Introduction to the Roadmap
A recent Tax Court case gave a resounding victory to the taxpayer who had pursued what some might view as an aggressive split-dollar life insurance plan to minimize estate taxes. Estate of Marion Levine v. Commr. 158 TC No. 2, February 28, 2022. This follows prior that held pretty strongly against other taxpayers cases using similar techniques. Understanding what the taxpayer did right in the Levine case, and how that contrasts to what taxpayers did wrong in a prior case, Estate of Cahill, can be used to guide taxpayers contemplating such planning. But even better guidance is possible. A careful reading of the Levine case to identify steps the Levine Court found favorable, can be used to craft a roadmap of how to implement a similar plan. Importantly, the lessons in the roadmap below should be considered by taxpayers undertaking almost any type of estate planning. While aspects of the Levine opinion are pretty narrowly limited to the split dollar insurance technique used in the case, many have broad applicability.
What is Intergenerational Split-Dollar,
Before providing a split-dollar insurance planning roadmap based on the Levine case, an explanation of what split-dollar life insurance is may be useful. “Split-dollar” is not a type of life insurance rather it is a means of paying for life insurance that is used in complex estate tax plans. In the family context split-dollar insurance arrangements are referred to as “private” split-dollar, in contrast to when the technique is used for a key employee. In a private or family split-dollar insurance plan is when two trusts or persons purchase insurance on the life of a particular family member. Typically, when the split-dollar technique is used in an estate plan, an irrevocable life insurance trust (“ILIT”) is the owner of the policy. The premiums for the policy involved are often paid by the taxpayer or a proxy for the taxpayer. In the Levine case the payor was a revocable trust established by Mrs. Levine. A similar structure was used in a prior case, Estate of Cahill (which was a resounding defeat to the taxpayer). Split-dollar arrangements are not limited to this approach.
The parties to the split-dollar arrangement can agree to allocate policy costs and benefits between them and the beneficiaries of the insured in a variety of ways. For example, in the Levine case, Mrs. Levine’s revocable trust advanced the funds for her life insurance trust to purchase policies on her children’s lives. And the insurance trust had to pay her revocable trust back the greater of premiums paid or the cash surrender value of the policies on the earlier the insured’s death or the termination of the split-dollar arrangement.
There are two types of split-dollar arrangements: (1) the economic benefit regime under Reg. Sec. 1.61-22; and (2) the loan regime under Reg. Sec. 1.7872-15. The prior cases in which the taxpayers lost, Cahill and Morrissette, as well as the current Levine case in which the taxpayer was victorious, only deal with economic benefit split-dollar.
In these types of economic benefit split-dollar arrangements, the insurance trust (ILIT) generally pays only for the term cost of the life insurance which is not material in the early years of the arrangement. Another party, such as a family member (often the insureds) or a family trust (eg, an existing funded marital (QTIP) or dynasty trust) pays the remaining portion, which is generally a significant portion of the insurance cost in the early years of the arrangement. In Levine case, Mrs. Levine’s revocable trust advanced premiums to her insurance trust. This arrangement can potentially accomplish estate planning goals:
1. It can reduce the current gifts the donor/insured is required to make to the ILIT to purchase the desired life insurance.
2. It can assure that the insurance proceeds are excluded from the donor/insured’s taxable estate.
3. The value of the receivable due to the taxpayer, or in the Levine case Mrs. Levine’s revocable trust, might be valued at substantially less than the face value of the monies advanced to the insurance trust. The $6.5 million advance in the Levine case was valued at about a third of that amount, resulting in Mrs. Levine’s estate eliminating 2/3rds of that value from her taxable estate. That was a substantial savings. This result was also dependent on the Levine Court accepting the intergenerational split-dollar approach to the plan.
What is an Inter-generational Split-Dollar (“IGSD”)?
