insured dies within three
years.
Transfers of term insurance and accidental death
insurance policies pose unique problems under the three
year rule.
The IRS has successfully argued that annually
renewable accidental death policies never get beyond the
three-year period, because there is a "transfer" by the
insured each year when the protection is renewed by a
143
premium, payment.
This position is difficult to
understand, because only one assignment is made with respect
to a particular person's package of rights in the policy.
Yet, planners must be aware that the IRS may attempt to
extend this rationale to annually renewable individual and
group-term life insurance policies.
Section 2035 should not deter the making of a life
insurance gift.
The donor-insured will fair no worse than
if he had continued to hold the policy until death.
Indeed,
there is little substantive change in tax treatment for life
insurance gifts from prior law.
Because of the uniquely
testamentary nature of life insurance, such gifts rarely
overcame the rebuttable presumption of contemplation of
death under old section 2035.
- 40 -
108
C.
Life Insurance and the Gift Tax
There may be gift tax consequences if community property
was used to purchase insurance.
Regulation § 25.2511-1(h)(9)
provides:
Where property held by a husband and wife
as community property is used to purchase
insurance upon the husband's life and a
third person is revocably designated as
beneficiary and under the State Law the
husband is considered to make absolute the
transfer by the wife, there is a gift by
the wife at the time of the proceeds of
such insurance.144
This regulation has been limited to situations in which the
surviving spouse receives less than his or her community
145
share.
When the surviving spouse receives his or her
community share or more, there must be donative intent in
order to
146 assess a gift tax on amounts payable to a third
party.
An assignment of life insurance in a noncommercial
setting generates a taxable gift.
The value of the policy
for gift tax purposes depends on the style of policy
involved.
The general rule is that the value
147 used is the
replacement cost of a comparable contract.
This rule,
however, is limited to single-premium and paid-up policies.
For whole life, term and other policies that have been in
existence for some time and on which further premiums are
- 39 -
109
due, the value consists of (1) the interpolated terminal
reserve value on the date of the gift (zero in the case
of term policies and slightly more than the cash surrender
value in permanent policies);
plus (2) the proportionate
part of the gross premium last paid before the gift which
covers the period extending beyond the date of the gift;
plus (3) the dividends accrued on the policy to the date
of the gift;
minus (4) any outstanding indebtedness
148
against the policy.
In the case of a newly issued
policy, the Supreme Court has ruled that the value of the
policy is the premium that
149 has just been paid to bring
the policy into force.
If the donor strips a policy of its cash value through
policy loans before making a gift of the policy to the donee,
the policy is transferred subject to the indebtedness.
The value of the policy for gift tax purposes will be only
the sum of (1) the excess of the interpolated terminal
reserve value over the cash value, plus (2) the unexpired
premium for the balance of the current period because the
indebtedness assumed by the donee reduces the value of
150
the (adjusted) taxable gift.
But this type of trans-
action raises a number of income tax issues.
If the
liability assumed by the donee exceeds the donor's basis
in the policy (the net premiums paid), the issue arises
- 40 -
110
whether the donor receives a taxable gain.
In 1969, the
IRS held that the donee's assumption of the policy loan
151
is treated as an amount realized by the donor,
so the
donor apparently could realize gain, which would be ordinary
152
in character.
This result is questionable because the
donee may never repay the loan, but simply collect reduced
death proceeds.
In effect, the loan can be viewed as a
prepayment of the income tax exempt death proceeds.
Another issue arising in this situation is whether a
transfer for value was effected that will cause a partial
loss of the income tax exemption for the insurance proceeds.
153
As previously discussed,
when a life insurance policy is
transferred for a valuable consideration, the income tax
exemption for the proceeds at the insured's death is limited
to the sum of the consideration and the premiums subsequently
paid by the transferee, unless the transferee's basis is
determined by reference to the transferor's basis 154
or the
transferee is in the exempt group of transferees.
It
is clear that the donee's assumption of the policy loan
represents return consideration to the donor.
Yet, if the
transaction is part gift and part sale, the donee's basis will
be determined in whole or in part by reference to the
donor's basis, and the transaction will fall within a "safe
harbor" of the transfer-for-value rule.
- 41 -
Indeed, a "remedial
transfer" that falls within a safe harbor can always be
155
made to erase any transfer-for-value taint on a policy.
The Tax Reform Act of 1976 enacted a full gift tax
marital deduction for the first $100,000 of interspousal
156
gifts.
If the spouse is the transferee, the gift tax
marital deduction and the $3,000 annual exclusion will
usually eliminate any adjusted taxable gifts resulting from
the policy transfer.
Utilization of the gift tax marital
deduction, however, will reduce the available estate tax
157
marital deduction.
Under the Tax Reform Act, if the
insured gave a policy to his spouse within three years of
death, and used the gift tax marital deduction, his estate
tax marital deduction was still reduced.
The Revenue Act
of 1978 changed this result, since the estate tax marital
deduction would not have been reduced if the
158 insured had
continued to hold the policy until death.
A final consideration is whether a gift of a life
insurance policy or premiums is a gift of a present
159 interest
so as to qualify for the annual $3,000 exclusion.
The
regulations define a present interest to be "an unrestricted
right to the immediate use, possession,
or enjoyment of the
160
property or the income from property."
The annual
exclusion is generally available for outright gifts of life
- 42 -
112
insurance policies, even for policies that have no cash
161
value.
The same general rule applies for outright gifts
162
of the premium payment.
But gifts in trust must be
scrutinized further.
With respect to gifts in trust,
the vesting of rights in the beneficiary is not enough to
secure the $3,000 exclusion.
"The question is . . . not
163
when title vests, but when enjoyment begins."
It is
the right to enjoy rather than actual enjoyment that is
164
pertinent.
Also, it is important to recall that the
annual exclusion, when allowed, is available with respect
to each trust beneficiary each year.
The reported decisions involving a policy assignment
to trust or payment of a premium by the insured on a policy
held in trust have generally determined that such gifts were
gifts of a future interest for which no annual exclusion is
allowed.
Such was the result in an early case in which
the trustee had the sole discretion to exercise all rights
and privileges under the policies placed in trust.
The
beneficiaries could not demand that policy dividends be
paid in cash, nor could they demand that the policies be
165
surrendered.
Recently, the annual exclusion was denied
where an employee assigned his rights in a split-dollar
policy to an irrevocable trust.
His only right in the policy
- 43 -
113
was to name a beneficiary for the death proceeds in excess
of the cash value.
Under the terms of the trust, the
trustee would collect the proceeds at the employee's
death and pay income and principal to the widow and
children as the trustee deemed necessary for their health,
support, maintenance, education, and general welfare.
The
IRS denied the section 2503(b) exclusion because the beneficiaries would have to survive the insured to receive any
benefits, and the amount that each beneficiary would receive
was not ascertainable because of the trustees
166
limited
discretionary power over distribution.
The device most commonly used to secure the annual
exclusion for insurance gifts in trust is the "Crummy power,"
so called because it derives
167 from the Ninth Circuit's decision
in Crummy v. Commissioner.
each trust beneficiary
A typical Crummy power gives
(e.g., children and grandchildren) a
noncumulative, annual power to withdraw up to $5,000 from
the trust during the grantor-insured's lifetime.
The power
can secure the $3,000 exclusion for the original policy
transfer and subsequent cash additions for each trust
beneficiary each year.
Although the Crummy case did not involve a life insurance
trust, it made an interpretation of section 2503(b) that is
- 44 -
11 *
applicable in the insurance context.
Mr. and Mrs. Crummy-
had created an irrevocable living trust for their four
children.
The grantors retained the right to make
additions to corpus in later years.
The trust agreement
provided that each child could demand from the trust the
lesser of $4,000 or the amount of such transfers from each
grantor.
In addition, the trust provided that if the child
was a minor, the child's guardian could make such a demand
on behalf of the child.
The trust instrument placed a
limit on the beneficiaries' right to demand the trust
property in that the demand would apply only to the transfer
made in the calendar year in which the demand was made.
In
any year in which the beneficiaries failed to demand possession of the property, the trustee was ordered to take the
property transferred to the trust in that year and invest
the property so as to benefit the beneficiaries at some future
date.
The Ninth Circuit held that the grantors would be
allowed the annual exclusion since the children had a
present right to the property transferred each year to the
trust.
The court of appeals determined that although it
would be unlikely that the children would ever make a demand
on the trustee, under California law the trustee could not
resist the decision if made by the children.
In the court's
view, therefore, the bare legal right to demand distributions
- 39 -
115
was sufficient to give the minor donees a present interest
168
in the trust property.
Five years later, the IRS accepted the Crummy rationale,
stating:
[A] gift in trust for the benefit of a minor
should not be classified as a future interest
merely because no guardian was in fact appointed.
Accordingly, if there is no impediment under the trust or local law to the
appointment of a guardian and the minor has
a right to demand distribution, the transfer
is a gift of a present interest that qualifies
for the annual exclusion. . . .169
In 1978, the IRS approved of a Crummy power in the context of
an insurance trust.
The donor established an irrevocable
trust funded with a $600,000 term policy on his life.
The
trust agreement required the trustee to apply all available
funds and assets of the trust toward the payment of premiums
due on any life insurance policies constituting any part of
the trust principal.
The donor made annual cash gifts to
the trust to enable the trustee to pay premiums.
the donor's life, the trust beneficiaries
During
(the donor's
four children) had a power to demand the lesser of $3,000 or
the market value of any property added to the trust.
This
demand, however, had to be made within the same calendar
year in which the property was added to the trust.
At
the donor's death, the trustee was required to retain all
- 32 -
116
assets in a single trust until the oldest child reached age
21, at which point the trust would split into separate
shares for the benefit of living children and the issue
of any deceased children.
The IRS determined that under
these facts each trust beneficiary had an immediate and unrestricted right to withdraw up to $3,000 each year, and
allowed the 2503(b) exclusion for the annual cash
170
additions.
In 1979, a Crummy power was again upheld.
The grantor
in this instance established an irrevocable trust funded
with an initial corpus of $10.
The trustees were the
grantor's wife and two unrelated individuals, and the beneficiaries were the grantor's wife and issue.
Under the
trust agreement, the wife was entitled to receive distributions
of income and corpus, in the discretion of the other two
trustees.
Each child of the grantor, or the lawful guardian
of such child, could demand $5,000, or 5% of the trust corpus
if greater, in any year in which an addition was made to the
trust.
The IRS allowed the annual exclusion for additions
171
to the trust because of the children's Crummy powers.
The use of a Crummy trust in an insurance context is thus
well-established.
The grantor-insured of a Crummy trust hopes that the
demand power will never be exercised.
Yet, there is no
certain way to prevent the exercise of the demand power if
the grantor desires the benefit of the annual exclusion.