In an inter-generational split-dollar arrangement the follow facts are typically found:
1. The person funding the insurance purchase is usually of advanced age, example 80+.
2. The person funding the life insurance may, but does not always, borrow the money from a lender.
3. The insurance policy is paid for with a single premium or premiums paid over a brief period, eg, several years as contrasted to a more typical longer period.
4. The insured is an adult child of the person advancing funds for the policy. The adult child or children are typically middle age, eg, 40-60.
5. The person advancing the funds, eg, Mrs. Levine, often dies within a relatively brief period of time after the split dollar plan is created. The estate of the person advancing the funds values the interest in the IGSD at a substantial discount from its face value. The rationale for a significant discount is that the donor’s estate is entitled to its repayment when the insured child dies years in the future, and therefore the present value of that repayment is materially less than face.
With this background, the remainder of this article will evaluate what Mrs. Levine’s plan did correctly and make suggestions for how a taxpayer, with the guidance of a skilled estate planning team, might evaluate such a plan (which does not remain risk free despite the recent Levine case). Also, whenever appropriate, generalizations from the Levine Court’s comments as to estate planning generally, will be offered.
The IRS Challenge of the Plan
The IRS challenged the plan from various perspectives (eg, the fiduciary relationships, as discussed below). But three key challenges were based on three different sections of the Internal Revenue Code:
• Inclusion under Sections 2036
• Inclusion under Section 2038.
• Disregard the restrictions of the split dollar agreement under Section 2703.
The challenge pertains to what is included in the taxpayer’s estate, and what is the value of the interest under the split-dollar plan that is included. In a split-dollar plan, the taxpayer transfers funds used by the insurance trust to pay the premium payments in exchange for a repayment right. The taxpayer, Mrs. Levine (actually her revocable trust but that is included in her estate) will be repaid the value of the economic benefit arrangement (or in a loan split-dollar arrangement, which was not involved in the Levine case, with interest at a fair rate under the loan arrangement).
Code Section 2036: Code Section 2036 can apply to include in the value of the taxpayer’s gross estate the value of all property that the decedent had transferred during lifetime, over which the decedent retained for life the right, alone or in conjunction with another person, to designate the person or persons who shall possess or enjoy the property or the income therefrom.
Code Section 2038: Includes in the gross value of an estate all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth) , by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power (in whatever capacity exercisable) by the decedent alone or by the decedent in conjunction with any other person (without regard) to when or from what source the decedent acquired such power), to alter, amend, revoke, or terminate, or where any such power is relinquished during the 3 year period ending on the date of the decedent’s death.
As to the above two Code Sections the Levine Court held that it “…was the Insurance Trust that bought the policies and held them. These policies were never owned by the Revocable Trust, and there was no “transfer” of these policies from the Revocable Trust to the Insurance Trust… The “property” is also not the receivable itself. That property belongs to the Revocable Trust and now it belongs to the Estate. It wasn’t “transferred”; it was retained, The Levine Court concluded that Mrs. Levine did not retain any right to possession or enjoyment of the property transferred. The Levine Court held that unless Mrs. Levine jointly held the right to terminate the split-dollar life-insurance policy with the irrevocable trust that held the policies, which she did not, the cash value of the policies held in the insurance trust were not included in her estate. The only asset in her estate was her rights under the split-dollar agreement which she could not accelerate or terminate.
The IRS argued in Levine that Mrs. Levine, through her attorneys-in-fact, stood on both sides of the transactions (the advance and the split-dollar agreement) and therefore could unwind the split-dollar transactions at will. This meant that Mrs. Levine, through the attorneys-in-fact, had the power to surrender the policies at any time for their cash-surrender values. But the court found that this was not the case because an independent trustee owed a fiduciary duty to beneficiaries, the grandchildren, who were different then the beneficiaries under Mrs. Levine’s estate.
Code Section 2703: The IRS argued that the special valuation rules under Code Section 2703 applied to Levine’s split-dollar arrangement. Section 2703(a) provides that “…the value of any property shall be determined without regard to —…
Credit: www.forbes.com /