The only meaningful legal restriction that he can impose
is through a spendthrift clause, which will not of itself
172
make the annual cash gifts future interests.
While
the grantor cannot be too restrictive regarding the legal
rights of the beneficiaries, he can take steps to assure
that the power will never be exercised.
The Crummy court
acknowledged that it was unlikely that the beneficiaries
even knew about the existence of the demand power.
Accordingly,
it would appear that no formal notice is required, although
the conservative draftsman may wish to provide for notice.
Indeed, the IRS recently denied the annual exclusion where
the trustee was not required to, and did not, notify
the
173
beneficiary of his right to exercise the power.
In
Private Letter Ruling 7946007, the Service reasoned that in
the case of a minor or incompetent adult beneficiary, the
grantor has done all that he can to confer the power upon
the beneficiary by giving him that right in the trust agreement.
Where the beneficiary is a A adult, however, the additional
step of actual notification was deemed necessary by the
174
IRS.
Typically, the annual demand power will be exercisable
in an amount not less than $3,000, to take full advantage
- 39 -
118
of the annual exclusion, and not more than the greater
of $5,000 or 5% of the value of the trust corpus.
The
latter is the maximum amount that will_not result in gift
175
or estate tax lapses each year.
On the beneficiary's
death, however, any unexercised demand right that had not
176
yet lapsed would be included in the gross estate.
A Crummy power may not be effective for all types of
insurance trusts.
For example, where the trust is funded
with an employee's interest in a group-term policy, premiums
will be paid by the employer or the insured directly to the
insurance company.
Because there are no cash additions to
the trust under these circumstances, the beneficiary's
demand power would be illusory, and the $3,000 exclusion
177
would likely be denied.
In Revenue Ruling 76-490,
however, the exclusion was allowed for employer premium
payments treated as gifts by the employee.
The employee
had assigned his group insurance to an irrevocable trust
that was to pay the proceeds to the beneficiary immediately
upon the employee's death.
The grantor may have to take additional steps to make
certain that the demand power is not illusory.
In the
typical case of a trust funded only with the insurance
policy, annual cash additions should be held by the trustee
until the beneficiaries' demand rights expire for the year.
1:19
- 49 -
Alternatively, the beneficiary could be given the right to
demand surrender of the policy or its conversion into
income-producing property.
The trust agreement should also
permit the beneficiaries a reasonable amount of time in
which to exercise their demand rights under the trust.
Planners should carefully draft Crummy trusts so as
to avoid possible application of the generation-s kipping
1 1
177A
transfer tax.
Moreover, the income tax consequences
of using Crummy powers should not be overlooked.
Generally,
a beneficiary is treated as the owner, for income tax
purposes, of that portion of a trust over which he has a
178
right to demand distribution.
In the case of a trust
funded only with an insurance policy, there is no income
that can be attributed to the beneficiary.
On the other
hand, if the grantor transfers other property to the trust,
perhaps to render the demand power valid, the following
amount would be included in the beneficiary's gross
179
income:
Trust income and
capital gain
Amount of demand power
Fair market value of
trust corpus when
demand power arose
Section 678(a) may pose an ever greater threat to Crummy
powers.
It provides:
- 39 -
120
A person other than the grantor [i.e., the
beneficiary] shall be treated as the owner
of any portion of a trust with respect to
\vhich . . . such person has previously released or otherwise modified such a power
and after the release or modification retains
such control as would, within the principles
of sections 671 to 677, inclusive, subject a
grantor of a trust to treatment as the owner
thereof. 1 8 0
In addition, there is no $5,000/5% shelter with regard to the
income tax as there is for gift and estate tax purposes.
Recent developments have generated some uncertainty
with respect to whether a Texas grantor's spouse should be
named as beneficiary under a Crummy trust during the grantor's
life.
Section 2036(a)(1) provides in relevant part that
a decedent's gross estate "shall include the value of all
property to the extent of any interest therein of which the
decedent has at any time made a transfer . . . under which he
has retained for his life . . . the possession or enjoyment
131
of, or the right to the income from the property."
Under Texas law, a gift of property from one spouse to the
other, or a gift of a spouse's one-half community property
interest to the other spouse, 182
results in separate ownership
of the property by the donee.
Income from separate property, however, becomes the community property of both
spouses.
183
- 51 -
121
184
In Wyly v. Commissioner,
the IRS contended that by
virtue of Texas community property law, a donee-spouse has
a retained life interest within the meaning of section
185
2036(a)(1) in the property transferred into trust.
Mr.
Wyly created an irrevocable trust, naming his wife the life
income beneficiary with the remainder to go to their grandchildren per stirpes.
The trustees were given the power
to invade corpus for the benefit of Mrs. Wyly, and she
could withdraw up to $5,000 annually.
The trust was funded
with shares of stock that were community property.
Since
he was not a beneficiary under the trust, Mr. Wyly gave
his one-half community interest in the corpus to his
wife.
Upon Mr. Wyly's death in 197 2, the Commissioner
assessed a deficiency against the estate, determining that
Wyly had retained an interest in the community property
186
187
transferred to the trust.
The Tax Court agreed.
188
In Castleberry v. Commissioner,
the decedent made gifts
to his wife of his one-half community property interest in
municipal bonds.
The petitioner did not include any portion
of the value of the bonds in the decedent's gross estate.
The Commission, however, determined that a portion of the
total fair market value should have been included under
2036(a)(1).
Again, the Tax Court upheld the Commissioner's
189
190
determination.
The decedent in Frankel v. United States
"
52
1
JL AwTV>
had made a number of lifetime transfers of his community
property interest in several bonds to his wife.
The tax-
payer brought suit in federal district court for a refund
of taxes paid, on the basis that such interests should not
have been included in the decedent's gross estate.
The
district court granted partial summary judgment for the
191
taxpayer, without discussing its reasoning.
On consolidated appeal to the Fifth Circuit, none of
the taxpayers disputed that the donors became automatically
possessed of a community
property interest in the income
192
from their gifts.
They argued, however, that the
resulting interests were so "limited, contingent, and
expectant" that they did not approach the level
193 required to
come within the ambit of section 2036(a)(1).
Circuit agreed.
The Fifth
The appellate court did not believe that
"an interest, created solely by operation of law as the
unavoidable result of what was in form and within the intendment of the parties the most complete conveyance
possible,
194
is a retention within [section 2036(a)]."
The court
went on to declare that there must be some act or omission
on the part of the donor, such as an express or implied
agreement between the donor and donee at
195 the time of the
transfer, for section 2036 (a) to apply.
Moreover, the
Fifth Circuit noted that its decision placed spouses in
123
- 39 -
community property states on an equal footing with those in
other states and found it inconceivable that Congress in196
tended a contrary result.
Despite the fact that the Fifth Circuit reversed the
lower court decision, it is still probably not a good idea
to include the grantor's spouse as beneficiary of a Crummy
trust during the insured's life.
Although the IRS may no
longer argue that designating the grantor's spouse as beneficiary results in the grantor retaining a life estate by
operation of law, generally the spouse will have sufficient
other assets so that additional trust income will not be
required.
In any event, an unfunded Crummy trust would
generate no income.
Further, the grantor would be taxed
under section 677(a)(1) on any trust income generated to
the extent that the trustee in his discretion
can distribute
197
income and/or principal to the spouse.
IV.
Planning Techniques
If substantial amounts of life insurance are involved,
the usual goal in estate planning is to serve dual objectives.
First, an attempt must be made to exclude the policy proceeds
from the estate of the insured and his spouse.
Second,
the proceeds should remain available for loans to, or
- 39 -
124
purchases from, the executor of the deceased insured
to provide necessary liquid funds for estate debts and
taxes.
The most obvious method to exclude insurance proceeds
from the estate of the insured is to avoid ownership of
the policy and control of the incidents of ownership.
A common path for a married individual is to assign the
policy to the beneficiary spouse.
But for the hazards of
section'2035, this technique can assure the exclusion of
the death proceeds from the insured's estate.
Yet, under
this alternative, the proceeds will not be excludible
from the beneficiary's estate.
Moreover, the availability
of the proceeds to satisfy the liquidity needs of the estate
of the insured is dependent entirely upon the cooperativeness and willingness of the beneficiary.
Further, the
beneficiary will not be protected against financial indiscretions if the policy proceeds are paid in a lump sum.
On the other hand, if a settlement option is selcted, the
payments will likely be inflexible and subject to the
nuances of contract and insurance law.
In contrast, an inter vivos trust vehicle can provide
the financial management and flexibility lacking in other
- 55 -
alternatives.
A trustee endowed with adequate powers may
utilize the proceeds for the purpose of loaning money to
or purchasing assets from the estate of the insured.
However,
in order to avoid the application of section 2042(1), the
trustee should not be required to take such action.
If
the living trust established to own the policies and subsequently administer the proceeds is a revocable trust,
the trust corpus including the insurance values will be
included in the grantor's gross estate.
The advantage
of such a trust, therefore, is clearly not estate tax savings,
but merely assurance of adequate and appropriate administration of the proceeds when they become available.
Utilizing
an irrevocable trust as the owner of the insurance, however,
assures that the proceeds will be excluded from the insured's
estate (if the three-year rule of section 2035 is avoided).
Yet, in this instance, the grantor loses control of cash
and other interim values of the insurance, and is exposed to
possible gift tax on the insurance values at the time of
transfer to the trust and subsequent premiums paid through
or on behalf of an unfunded trust.
If an irrevocable trust arrangement is used, consideration must be given to the channeling of insurance to a
trust having appropriate dispositive provisions either to
assure availability of the marital deduction in relation to
- 39 -
126
the insurance values, or to exclude the proceeds successfully from the estate of the surviving spouse-trust
beneficiary.
In deciding which type of trust provisions
to employ, tax economies available by the exclusion of
the proceeds from the estate of the surviving spouse must
be compared with those which would be realized by the
qualification of interim values for the gift tax marital
deduction at the time of the transfer.
In any event,
a living insurance trust normally involves the use of the
trust as- a receptacle for pour-over legacies under the
will of the grantor-spouse, thus effecting unified
estate administration and management.
This generally
requires the creation within the trust of two separate
shares:
one that qualifies for the marital deduction and
one that does not, serving instead as a family "sprinkling"
trust.
Obviously, any inter vivos trust designed to break
into marital and nonmarital shares must contain appropriate
formula provisions to avoid overqualification for the
marital deduction.
V.
Business Use of Life Insurance
A final consideration is the utilization of life insurance
in connection with a client's business interests.
Such in-
terests often represent the principal assets of the client's
57
estate.
Life insurance is commonly used to maximize the
value of such business interests.
For example, "key-man"
insurance is often purchased by a business on the life of
a person vital to the success of the business.
Such
insur«rtc.e protects the business from the monetary loss
that may result from the "key-man's" premature death.
Although the premiums paid on such insurance are not
198
deductible,
the policy proceeds will generally be
199
received tax free.
In-addition, life insurance is frequently used to provide funds for business purchase agreements.
"Buy-sell"
agreements provide liquidity for the estate of the
deceased owner of a closely-held business.
Of key concern
in such arrangements is the method by which the surviving
owners (or business entity) will be placed in a financial
position to carry out the buy-out commitment.
The use of
life insurance as a source of funds is often helpful in
this regard.
As is the case with key-man insurance, the
200
premiums are not deductible,
but the proceeds from such
201
policies are received free of income tax.
VI.
Conclusion
For some estates, life insurance provides the only
viable means of providing for the family in the event of
"
5 8
"128
the wage earner's premature death.
For other estates, life
insurance provides an important method of transfering wealth
with minimum tax depletion.
reasons:
This is true for a number of
(1) death proceeds of insurance are exempt from
federal income tax;
(2) it is relatively easy to arrange
a method by which the proceeds escape the federal estate tax;
(3) the yearly interest increment in a cash value policy may
never be taxed, even if borrowed out by the policyholder, yet
the interest paid on policy loans is deductible in certain
circumstances;
and (4) a surviving spouse has a $1,000
annual income tax exclusion for the interest portion of life
insurance proceeds paid in installments.
Indeed, life
insurance is an indispensable tool to the estate planner.
To utilize life insurance effectively, however, planners
must understand the policy provisions, the tax treatment,
and the legal aspects involved.
- 32 -
129
FOOTNOTES
1. See generally Life Insurance Desk Book (4th ed. 197 6);
J. Creedon, Some Uses of Life Insurance in Estate Planning
(1974);
B. Harnett, Taxation of Life Insurance (1957).
2. D. McGill, Legal Aspects of Life Insurance 25 (1959).
3. See generally W. Beadier, J. Greider, Law and the Life
Insurance Contract (3d ed. 1974);
on Insurance Law (1971);
R. Keeton, Basic Text
W. Meyer, Life & Health Insurance
(1971) .
4. See Tex. Ins. Code Ann, art. 3.49 (Vernon 1963);
Anders, 87 Tex. 287, 28 S.W. 274 (1894).
Cheeves v.
See generally
W. Meyer, Life & Health Insurance, Ch. 4 (1971).
5. See Drane v. Jefferson Std. Life Ins. Co., 139 Tex. 101, 161
S.W.2d 1054 (1942) .
6. See Biggs v. Washington Nat.
Ins. Co., 275 S.W.2d 566 (Tex.
Civ. App.—Waco 1955, no writ).
7. Id.
8. See, e.g., Goldbaum v. Blum, 79 Tex. 638, 15 S.W. 564 (1391);
Cawthon v. Perry, 76 Tex. 383, 3 S.W. 268 (1837).
9. See generally M. Greene, Risk and Insurance (3d ed. 1973).
10. See Helvering v. Le Gierse, 312 U.S. 531 (1941);
65-57, 1965-1 C.B. 56.
130
Rev. Rul.
11. See Life Insurance Desk Book 352-59 (4th ed. 1976);
K. Black & S. Huebner, Life Insurance 54-86 (9th ed.
1976) [hereinafter referred to as Life Insurance].
12. See Life Insurance, supra note 11, at 54-63.
13.
Id. at 64-78.
14.
Id. at 79-86.
15. D. Gregg & V. Lucas, Life and Health Insurance Handbook
45 (3d ed. 1973) .
16. See generally Life Insurance, supra note 11, at 170-74.
17.
Id. at 170-71.
18.
Id. at 171-72.
19.
Id. at 172-73.
20.
Id. at 173-74.
21.
I.R.S. § 101 (a) .
22.
I.R.C. § 101 (c) .
23.
I.R.C. § 101 (d) (1) .
24.
I.R.C. § 101(d) (1) (B) .
25.
I.R.C. § 101 (b) .
26.
I.R.C. § 101 (a) (2) .
27.
I.R.C. § 101 (a) (2) (A) .
28.
I.R.C. § 101 (a) (2) (B) .
29.
I.R.C. § 101 (e) .
30.
See Ashercraft v. Commissioner, 252 F.2d 200 (7th Cir. 1958)
131
31. I.R.C. § 72.
32. Treas. Reg. § 1.72-ll(d).
33.
Id.
See Blum v. Higgins, 150 F.2d 471 (2d Cir. 1945).
34. I.R.C. § 72 (e) (1) .
35. I.R.C. § 262.
36. I.R.C. § 163.
37. See Colston v. Burnet, 59 F.2d 867 (D.C. Cir. 1932);
Dean v. Commissioner, 35 T.C. 1083 (1961).
38. I.R.C. § 162(a);
Treas. Reg. §§ 1.162-7 (a), (b)(1).
Premium payments deemed "unreasonable" compensation may
be treated as constructive dividends.
B. 3ittker & J.
Eustice, Federal Income Taxation of Corporation and
Shareholders § 7.05 (1971).
39. I.R.C. § 61;
Treas. Reg. § 1.61-2(d)(2)(ii)(a).
40. Rev. Rul. 55-747, 1955-2 C.B. 228.
41.
I.R.C. § 79.
See also Rev. Rul. 56-400, 1956-2 C.B. 116.
42.
I.R.C. § 264 (a) (1) .
43.
I.R.C. § 2042.
44.
I.R.C. § 2042(1).
Although couched in terms of "receivable
by the executor," this provision is commonly referred to as
requiring inclusion of insurance proceeds payable to the
insured's estate.
See Treas. Reg. § 20.2042-1 (b) (1).
45. See Treas. Reg. § 20.2042-1 (b).
46. Id.
199
JLO, ;,<
47.
See, e.g., Proutt v. Commissioner, 125 F.2d 591 (6th Cir.
1942);
48.
Commissioner v. Jones, 62 F.2d 496 (6th Cir. 1932).
I.R.C. § 2042(2).
Section 2042(2) does not require that
the insured possessed the capacity to exercise the power.
Commissioner v. Noel, 380 U.S. 678 (1965).
49.
Treas. Reg. § 20.2042-1 (c) (4) .
50.
Treas. Reg. § 2042-1 (c) (2).
The incidents of ownership
listed in the regulations have consistently been held
taxable.
See, e.g., Chase Nat'1 Bank v. United States,
278 U.S. 327 (1929) (right to change beneficiary an
incident of ownership);
Estate of Lumpkin v. Commissioner,
474 F.2d 1092 (5th Cir. 1973) (selection of settlement
option an incident of ownership);
Prichard v. United
States, 397 F.2d 60 (5th Cir. 1968) (right to cash
surrender value or to borrow on policy an incident of
ownership);
Selznick v. Commissioner, 15 T.C. 716 (1950),
aff'd, 195 F.2d 735 (9th Cir. 1952) (right to cancel
policies an incident of ownership);
Broderick v. Keefe,
112 F.2d 293 (1st Cir. 1940) (right to change contingent
beneficiary after primary beneficiary's death an incident
of ownership);
Schwager v. Commissioner, 64 T.C. 781 (1975)
(right of decedent to veto change of beneficiary under a
split-dollar policy owned by employer an incident of
ownership).
51.
See H.R. Rep. No. 1337, 83d Cong., 2d Sess. 91 (1954);
S. Rep. No. 1622, 83d Cong., 2d Sess. 124 (1954).
52.
I.R.C. § 2042 (2) .
53.
Id.
54.
Id.
55.
Treas. Reg. § 20.2042-1 (c) (3).
56.
Id.
57.
Treas. Reg. § 20.2042-1 (c) (5) .
58.
Id.
59.
Treas. Reg. § 20.2042-1 (c) (4) .
60.
Terriberry v. United States, 517 F.2d 286 (5th Cir.
1975);
Rose v. United States, 411 F.2d 259 (5th Cir.
1975);
Estate of Skifter v. Commissioner, 468 F.2d
699 (2d Cir. 1972);
Estate of Fruehauf v. Commissioner,
427 F.2d 80 (6th Cir. 1970).
61.
Estate of Connelly v. United States, 551 F.2d 545 (3d
Cir. 1977);
Estate of Lumpkin v. Commissioner, 474 F.2d
1092 (5th Cir. 1973) .
62.
427 F.2d 80 (6th Cir. 1970).
63.
Id. at 82.
64.
Id. at 82.
65.
Id.
66.
Estate of Fruehauf v. Commissioner, 50 T.C. 915, 926
(1968) .
1rh\
67.
Estate of Fruehauf v. Commissioner, 427 F.2d 80, 84-86
(6th Cir. 1970).
68.
Id.
The IRS agreed with the final result in Fruehauf.
See Rev. Rul. 76-261, 1976-2 C.B. 276 (powers of a
decedent-trustee to use the loan value of the policy to
pay premiums, receive annual dividends, borrow on the
policy, assign it, pledge it and determine how the
proceeds will be used are considered incidents of
ownership).
69.
486 F.2d 699 (2d Cir. 1972).
70.
Id. at 701.
71.
Id.
72.
Estate of Skifter v. Commissioner, 56 T.C. 1190 (1971).
73.
S. Rep. No. 1627, 83d Cong., 2d Sess. 124 (1954).
The
report provides that "[n]o other property is subject to
estate tax where the decedent initially purchased it and
then long before his death gave away all rights to the
property and to discriminate against life insurance in
this regard is not justified."
74.
Id.
Estate of Skifter v. Commissioner, 468 F.2d 699, 702
(2d Cir. 1972).
75.
Id. at 702-03.
76.
Id. at 703.
The Commissioner cited United States v.
O'Malley, 383 U.S. 627 (1966) and Lober v. United States,
346 U.S. 335 (1953) as supporting his argument.
135
77. Estate of Skifter v. Commissioner, 468 F.2d 699, 703
(2d Cir. 1972).
78. Id. at 703-04.
79.
Id. at 703.
80.
Id. at 704-05.
81.
Id. at 702.
82.
474 F.2d 1092 (5th Cir. 1973).
Lumpkin is discussed
in Note, Federal Estate Tax - "Incidents of Ownership"
in Group Life Insurance, A Phrase Searching for Definition,
52 N.C.L. Rev. 671 (1974) .
83.
Id. at 1093.
84.
Id. at 1097-98.
85.
Id. at 1095.
86.
Id. at 1097.
87.
Id. at 1097-98.
88. See note 7 6 supra and accompanying text.
89. Estate of Lumpkin v. Commissioner, 474 F.2d 1092, 1097
(5th Cir. 1973) .
The applicability of section 2036,
however, is questionable.
90.
Id.
The IRS has indicated its acquiescence in Lumpkin's
substantial degree of control test.
Rev. Rul. 76-261,
1976-2 C.B. 276.
91.
511 F.2d 259 (5th Cir. 1975).
92.
Id. at 260.
93.
Id.
Decedent-trustee could cancel or convert the policies,
"126
withdraw or surrender dividends, or borrow against their
cash value.
94.
Id. at 261-62.
95.
Id. at 265.
One commentator analyzed this statement in
the following manner:
"With this flight of almost flowery
(and almost uninterpretable) rhetoric, the Rose court
tries to distinguish a little bit of sleight of hand from
a little bit of straight reasoning."
Ownership in Life Insurance:
Est-. 720, 722 (1976).
Munch, Incidents of
Courts Disagree, 115 Tr. &
This author accused the Fifth
Circuit of marshalling facts and arguments necessary to
reach a preconceived goal.
Id.
96. Estate of Lumpkin v. Commissioner, 511 F.2d 259, 263 (5th
Cir. 1975).
97.
Id. at 262-63.
98.
Id. at 265.
99.
517 F.2d 286 (5th Cir. 1975).
See note 8 0 supra and accompanying text.
100.
101.
102.
Id. at 289.
103.
Id. at 290 (dissenting opinion).
104.
Id. at 289.
105.
551 F.2d 545 (3d Cir. 1977).
106.
Id. at 551.
107.
Id.
The Connelly court relied on a case no longer
accepted by the I.R.S.
See Billings v. Commissioner,
35 B.T.A. 1147 (1937); acq. 1937-2 C.B. 3, acq, withdrawn
1972-1 C.B. 3.
108.
See note 95 supra and accompanying text.
109.
71 T.C. 8 (1978).
For a general discussion of Margrave
see Note, 10 Tex. Tech L. Rev. 1119 (1979).
110.
111.
112.
Id.
The decedent signed the application as the insured.
113.
114.
Id. at 9.
The application also provided that if the
beneficiary was not "living," the proceeds would be payable
to the estate of the insured.
If the decedent had, prior
to his death, either revoked the trust or amended it to
make his estate the remainderman and Mrs. Margrave had
not changed the beneficiary designation, the decedent's
estate would have become the primary beneficiary of the
proceeds.
The Commissioner made no argument that the
proceeds should be included in the decedent's estate
based on this contingent designation.
The Bank, as trustee,
was named the beneficiary of other insurance policies on
the life of the decedent.
These policies were included
in the decedent's gross estate because the decedent was
the owner.
Id. at 8-9 n.2.
115.
Id. at 9.
116.
Id.
The Bank was also the decedent's executor.
117.
Id.
The majority noted that the Commissioner did not
argue that the proceeds should be included in the gross
estate under section 2042(1).
Id. at 9 n.3.
The
majority stated that there was nothing in the record to
indicate that the trust was under a legal obligation
"to pay taxes, debts, or other charges enforceable
against the estate."
Estate of Margrave v. Commissioner,
71- T.C. 8, 9 n.3 (1978), quoting Treas. Reg. 20.2042-1 (b) (1) ,
and citing Freedman v. United States, 382 F.2d 742, 744 n.5
(5th Cir. 19 67) and United States v. First Nat'l Bank and
Trust Co., 133 F.2d 886 (8th Cir. 1943).
Judge Chabot,
however, argued that, in this case, the designation of
the trustee as beneficiary of the insurance policy
served the same testamentary purpose as a designation of
the decedent's executor.
Estate of Margrave v.
Commissioner, 71 T.C. 8, 16-18 (1978) (dissenting opinion).
Accordingly, he reasoned that the value of the proceeds
were includable in the decedent's gross estate under
section 2042(1).
118.
Id. at 10.
Id.
Judge Simpson agreed.
The Commissioner also argued that the insurance
proceeds were includable under section 2041.
Id.
In
this regard, the Tax Court held that although the decedent
possessed a general power of appointment over the trust
corpus, with regard to the insurance proceeds, the
section 2041 power applied to nothing more than a nontaxable expectancy.
Id. at 12.
dissenting judges in Margrave.
opinions were written.
There were seven
Three dissenting
Judge Goffe concurred with
the majority in all results, but felt that it was
necessary to clarify that the dissenters should not
disregard the uncontradicted testamentary of the insurance
agent that the decedent and his wife had no prearranged
plan for disposition of the proceeds.
Id. at 12-13
(concurring opinion).
119.
Id.
120.
Id.
121.
Id. citing Treas. Reg. § 20.2042-1 (c) (2) (1958).
122.
See notes 127-30 infra, and accompanying text.
123.
Note, 10 Tex. Tech L. Rev.J119,1134
124.
Rev. Rul. 71-463, 1971-2 C.B. 333, revoked by Rev. Rul.
(1979).
72-167, 1972-1 C.B. 307.
125.
Treas. Reg. § 20.2042-1 (c) (6) finalized on April 26,
1974 (T.D. 7312).
The regulations make it clear,
however, that the value of certain policy proceeds shall
be considered in determining the value of the stock
140
interest includable in the gross estate of the deceased
insured shareholder.
See Treas. Reg. § 20.2031-2 (f).
126.
Treas. Reg. § 20 . 2042-1 (c) (6) .
127.
See note 122 supra, and accompanying text.
128.
Prichard v. United States, 397 F.2d 600 (9th Cir. 1968).
129.
Id.
130.
Id.
131.
See United States v. Rhode Island Hospital Trust Co., 355
F.2d 7 (1st Cir. 1966);
Piggott v. Commissioner, 340
F.-2d 829 (6th Cir. 1965) .
But see, Morton v. United
States, 457 F.2d 750 (4th Cir. 1972).
132.
Treas. Reg. § 20.2031-8(a)(1).
133.
I.R.C. § 2036(a)(1).
134.
I.R.C. § 2036(a)(2).
135.
I.R.C. § 2038.
136.
I.R.C. § 2039.
137.
I.R.C. § 2035 (b) (1).
138.
I.R.C. § 2043.
139.
General Explanation of the Tax Reform Act of 1976, p. 529.
140.
I.R.C. § 2035 (b) (2) .
141.
I.R.C. § 6019(a).
142.
I.R.C. § 2035(b).
143.
See, e.g., Bel v. Commissioner, 452 F.2d 683 (5th Cir. 1971).
See also Rev. Rul. 71-497, 1971-2 C.B. 329.
JL 1 .
144.
Treas. Reg.j29.2511-1(h)(9).
Cf. Commissioner v. Chase
Manhattan Bank, 259 F.2d 231 (5th Cir. 1958)
(applying
Texas community property law).
145.
See Kaufman v. United States, 462 F.2d 439 (5th Cir.
1972).
146.
The Kaufman court stated in footnote 7 of the opinion:
As we interpret Chase Manhattan and
26 C.F.R. § 25.2511-1(g)(1) (1972),
no evidence of donative intent need
be shown in order to assess a gift
tax where the wife receives less than
her share of the community. We do
not interpret 26 C.F.R. § 25.2511(h)(9)
(1972), Rev. Rul. 48, 1953-1 Cum. Bull.
268 to speak to the situation—that - we
have before us.
If they can be construed to apply, we refuse to follow
them. Our holding is contrary to Cox
v. United States, 286 F. Supp. 761
(W.D. La. 1968) .
Id*
147.
Treas. Reg. § 25.2912-6(a).
148.
Id.
149.
Powers v. Commissioner, 312 U.S. 259 (1941).
150.
I.R.C. § 2512(b);
151.
Rev. Rul. 69-187, 1969-1 C.B. 45.
152.
I.R.C. § 72(e).
153.
See notes 26-28 supra, and accompanying text.
154.
I.R.C. § 101 (a) (2) .
Treas. Reg. § 25.2512-6(a).
1 <19
155.
Treas. Reg. § 1.101-1(b) (3) (iii).
156.
I.R.C. § 2523 (a) (2) (A) .
157.
I.R.C. § 2056(c)(1)(B).
158.
Id.
159.
I.R.C. § 2503(b);
160.
Treas. Reg. § 25.2503-3(b).
161.
Treas. Reg. § 25.2503-3(a).
Treas. Reg. § 25.2503-3(b).
See Rev. Rul. 55-408, 1955-1
C.B. 113.
162.
Treas. Reg. § 26.2503-3 (c), example 6.
163.
Fondren v. Commissioner, 324 U.S. 18 (1944) .
164.
Id.
165.
Caudle v. Commissioner, 4 T.C.M. 324 (1945).
166.
Private Letter Ruling 7751080.
167.
397 F.2d 82 (9th Cir. 1968).
168.
Id. at 87.
169.
Rev. Rul. 73-405, 1973-2 C.B. 321, revoking Rev. Rul.
54-91, 1954-1 C.B. 207.
170.
Private Letter Ruling 7826050.
See also Private Letter
Ruling 79002007 for a similar result in a situation
involving close corporation stocks held in trust, but
subject to a demand power.
*7£?09031.
171.
Private Letter Ruling
172.
Rev. Rul. 55-344, 1954-2 C.B. 319.
/n
so
173.
Private Letter Ruling 7946007.
174.
Id.
175.
I.R.C. § 2041 (b)(2) and 2514(e).
176.
I.R.C. §§ 2041 (a)(2), (b)(2).
177. Rev. Rul. 76-490, 1976-2 C.B. 300.
177/k X.R.C, 5 U,Ci'Q-$. zui-it178.
I.R.C. § 678(a)(1).
See Rev. Rul. 67-241, 1967-2
C.B. 225.
179.
Treas. Reg. § 1.671-3 (a) (3), (b)(3).
180.
I.R.C. § 678(a).
181.
1,-R.C. § 2036 (a) (1) .
182.
See Story v. Marshall, 24 Tex. 305 (1859).
183.
See Arnold v. Leonard, 114 Tex. 535, 273 S.W. 799 (1925).
See also Tex. Const, art. 16, § 15;
Tex. Fam. Code Ann.
ch. 5 (Vernon 1975).
184.
69 T.C. 227 (1977), rev'd, 610 F.2d 1282 (5th Cir. 1980).
185.
The Service's position on this issue appears in Rev. Rul.
75-504, 1975-2 C.B. 363.
186.
Estate of Wyly v. Commissioner, 69 T.C. 227, 228-29
(1977), rev'd, 610 F.2d 1282 (5th Cir. 1980).
187.
Id. at 233.
188.
68 T.C. 682 (1977), rev'd, 610 F.2d 1282 (5th Cir. 1980).
189.
Id. at 693.
190.
The decision is unreported.
144
191.
610 F. 2d at 1289.
192.
Id. at 1286.
The appeals were consolidated because
they all involved the same legal issues.
193.
Id.
194.
Id. at 1294.
195.
Id.
196.
Id. at 1295.
197.
I. R.C. § 677 (a) (1) .
198.
I. R.C. § 264 (a) (1) .
199.
I i-R.C. § 101(a) .
200.
See note 19% supra.
201.
I. R.C. § 101 (a).
140